HMN FINANCIAL INC (Form: 10-Q, Received: 05/05/2017 13:09:07)

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 March 31, 2017

[ ] 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)		(Z ip 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, a smaller reporting company or an emerging growth company. See the definitions of “large accelerated filer,” “accelerated filer,” “smaller reporting company” and “emerging growth 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)

Emerging growth 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.

C lass		Outstanding at April 2 5, 2017
Common stock, $0.01 par value		4,495,258

HMN FINANCIAL, INC.

CONTENTS

PART I – FINANCIAL INFORMATION
		Page
Item 1:	Financial Statements

	Consolidated Balance Sheets at March 31, 2017 and December 31, 2016	3

	Consolidate d Statements of Comprehensive Income for the Three Months Ended March 31, 2017 and 2016	4

	Consolidated Statement of Stockholders' Equity for the Three Month Period Ended March 31, 2017	5

	Consolidated Statements of Cash Flows for the Three Months Ended March 31, 201 7 and 2016	6

	Notes to Consolidated Financial Statements	7

Item 2:	Management's Discussion and Analysis of Financial Condition and Results of Operations	2 6

Item 3:	Quantitative and Qualitative Disclosures About Market Risk	3 6

Item 4:	Controls and Procedures	3 6

PART II – OTHER INFORMATION

Item 1:	Legal Proceedings	3 7

Item 1A:	Risk Factors	3 7

Item 2:	Unregistered Sales of Equity Securities and Use of Proceeds	3 7

Item 3:	Defaults Upon Senior Securities	3 7

Item 4:	Mine Safety Disclosures	3 7

Item 5:	Other Information	3 7

Item 6:	Exhibits	3 7

Signatures		3 8

PART I – FINANCIAL INFORMATION

I tem 1 : Financial Statements

HMN FINANCIAL, INC. AND SUBSIDIARIES
Consolidated Balance Sheets

	March 31,			December 31,
(Dollars in thousands)	2017			2016
	(unaudited)
Assets
Cash and cash equivalents	$	12,489			27,561
Securities available for sale:
Mortgage-backed and related securities (amortized cost $785 and $993)		797			1,005
Other marketable securities (amortized cost $78,812 and $78,846)		77,751			77,472
		78,548			78,477

Loans held for sale		2,430			2,009
Loans receivable, net		565,040			551,171
Accrued interest receivable		2,417			2,626
Real estate, net		642			611
Federal Home Loan Bank stock, at cost		817			770
Mortgage servicing rights, net		1,624			1,604
Premises and equipment, net		8,121			8,223
Goodwill		802			802
Core deposit intangible		429			454
Prepaid expenses and other assets		1,800			1,768
Deferred tax asset, net		5,822			5,947
Total assets	$	680,981			682,023

Liabilities and Stockholders ’ Equity
Deposits	$	591,376			592,811
Other borrowings		7,000			7,000
Accrued interest payable		205			236
Customer escrows		1,513			1,011
Accrued expenses and other liabilities		3,487			5,046
Total liabilities		603,581			606,104
Commitments and contingencies
Stockholders ’ equity:
Serial preferred stock ($.01 par value): authorized 500,000 shares; none issued or outstanding		0			0
Common stock ($.01 par value): authorized 16,000,000; issued shares 9,128,662		91			91
Additional paid-in capital		50,430			50,566
Retained earnings, subject to certain restrictions		88,102			86,886
Accumulated other comprehensive loss		(632	)		(820	)
Unearned employee stock ownership plan shares		(2,175	)		(2,223	)
Treasury stock, at cost 4,633,404 and 4,639,739 shares		(58,416	)		(58,581	)
Total stockholders’ equity		77,400			75,919
Total liabilities and stockholders ’ equity	$	680,981			682,023

See accompanying notes to consolidated financial statements.

HMN FINANCIAL, INC. AND SUBSIDIARIES
Consolidated Statements of Comprehensive Income
(unaudited)

	Three Months Ended March 31,
(Dollars in thousands, except per share data)	2017			2016
Interest income:
Loans receivable	$	6,360			6,094
Securities available for sale:
Mortgage-backed and related		7			20
Other marketable		268			372
Cash equivalents		23			38
Other		2			1
Total interest income		6,660			6,525

Interest expense:
Deposits		292			226
Federal Home Loan Bank advances and other borrowings		115			148
Total interest expense		407			374
Net interest income		6,253			6,151
Provision for loan losses		(270	)		(732	)
Net interest income after provision for loan losses		6,523			6,883

Non-interest income:
Fees and service charges		825			779
Loan servicing fees		301			261
Gain on sales of loans		519			487
Other		236			228
Total non-interest income		1,881			1,755

Non-interest expense:
Compensation and benefits		3,944			3,695
Gains on real estate owned		(6	)		(349	)
Occupancy and equipment		1,040			990
Data processing		291			273
Professional services		259			251
Other		819			831
Total non-interest expense		6,347			5,691
Income before income tax expense		2,057			2,947
Income tax expense		841			1,173
Net income		1,216			1,774
Other comprehensive income, net of tax		188			138
Comprehensive income avail able to common shareholders	$	1,404			1,912
Basic earnings per share	$	0.29			0.43
Diluted earnings per share	$	0.25			0.38

See accompanying notes to consolidated financial statements.

HMN FINANCIAL, INC. AND SUBSIDIARIES

Consolidated Statement of Stockholders' Equity

For the Three Month Period Ended March 31, 20 1 7

(unaudited)

											Unearned
											Employee
								Accumulated			Stock						Total
			Additional					Other			Ownership						Stock-
	Common		Paid-In			Retained		Comprehensive			Plan			Treasury			Holders ’
(Dollars in thousands)	Stock		Capital			Earnings		Loss			Shares			Stock			Equity
Balance, December 31, 201 6	$	91		50,566			86,886		(820	)		(2,223	)		(58,581	)		75,919
Net income							1,216											1,216
Other comprehensive income									188									188
Stock compensation expense				10														10
Restricted stock awards				(219	)										219			0
Stock awards withheld for tax withholding															(54	)		(54	)
Amortization of restricted stock awards				36														36
Earned employee stock ownership plan shares				37								48						85
Balance, March 31, 201 7	$	91		50,430			88,102		(632	)		(2,175	)		(58,416	)		77,400

See accompanying notes to co nsolidated financial statements.

HMN FINANCIAL, INC. AND SUBSIDIARIES

Consolidated Statements of Cash Flows

(unaudited)

	Three Months Ended March 31,
(D ollars in thousands)	20 17			20 16
Cash flows from operating activities:
Net income	$	1,216			1,774
Adjustments to reconcile net income to cash provided by operating activities:
Provision for loan losses		(270	)		(732	)
Depreciation		233			195
Amortization of discounts, net		0			(8	)
Amortization of deferred loan fees		(40	)		(383	)
Amortization of core deposit intangible		25			19
Amortization of fair value adjustments on purchased assets and liabilities		(24	)		(171	)
Amortization of mortgage servicing rights		124			132
Capitalized mortgage servicing rights		(144	)		(89	)
Gain on sales of real estate owned		(6	)		(349	)
Gain on sales of loans		(519	)		(487	)
Proceeds from sale of loans held for sale		20,958			16,494
Disbursements on loans held for sale		(15,856	)		(12,303	)
Amortization of restricted stock awards		36			49
Amortization of unearned employee stock ownership plan shares		48			49
Earned employee stock ownership plan shares priced above original cost		37			12
Stock option compensation expense		10			20
Decrease in accrued interest receivable		209			120
Decrease in accrued interest payable		(31	)		(12	)
Decrease in other assets		26			205
(Decrease) increase in other liabilities		(1,569	)		77
Other, net		10			16
Net cash provided by operating activities		4,473			4,628
Cash flows from investing activities:
Principal collected on securities available for sale		234			307
Proceeds collected on maturities of securities available for sale		5,000			56,020
Purchases of securities available for sale		(4,999	)		(49,968	)
Purchase of Federal Home Loan Bank stock		(667	)		(79	)
Redemption of Federal Home Loan Bank stock		620			0
Proceeds from sales of real estate		15			1,305
Net increase in loans receivable		(18,626	)		(30,779	)
Purchases of premises and equipment		(138	)		(309	)
Net cash used by investing activities		(18,561	)		(23,503	)
Cash flows from financing activities:
Decrease in deposits		(1,432	)		(7,869	)
Stock awards repurchased for tax withholding		(54	)		0
Proceeds from borrowings		15,500			0
Repayment of borrowings		(15,500	)		0
Increase in customer escrows		502			728
Net cash used by financing activities		(984	)		(7,141	)
Decrease in cash and cash equivalents		(15,072	)		(26,016	)
Cash and cash equivalents, beginning of period		27,561			39,782
Cash and cash equivalents, end of period	$	12,489			13,766
Supplemental cash flow disclosures:
Cash paid for interest	$	438			387
Cash paid for income taxes		1,765			156
Supplemental noncash flow disclosures:
Loans transferred to loans held for sale		5,054			4,408
Transfer of loans to real estate		40			591

See accompanying notes to consolidated financial statements.

HMN FINANCIAL, INC. AND SUBSIDIARIES

Notes to Consolidated Financial Statements

(unaudited)

(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 does business as Home Federal Investment Services and offers financial planning products and services, and HFSB Property Holdings, LLC (HPH), which is currently inactive, but has acted 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.

Certain amounts in the consolidated financial statements for the prior year have been reclassified to conform to the current year presentation.

(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 (GAAP). 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 three-month period ended March 31, 2017 are not necessarily indicative of the results which may be expected for the entire year.

(3) New Accounting Standards

In January 2016, the FASB issued ASU 2016-01, Financial Instruments – Overall (Subtopic 825-10) Recognition and Measurement of Financial Assets and Financial Liabilities. The amendments in this ASU require, among other things, equity investments to be measured at fair value with changes in fair value recognized in net income and that public business entities use the exit price notion when measuring the fair value of financial instruments for disclosure purposes. The amendments also require an entity to present separately in other comprehensive income the portion of the total change in the fair value of a liability resulting from a change in the instrument-specific credit risk when the entity has elected to measure the liability at fair value in accordance with the fair value option for financial instruments. In addition, the amendments also eliminate the requirement for public business entities to disclose the method(s) and significant assumptions used to estimate the fair value that is required to be disclosed for financial instruments measured at amortized cost on the balance sheet. The ASU is intended to reduce diversity in practice and is effective for public business entities for fiscal years beginning after December 15, 2017, including interim periods within those fiscal years. The amendments should be applied by means of a cumulative-effect adjustment to the balance sheet as of the beginning of the fiscal year of adoption. The adoption of this ASU in the first quarter of 2018 is not anticipated to have a material impact on the Company’s consolidated financial statements.

In February 2016, the FASB issued ASU 2016-02, Leases (Topic 842) . The amendments in the ASU create Topic 842 , Leases , and supersede the lease requirements in Topic 840, Leases . The objective of this ASU is to establish the principles that lessees and lessors shall apply to report useful information to users of financial statements about the amount, timing, and uncertainty of cash flows arising from a lease. The main difference between previous GAAP and this ASU is the recognition of lease assets and lease liabilities by lessees for those leases classified as operating leases under previous GAAP. The amendment requires a lessee to recognize in the statement of financial position a liability to make lease payments (the lease liability) and the right-of-use asset representing its right to use the underlying asset for the lease term. The accounting applied by a lessor is largely unchanged from that applied under previous GAAP. In transition, lessees and lessors are required to recognize and measure leases at the beginning of the earliest period presented using a modified retrospective approach. The modified retrospective approach includes a number of optional practical expedients that entities may elect to apply that will, in effect, continue to account for leases that commence before the effective date in accordance with previous GAAP unless the lease is modified. The amendments in the ASU, for public business entities, are effective for fiscal years beginning after December 15, 2018, including interim periods within those fiscal years. The adoption of this ASU in the first quarter of 2019 is not anticipated to have a material impact on the Company’s consolidated financial statements.

In June 2016, the FASB issued ASU 2016-13, Financial Instruments-Credit Losses (Topic 326): Measurement of Credit Losses on Financial Instruments. The amendments in this ASU affect all entities that measure credit losses on financial instruments including loans, debt securities, trade receivables, net investments in leases, off-balance sheet credit exposures, reinsurance receivables, and any other financial asset that has a contractual right to receive cash that is not specifically excluded. The main objective of this ASU is to provide financial statement users with more decision-useful information about the expected credit losses on financial instruments and other commitments to extend credit held by a reporting entity at each reporting date. To achieve this objective, the amendments in this ASU replace the incurred loss impairment methodology required in current GAAP with a methodology that reflects expected credit losses that requires consideration of a broader range of reasonable and supportable information to estimate credit losses. The amendments in this ASU will affect entities to varying degrees depending on the credit quality of the assets held by the entity, the duration of the assets held, and how the entity applies the current incurred loss methodology. The amendments in this ASU, for public business entities that are U.S. Securities and Exchange Commission (SEC) filers, are effective for fiscal years beginning after December 15, 2019, including interim periods within those annual periods. All entities may adopt the amendments in the ASU early as of the fiscal years beginning after December 15, 2018, including interim periods within those fiscal years. Amendments should be applied using a modified retrospective transition method by means of a cumulative-effect adjustment to equity as of the beginning of the period in which the guidance is adopted. Management is still in the process of evaluating the impact that the adoption of this ASU in the first quarter of 2020 will have on the Company’s consolidated financial statements.

In August 2016, the FASB issued ASU 2016-15, Statement of Cash Flows (Topic 230): Classification of Certain Cash Receipts and Cash Payments. The amendments in this ASU affect all entities that are required to present a statement of cash flows under Topic 230 and address the following eight specific cash flow issues: debt prepayment or debt extinguishment costs; settlement of zero-coupon debt instruments or other debt instruments with coupon interest rates that are insignificant in relation to the effective interest rate of the borrowing; contingent consideration payments made after a business combination; proceeds from the settlement of insurance claims; proceeds from the settlement of corporate-owned life insurance policies; distributions received from equity method investees; beneficial interest in securitization transactions; and separately identifiable cash flows and application of the predominance principle. This ASU is intended to reduce diversity in practice and is effective for public business entities for fiscal years beginning after December 15, 2017, and interim periods within those fiscal years with early adoption permitted. Upon adoption, the amendments should be applied using a retrospective transition method to each period presented. The adoption of this ASU in the first quarter of 2018 is not anticipated to have a material impact on the Company’s consolidated financial statements.

In January 2017, the FASB issued ASU 2017-03, Accounting Changes and Error Corrections (Topic 250) and Investments – Equity Method and Joint Ventures (Topic 323). The amendments in the ASU add and amend SEC paragraphs pursuant to the SEC staff announcement at the September 22, 2016 and November 17, 2016 Emerging Issues Task Force (EITF) meetings. The September announcement is about the disclosure of the impact that recently issued accounting standards will have on the financial statements of a registrant when such standards are adopted in a future period. The announcement applies to ASU 2014-09, Revenue from Contracts with Customers (Topic 606) ; ASU 2016-02, Leases (Topic 842) ; and ASU 2016-13, Financial Instruments – Credit Losses (Topic 326): Measurement of Credit Losses on Financial Instruments and to any subsequent amendments to these ASU’s that are issued prior to their adoption. The November announcement made amendments to conform the SEC Observer comment on accounting for tax benefits resulting from investments in qualified affordable housing projects to the guidance issued in Accounting Standards Update No. 2014-01, Investments-Equity Method and Joint Ventures (Topic 323); A ccounting for Investments in Qualified Affordable Housing Projects. This ASU is intended to improve transparency and is effective for public business entities upon issuance. The adoption of this ASU is not anticipated to have a material impact on the Company’s consolidated financial statements other than to enhance the disclosures on the effects of new accounting pronouncements as they move closer to adoption in future periods.

In January 2017, the FASB issued ASU 2017-04, Intangibles-Goodwill and Other (Topic 350): Simplifying the Test for Goodwill Impairment. The amendments in this ASU were issued to address concerns over the cost and complexity of the two-step goodwill impairment test and resulted in the removal of the second step of the test. The amendments require an entity to apply a one-step quantitative test and record the amount of goodwill impairment as the excess of a reporting unit’s carrying amount over its fair value, not to exceed the total amount of goodwill allocated to the reporting unit. The new guidance does not amend the optional qualitative assessment of goodwill impairment. This ASU is intended to reduce the cost and complexity of the two-step goodwill impairment test and is effective for public business entities for fiscal years beginning after December 15, 2019, and interim periods within those fiscal years with early adoption permitted for testing performed after January 1, 2017. Upon adoption, the amendments should be applied using a prospective basis and the entity is required to disclose the nature of and reason for the change in accounting principle upon transition. The adoption of this ASU in the fourth quarter of 2020 when the annual assessment is completed is not anticipated to have a material impact on the Company’s consolidated financial statements.

In March 2017, the FASB issued ASU 2017-0 8, Receivables – Nonrefundable Fees and Other Costs (Subtopic 310-20): Premium Amortization on Purchased Callable Debt Securities . The amendments in this ASU shorten the amortization period for certain callable debt securities held at a premium. Specifically, the amendments require the premium to be amortized to the earliest call date. The amendments do not require an accounting change for securities held at a discount as discounts continue to be amortized to maturity. This ASU is intended to more closely align the amortization period of premiums and discounts to expectations incorporated in market pricing on the underlying securities. In most cases, market participants price securities to the call date that produces the worst yield when the coupon is above current market rates and prices securities to maturity when the coupon is below market rates. As a result, the amendments more closely align interest income recorded on bonds held at a premium or a discount with the economics of the underlying instrument. This ASU is intended to reduce diversity in practice and is effective for public business entities for fiscal years, and interim periods within those fiscal years, beginning after December 15, 2018 with early adoption permitted. Upon adoption, the amendments should be applied using a modified retrospective basis through a cumulative-effect adjustment directly to retained earnings as of the beginning of the period of adoption. Additionally, in the period of adoption, an entity should provide disclosures about a change in accounting principles. The adoption of this ASU in the first quarter of 2019 is not anticipated to have a material impact on the Company’s consolidated financial statements.

( 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 of the Company for which fair values are determined on a recurring basis as of March 31, 2017 and December 31, 2016.

	Carrying value at March 31, 201 7
(Dollars in thousands)	Total		Level 1		Level 2		Level 3
Securities available for sale	$	78,548		0		78,548		0
Mortgage loan commitments		124		0		124		0
Total	$	78,672		0		78,672		0

	Carrying value at December 31, 201 6
(Dollars in thousands)	Total		Level 1		Level 2		Level 3
Securities available for sale	$	78,477		0		78,477		0
Mortgage loan commitments		66		0		66		0
Total	$	78,543		0		78,543		0

There were no transfers between Levels 1, 2, or 3 during the three months ended March 31, 201 7.

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 GAAP. 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 that were still held at March 31, 2017 and December 31, 2016, 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 March 31, 2017 and December 31, 2016.

	Carrying value at March 31, 20 17
(Dollars in thousands)	Total		Level 1		Level 2		Level 3		Three months ended March 31, 201 7 t otal gains (losses)
Loans held for sale	$	2,430		0		2,430		0		18
Mortgage servicing rights , net		1,624		0		1,624		0		0
Loans ⁽¹⁾		4,028		0		4,028		0		9
Real estate, net ⁽²⁾		642		0		642		0		0
Total	$	8,724		0		8,724		0		27


	Carrying value at December 31, 2016
(Dollars in thousands)	Total		Level 1		Level 2		Level 3		Year ended December 31, 2016 total gains (losses)
Loans held for sale	$	2,009		0		2,009		0		14
Mortgage servicing rights , net		1,604		0		1,604		0		0
Loans ⁽¹⁾		3,582		0		3,582		0		(380	)
Real estate, net ⁽²⁾		611		0		611		0		(197	)
Total	$	7,806		0		7,806		0		(563	)

⁽¹⁾	Represents carrying value and related write-downs of 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 March 31, 2017 and December 31, 2016. 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 March 31, 2017 and December 31, 2016 are shown below.

	March 31, 201 7													December 31, 201 6
							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	$	12,489			12,489			12,489							27,561			27,561			27,561
Securities available for sale		78,548			78,548					78,548					78,477			78,477					78,477
Loans held for sale		2,430			2,430					2,430					2,009			2,009					2,009
Loans receivable, net		565,040			566,244					566,244					551,171			552,395					552,395
Federal Home Loan Bank stock		817			817					817					770			770					770
Accrued interest receivable		2,417			2,417					2,417					2,626			2,626					2,626
Financial liabilities:
Deposits		591,376			591,859					591,859					592,811			593,297					593,297
Other borrowings		7,000			7,018					7,018					7,000			7,018					7,018
Accrued interest payable		205			205					205					236			236					236
Off-balance sheet financial instruments:
Commitments to extend credit		124			124								205,170		66			66								184,596
Commitments to sell loans		(32	)		(32	)							11,934		(22	)		(22	)							9,595

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, with the exception of the adjustable rate portfolio, was calculated by discounting the scheduled cash flows through the estimated maturity using anticipated prepayment speeds and using discount rates that reflect the credit and interest rate risk inherent in each loan portfolio. The fair value of the adjustable loan portfolio was estimated by grouping the loans with similar characteristics and comparing the characteristics of each group to the prices quoted for similar types of loans in the secondary market.

Federal Home Loan Bank Stock

The carrying amount of Federal Home Loan Bank (FHLB) stock approximates its fair value.

Accrued Interest Receivable

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

Deposits

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

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

Other Borrow ings

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 FHLB for borrowings of similar remaining maturities.

Accrued Interest Payable

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

Commitments to Extend Credit

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

Commitments to Sell Loans

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

( 6 ) Other Comprehensive Income

Other comprehensive income is defined as the change in equity during a period from transactions and other events from nonowner sources. Comprehensive income is the total of net income and other comprehensive income, which for the Company is comprised of unrealized gains and losses on securities available for sale. The components of other comprehensive income and the related tax effects were as follows:

	For the period ended March 31,
(Dollars in thousands)	20 17						20 16
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	$	313		125		188		229		91		138
Other comprehensive income	$	313		125		188		229		91		138

( 7 ) Securities Available For Sale

The following table shows the gross unrealized losses and fair value s 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 March 31, 2017 and December 31, 2016.

	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
March 31, 201 7
Collateralized mortgage obligations:
F ederal National Mortgage Association (FNMA)		1	$	254		(1	)		1	$	63		(1	)	$	317		(2	)
Other marketable securities:
U.S. Government agency obligations		14		69,020		(958	)		0		0		0			69,020		(958	)
Municipal obligations		8		1,128		(3	)		0		0		0			1,128		(3	)
Corporate preferred stock		0		0		0			1		525		(175	)		525		(175	)
Total temporarily impaired securities		23	$	70,402		(962	)		2	$	588		(176	)	$	70,990		(1,138	)

	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
December 31, 201 6
Collateralized mortgage obligations:
FNMA		1	$	262		(3	)		1	$	104		(2	)	$	366		(5	)
Other marketable securities:
U.S. Government agency obligations		13		63,896		(1,079	)		0		0		0			63,896		(1,079	)
Municipal obligations		14		2,327		(19	)		2		214		(1	)		2,541		(20	)
Corporate preferred stock		0		0		0			1		350		(350	)		350		(350	)
Total temporarily impaired securities		28	$	66,485		(1,101	)		4	$	668		(353	)	$	67,153		(1,454	)

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 March 31, 2017 relates to a single trust preferred security that was issued by the holding company of a small community bank. Typical of most trust preferred issuances, the issuer has the ability to defer interest payments for up to five years with interest payable on the deferred balance. Since January 2015, the issuer had deferred its scheduled interest payment as allowed by the terms of the security agreement. In April 2017, the issuer paid all previously deferred interest that was due and all payments were current as of April 15, 2017. The issuer’s subsidiary bank has generated modest net income amounts over the past several years and 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 March 31, 2017. 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 securities and that the decrease in the market value is primarily due to a lack of liquidity in the market for trust preferred securities. Management will continue to monitor the credit risk of the issuer and may be required to recognize other-than-temporary impairment charges on this security in future periods.

A summary of securities available for sale at March 31, 201 7 and December 31, 2016 is as follows:

(Dollars in thousands)	Amortized cost		Gross unrealized gains		Gross unrealized losses			Fair value
March 31, 201 7
Mortgage-backed securities:
Federal Home Loan Mortgage Corporation (FHLMC)	$	251		9		0			260
FNMA		215		5		0			220
Collateralized mortgage obligations:
FNMA		319		0		(2	)		317
		785		14		(2	)		797
Other marketable securities:
U.S. Government agency obligations		74,978		11		(958	)		74,031
Municipal obligations		2,814		5		(3	)		2,816
Corporate obligations		262		2		0			264
Corporate preferred stock		700		0		(175	)		525
Corporate equity		58		57		0			115
		78,812		75		(1,136	)		77,751
	$	79,597		89		(1,138	)		78,548

(Dollars in thousands)	Amortized cost		Gross unrealized gains		Gross unrealized losses			Fair value
December 31, 201 6
Mortgage-backed securities:
FHLMC	$	327		10		0			337
FNMA		295		7		0			302
Collateralized mortgage obligations:
FNMA		371		0		(5	)		366
		993		17		(5	)		1,005
Other marketable securities:
U.S. Government agency obligations		74,979		16		(1,079	)		73,916
Municipal obligations		2,819		0		(20	)		2,799
Corporate obligations		290		2		0			292
Corporate preferred stock		700		0		(350	)		350
Corporate equity		58		57		0			115
		78,846		75		(1,449	)		77,472
	$	79,839		92		(1,454	)		78,477

The following table indicates amortized cost and estimated fair value of securities available for sale at March 31, 2017 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 C ost		Fair V alue
Due less than one year	$	15,801		15,621
Due after one year through five years		62,688		61,937
Due after five years through ten years		249		249
Due after ten years		801		626
No stated maturity		58		115
Total	$	79,597		78,548

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 expected 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 March 31, 201 7 and December 31, 2016 is as follows:

(Dollars in thousands)	March 31, 2017			December 31, 2016
Single family	$	106,204			103,255
Commercial real estate:
Real estate rental and leasing		164,646			153,343
Other		148,878			145,737
		313,524			299,080
Consumer		72,282			73,283
Commercial business:
Transportation industry		10,345			10,509
Other		71,954			74,667
		82,299			85,176
Total loans		574,309			560,794
Less:
Unamortized discounts		20			20
Net deferred loan costs		(341	)		(300	)
Allowance for loan losses		9,590			9,903
Total loans receivable, net	$	565,040			551,171

( 9 ) Allowance for Loan Losses and Credit Quality Information

The allowance for loan losses is summarized as follows:

(Dollars in thousands)	Single Family			Commercial Real Estate			Consumer			Commercial Business			Total
Balance, December 31, 201 6	$	1,186			4,953			1,613			2,151			9,903
Provision for losses		(76	)		(90	)		(108	)		4			(270	)
Charge-offs		0			0			(201	)		0			(201	)
Recoveries		0			95			28			35			158
Balance, March 31, 201 7	$	1,110			4,958			1,332			2,190			9,590

Balance, December 31, 2015	$	990			6,078			1,200			1,441			9,709
Provision for losses		60			(823	)		184			(153	)		(732	)
Charge-offs		0			0			(7	)		0			(7	)
Recoveries		0			182			18			193			393
Balance, March 31, 2016	$	1,050			5,437			1,395			1,481			9,363

Allocated to:
Specific reserves	$	235			248			434			71			988
General reserves		951			4,705			1,179			2,080			8,915
Balance, December 31, 201 6	$	1,186			4,953			1,613			2,151			9,903

Allocated to:
Specific reserves	$	197			270			264			67			798
General reserves		913			4,688			1,068			2,123			8,792
Balance, March 31, 2017	$	1,110			4,958			1,332			2,190			9,590

Loans receivable at December 31, 201 6:
Individually reviewed for impairment	$	1,107			1,880			940			643			4,570
Collectively reviewed for impairment		102,148			297,200			72,343			84,533			556,224
Ending balance	$	103,255			299,080			73,283			85,176			560,794

Lo ans receivable at March 31, 2017:
Individually reviewed for impairment	$	1,397			2,106			747			576			4,826
Collectively reviewed for impairment		104,807			311,418			71,535			81,723			569,483
Ending balance	$	106,204			313,524			72,282			82,299			574,309

The following table summarizes the amount of classified and unclassified loans at March 31, 201 7 and December 31, 2016:

	March 31, 201 7
	Classified								Unclassified
(Dollars in thousands)	Special Mention		Substandard		Doubtful		Loss		Total		Total		Total Loans
Single family	$	532		1,980		46		0		2,558		103,646		106,204
Commercial real estate:
Real estate rental and leasing		9,444		3,372		0		0		12,816		151,830		164,646
Other		3,692		6,860		0		0		10,552		138,326		148,878

Consumer		0		486		107		154		747		71,535		72,282
Commercial business:
Transportation industry		7		3,927		0		0		3,934		6,411		10,345
Other		8,127		3,154		0		0		11,281		60,673		71,954
	$	21,802		19,779		153		154		41,888		532,421		574,309

	December 31, 201 6
	Classified								Unclassified
(Dollars in thousands)	Special Mention		Substandard		Doubtful		Loss		Total		Total		Total Loans
Single family	$	457		2,130		74		0		2,661		100,594		103,255
Commercial real estate:
Real estate rental and leasing		1,577		3,156		0		0		4,733		148,610		153,343
Other		1,702		7,187		0		0		8,889		136,848		145,737

Consumer		0		531		110		299		940		72,343		73,283
Commercial business:
Transportation industry		0		4,065		0		0		4,065		6,444		10,509
Other		3,973		2,916		0		0		6,889		67,778		74,667
	$	7,709		19,985		184		299		28,177		532,617		560,794

Classified loans represent special mention, substandard (performing and non-performing), and non-performing loans categorized as doubtful and loss. Loans classified as special mention are loans that have potential weaknesses that, if left uncorrected, may result in deterioration of the repayment prospects for the asset or in the Bank’s credit position at some future date. Loans classified as substandard are loans that are generally inadequately protected by the current net worth and paying capacity of the obligor, or by the collateral pledged, if any. Loans classified as substandard have a well-defined weakness or weaknesses that jeopardize the liquidation of the debt. Substandard loans are characterized by the distinct possibility that the Bank will sustain some loss if the deficiencies are not corrected. Loans classified as doubtful have the weaknesses of those classified as substandard, with additional characteristics that make collection in full on the basis of currently existing facts, conditions and values questionable, and there is a high possibility of loss. A loan classified as loss is essentially uncollateralized and/or considered uncollectible and of such little value that continuance as an asset on the balance sheet may not be warranted. Loans classified as substandard or doubtful require the Bank to perform an analysis of the individual loan and charge off any loans, or portion thereof, that are deemed uncollectible.

The aging of past due loans at March 31, 2017 and December 31, 2016 are 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
March 31, 201 7
Single family	$	457		0		126		583		105,621		106,204		0
Commercial real estate:
Real estate rental and leasing		259		0		0		259		164,387		164,646		0
Other		0		0		0		0		148,878		148,878		0
Consumer		262		57		300		619		71,663		72,282		0
Commercial business:
Transportation industry		0		0		0		0		10,345		10,345		0
Other		14		0		226		240		71,714		71,954		0
	$	992		57		652		1,701		572,608		574,309		0
December 31, 2016
Single family	$	342		158		179		679		102,576		103,255		0
Commercial real estate:
Real estate rental and leasing		0		0		0		0		153,343		153,343		0
Other		0		0		0		0		145,737		145,737		0
Consumer		412		117		140		669		72,614		73,283		0
Commercial business:
Transportation industry		0		0		0		0		10,509		10,509		0
Other		85		0		274		359		74,308		74,667		0
	$	839		275		593		1,707		559,087		560,794		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 March 31, 2017 and December 31, 2016:

	March 31, 2017						December 31, 201 6
(Dollars in thousands)	Recorded Investment		Unpaid Principal Balance		Related Allowance		Recorded Investment		Unpaid Principal Balance		Related Allowance
Loans with no related allowance recorded:
Single family	$	533		533		0		217		217		0
Commercial real estate:
Real estate rental and leasing		39		110		0		40		122		0
Other		26		1,682		0		26		1,771		0
Consumer		304		305		0		312		312		0
Commercial business:
Other		226		301		0		274		356		0

Loans with an allowance recorded:
Single family		864		864		197		890		890		235
Commercial real estate:
Real estate rental and leasing		259		259		27
Other		1,782		1,782		243		1,814		1,814		248
Consumer		443		460		264		628		644		434
Commercial business:
Other		350		902		67		369		921		71

Total:
Single family		1,397		1,397		197		1,107		1,107		235
Commercial real estate:
Real estate rental and leasing		298		369		27		40		122		0
Other		1,808		3,464		243		1,840		3,585		248
Consumer		747		765		264		940		956		434
Commercial business:
Other		576		1,203		67		643		1,277		71
	$	4,826		7,198		798		4,570		7,047		988

The following table summarizes the average recorded investment and interest income recognized on impaired loans during the three months ended March 31, 201 7 and 2016:

	March 31, 201 7				March 31, 201 6
Dollars in thousands)	AveragRecorded Investment		Interest Income Recognized		Average Recorded Investment		Interest Income Recognized
Loans with no related allowance recorded:
Single family	$	375		3		973		6
Commercial real estate:
Real estate rental and leasing		40		0		44		1
Other		26		24		26		161
Consumer		308		3		489		1
Commercial business:
Other		250		0		0		0

Loans with an allowance recorded:
Single family		877		3		1,016		3
Commercial real estate:
Real estate rental and leasing		130		0		0		0
Other		1,798		8		2,196		7
Consumer		536		1		521		3
Commercial business:
Other		360		3		406		4

Total:
Single family		1,252		6		1,989		9
Commercial real estate:
Real estate rental and leasing		170		0		44		1
Other		1,824		32		2,222		168
Consumer		844		4		1,010		4
Commercial business:
Other		610		3		406		4
	$	4,700		45		5,671		186

At March 31, 201 7 and December 31, 2016, non-accruing loans totaled $3.4 million and $3.3 million, respectively, for which the related allowance for loan losses was $0.6 million and $0.8 million, respectively. All of the interest income 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 $0.8 million and $0.7 million, at March 31, 2017 and December 31, 2016, respectively. Non-accrual loans also include certain loans that have had terms modified in a TDR.

T he non-accrual loans at March 31, 2017 and December 31, 2016 are summarized as follows:

(Dollars in thousands)	March 31, 2017		December 31, 2016

Single family	$	1,073	$	916
Commercial real estate:
Real estate rental and leasing		298		41
Other		1,317		1,343
Consumer		453		630
Commercial business:
Other		293		343
	$	3,434	$	3,273

A t March 31, 2017 and December 31, 2016, there were loans included in loans receivable, net, with terms that had been modified in a TDR totaling $3.6 million and $3.3 million, respectively. For the loans that were restructured in the first quarter of 2017, $45,000 were classified but performing and $0.5 million were non-performing at March 31, 2017. Of the loans that were restructured in the first quarter of 2016, $31,000 were classified but performing, and $75,000 were non-performing at March 31, 2016.

The following table summarizes troubled debt restructurings at March 31, 2017 and December 31, 2016:

	March 31, 201 7						December, 31, 201 6
(Dollars in thousands)	Accruing		Non-Accrual		Total		Accruing		Non-Accrual		Total
Single f amily	$	325		587		912		191		257		448
Commercial real estate		491		1,260		1,751		497		1,277		1,774
Consumer		294		304		598		309		400		709
Commercial business		283		67		350		300		69		369
	$	1,393		2,218		3,611		1,297		2,003		3,300

As of March 31, 201 7, the Bank had commitments to lend an additional $0.7 million to a borrower who has TDR and non-accrual loans. These additional funds are for the construction of single family homes with a maximum loan-to-value ratio of 75%. These loans are secured by the home under construction. At December 31, 2016, there were commitments to lend additional funds of $0.4 million to this same borrower.

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 twelve 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 twelve month period. All loans classified as TDRs are considered to be impaired.

When a loan is modified in a TDR, there may be a direct, material impact on the loans within the consolidated balance sheets, as principal balances may be partially forgiven. The financial effects of TDRs are presented in the following table and represent the difference between the outstanding recorded balance pre-modification and post-modification, for the three months ended March 31, 2017 and March 31, 2016.

	Three Months Ended March 31, 201 7						Three Months Ended March 31, 201 6
(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 r estructurings:
Single family		3	$	282		514		0	$	0		0
Consumer		2		45		45		6		106		107
Total		5	$	327		559		6	$	106		107

There were no l oans that were restructured within the twelve months preceding March 31, 2017 and March 31, 2016 that defaulted during the three months ended March 31, 2017 and March 31, 2016.

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 were $0.6 million, or 6.1%, of the total $9.6 million in loan loss reserves at March 31, 2017 and $0.6 million, or 6.2%, of the total $9.9 million in loan loss reserves at December 31, 2016.

The following is additional information with respect to loans acquired through acquisitions:

(Dollars in thousands)	Contractual Principal Receivable			Accretable Difference			Net Carrying Amount
Purchased performing loans:
Balance at December 31, 2016	$	16,742			(332	)		16,410
Change due to payments/refinances		(1,379	)		25			(1,354	)
Balance at March 31, 2017	$	15,363			(307	)		15,056

(Dollars in thousands)	Contractual Principal Receivable			Non- Accretable Difference			Net Carrying Amount
Purchased credit impaired loans:
Balance at December 31 , 2016	$	435			(52	)		383
Change due to payments/refinances		(43	)		4			(39	)
Balance at March 31, 201 7	$	392			(48	)		344

T he Company has 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 March 31, 2017 was $0.3 million.

No provision for loan losses was recognized during the period ended March 31, 201 7 related to acquired loans as there was no significant change to the credit quality of those loans.

( 1 0 ) Intangible Assets

The Company ’s intangible assets consist of core deposit intangibles, goodwill, and mortgage servicing rights. A summary of mortgage servicing activity is as follows:

(Dollars in thousands)	Three Months ended March 31, 201 7			Twelve Months ended December 31, 201 6			Three Months ended March 31, 201 6
Balance, beginning of period	$	1,604			1,499			1,499
Originations		144			706			89
Amortization		(124	)		(601	)		(132	)
Balance, end of period	$	1,624			1,604			1,456
Fair value of mortgage servicing rights	$	3,043			2,952			2,427

All of the loans sold where the Company continues to service the loans are serviced for FNMA under the individual loan sale program. The following is a summary of the risk characteristics of the loans being serviced for FNMA at March 31, 2017.

			Weighted			Weighted
	Loan		Average			Average
	Principal		Interest			Remaining		Number
(Dollars in thousands)	Balance		Rate			Term (months)		of Loans
Original term 30 year fixed rate	$	244,936		4.07	%		304		2,002
Original term 15 year fixed rate		107,766		3.11			138		1,143
Adjustable rate		57		2.75			290		2

The gross carrying amount of intangible assets and the associated accumulated amortization at March 31, 2017 and 2016 is presented in the following table. Amortization expense for intangible assets was $149,000 and $151,000 for the three months ended March 31, 2017 and 2016, respectively.

	March 31, 2017
	Gross					Unamortized
	Carrying		Accumulated			Intangible
(Dollars in thousands)	Amount		Amortization			Assets
Mortgage servicing rights	$	4,046		(2,422	)		1,624
Core deposit intangible		574		(145	)		429
Goodwill		802		0			802
Total	$	5,422		(2,567	)		2,855

	March 31, 201 6
	Gross					Unamortized
	Carrying		Accumulated			Intangible
(Dollars in thousands)	Amount		Amortization			Assets
Mortgage servicing rights	$	3,749		(2,293	)		1,456
Core deposit intangible		420		(46	)		374
Total	$	4,169		(2,339	)		1,830

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

(Dollars in thousands)	Mortgage Servicing Rights		Core Deposit Intangible		Total Intangible Assets
Year ending December 31,
201 7	$	341		74		415
201 8		369		99		468
2019		317		99		416
2020		235		99		334
2021		184		47		231
Thereafter		178		11		189
Total	$	1,624		429		2,053

Projections of amortization are based on existing asset balances and the existing interest rate environment as of March 31, 20 17. The Company’s actual experience may be significantly different depending upon changes in mortgage interest rates and other market conditions.

( 1 1 ) Earnings per Common Share

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

	Three months ended March 31,
(Dollars in thousands, except per share data)	201 7		201 6
Weighted average number of common shares outstanding used in basic earnings per common share calculation		4,203,587		4,166,003
Net dilutive effect of:
Restricted stock awards , options and warrants		653,929		514,245
Weighted average number of shares outstanding adjusted for effect of dilutive securities		4,857,516		4,680,248
Income available to common shareholders	$	1,216		1,774
Basic earnings per common share	$	0.29		0.43
Diluted earnings per common share	$	0.25		0.38

(1 2 ) Regulatory Capital and Oversight

Effective January 1, 2015 t he capital requirements of the Bank were changed to implement the regulatory requirements of the Basel III capital reforms. The Basel III requirements, among other things, (i) apply a strengthened set of capital requirements to the Bank (the Company is exempt, pursuant to the Small Bank Holding Company Policy Statement (Policy Statement) described below), including requirements relating to common equity as a component of core capital, (ii) implement a “capital conservation buffer” against risk and a higher minimum tier 1 capital requirement, and (iii) revise the rules for calculating risk-weighted assets for purposes of such requirements. The rules made corresponding revisions to the prompt corrective action framework and include capital ratios and buffer requirements which 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, the Bank must meet specific capital guidelines that involve quantitative measures of its assets, liabilities and certain off-balance sheet items as calculated under regulatory accounting practices. The capital amounts and classification are also subject to qualitative judgments by the regulators about components, risk weightings and other factors.

T he Federal Reserve Bank amended its Policy Statement, to exempt 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 capital requirements.

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

T he Bank’s average total assets for the first quarter of 2017 were $674.9 million, its adjusted total assets were $673.7 million, and its risk-weighted assets were $588.0 million. The following table presents the Bank’s capital amounts and ratios at March 31, 2017 for actual capital, required capital and excess capital, including ratios in order to qualify as being well capitalized under the revised Prompt Corrective Actions regulations.

	Actual					Required to be Adequately Capitalized					Excess Capital					To Be Well Capitalized Under Prompt Corrective Action Provisions
(Dollars in thousands)	Amount		Percent of Assets ⁽¹⁾			Amount		Percent of Assets ⁽¹⁾			Amount		Percent of Assets ⁽¹⁾			Amount		Percent of Assets ⁽¹⁾
March 31, 2017
Common equity tier 1 capital	$	79,078		13.45	%	$	26,459		4.50	%	$	52,619		8.95	%	$	38,219		6.50	%
Tier 1 leverage		79,078		11.74			26,946		4.00			52,132		7.74			33,683		5.00
Tier 1 risk-based capital		79,078		13.45			35,279		6.00			43,799		7.45			47,038		8.00
Total risk-based capital		86,457		14.70			47,038		8.00			39,419		6.70			58,798		10.00

Beginning in 2016, the Bank must maintain a capital conservation buffer composed of common equity tier 1 capital above its minimum risk-based capital requirements in order to avoid limitations on capital distributions, including dividend payments and certain discretionary bonus payments to executive officers. For 2017, the capital conservation buffer is 1.25%. The buffer amount will increase incrementally each year until 2019 when the entire 2.50% capital conservation buffer will be fully phased in.

Management believes that, as of March 31, 2017, the Bank’s capital ratios were in excess of those quantitative capital ratio standards set forth under the current prompt corrective action regulations, including the capital conservation buffer described above. However, there can be no assurance that the Bank will continue to maintain such status in the future . The Office of the Comptroller of the Currency has extensive discretion in its supervisory and enforcement activities, and can adjust the requirement to be “well-capitalized” in the future.

(1 3 ) Stockholders’ Equity

The Company's certificate of incorporation authorizes the issuance of up to 500,000 shares of preferred stock, and on December 23, 2008, the Company completed the sale of 26,000 shares of Fixed Rate Cumulative Perpetual Preferred Stock, Series A (the Preferred Stock) to the U.S. Department of the Treasury (Treasury). The Preferred Stock had a liquidation value of $1,000 per share and a related warrant was also issued to purchase 833,333 shares of HMN common stock at an exercise price of $4.68 per share (the Warrant). The transaction was part of the Treasury’s Capital Purchase Program under the Emergency Economic Stabilization Act of 2008.

On February 17, 2015, the Company redeemed the final 10,000 shares of outstanding Preferred Stock. On May 21, 2015, the Treasury sold the Warrant at an exercise price of $4.68 per share to three unaffiliated third party investors for an aggregate purchase price of $5.7 million. 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 were still outstanding as of March 31, 2017 and 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 effect on the Company’s capital, financial condition or results of operations.

(1 4 ) Other Borrowings

On December 15, 2014, the Company entered into a Loan Agreement with an unrelated third party, providing for a term loan of up to $10.0 million that was evidenced by a promissory note (the Note) with an interest rate of 6.5 0% per annum. The principal balance of the loan is payable in consecutive equal annual installments of $1.0 million on each anniversary of the date of the Loan Agreement, commencing on December 15, 2015, with the balance due on December 15, 2021. Provided that no default or event of default has occurred and is continuing, the Company may, at its option, elect to defer payment of one installment of principal on the Note otherwise due prior to the maturity date, in which event such installment will become due and payable on the maturity date. The Company may voluntarily prepay the Note in whole or in part without penalty. The Company made the scheduled $1.0 million principal payment on December 15, 2015 and made a $2 million principal payment on December 15, 2016. The outstanding loan balance was $7.0 million at March 31, 2017 and December 31, 2016.

(1 5 ) Commitments and Contingencies

The Bank issue s standby letters of credit which guarantee the performance of customers to third parties. The standby letters of credit issued and available at March 31, 2017 were approximately $1.9 million, expire over the next 36 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 .

(1 6 ) Business Segments

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

The Company evaluates performance and allocates resources based on the segment ’s net income, return on average assets and 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 reconciliations 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 quarter ended March 31, 201 7 :
Interest income - external customers	$	6,660		0			0			6,660
Non-interest income - external customers		1,881		0			0			1,881
Intersegment non-interest income		53		1,418			(1,471	)		0
Interest expense		294		113			0			407
Non-interest expense		6,213		187			(53	)		6,347
Income tax expense (benefit)		939		(98	)		0			841
Net income		1,418		1,216			(1,418	)		1,216
Total assets		680,190		83,580			(82,789	)		680,981

At or for the quarter ended March 31, 2016:
Interest income - external customers	$	6,525		0			0			6,525
Non-interest income - external customers		1,755		0			0			1,755
Intersegment non-interest income		53		1,969			(2,022	)		0
Interest expense		226		148			0			374
Non-interest expense		5,561		183			(53	)		5,691
Income tax expense (benefit)		1,309		(136	)		0			1,173
Net income		1,969		1,774			(1,969	)		1,774
Total assets		637,104		80,868			(79,816	)		638,156

HMN FINANCIAL, INC.

Item 2: MANAGEMENT'S DISCUSSION AND ANALYSIS

OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

Forward-looking Information

Safe Harbor Statement

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 growing our core deposit relationships and loan balances, enhancing the financial performance of our core banking operations, maintaining or improving credit quality, reducing non-performing assets, and generating improved financial results (including profitability); 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 maintenance thereof; improvements in loan production; changes in the size of the Bank’s loan portfolio; the amount of the Bank’s non-performing assets and the appropriateness of the allowance therefor; our ability to integrate acquired operations; anticipated future levels of the provision for loan losses; future losses on non-performing assets; the amount and composition of interest-earning assets; the amount and composition 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 deposits that will be withdrawn from checking and money market accounts and how the withdrawn deposits will be replaced; the projected changes in net interest income based on rate shocks; the range that interest rates may fluctuate over the next twelve months; the net market risk of interest rate shocks; the future outlook for the issuer of the trust preferred securities held by the Bank; the ability of the Bank to pay dividends to HMN; the ability of HMN to pay the principal and interest payments on its third party note payable; the ability to remain well capitalized; 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 FHLB; 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; acquisition integration costs; our ability to attract and retain employees; or other significant uncertainties. Additional factors that may cause actual results to differ from the Company’s assumptions and expectations include those set forth in the Company’s most recent filing on Forms 10-K with the Securities and Exchange Commission. All forward-looking statements are qualified by, and should be considered in conjunction with, such cautionary statements. For additional discussion of the risks and uncertainties applicable to the Company, see the “Risk Factors” sections of the Company’s Annual Report on Form 10-K for the year ended December 31, 2016.

All statements in this 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 composition of interest-earning assets and non-interest and interest-bearing liabilities, and the level of non-performing assets. The Company's net earnings are also affected by the generation of non-interest income, which consists primarily of gains from the sale of loans and real estate owned, fees for servicing loans, commissions on the sale of uninsured investment products, and service charges on deposit accounts. The Bank incurs expenses in addition to interest expense in the form of salaries and benefits, occupancy and equipment expenses, provisions for loan losses, deposit insurance, amortization expense on mortgage servicing assets, data processing costs, fees for professional services, and income taxes. The earnings of financial institutions, such as the Bank, are also significantly affected by prevailing economic and competitive conditions, particularly changes in interest rates, government monetary and fiscal policies, and regulations of various regulatory authorities. Lending activities are influenced by the demand for and supply of business credit, single-family and commercial properties, competition among lenders, the level of interest rates and the availability of funds. Deposit flows and costs of deposits are influenced by prevailing market rates of interest on competing investments, account maturities and the levels of personal income and savings.

Critical Accounting Estimates

Critical accounting policies are those policies that the Company's management believes are the most important to understanding the Company ’s financial condition and operating results. These critical accounting policies often involve estimates and assumptions that could have a material impact on the Company’s consolidated financial statements. The Company has identified the following critical accounting policies that management believes involve the most difficult, subjective, and/or complex judgments that are inherently uncertain. Therefore, actual financial results could differ significantly depending upon the estimates, assumptions and other factors used.

Allowance for Loan Losses and Related Provision

The allowance for loan losses is based on periodic analysis of the loan portfolio and is maintained at an amount considered to be appropriate by management to provide for probable losses inherent in the loan portfolio as of the balance sheet dates. In this analysis, management considers factors including, but not limited to, specific occurrences of loan impairment, actual and anticipated changes in the size of the portfolios, national and regional economic conditions such as unemployment data, loan delinquencies, local economic conditions, demand for single-family homes, demand for commercial real estate and building lots, loan portfolio composition and historical loss experience and observations made by the Company's ongoing internal audit and regulatory exam processes. Loans are charged off to the extent they are deemed to be uncollectible. The Company has established separate processes to determine the appropriateness of 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 for 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 portions thereof, that are deemed uncollectable.

The appropriateness of the allowance for loan losses is dependent upon management ’s estimates of variables affecting valuation, appraisals of collateral, evaluations of performance and status, and the amounts and timing of future cash flows expected to be received on impaired loans. Such estimates, appraisals, evaluations and cash flows may be subject to adjustments due to changing economic prospects of borrowers or properties. The fair market value of collateral dependent loans are typically based on the appraised value of the property less estimated selling costs. The estimates are reviewed periodically and adjustments, if any, are recorded in the provision for loan losses in the periods in which the adjustments become known. Because of the size of some loans, changes in estimates can have a significant impact on the loan loss provision. The allowance is allocated to individual loan categories based upon the relative risk characteristics of the loan portfolios and the actual loss experience. The Company increases its allowance for loan losses by charging the provision for loan losses against income and decreases its allowance by crediting the provision for loan losses. The allowance is also credited for recoveries received on previously charged off loans. The activity in the allowance in the first quarter of 2017 resulted in a credit to the loan loss provision. The methodology for establishing the allowance for loan losses takes into consideration probable losses that have been identified in connection with specific loans as well as losses in the loan portfolio that have not been specifically identified. Although management believes that based on current conditions the allowance for loan losses is maintained at an appropriate amount to provide for probable loan losses inherent in the portfolio as of the balance sheet dates, future conditions may differ substantially from those anticipated in determining the allowance for loan losses and adjustments may be required in the future.

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 assets and liabilities.

The Company maintains significant net deferred tax assets for deductible temporary differences, the largest of which relates to the allowance for loan and real estate losses and net operating loss carryforwards. For income tax purposes, only net charge-offs are deductible, not the entire provision for loan losses. Under U.S. generally accepted accounting principles, a valuation allowance is required to be recognized if it is “more likely than not” that the deferred tax asset will not be realized. The determination of the realizability of the deferred tax assets is highly subjective and dependent upon management’s judgment and evaluation of both positive and negative evidence, including the forecasts of future income, tax planning strategies, and assessments of the current and future economic and business conditions. The Company considers both positive and negative evidence regarding the ultimate realizability of deferred tax assets. Positive evidence includes the Company’s cumulative net income in the prior three year period, the ability to implement tax planning strategies to accelerate taxable income recognition, and the probability that taxable income will be generated in future periods. It is possible that future conditions may differ substantially from those anticipated in determining that no valuation allowance was required on deferred tax assets and adjustments may be required in the future.

Determining the ultimate settlement of any tax position requires significant estimates and judgments in arriving at the amount of tax benefits to be recognized in the financial statements. It is possible that the tax benefits realized upon the ultimate resolution of a tax position may result in tax benefits that are significantly different from those estimated.

Accounting for Loans Acquired in a Business Combination

Loans acquired in a business combination are initially recorded at their acquisition date fair values. The fair values of the purchased loans are based on the present value of the expected cash flows, including principal, interest and prepayments. Periodic principal and interest cash flows are adjusted for expected losses and prepayments, then discounted to determine the present value and summed to arrive at the estimated fair value. Fair value estimates involve assumptions and judgments as to credit risk, interest rate risk, prepayment risk, liquidity risk, default rates, loss severity, payment speeds, collateral values and discount rate. Purchased loans are divided into loans with evidence of credit quality deterioration, which are accounted for under ASC topic 310-30 (purchased credit impaired (PCI)) , and loans that do not meet this criteria, which are accounted for under ASC topic 310-20 (performing). PCI loans have experienced a deterioration of credit quality from origination to acquisition for which it is probable that the Bank will not be able to collect all principal and interest payments on the loan. In the assessment of credit quality, numerous assumptions, interpretations and judgments must be made, based on internal and third-party credit quality information and ultimately the determination as to the probability that all contractual cash flows will not be able to be collected. This is a point in time assessment and inherently subjective due to the nature of the available information and judgment involved.

Subsequent to the acquisition date, the Bank continues to estimate the amount and timing of cash flows expected to be collected on PCI loans. The present value of any decreases in expected cash flows after the acquisition date will generally result in an impairment charge recorded as a provision for loan losses, resulting in an increase to the allowance for loan losses. Increases in expected cash flows will generally result in a recovery of any previously recorded allowance for loan losses, to the extent applicable, and/or a reclassification from the nonaccretable difference to accretable yield, which will be recognized prospectively. For acquired performing loans, the difference between the acquisition date fair value and the contractual amounts due at the acquisition date represents the fair value adjustment. Fair value adjustments may be discounts or premiums to a loan's cost basis and are accreted or amortized into interest income over the loan's remaining life using the level yield method.

Subsequent to the acquisition date, the methods utilized to estimate the required allowance for loan losses for these loans is similar to originated loans. See Note 9 “ Allowance for Loan Losses and Credit Quality Information ” in the Notes to Consolidated Financial Statements for more information regarding acquired loan disclosures.

Acquisition

On April 8, 2016, the Bank completed the acquisition of loans, totaling approximately $12 million, and deposits, totaling approximately $19 million, related to the Deerwood Bank branch in Albert Lea, Minnesota. The acquired loans and deposits are being serviced from Home Federal’s existing branch location at 143 West Clark Street, Albert Lea, Minnesota.

RESULTS OF OPERATIONS FOR THE QUARTER ENDED MARCH 31, 201 7 COMPARED TO THE QUARTER ENDED MARCH 31, 201 6

Net Income

Net income was $1.2 million for the first quarter of 2017, a decrease of $0.6 million compared to net income of $1.8 million for the first quarter of 2016. Diluted earnings per share for the first quarter of 2017 was $0.25, a decrease of $0.13 from diluted earnings per share of $0.38 for the first quarter of 2016. The decrease in net income between the periods was due primarily to the $0.4 million increase in the provision for loan losses between the periods. The increase in the provision for loan losses reflects the increase in loan growth and the decrease in recoveries received on previously charged off loans in the first quarter of 2017 when compared to the same period of 2016. Gains on real estate owned decreased $0.3 million between the periods due to a decrease in sales activity. Compensation and benefit expense increased $0.2 between the periods due to an increase in employees and normal annual salary increases. These increases in expenses were partially offset by a $0.4 million decrease in income tax expense due to the decreased pre-tax income between the periods.

Net Interest Income

Net interest income was $6.3 million for the first quarter of 2017, an increase of $0.1 million, or 1.7%, compared to $6.2 million for the first quarter of 2016. Interest income was $6.7 million for the first quarter of 2017, an increase of $0.2 million, or 2.1%, from $6.5 million for the first quarter of 2016. Interest income increased between the periods primarily because of an increase in the average interest-earning assets and a change in the composition of the average interest-earning assets held, which resulted in a 15 basis point increase in the average yields earned between the periods. While the average interest-earning assets increased $44.4 million between the periods, the average interest-earning assets held in higher yielding loans increased $83.3 million and the amount of average interest-earning assets held in lower yielding cash and investments decreased $38.9 million between the periods. The increase in the average outstanding loans between the periods was primarily the result of an increase in the commercial loan portfolio, which occurred because of an increase in loan originations and a reduction in loan payoffs between the periods. The loan balances also increased $5.7 million due to an acquisition that occurred in the second quarter of 2016. The yield on average interest-earning assets between the periods was negatively impacted by $0.4 million, or 33 basis points, due to changes in the yield enhancements recognized on loan prepayment penalties, yield adjustments on purchased loans, and interest payments received on non-accruing and previously charged off loans. In the first quarter of 2017, the Company recognized $0.2 million from these types of yield enhancements compared to $0.6 million in the first quarter of 2016. These yield enhancements improved the average yield on interest earning assets by 9 basis points and 42 basis points in the first quarters of 2017 and 2016, respectively. The average yield earned on interest-earning assets was 4.16% for the first quarter of 2017, a decrease of 18 basis points from 4.34% for the first quarter of 2016. The decrease in the average yield earned on interest-earning assets is primarily related to the decrease in yield enhancements recognized between the periods.

Interest expense was $0.4 million for the first quarter of 2017, the same as the first quarter of 2016. The average interest rate paid on non-interest and interest-bearing liabilities was 0.28% for the first quarter of 2017, an increase of 1 basis point from 0.27% for the first quarter of 2016. The average interest rate paid increased between the periods due to an increase in the rates paid on certain money market accounts that was partially offset by a change in the composition of the average non-interest and interest-bearing liabilities held between the periods. While the average non-interest and interest-bearing liabilities increased $33.8 million between the periods, the amount held in lower rate checking and money market accounts increased $31.7 million and the amount held in higher rate certificates of deposits and other borrowings increased $2.1 million. The increase in the average outstanding deposits between the periods was primarily the result of organic deposit growth but also increased $14.8 million as a result of an acquisition that occurred in the second quarter of 2016.

Net interest margin (net interest income divided by average interest-earning assets) for the first quarter of 2017 was 3.91%, a decrease of 18 basis points, compared to 4.09% for the first quarter of 2016. The decrease in the net interest margin is primarily related to the decrease in yield enhancements recognized between the periods.

A summary of the Company ’s net interest margin for the three-month periods ended March 31, 2017 and 2016 is as follows:

	For the three-month period ended
	March 31, 2017							March 31, 2016
(Dollars in thousands)	Average Outstanding Balance		Interest Earned/ Paid		Yield/ Rate			Average Outstanding Balance		Interest Earned/ Paid		Yield/ Rate
Interest-earning assets:
Securities available for sale	$	76,197		275		1.46	%	$	97,362		392		1.62	%
Loans held for sale		1,656		18		4.41			2,104		24		4.59
Mortgage loans, net		110,064		1,111		4.09			96,526		1,009		4.20
Commercial loans, net		371,153		4,385		4.79			307,653		4,250		5.56
Consumer loans, net		72,255		846		4.75			65,485		811		4.98
Cash equivalents		17,036		23		0.55			34,890		38		0.44
Federal Home Loan Bank stock		786		2		1.03			694		1		0.58
Total interest-earning assets		649,147		6,660		4.16			604,714		6,525		4.34

Interest-bearing liabilities and non-interest-bearing deposits:
Checking		92,063		20		0.09			83,221		11		0.05
Savings		75,273		15		0.08			67,664		15		0.09
Money market		162,540		105		0.26			158,920		87		0.22
Certificates		101,950		152		0.60			98,430		113		0.46
Advances and other borrowings		7,399		115		6.30			9,000		148		6.61
Total interest-bearing liabilities		439,225							417,235
Non-interest checking		154,407							142,761
Other non-interest- bearing escrow deposits		1,339							1,138
Total interest-bearing liabilities and non-interest- bearing deposits	$	594,971		407		0.28		$	561,134		374		0.27
Net interest income			$	6,253						$	6,151
Net interest rate spread						3.88	%						4.07	%
Net interest margin						3.91	%						4.09	%

Provision for Loan Losses

The provision for loan losses was ($0.3 million) for the first quarter of 2017, an increase of $0.4 million compared to the provision for loan losses of ($0.7 million) for the first quarter of 2016. The provision increased in the first quarter of 2017 primarily because of an increase in loan growth and a decrease in recoveries received on previously charged off loans in the first quarter of 2017 when compared to the same period of 2016.

A reconciliation of the Company ’s allowance for loan losses for the first quarters of 2017 and 2016 is as follows:

(Dollars in thousands)	201 7			201 6
Balance at January 1,	$	9,903		$	9,709
Provision		(270	)		(732	)
Charge offs:
Consumer		(201	)		(7	)
Recoveries		158			393
Balance at March 31,	$	9,590		$	9,363

General allowance	$	8,792		$	8,379
Specific allowance		798			984
	$	9,590		$	9,363

Non-Interest Income

Non-interest income was $1.9 million for the first quarter of 2017, an increase of $0.1 million, or 7.2%, from $1.8 million for the first quarter of 2016. Fees and service charges increased $46,000 between the periods due primarily to an increase in unused loan commitment fees and debit card income. Loan servicing fees increased $40,000 between the periods due to an increase in the number of commercial loans being serviced. Gain on sales of loans increased $32,000 between the periods primarily due to an increase in the gains recognized on the sale of single-family loans due to increased volume.

Non-Interest Expense

Non-interest expense was $6.3 million for the first quarter of 2017, an increase of $0.6 million, or 11.5%, from $5.7 million for the first quarter of 2016. Gains on the sale of real estate owned decreased $0.3 million due to a decrease in sales activity between the periods. Compensation and benefits expense increased $0.2 million between the periods due to an increase in employees and normal annual salary increases. Occupancy and equipment expense increased $0.1 million between the periods because of increases in non-capitalized software and equipment expenses. Other operating expense decreased slightly due to a decrease in acquisition related expenses between the periods. Data processing expense increased slightly because of an increase in mobile banking and on-line banking costs due to increased customer activity between the periods. Professional services expense increased marginally due to increased legal expenses between the periods.

Incom e Taxes

Income tax expense was $ 0.8 million for the first quarter of 2017, a decrease of $0.4 million from $1.2 million for the first quarter of 2016. The decrease in income tax expense between the periods is primarily related to the decrease in pre-tax income in the first quarter of 2017 when compared to the first quarter of 2016.

FINANCIAL CONDITION

Non-Performing Assets

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

	March 31,			December 31,
(Dollars in thousands)	201 7			201 6
Non -Performing Loans:
Single family real estate	$	1,073		$	916
Commercial real estate		1,615			1,384
Consumer		453			630
Commercial business		293			343
Total		3,434			3,273

Foreclosed and Repossessed Assets:
Single family real estate		40			0
Commercial real estate		602			611
Consumer		16			16
Total non -performing assets	$	4,092		$	3,900
Total as a percentage of total assets		0.60	%		0.57	%
Total non -performing loans	$	3,434		$	3,273
Total as a percentage of total loans receivable, net		0.61	%		0.59	%
Allowance for loan losses to non-performing loans		279.29	%		302.56	%

Delinquency Data:
Delinquencies ⁽¹⁾
30+ days	$	702		$	917
90+ days		0			0
Delinquencies as a percentage of loan and lease portfolio ⁽¹⁾
30+ days		0.12	%		0.16	%
90+ days		0.00	%		0.00	%

⁽¹⁾ Excludes non-accrual loans.

Total non-performing assets were $4.1 million at March 31, 2017, an increase of $0.2 million, or 4.91%, from $3.9 million at December 31, 2016. Non-performing loans increased $161,000 and foreclosed and repossessed assets increased $31,000 during the first quarter of 2017.

Dividends

The declaration of dividends is subject to, among other things, the Company's financial condition and results of operations, the Bank's compliance with regulatory capital requirements and other regulatory restrictions, tax considerations, industry standards, economic conditions, general busines s practices and other factors. The Company has not made any dividend payments to common stockholders during the three year period ending March 31, 2017.

LIQUIDITY AND CAPITAL RESOURCES

For the quarter ended March 31, 20 17, the net cash provided by operating activities was $4.5 million. The Company collected $5.2 million in principal repayments and maturities on securities during the quarter. It received $0.5 million related to increases in customer escrows, $0.6 million on the redemption of FHLB stock, and $15.5 million in proceeds from borrowings. The Company had a net decrease in deposit balances of $1.4 million during the quarter. It also purchased $5.0 million in securities, purchased $0.7 million in FHLB stock, paid out $0.1 million for premises and equipment, repaid borrowings of $15.5 million, repurchased stock in cashless exchange of $0.1 million, and loans receivable increased $18.6 million.

The Company has certificates of dep osits with outstanding balances of $53.8 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 cash outflows from deposits that do not renew will be replaced with a combination of other customer’s deposits or FHLB advances. FRB borrowings or proceeds from the sale of securities could also be used to fund unanticipated outflows of deposits.

The Company ha d four deposit customers with aggregate deposits greater than $5.0 million as of March 31, 2017. The $43.1 million in funds held by these customers may be withdrawn at any time, but management anticipates that the majority of these deposits will not be withdrawn from 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. FRB borrowings 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 $ 106.1 million from the FHLB at March 31, 2017 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, in excess of the $88.6 million that was available at March 31, 2017, from the FRB based on the increased collateral levels or obtain additional deposits.

The Company’s primary source of cash is dividends from the Bank. At March 31, 2017, the Company had $3.0 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 the principal and interest amounts on the third party note payable.

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 Company level expenses and 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. Additional capital would also potentially permit the Company to implement a strategy of growing Bank assets. Depending on the circumstances, if it were to raise capital, the Company may deploy it to the Bank for general banking purposes, or may retain some or all of it for use by the Company.

If the Company were to raise capital through the issuance of additional shares of common stock or other equity securities, it would dilute the ownership interests of existing stockholders, and, if issued at 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 and deposit taking activities. Management actively monitors and manages its interest rate risk exposure.

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

The following table discloses the projected changes in the market value of 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 March 31, 2017.

	Market Value
(Dollars in thousands) Basis point change in interest rates		-100		0		+100			+200
Total market risk sensitive assets	$	685,473		671,973			658,538			644,244
Total market risk sensitive liabilities		584,455		542,448			504,371			472,357
Off-balance sheet financial instruments		(301	)	0			(32	)		(7	)
Net market risk	$	101,319		129,525			153,839			171,894
Percentage change from current market value		(21.78	%)	0.00	%		18.77	%		32.71	%

The preceding table was prepared utilizing a model using the following assumptions (the Model Assumptions) regarding prepayment and decay ratios that were determined by management based upon their review of historical prepayment speeds and future prepayment projections. Fixed rate loans were assumed to prepay at annual rates of between 1% to 40%, depending on the note rate and the period to maturity. Adjustable rate mortgages (ARMs) were assumed to prepay at annual rates of between 7% and 51%, 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 and money market accounts were assumed to decay at an annual rate of 19%, and 5% to 7%, respectively. Retail checking accounts were assumed to decay at an annual rate of 15%. Commercial checking accounts and money market accounts were assumed to decay at annual rates of 11% and 24%, respectively. Callable investments were projected to be called at the first call date where the projected interest rate on similar remaining term instruments exceeded the interest rate on the callable advance or investment.

Certain shortcomings are inherent in the method of analysis presented in the above 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 that are approaching their lifetime interest rate caps could be different from the values disclosed in the table. Certain liabilities, such as certificates of deposit, have fixed rates that restrict interest rate changes until maturity. In the event of a change in interest rates, prepayment and early withdrawal levels may deviate significantly from those assumed in calculating the foregoing table. The ability of many borrowers to service their debt may also decrease in the event of a substantial sustained increase in interest rates.

Asset/Liability Management

The Company ’s management reviews the impact that changing interest rates will have on 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 impact on net interest income during the twelve month period ending March 31, 2018 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	$	2,808			10.78	%
+100		1,385			5.32
0		0			0.00
-100		(1,540	)		(5.91	)

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 there are more adjustable rate loans that would re-price to higher interest rates than there are deposits that would re-price 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 that meets frequently to discuss changes in the interest rate risk position and projected profitability. This Committee makes adjustments to the asset-liability position of the Bank that are reviewed by the Board of Directors of the Bank. This Committee also reviews the Bank's portfolio, formulates investment strategies and oversees the timing and implementation of transactions as intended to assure attainment of the Bank's objectives in an effective manner. In addition, each quarter the Board reviews the Bank's asset/liability position, including simulations of the effect on the Bank's capital of various interest rate scenarios.

In managing its asset/liability composition, the Bank may, at times, depending on the relationship between long-term and short-term interest rates, market conditions and consumer preference, place more emphasis on managing net interest margin than on better matching the interest rate sensitivity of its assets and liabilities in an effort to enhance net interest income. Management believes that the increased net interest income resulting from a mismatch in the maturity of its asset and liability portfolios can, in certain situations, provide high enough returns to justify the increased exposure to sudden and unexpected changes in interest rates.

To the extent consistent with its interest rate spread objectives, the Bank attempts to manage its interest rate risk and has taken a number of steps to restructure its balance sheet in order to better match the maturities of its assets and liabilities. In the past, more long-term fixed rate loans were placed into the single family loan portfolio. In recent years, the Bank has continued to focus its 30 year fixed rate single family residential lending program on loans that are saleable to third parties and generally places only adjustable rate or shorter-term fixed rate loans that meet certain risk characteristics into its loan portfolio. A significant portion of the Bank’s commercial loan production continues to be in adjustable rate loans that reprice every one, two, or three years.

Off-Balance Sheet Arrangements

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

Item 3: Quantitative and Qualitative Disclosures A bout 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 judgements 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.

T here 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, 2016. 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, 2016.

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

(a) Not applicable.

(b) Not applicable .

Period

(a) Total

Number of

Purchased

(b) Average Price

Paid per Share

Shares Purchased as

Part of Publicly

Announced Plans or

Programs

(d) Maximum Number

of Shares that May Yet

Be Purchased Under the Plans

or Programs

January 1 through January 31, 2017 ⁽¹⁾

2,968

18.10

Total

2,968

18.10

⁽¹⁾ Represents restricted stock withheld pursuant to the terms of awards granted under the HMN Financial, Inc. 2009 Equity Incentive Plan (the “2009 Plan”) in January of the previous three years. The 2009 Plan provides that the value of shares withheld shall be the closing price of the Company’s common stock on the date of determination.

ITEM 3. D efaults 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 requirement s 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 :	May 5, 2017	/s/ Bradley Krehbiel
		Bradley Krehbiel, President and Chief Executive Officer
		(Principal Executive Officer)


Date :	May 5, 2017	/s/ Jon Eberle
		Jon Eberle, Senior Vice President and
		Chief Financial Officer
		(Principal Financial Officer)

HMN FINANCIAL, INC.

INDEX TO EXHIBITS

FOR FORM 10 -Q

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


10.1	HMN Financial, Inc. 2017 Equity Incentive Plan	Filed Electronically

10.2	Form of Directors ’ Restricted Stock Agreement for awards granted to directors under the HMN Financial, Inc. 2017 Equity Incentive Plan	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 March 31, 201 7, filed with the SEC on May 5, 2017, formatted in Extensible Business Reporting Language (XBRL); (i) the Consolidated Balance Sheets at March 31, 2017 and December 31, 2016, (ii) the Consolidated Statements of Comprehensive Income for the Three Months Ended March 31, 2017 and 2016, (iii) the Consolidated Statement of Stockholders’ Equity for the Three Month Period Ended March 31, 2017, (iv) the Consolidated Statements of Cash Flows for the Three Months Ended March 31, 2017 and 2016, and (v) Notes to Consolidated Financial Statements.	Filed Electronically

Exhibit 10.1

HMN FINANCIAL, INC.

2017 EQUITY INCENTIVE PLAN

1. Purpose . The purpose of the HMN Financial, Inc. 2017 Equity Incentive Plan (the “Plan”) is to attract and retain the best available personnel for positions of responsibility with the Company, to provide additional incentives to them and align their interests with those of the Company’s stockholders, and to thereby promote the Company’s long-term business success.

2. Definitions . The capitalized terms used in the Plan have the meanings set forth below.

(a) “ Affiliate ” means any entity that is a Subsidiary or Parent of the Company.

(b) “ Agreement ” means any written or electronic agreement, notice or other document containing the terms and conditions applicable to each Award granted under the Plan, including all amendments thereto. An Agreement is subject to the terms and conditions of the Plan.

(c) “ Award ” means a grant made under the Plan in the form of Options, Stock Appreciation Rights, Restricted Stock, Stock Units, or an Other Stock-Based Award.

(d) “ Bank ” means Home Federal Savings Bank, a federally chartered savings bank and a wholly owned subsidiary of Company.

(e) “ Board ” means the Board of Directors of the Company.

(f) “ Cause ” means a Participant’s (i) act or acts of dishonesty intended to result in substantial gain or personal enrichment of the Participant at the expense of the Company or any Affiliate; (ii) unlawful conduct or gross misconduct that is willful and deliberate on the Participant’s part and that, in either event, is injurious to the Company or any Affiliate; (iii) conviction of a felony; (iv) failure to perform his or her duties and responsibilities as an officer or employee of the Company or any Affiliate, which failure has not been cured by the Participant within 30 days after written notice thereof to the Participant from the Company or such Affiliate, as applicable; or (v) material breach of any employment, confidentiality, non-disclosure, non-solicitation, non-competition or similar agreement with the Company or any Affiliate, or of the Company’s code of business conduct.

(g) “ Change in Control ” means the occurrence of any one of the following:

(1) Any “person” (as defined in Sections 13(d) and 14(d) of the Exchange Act) acquires or becomes a “beneficial owner” (as defined in Rule 13d-3 or any successor rule under the Exchange Act), directly or indirectly, of securities of the Company or the Bank representing 35% or more of the combined voting power of the then outstanding Voting Securities of the Company or the Bank, respectively, except that the following shall not constitute a Change in Control:

(A) any acquisition or beneficial ownership by the Company, the Bank or any Affiliate;

(B) any acquisition or beneficial ownership by any employee benefit plan (or related trust) sponsored or maintained by the Company, the Bank or one or more of their Affiliates;

(C) any acquisition or beneficial ownership by any corporation (including without limitation an acquisition in a transaction of the nature described in part (3) of this definition) with respect to which, immediately following such acquisition, more than 65% of the combined voting power of the Company’s or the Bank’s then outstanding Voting Securities, as the case may be, is beneficially owned, directly or indirectly, by all or substantially all of the persons who beneficially owned Voting Securities of the Company or the Bank, as applicable, immediately prior to such acquisition in substantially the same proportions as their ownership of such Voting Securities immediately prior to such acquisition; or

(D) any acquisition of Voting Securities directly from the Company or the Bank.

(2) Continuing Directors shall not constitute a majority of the members of the Board. For purposes of this Plan, “Continuing Directors” means: (A) individuals who, on the effective date of this Plan, are directors of the Company, (B) individuals elected as directors of the Company subsequent to the effective date of this Plan for whose election proxies shall have been solicited by the Board or (C) any individual elected or appointed by the Board to fill vacancies on the Board caused by death or resignation (but not by removal) or to fill newly-created directorships, provided that a “Continuing Director” shall not include an individual whose initial assumption of office occurs as a result of an actual or threatened election contest with respect to the threatened election or removal of directors (or other actual or threatened solicitation of proxies or consents) by or on behalf of any person other than the Board;

(3) Consummation of a Corporate Transaction, unless immediately following such Corporate Transaction, all or substantially all of the persons who were the beneficial owners of Voting Securities of the Company or the Bank, as the case may be, immediately prior to such Corporate Transaction beneficially own, directly or indirectly, more than 65% of the combined voting power of the then outstanding Voting Securities of the surviving or acquiring corporation in such Corporate Transaction in substantially the same proportions as their ownership, immediately prior to such Corporate Transaction, of the Voting Securities of the Company or the Bank, as the case may be; or

(4) Approval by the shareholders of the Company of a complete liquidation or dissolution of the Company or the Bank.

Notwithstanding the foregoing provisions of this Section 2(g): (i) to the extent that any Award constitutes a deferral of compensation subject to Code Section 409A, and if that Award provides for a change in the time or form of payment upon a Change in Control, then no Change in Control shall be deemed to have occurred upon an event described in this Section 2(g) unless the event would also constitute a change in ownership or effective control of, or a change in the ownership of a substantial portion of the assets of, the Company or the Bank under Code Section 409A; and (ii) a Change in Control shall not be deemed to occur with respect to a Participant if (A) the acquisition or beneficial ownership of the 35% or greater interest referred to in Section 2(g)(1) is by the Participant or by a group, acting in concert, that includes the Participant or (B) a majority of the then combined voting power of the then outstanding Voting Securities of the surviving or acquiring corporation (or its Parent) shall, immediately after a Corporate Transaction referred to in Section 2(g)(3), be beneficially owned, directly or indirectly, by the Participant or by a group, acting in concert, that includes the Participant.

(h) “ Code ” means the Internal Revenue Code of 1986, as amended and in effect from time to time. For purposes of the Plan, references to sections of the Code shall be deemed to include any applicable regulations thereunder and any successor or similar statutory provisions.

(i) “ Committee ” means two or more Non-Employee Directors designated by the Board to administer the Plan under Section 3 hereof, each member of which shall be (i) an independent director within the meaning of the rules and regulations of The NASDAQ Stock Market, (ii) a non-employee director within the meaning of Exchange Act Rule 16b-3, and (iii) an “outside director” for purposes of Code Section 162(m).

(j) “ Common Stock ” means the common stock, par value $.01, of the Company.

(k) “ Company ” means HMN Financial, Inc., a Delaware corporation, and any successor thereto.

(l) “ Corporate Transaction ” means (i) a sale of substantially all of the assets of the Company or the Bank, or (ii) a merger, consolidation, share exchange or similar transaction involving the Company or the Bank, regardless of whether the Company or the Bank, as applicable, is the surviving corporation.

(m) “ Disability ” means, unless otherwise defined in an Agreement, the inability of a Participant to perform on a full-time basis the duties and responsibilities of the Participant’s employment with the Company or the Bank by reason of illness or other physical or mental impairment or condition, if such inability continues for an uninterrupted period of 180 days or more during any 360-day period. A period of inability shall be “uninterrupted” unless and until the Participant returns to full-time work for a continuous period of at least 30 days.

(n) “ Employee ” means an employee (including an officer or director who is also an employee) of the Company or an Affiliate.

(o) “ Exchange Act ” means the Securities Exchange Act of 1934, as amended and in effect from time to time.

(p) “ Fair Market Value ” of a Share means the fair market value of a Share determined as follows:

(1) If the Shares are readily tradable on an established securities market (as determined under Code Section 409A), then Fair Market Value will be the closing sales price for a Share on the principal securities market on which it trades on the date for which it is being determined, or if no sale of Shares occurred on that date, on the next preceding date on which a sale of Shares occurred; or

(2) If the Shares are not then readily tradable on an established securities market (as determined under Code Section 409A), then Fair Market Value will be determined by the Committee as the result of a reasonable application of a reasonable valuation method that satisfies the requirements of Code Section 409A.

(q) “ Full Value Award ” means an Award other than an Option or Stock Appreciation Right.

(r) “ Grant Date ” means the date on which the Committee approves the grant of an Award under the Plan, or such later date as may be specified by the Committee on the date the Committee approves the Award.

(s) “ Incentive Stock Option ” or “ ISO ” means any Option designated as such and granted in accordance with the requirements of Code Section 422.

(t) “ Non-Employee Director ” means a member of the Board who is not an Employee.

(u) “ Non-Qualified Stock Option ” means an Option other than an Incentive Stock Option.

(v) “ Option ” means a right granted under the Plan to purchase a specified number of Shares at a specified price.

(w) “ Other Stock-Based Award ” means an Award described in Section 11 of this Plan.

(x) “ Parent ” means a “parent corporation,” as defined in Code Section 424(e).

(y) “ Participant ” means a person to whom an Award is or has been made in accordance with the Plan.

(z) “ Performance-Based Compensation ” means an Award to a person who is, or is determined by the Committee to likely become, a “covered employee” (as defined in Code Section 162(m)(3)) and that is intended to constitute “performance-based compensation” within the meaning of Code Section 162(m)(4)(C).

(aa) “ Performance Period ” means the period of time, as specified in an Agreement, during which performance goals based on Performance Measures must be achieved.

(bb) “ Performance Measures ” means any business or performance criteria selected by the Committee on which it will base performance goals that must be satisfied as a condition precedent to the vesting of an Award. For any Award intended to constitute Performance-Based Compensation, the Performance Measures shall consist of one or a combination of two or more of the following business or performance criteria: interest income; net interest income; income before income tax expense; net income; net income available to common stockholders; earnings per common share (basic or diluted); profitability as measured by return ratios (including, but not limited to, return on average assets, return on average equity) or by the degree to which any of the foregoing earnings measures exceed a percentage of interest income; cash flow; market share; net interest margin; stock price; total stockholder equity; asset quality; non-performing assets; interest income growth; operating income; cash flow per share; improvement in, or attainment of, non-interest expense levels or cost savings. Any performance goal based a Performance Measure may be expressed in absolute amounts, on a per share basis (basic or diluted), relative to one or more other Performance Measures, as a growth rate or change from preceding periods, or as a comparison to the performance of specified companies, indices or other external measures, and may relate to one or any combination of Company, Affiliate, division, business unit, operational unit or individual performance.

(cc) “ Prior Plan ” means the HMN Financial, Inc. 2009 Equity Incentive Plan.

(dd) “ Restricted Stock ” means Shares issued to a Participant that are subject to such restrictions on transfer, vesting conditions and other restrictions or limitations as may be set forth in this Plan and the applicable Agreement.

(ee) “ Securities Act ” means the Securities Act of 1933, as amended and in effect from time to time.

(ff) “ Service ” means the provision of services by a Participant to the Company or any Affiliate in any Service Provider capacity. A Service Provider’s Service shall be deemed to have terminated either upon an actual cessation of providing services, or upon the entity for which the Service Provider provides services ceasing to be an Affiliate. Except as otherwise provided in any Agreement, Service shall not be deemed terminated in the case of (i) any approved leave of absence; (ii) transfers among the Company and any Affiliates in any Service Provider capacity; or (iii) any change in status so long as the individual remains in the service of the Company or any Affiliate in any Service Provider capacity.

(gg) “ Service Provider ” means an Employee, a Non-Employee Director, or any consultant or advisor who is a natural person and who provides services (other than in connection with (i) a capital-raising transaction or (ii) promoting or maintaining a market in Company securities) to the Company or any Affiliate.

(hh) “ Share ” means a share of Common Stock.

(ii) “ Stock Appreciation Right ” or “SAR” means the right to receive, in cash and/or Shares as determined by the Committee, an amount equal to the appreciation in value of a specified number of Shares between the Grant Date of the SAR and its exercise date.

(jj) “ Stock Unit ” means a right to receive, in cash and/or Shares as determined by the Committee, the Fair Market Value of a Share, subject to such restrictions on transfer, vesting conditions and other restrictions or limitations as may be set forth in this Plan and the applicable Agreement.

(kk) “ Subsidiary ” means a “subsidiary corporation,” as defined in Code Section 424(f), of the Company.

(ll) “ Substitute Award ” means an Award granted upon the assumption of, or in substitution or exchange for, outstanding award(s) granted by a company or other entity acquired by the Company or any Affiliate or with which the Company or any Affiliate combines. The terms and conditions of a Substitute Award may vary from the terms and conditions set forth in the Plan to the extent that the Committee at the time of the grant may deem appropriate to conform, in whole or in part, to the provisions of the award in substitution for which it has been granted.

(mm) “ Successor ” means the guardian or legal representative of an incompetent Participant, or if the Participant is deceased, means the estate of the Participant or the person or persons who may, be bequest or inheritance, or pursuant to the terms of an Award, acquire the right to exercise an Option or Stock Appreciate Right or to receive cash and/or Shares issuable in satisfaction of an Award in the event of a Participant’s death.

(nn) “ Transferee ” means any “family member” (as defined by General Instruction A.1.(a)(5) to Form S-8 under the Securities Act) of the Participant.

(oo) “ Voting Securities ” of an entity means the outstanding equity securities (or comparable equity interests) entitled to vote generally in the election of directors of such entity.

3. Administration of the Plan .

(a) Administration . The authority to control and manage the operations and administration of the Plan shall be vested in the Committee in accordance with this Section 3.

(b) Scope of Authority . Subject to the terms of the Plan, the Committee shall have the exclusive authority, in its discretion, to take such actions as it deems necessary or advisable to administer the Plan, including:

(1) determining the Service Providers to whom Awards will be granted, the timing of each such Award, the types of Awards and the number of Shares covered by each Award, the terms, conditions, performance criteria, restrictions and other provisions of Awards, and the manner in which Awards are paid or settled;

(2) cancelling or suspending an Award, accelerating the vesting or extending the exercise period of an Award, or otherwise amending the terms and conditions of any outstanding Award, subject to the requirements of Sections 6(b), 15(d) and 15(e); and

(3) adopting sub-plans or special provisions applicable to Awards, establishing, amending or rescinding rules to administer the Plan, interpreting the Plan and any Award or Agreement, reconciling any inconsistency, correcting any defect or supplying an omission in the Plan or any Agreement, and making all other determinations necessary or desirable for the administration of the Plan; and

(4) granting Substitute Awards under the Plan.

Notwithstanding the foregoing, the Board shall perform the duties and have the responsibilities of the Committee with respect to Awards made to Non-Employee Directors.

(c) Acts of the Committee; Delegation . A majority of the members of the Committee shall constitute a quorum for any meeting of the Committee, and any act of a majority of the members present at any meeting at which a quorum is present or any act unanimously approved in writing by all members of the Committee shall be the act of the Committee. Any such action of the Committee shall be valid and effective even if one or more members of the Committee at the time of such action are later determined not to have satisfied all of the criteria for membership in clauses (i), (ii) and (iii) of Section 2(i). To the extent not inconsistent with applicable law or stock exchange rules, the Committee may delegate all or any portion of its authority under the Plan to any one or more of its members or, as to Awards to Participants who are not subject to Section 16 of the Exchange Act, to one or more directors or executive officers of the Company or to a committee of the Board comprised of one or more directors of the Company. The Committee may also delegate non-discretionary administrative responsibilities in connection with the Plan to such other persons as it deems advisable.

(d) Finality of Decisions . The Committee’s interpretation of the Plan and of any Award or Agreement made under the Plan and all related decisions or resolutions of the Board or Committee shall be final and binding on all parties with an interest therein.

(e) Indemnification . Each person who is or has been a member of the Committee or of the Board, and any other person to whom the Committee delegates authority under the Plan, shall be indemnified and held harmless by the Company, to the extent permitted by law, against and from (i) any loss, cost, liability or expense that may be imposed upon or reasonably incurred by such person in connection with or resulting from any claim, action, suit or proceeding to which such person may be a party or in which such person may be involved by reason of any action taken or failure to act, made in good faith, under the Plan and (ii) any and all amounts paid by such person in settlement thereof, with the Company’s approval, or paid by such person in satisfaction of any judgment in any such action, suit or proceeding against such person, provided such person shall give the Company an opportunity, at the Company’s expense, to handle and defend the same before such person undertakes to handle and defend it on such person’s own behalf. The foregoing right of indemnification shall not be exclusive of any other rights of indemnification to which such person or persons may be entitled under the Company’s Certificate of Incorporation or Bylaws, as a matter of law, or otherwise, or any power that the Company may have to indemnify them or hold them harmless.

4. Shares Available Under the Plan .

(a) Maximum Shares Available . Subject to Sections 4(b) and (c), and to adjustment as provided in Section 16, the number of Shares that may be the subject of Awards and issued under the Plan shall be 375,000, plus any Shares remaining available for future grants under the Prior Plan on the effective date of this Plan. No further awards may be made under the Prior Plan after the effective date of this Plan. All Shares authorized for grant under this Plan may be granted as Incentive Stock Options. Shares issued under the Plan may come from authorized and unissued shares or treasury shares. In determining the number of Shares to be counted against this share reserve in connection with any Award, the following rules shall apply:

(1) Shares that are subject to Awards of Options or Stock Appreciation Rights shall be counted against the share reserve as one Share for every one Share granted.

(2) Shares that are subject to Full Value Awards shall be counted against the share reserve as 1.5 Shares for every one Share granted.

(3) Where the number of Shares subject to an Award is variable on the Grant Date, the number of Shares to be counted against the share reserve shall be the maximum number of Shares that could be received under that particular Award, until such time as it can be determined that only a lesser number of shares could be received.

(4) Where two or more types of Awards are granted to a Participant in tandem with each other, such that the exercise of one type of Award with respect to a number of Shares cancels at least an equal number of Shares of the other, the number of Shares to be counted against the share reserve shall be the largest number of Shares that would be counted against the share reserve under either of the Awards.

(5) Shares subject to Substitute Awards shall not be counted against the share reserve, nor shall they reduce the Shares authorized for grant to a Participant in any calendar year.

(6) Awards that may be settled solely in cash shall not be counted against the share reserve, nor shall they reduce the Shares authorized for grant to a Participant in any calendar year.

(b) Effect of Forfeitures and Other Actions . Any Shares subject to an Award, or to an award granted under the Prior Plan that is outstanding on the effective date of this Plan (a “Prior Plan Award”), that expires, is cancelled or forfeited or is settled for cash shall, to the extent of such cancellation, forfeiture, expiration or cash settlement, again become available for Awards under this Plan, and the share reserve under Section 4(a) shall be correspondingly replenished as provided in Section 4(c) below. The following Shares shall not, however, again become available for Awards or replenish the share reserve under Section 4(a): (i) Shares tendered (either actually or by attestation) by the Participant or withheld by the Company in payment of the exercise price of a stock option issued under this Plan or the Prior Plan, (ii) Shares tendered (either actually or by attestation) by the Participant or withheld by the Company to satisfy any tax withholding obligation with respect to an award under this Plan or the Prior Plan, (iii) Shares repurchased by the Company with proceeds received from the exercise of a stock option issued under this Plan or the Prior Plan, and (iv) Shares subject to a stock appreciation right award issued under this Plan or the Prior Plan that are not issued in connection with the stock settlement of that award upon its exercise.

(c) Counting Shares Again Available . Each Share that again becomes available for Awards as provided in Section 4(b) shall correspondingly increase the share reserve under Section 4(a), with such increase based on the same share ratio by which the applicable share reserve was decreased upon the grant of the applicable award.

(d) No Fractional Shares . Unless otherwise determined by the Committee, the number of Shares subject to an Award shall always be a whole number. No fractional Shares may be issued under the Plan, but the Committee may, in its discretion, adopt any rounding convention it deems suitable or pay cash in lieu of any fractional Share in settlement of an Award.

( e) Individual Option and SAR Limit . The aggregate number of Shares subject to Option and/or Stock Appreciation Right Awards granted during any calendar year to any one Participant other than a Non-Employee Director shall not exceed 100,000 Shares (subject to adjustment as provided in Section 16).

(f) Performance-Based Compensation Limit . With respect to Awards of Performance-Based Compensation, (i) the maximum number of Shares that may be the subject of Full Value Awards that are denominated in Shares or Share equivalents and that are granted to any Participant during any calendar year shall not exceed 100,000 Shares (subject to adjustment as provided in Section 16); and (ii) the maximum amount payable with respect to Full Value Awards that are denominated other than in Shares or Share equivalents and that are granted to any one Participant during any calendar year shall not exceed $750,000.

(g) Limits on Awards to Non-Employee Directors . The aggregate grant date fair value (as determined in accordance with generally accepted accounting principles applicable in the United States) of all Awards granted during any calendar year to any Non-Employee Director (excluding any Awards granted at the election of a Non-Employee Director in lieu of all or any portion of retainers or fees otherwise payable to Non-Employee Directors in cash) shall not exceed $100,000.

( h) Effect of Plans Operated by Acquired Companies . If a company acquired by the Company or any Subsidiary or with which the Company or any Subsidiary combines has shares available under a pre-existing plan approved by stockholders and not adopted in contemplation of such acquisition or combination, the shares available for grant pursuant to the terms of such pre-existing plan (as adjusted, to the extent appropriate, using the exchange ratio or other adjustment or valuation ratio or formula used in such acquisition or combination to determine the consideration payable to the holders of common stock of the entities party to such acquisition or combination) may be used for Awards under the Plan and shall supplement the Share reserve under Section 4(a). Awards using such available shares shall not be made after the date awards or grants could have been made under the terms of the pre-existing plan absent the acquisition or combination, and shall only be made to individuals who were not Employees or Non-Employee Directors prior to such acquisition or combination.

5. Eligibility . Participation in the Plan shall be limited to (i) Service Providers and (ii) any individual the Company desires to induce to become a Service Provider, so long as any such inducement grant is effective only upon such individual becoming a Service Provider. The granting of Awards is solely at the discretion of the Committee, except that Incentive Stock Options may only be granted to Employees.

6. General Terms of Awards .

(a) Award Agreement . Each Award shall be evidenced by an Agreement setting forth the amount of the Award together with such other terms and conditions applicable to the Award (and not inconsistent with the Plan) as determined by the Committee. An Award to a Participant may be made singly or in combination with any form of Award.

(b) Vesting and Term . Each Agreement shall set forth the period until the applicable Award is scheduled to expire (which shall not be more than ten years from the Grant Date), and, consistent with the requirements of this Section 6(b), the applicable vesting conditions and any applicable Performance Period. Awards that vest based solely on the satisfaction by the Participant of service-based vesting conditions shall be subject to a vesting period of not less than one year from the applicable Grant Date, and Awards whose grant or vesting is subject to the satisfaction of performance goals over a Performance Period shall be subject to a Performance Period of not less than one year. The foregoing minimum vesting and Performance Periods will not, however, apply in connection with: (i) a Change in Control, (ii) a termination of Service due to death or Disability, (iii) to a Substitute Award that does not reduce the vesting period of the award being replaced, (iv) Awards made in payment of or exchange for other compensation already earned and payable, and (v) Awards involving an aggregate number of Shares not in excess of 5% of the Plan’s share reserve specified in Section 4(a). For purposes of Awards to Non-Employee Directors, a vesting period will be deemed to be one year if runs from the date of one annual meeting of the Company’s stockholders to the date of the next annual meeting of the Company’s stockholders.

(c) Transferability . Except as provided in this Section 6(c), (i) during the lifetime of a Participant, only the Participant (or that Participant’s Successor) may exercise an Option or Stock Appreciation Right, or receive payment with respect to any other Award; and (ii) no Award may be sold, assigned, transferred, exchanged or encumbered, voluntarily or involuntarily, other than to a Successor in the event of a Participant’s death. Any attempted transfer in violation of this Section 6(c) shall be of no effect. The Committee may, however, provide in an Agreement or otherwise that an Award (other than an Incentive Stock Option) may be transferred or assigned pursuant to a divorce decree or a domestic relations order, and may be transferable, to the extent permitted by law, to a Transferee if the Participant does not receive any consideration for the transfer. Any Award held by a Transferee shall continue to be subject to the same terms and conditions that were applicable to that Award immediately before the transfer thereof to the Transferee. For purposes of any provision of the Plan relating to notice to a Participant or to acceleration or termination of an Award upon the death or termination of employment of a Participant, the references to “Participant” shall mean the original grantee of an Award and not any Transferee.

(d) Termination of Service . Unless otherwise provided in an Agreement or another then-effective written agreement between a Participant and the Company, and subject to Section 12 of this Plan, if a Participant’s Service with the Company and all of its Affiliates terminates, the following provisions shall apply (in all cases subject to the scheduled expiration of an Option or Stock Appreciation Right, as applicable):

(1) Upon termination of Service for Cause, all unexercised Option and SAR Awards and all unvested portions of any other outstanding Awards shall be immediately forfeited and terminated without consideration.

(2) Upon termination of Service for any other reason, all unvested and unexercisable portions of any outstanding Awards shall be immediately forfeited and terminated without consideration.

(3) Upon termination of Service for any reason other than Cause, death or Disability, the currently vested and exercisable portions of Options and SARs may be exercised within three months of the date of such termination. However, if a Participant thereafter dies during such three-month period, the vested and exercisable portions of the Option and SAR Awards may be exercised for a period of one year after the date of such termination

(4) Upon termination of Service due to death or Disability, the currently vested and exercisable portions of Option and SAR Awards may be exercised within one year of the date of such termination.

(e) Rights as Stockholder . No Participant, Successor, or Transferee shall have any rights as a stockholder with respect to any securities covered by an Award unless and until the date the Participant, Successor, or Transferee becomes the holder of record of the Shares, if any, to which the Award relates.

(f) Performance-Based Awards . Any Award may be granted as a performance-based Award if the Committee establishes one or more measures of corporate, business unit or individual performance which must be attained, and the Performance Period over which the specified performance is to be attained, as a condition to the grant, vesting, exercisability, lapse of restrictions and/or settlement in cash or Shares of such Award. In connection with any such Award, the Committee shall determine the extent to which performance goals have been attained and other applicable terms and conditions have been satisfied, and the degree to which the grant, vesting, exercisability, lapse of restrictions and/or settlement of such Award has been earned. Any performance-based Award that is intended by the Committee to qualify as Performance-Based Compensation shall additionally be subject to the requirements of Section 17 of this Plan. Except as provided in Section 17 with respect to Performance-Based Compensation, the Committee shall also have the authority to provide, in an Agreement or otherwise, for the modification of a Performance Period and/or adjustments or waivers of the achievement of performance goals under specified circumstances such as (i) the occurrence of events that are unusual in nature or infrequently occurring, such as a Change in Control, acquisitions, divestitures, restructuring activities, recapitalizations, or asset write-downs, (ii) a change in applicable tax laws or accounting principles, or (iii) the Participant’s death or Disability.

(g) Dividends and Dividend Equivalents . No dividends, dividend equivalents or distributions will be paid with respect to Shares subject to an Option or SAR Award. Any dividends or distributions payable with respect to Shares that are subject to the unvested portion of a Restricted Stock Award will be subject to the same restrictions and risk of forfeiture as the Shares to which such dividends or distributions relate. In its discretion, the Committee may provide in an Award Agreement for a Stock Unit Award or an Other Stock-Based Award that the Participant will be entitled to receive dividend equivalents, based on dividends actually declared and paid on outstanding Shares, on the units or other Share equivalents subject to the Stock Unit Award or Other Stock-Based Award, and such dividend equivalents will be subject to the same restrictions and risk of forfeiture as the units or other Share equivalents to which such dividend equivalents relate . The additional terms of any such dividend equivalents will be as set forth in the applicable Agreement, including the time and form of payment and whether such dividend equivalents will be credited with interest or deemed to be reinvested in additional units or Share equivalents. Any Shares issued or issuable during the term of this Plan as the result of the reinvestment of dividends or the deemed reinvestment of dividend equivalents in connection with an Award or a Prior Plan Award shall be counted against, and replenish upon any subsequent forfeiture, the Plan’s share reserve as provided in Section 4.

7. Restricted Stock Awards .

(a) Vesting and Consideration . Shares subject to a Restricted Stock Award shall be subject to vesting and the lapse of applicable restrictions based on such conditions or factors and occurring over such period of time as the Committee may determine in its discretion. The Committee may provide whether any consideration other than Services must be received by the Company or any Affiliate as a condition precedent to the grant of a Restricted Stock Award, and may correspondingly provide for Company reacquisition or repurchase rights if such additional consideration has been required and some or all of a Restricted Stock Award does not vest.

(b) Shares Subject to Restricted Stock Awards . Unvested Shares subject to a Restricted Stock Award shall be evidenced by a book-entry in the name of the Participant with the Company’s transfer agent or by one or more stock certificates issued in the name of the Participant. Any such stock certificate shall be deposited with the Company or its designee, together with an assignment separate from the certificate, in blank, signed by the Participant, and bear an appropriate legend referring to the restricted nature of the Restricted Stock evidenced thereby. Any book-entry shall be subject to comparable restrictions and corresponding stop transfer instructions. Upon the vesting of Shares of Restricted Stock, and the Company’s determination that any necessary conditions precedent to the release of vested Shares (such as satisfaction of tax withholding obligations and compliance with applicable legal requirements) have been satisfied, such vested Shares shall be made available to the Participant (or a Successor or a Transferee as the case may be) in such manner as may be prescribed or permitted by the Committee. Except as otherwise provided in the Plan or an applicable Agreement, a Participant with a Restricted Stock Award shall have all the rights of a shareholder, including the right to vote the Shares of Restricted Stock.

8. Stock Unit Awards .

(a) Vesting and Consideration . A Stock Unit Award shall be subject to vesting and the lapse of applicable restrictions based on such conditions or factors and occurring over such period of time as the Committee may determine in its discretion. If vesting of a Stock Unit Award is conditioned on the achievement of specified performance goals, the extent to which they are achieved over the specified performance period shall determine the number of Stock Units that will be earned and eligible to vest, which may be greater or less than the target number of Stock Units stated in the Agreement. The Committee may provide whether any consideration other than Services must be received by the Company or any Affiliate as a condition precedent to the settlement of a Stock Unit Award.

(b) Payment of Award . Following the vesting of a Stock Unit Award, and the Company’s determination that any necessary conditions precedent to the settlement of the Award (such as satisfaction of tax withholding obligations and compliance with applicable legal requirements) have been satisfied, settlement of the Award and payment to the Participant shall be made at such time or times in the form of cash, Shares (which may themselves be considered Restricted Stock under the Plan) or a combination of cash and Shares as determined by the Committee.

9. Stock Option Awards .

(a) Type and Exercise Price . The Agreement pursuant to which an Option Award is granted shall specify whether the Option is an Incentive Stock Option or a Non-Qualified Stock Option. The exercise price at which each Share subject to an Option Award may be purchased shall be determined by the Committee and set forth in the Agreement, and shall not be less than the Fair Market Value of a Share on the Grant Date, except in the case of Substitute Awards (to the extent consistent with Code Section 409A and, in the case of Incentive Stock Options, Code Section 424).

(b) Payment of Exercise Price . The purchase price of the Shares with respect to which an Option Award is exercised shall be payable in full at the time of exercise. The purchase price may be paid in cash or in such other manner as the Committee may permit, including by payment under a broker-assisted sale and remittance program, by withholding Shares otherwise issuable to the Participant upon exercise of the Option or by delivery to the Company of Shares (by actual delivery or attestation) already owned by the Participant (in each case, such Shares having a Fair Market Value as of the date the Option is exercised equal to the purchase price of the Shares being purchased).

(c) Exercisability and Expiration . Each Option Award shall be exercisable in whole or in part on the terms provided in the Agreement. No Option Award shall be exercisable more than seven years after its Grant Date. In no event shall any Option Award be exercisable at any time after its scheduled expiration. When an Option Award is no longer exercisable, it shall be deemed to have terminated.

(d) No Reload Options . Options will not be granted under the Plan in consideration for, and the grant of Options will not be conditioned on, the delivery of Shares to the Company in payment of the exercise price and/or tax withholding obligation under any other Option.

(e) Incentive Stock Options .

(1) An Option will constitute an Incentive Stock Option only if the Participant receiving the Option is an Employee, and only to the extent that (i) it is so designated in the applicable Agreement and (ii) the aggregate Fair Market Value (determined as of Option Grant Date) of the Shares with respect to which Incentive Stock Options held by the Participant first become exercisable in any calendar year (under the Plan and all other plans of the Company and its Affiliates) does not exceed $100,000 (or such other limit as may be required by the Code to qualify the Option as an Incentive Stock Option). To the extent an Option granted to a Participant exceeds this limit, the Option shall be treated as a Non-Qualified Stock Option.

(2) No Participant may receive an Incentive Stock Option under the Plan if, immediately after the grant of such Award, the Participant would own (after application of the rules contained in Code Section 424(d)) Shares possessing more than 10% of the total combined voting power of all classes of stock of the Company or an Affiliate, unless (i) the option price for that Incentive Stock Option is at least 110% of the Fair Market Value of the Shares subject to that Incentive Stock Option on the Grant Date and (ii) that Option will expire no later than five years after its Grant Date.

(3) For purposes of continued Service by a Participant who has been granted an Incentive Stock Option Award, no approved leave of absence may exceed three months unless reemployment upon expiration of such leave is provided by statute or contract. If reemployment is not so provided, then on the date six months following the first day of such leave, any Incentive Stock Option held by the Participant shall cease to be treated as an Incentive Stock Option and shall be treated for tax purposes as a Non-Qualified Stock Option.

(4) If an Incentive Stock Option Award is exercised after the expiration of the exercise periods that apply for purposes of Code Section 422, such Option shall thereafter be treated as a Non-Qualified Stock Option.

(5) The Agreement covering an Incentive Stock Option shall contain such other terms and provisions that the Committee determines necessary to qualify the Option as an Incentive Stock Option.

10. Stock Appreciation Right Awards .

(a) Nature of Award . An Award of Stock Appreciation Rights shall be subject to such terms and conditions as are determined by the Committee, and shall provide a Participant the right to receive upon exercise of the SAR Award all or a portion of the excess of (i) the Fair Market Value as of the date of exercise of the SAR Award of the number of Shares as to which the SAR Award is being exercised, over (ii) the aggregate exercise price for such number of Shares. The per Share exercise price for any SAR Award shall be determined by the Committee and set forth in the applicable Agreement, and shall not be less than the Fair Market Value of a Share on the Grant Date, except in the case of Substitute Awards (to the extent consistent with Code Section 409A).

(b) Exercise of SAR . Each SAR Award may be exercisable in whole or in part at the times, on the terms and in the manner provided in the Agreement; provided that no SAR Award shall be exercisable more than seven years after its Grant Date. No Stock Appreciation Right shall be exercisable at any time after its scheduled expiration. When a SAR Award is no longer exercisable, it shall be deemed to have terminated. Upon exercise of a SAR Award, payment to the Participant (or a Successor or Transferee) shall be made at such time or times as shall be provided in the Agreement in the form of cash, Shares or a combination of cash and Shares as determined by the Committee. The Agreement may provide for a limitation upon the amount or percentage of the total appreciation on which payment (whether in cash and/or Shares) may be made in the event of the exercise of a SAR Award.

11. Other Stock-Based Awards . The Committee may from time to time grant Shares and other Awards that are valued by reference to and/or payable in whole or in part in Shares under the Plan. The Committee shall determine the terms and conditions of such Awards, which shall be consistent with the terms and purposes of the Plan. The Committee may direct the Company to issue Shares subject to restrictive legends and/or stop transfer instructions that are consistent with the terms and conditions of the Award to which the Shares relate.

12. Change in Control .

( a) Corporate Transactions . Unless otherwise provided in an applicable Agreement or another written agreement between a Participant and the Company, the following provisions shall apply to outstanding Awards in the event of a Change in Control that involves a Corporate Transaction.

(1) Continuation, Assumption or Replacement of Awards . In the event of a Corporate Transaction, then the surviving or successor entity (or its Parent) may continue, assume or replace Awards outstanding as of the date of the Corporate Transaction (with such adjustments as may be required or permitted by Section 16), and such Awards or replacements therefor shall remain outstanding and be governed by their respective terms, subject to Section 12(a)(4) below. A surviving or successor entity may elect to continue, assume or replace only some Awards or portions of Awards. For purposes of this Section 12(a)(1), an Award shall be considered assumed or replaced if, in connection with the Corporate Transaction and in a manner consistent with Code Section 409A (and Code Section 424 if the Award is an ISO), either (i) the contractual obligations represented by the Award are expressly assumed by the surviving or successor entity (or its Parent) with appropriate adjustments to the number and type of securities subject to the Award and the exercise price thereof that preserves the intrinsic value of the Award existing at the time of the Corporate Transaction, or (ii) the Participant has received a comparable equity-based award that preserves the intrinsic value of the Award existing at the time of the Corporate Transaction and contains terms and conditions that are substantially similar to those of the Award.

(2) Acceleration . If and to the extent that outstanding Awards under the Plan are not continued, assumed or replaced in connection with a Corporate Transaction, then (i) all outstanding Option and SAR Awards shall become fully vested and exercisable for such period of time prior to the effective time of the Corporate Transaction as is deemed fair and equitable by the Committee, and shall terminate at the effective time of the Corporate Transaction, (ii) all outstanding Full Value Awards shall fully vest immediately prior to the effective time of the Corporate Transaction, and (iii) to the extent vesting of any Award is subject to satisfaction of specified performance goals, such Award shall be deemed “fully vested” for purposes of this Section 12(a)(2) if the performance goals are deemed to have been satisfied at the target level of performance and the vested portion of the Award at that level of performance is proportionate to the portion of the performance period that has elapsed as of the effective time of the Corporate Transaction. The Committee shall provide written notice of the period of accelerated exercisability of Option and SAR Awards to all affected Participants. The exercise of any Option or SAR Award whose exercisability is accelerated as provided in this Section 12(a)(2) shall be conditioned upon the consummation of the Corporate Transaction and shall be effective only immediately before such consummation.

(3) Payment for Awards . If and to the extent that outstanding Awards under the Plan are not continued, assumed or replaced in connection with a Corporate Transaction, then the Committee may provide that some or all of such outstanding Awards shall be canceled at or immediately prior to the effective time of the Corporate Transaction in exchange for payments to the holders as provided in this Section 12(a)(3). The Committee will not be required to treat all Awards similarly for purposes of this Section 12(a)(3). The payment for any Award canceled shall be in an amount equal to the difference, if any, between (i) the fair market value (as determined in good faith by the Committee) of the consideration that would otherwise be received in the Corporate Transaction for the number of Shares subject to the Award, and (ii) the aggregate exercise price (if any) for the Shares subject to such Award. If the amount determined pursuant to the preceding sentence is not a positive number with respect to any Award, such Award may be canceled pursuant to this Section 12(a)(3) without payment of any kind to the affected Participant. With respect to an Award whose vesting is subject to the satisfaction of specified performance goals, the number of Shares subject to such an Award for purposes of this Section 12(a)(3) shall be the number of Shares as to which the Award would have been deemed “fully vested” for purposes of Section 12(a)(2). Payment of any amount under this Section 12(a)(3) shall be made in such form, on such terms and subject to such conditions as the Committee determines in its discretion, which may or may not be the same as the form, terms and conditions applicable to payments to the Company’s stockholders in connection with the Corporate Transaction, and may, in the Committee’s discretion, include subjecting such payments to vesting conditions comparable to those of the Award canceled, subjecting such payments to escrow or holdback terms comparable to those imposed upon the Company’s stockholders under the Corporate Transaction, or calculating and paying the present value of payments that would otherwise be subject to escrow or holdback terms.

(4) Termination After a Corporate Transaction . If and to the extent that Awards are continued, assumed or replaced under the circumstances described in Section 12(a)(1), and if within two years after the Corporate Transaction a Participant experiences an involuntary termination of Service for reasons other than Cause, then (i) outstanding Option and SAR Awards issued to the Participant that are not yet fully exercisable shall immediately become exercisable in full and shall remain exercisable for one year following the Participant’s termination of employment, and (ii) any Full Value Awards that are not yet fully vested shall immediately vest in full (with vesting in full for a performance-based award determined as provided in Section 12(a)(2), except that the proportionate vesting amount will be determined with respect to the portion of the performance period during which the Participant was a Service Provider).

( b) Other Change in Control . If within two years after a Change in Control described in Section 2(g)(1) or 2(g)(2), a Participant experiences an involuntary termination of Service for reasons other than Cause, then outstanding Awards issued to the Participant shall be subject to accelerated vesting and exercisability in the same manner and to the same degree as provided in Section 12(a)(4). In addition to the foregoing, the Committee may, in its discretion in connection with any Change in Control that is not a Corporate Transaction, take such other action as it deems appropriate with respect to outstanding Awards, which may include: (i) providing for the cancellation of any Award in exchange for payments in a manner similar to that provided in Section 12(a)(3) or (ii) making such adjustments or modifications to the Awards then outstanding as the Committee deems appropriate to reflect such Change in Control. The Committee will not be required to treat all Awards similarly in such circumstances, and may include such further provisions and limitations in any Award Agreement as it may deem equitable and in the best interests of the Company.

13. Plan Participation and Service Provider Status . Status as a Service Provider shall not be construed as a commitment that any Award will be made under the Plan to that Service Provider or to eligible Service Providers generally. Nothing in the Plan or in any Agreement or related documents shall confer upon any Service Provider or Participant any right to continuous Service with the Company or any Affiliate, nor shall it interfere with or limit in any way any right of the Company or any Affiliate to terminate the person’s Service at any time with or without Cause or change such person’s compensation, other benefits, job responsibilities or title.

14. Tax Withholding . The Company or any Affiliate, as applicable, shall have the right to (i) withhold from any cash payment under the Plan or any other compensation owed to a Participant an amount sufficient to cover any required withholding taxes related to the grant, vesting, exercise or settlement of an Award, and (ii) require a Participant or other person receiving Shares under the Plan to pay a cash amount sufficient to cover any required withholding taxes before actual receipt of those Shares. In lieu of all or any part of a cash payment from a person receiving Shares under the Plan, a Participant may elect to satisfy all or any part of the required tax withholding obligations (but not to exceed the maximum individual statutory tax rate in each applicable jurisdiction) by authorizing the Company to withhold a number of the Shares that would otherwise be delivered to the Participant pursuant to the Award, or by transferring to the Company Shares already owned by the Participant, with the Shares so withheld or delivered having a Fair Market Value on the date the taxes are required to be withheld equal to the amount of taxes to be withheld.

15. Effective Date, Duration, Amendment and Termination of the Plan .

(a) Effective Date . The Plan shall become effective on the date it is approved by the Company’s shareholders, which shall be considered the date of its adoption for purposes of Treasury Regulation §1.422-2(b)(2)(i). No Awards shall be made under the Plan prior to its effective date.

(b) Duration of the Plan . The Plan shall remain in effect until all Shares subject to it shall be distributed, all Awards have expired or terminated, the Plan is terminated pursuant to Section 15(c), or the tenth anniversary of the date of stockholder approval of the Plan, whichever occurs first (the “ Termination Date ”). Awards made before the Termination Date shall continue to be outstanding in accordance with their terms and the terms of the Plan unless otherwise provided in the applicable Agreements.

(c) Amendment and Termination of the Plan . The Board may at any time terminate, suspend or amend the Plan. The Company shall submit any amendment of the Plan to its shareholders for approval only to the extent required by applicable laws or regulations or the rules of any securities exchange on which the Shares may then be listed. No termination, suspension, or amendment of the Plan may materially impair the rights of any Participant under a previously granted Award without the Participant's consent, unless such action is necessary to comply with applicable law or stock exchange rules.

(d) Amendment of Awards . Subject to Section 15(e), the Committee may unilaterally amend the terms of any Agreement evidencing an Award previously granted, except that no such amendment may materially impair the rights of any Participant under the applicable Award without the Participant's consent, unless such amendment is necessary to comply with applicable law or stock exchange rules or any compensation recovery policy as provided in Section 18(i).

(e) No Option or SAR Repricing . Except as provided in Section 16, no Option or Stock Appreciation Right Award granted under the Plan may be (i) amended to decrease the exercise price thereof, (ii) cancelled in conjunction with the grant of any new Option or Stock Appreciation Right Award with a lower exercise price, (iii) cancelled in exchange for cash, other property or the grant of any Full Value Award at a time when the per share exercise price of the Option or Stock Appreciation Right Award is greater than the current Fair Market Value of a Share, or (iv) otherwise subject to any action that would be treated under accounting rules as a “repricing” of such Option or Stock Appreciation Right Award, unless such action is first approved by the Company’s shareholders.

16. Adjustment for Changes in Capitalization . In the event of any equity restructuring (within the meaning of FASB ASC Topic 718) that causes the per share value of Shares to change, such as a stock dividend, stock split, spinoff, rights offering or recapitalization through an extraordinary dividend, the Committee shall make such adjustments as it deems equitable and appropriate to (i) the aggregate number and kind of Shares or other securities issued or reserved for issuance under the Plan, (ii) the number and kind of Shares or other securities subject to outstanding Awards, (iii) the exercise price of outstanding Options and SARs, and (iv) any maximum limitations prescribed by the Plan with respect to certain types of Awards or the grants to individuals of certain types of Awards. In the event of any other change in corporate capitalization, including a merger, consolidation, reorganization, or partial or complete liquidation of the Company, such equitable adjustments described in the foregoing sentence may be made as determined to be appropriate and equitable by the Committee to prevent dilution or enlargement of rights of Participants. In either case, any such adjustment shall be conclusive and binding for all purposes of the Plan. No adjustment shall be made pursuant to this Section 16 in connection with the conversion of any convertible securities of the Company, or in a manner that would cause Incentive Stock Options to violate Section 422(b) of the Code or cause an Award to be subject to adverse tax consequences under Section 409A of the Code .

17. Performance-Based Compensation .

(a) Designation of Awards . If the Committee determines at the time a Full Value Award is granted to a Participant who is then an executive officer of the Company that such Participant is, or is likely to be, a “covered employee” for purposes of Code Section 162(m) as of the end of the tax year in which the Company would ordinarily claim a tax deduction in connection with such Award, then the Committee may provide that this Section 17 will be applicable to such Award, which shall be considered Performance-Based Compensation.

(b) Compliance with Code Section 162(m) . If an Award is subject to this Section 17, then the grant of the Award, the vesting and lapse of restrictions thereon and/or the distribution of cash, Shares or other property pursuant thereto, as applicable, shall be subject to the achievement over the applicable performance period of one or more performance goals based on one or more of the Performance Measures specified in Section 2(bb). The Committee will select the applicable Performance Measure(s) and specify the performance goal(s) based on those Performance Measures for any Performance Period, specify in terms of an objective formula or standard the method for calculating the amount payable to a Participant if the performance goal(s) are satisfied, and certify the degree to which applicable performance goals have been satisfied and any amount that vests and is payable in connection with an Award subject to this Section 17, all within the time periods prescribed by and consistent with the other requirements of Code Section 162(m). In specifying the performance goals applicable to any Performance Period, the Committee may provide that one or more objectively determinable adjustments shall be made to the performance measures on which the performance goals are based, which may include adjustments that would cause such measures to be considered “non-GAAP financial measures” within the meaning of Rule 101 under Regulation G promulgated by the Securities and Exchange Commission, including adjustments for events that are unusual in nature or infrequently occurring, such as a Change in Control, acquisitions, divestitures, restructuring activities or asset write-downs, or for changes in applicable tax laws or accounting principles. The Committee may also adjust performance measures for a performance period to the extent permitted by Code Section 162(m) in connection with an event described in Section 16 to prevent the dilution or enlargement of a Participant’s rights with respect to Performance-Based Compensation. The Committee may adjust downward, but not upward, any amount determined to be otherwise payable in connection with an Award subject to this Section 17. The Committee may also provide, in an Agreement or otherwise, that the achievement of specified performance goals in connection with an Award subject to this Section 17 may be waived upon the death or Disability of the Participant or under any other circumstance with respect to which the existence of such possible waiver will not cause the Award to fail to qualify as “performance-based compensation” under Code Section 162(m).

18. Other Provisions .

(a) Unfunded Plan . The Plan shall be unfunded and the Company shall not be required to segregate any assets that may at any time be represented by Awards under the Plan. Neither the Company, its Affiliates, the Committee, nor the Board shall be deemed to be a trustee of any amounts to be paid under the Plan nor shall anything contained in the Plan or any action taken pursuant to its provisions create or be construed to create a fiduciary relationship between the Company and/or its Affiliates, and a Participant or Successor or Transferee. To the extent any person has or acquires a right to receive a payment in connection with an Award under the Plan, this right shall be no greater than the right of an unsecured general creditor of the Company.

(b) Limits of Liability . Any liability of the Company to any Participant or Successor or Transferee with respect to an Award shall be based solely upon contractual obligations created by the Plan and the Award Agreement. Except as may be required by law, neither the Company nor any member of the Board or of the Committee, nor any other person participating (including participation pursuant to a delegation of authority under Section 3(c) of the Plan) in any determination of any question under the Plan, or in the interpretation, administration or application of the Plan, shall have any liability to any party for any action taken, or not taken, in good faith under the Plan.

(c) Compliance with Applicable Legal Requirements and Company Policies . No Shares distributable pursuant to the Plan shall be issued and delivered unless and until the issuance of the Shares complies with all applicable legal requirements, including compliance with the provisions of applicable state and federal securities laws, and the requirements of any securities exchanges on which the Company’s Shares may, at the time, be listed. During any period in which the offering and issuance of Shares under the Plan is not registered under federal or state securities laws, Participants shall acknowledge that they are acquiring Shares under the Plan for investment purposes and not for resale, and that Shares may not be transferred except pursuant to an effective registration statement under, or an exemption from the registration requirements of, such securities laws. Any stock certificate or book-entry evidencing Shares issued under the Plan that are subject to securities law restrictions shall bear or be accompanied by an appropriate restrictive legend or stop transfer instruction. Notwithstanding any other provision of this Plan, the acquisition, holding or disposition of Shares acquired pursuant to the Plan shall in all events be subject to compliance with applicable Company policies, including those relating to insider trading, pledging or hedging transactions, minimum post-vesting holding periods and stock ownership guidelines, and to forfeiture or recovery of compensation as provided in Section 18(i).

(d) Other Benefit and Compensation Programs . Payments and other benefits received by a Participant under an Award made pursuant to the Plan shall not be deemed a part of a Participant’s regular, recurring compensation for purposes of the termination, indemnity or severance pay laws of any country and shall not be included in, nor have any effect on, the determination of benefits under any other employee benefit plan, contract or similar arrangement provided by the Company or an Affiliate unless expressly so provided by such other plan, contract or arrangement, or unless the Committee expressly determines that an Award or portion of an Award should be included to accurately reflect competitive compensation practices or to recognize that an Award has been made in lieu of a portion of competitive cash compensation.

(e) Governing Law . To the extent that federal laws do not otherwise control, the Plan and all determinations made and actions taken pursuant to the Plan shall be governed by the laws of the State of Delaware without regard to its conflicts-of-law principles and shall be construed accordingly.

(f) Severability . If any provision of the Plan shall be held illegal or invalid for any reason, the illegality or invalidity shall not affect the remaining parts of the Plan, and the Plan shall be construed and enforced as if the illegal or invalid provision had not been included.

(g) Code Section 409A . It is intended that (i) all Awards of Options, SARs and Restricted Stock under the Plan will not provide for the deferral of compensation within the meaning of Code Section 409A and thereby be exempt from Code Section 409A, and (ii) all other Awards under the Plan will either not provide for the deferral of compensation within the meaning of Code Section 409A, or will comply with the requirements of Code Section 409A, and Awards shall be structured and the Plan administered and interpreted in accordance with this intent. The Plan and any Agreement may be unilaterally amended by the Company in any manner deemed necessary or advisable by the Committee or Board in order to maintain such exemption from or compliance with Code Section 409A, and any such amendment shall conclusively be presumed to be necessary to comply with applicable law. Notwithstanding anything to the contrary in the Plan or any Agreement, with respect to any Award that constitutes a deferral of compensation subject to Code Section 409A:

(1) If any amount is payable under such Award upon a termination of Service, a termination of Service will be deemed to have occurred only at such time as the Participant has experienced a “separation from service” as such term is defined for purposes of Code Section 409A;

(2) If any amount shall be payable with respect to any such Award as a result of a Participant’s “separation from service” at such time as the Participant is a “specified employee” within the meaning of Code Section 409A, then no payment shall be made, except as permitted under Code Section 409A, prior to the first business day after the earlier of (i) the date that is six months after the Participant’s separation from service or (ii) the Participant’s death. Unless the Committee has adopted a specified employee identification policy as contemplated by Code Section 409A, specified employees will be identified in accordance with the default provisions specified under Code Section 409A.

None of the Company, the Board, the Committee nor any other person involved with the administration of this Plan shall (i) in any way be responsible for ensuring the exemption of any Award from, or compliance by any Award with, the requirements of Code Section 409A, (ii) have any obligation to design or administer the Plan or Awards granted thereunder in a manner that minimizes a Participant ’s tax liabilities, including the avoidance of any additional tax liabilities under Code Section 409A, and (iii) shall have any liability to any Participant for any such tax liabilities.

(h) Rule 16b-3 . It is intended that the Plan and all Awards granted pursuant to it shall be administered by the Committee so as to permit the Plan and Awards to comply with Exchange Act Rule 16b-3. If any provision of the Plan or of any Award would otherwise frustrate or conflict with the intent expressed in this Section 18(h), that provision to the extent possible shall be interpreted and deemed amended in the manner determined by the Committee so as to avoid the conflict. To the extent of any remaining irreconcilable conflict with this intent, the provision shall be deemed void as applied to Participants subject to Section 16 of the Exchange Act to the extent permitted by law and in the manner deemed advisable by the Committee.

(i) Forfeiture and Compensation Recovery .

(1) The Committee may specify in an Agreement that the Participant’s rights, payments, and benefits with respect to an Award will be subject to reduction, cancellation, forfeiture or recovery by the Company upon the occurrence of certain specified events, in addition to any otherwise applicable vesting or performance conditions of an Award. Such events may include termination of Service for Cause; violation of any material Company or Affiliate policy; breach of noncompetition, non-solicitation or confidentiality provisions that apply to the Participant; a determination that the payment of the Award was based on an incorrect determination that financial or other criteria were met or other conduct by the Participant that is detrimental to the business or reputation of the Company or its Affiliates.

(2) Awards and any compensation associated therewith may be made subject to forfeiture, recovery by the Company or other action pursuant to any compensation recovery policy adopted by the Board or the Committee at any time, including in response to the requirements of Section 10D of the Exchange Act and any implementing rules and regulations thereunder, or as otherwise required by law. Any Agreement may be unilaterally amended by the Committee to comply with any such compensation recovery policy.

Exhibit 10.2

HMN FINANCIAL, INC.

2017 EQUITY INCENTIVE PLAN

RESTRICTED STOCK AGREEMENT

(Non-Employee Directors)

HMN Financial, Inc. (the “Company”), pursuant to its 2017 Equity Incentive Plan (the “Plan”), hereby grants to you, the Participant named below, an award of shares of the Company’s common stock whose vesting is subject the satisfaction of service-based conditions (the “Restricted Shares”). The terms and conditions of this Restricted Stock Award are set forth in this Restricted Stock Agreement (the “Agreement”), consisting of this cover page and the Terms and Conditions on the following pages, and in the Plan document, a copy of which has been provided to you. Any capitalized term used but not defined in this Agreement will be defined as provided in the Plan, as it currently exists or as it may be amended.

Full Name of Participant:
Number of Restricted Shares Granted:	Grant Date:
Vesting Date: [Date of next annual stockholders meeting]

By signing below or otherwise evidencing your acceptance of this Agreement in a manner approved by the Company, you agree to all of the terms and conditions contained in this Agreement and in the Plan document. You acknowledge that you have reviewed these documents and that they set forth the entire agreement between you and the Company regarding your rights and obligations in connection with this Restricted Stock Award.

PARTICIPANT:		HMN FINANCIAL, INC.


		By:
[Name]		Title:

HMN Financial, Inc.

2017 Equity Incentive Plan

Restricted Stock Agreement

Terms and Conditions

Grant of Restricted Shares . The Company hereby grants to you, as of the Grant Date specified on the cover page of this Agreement and subject to the terms and conditions in this Agreement and the Plan, an Award of the number of Restricted Shares specified on the cover page of this Agreement. Unless and until these Restricted Shares vest as provided in Section 4 below, they are subject to the restrictions specified in Section 3 of this Agreement.

Delivery of Restricted Shares . As soon as practicable after the Grant Date, the Company will cause its transfer agent to either maintain a book entry account in your name reflecting the issuance of the Restricted Shares, or issue one or more stock certificates in your name evidencing the Restricted Shares. Any such stock certificate will be deposited with the Company or its designee, and bear an appropriate legend referring to the restricted nature of the Restricted Stock evidenced thereby. Any book-entry that reflects the issuance of such Restricted Shares will be subject to stop transfer instructions as provided in Sections 7(b) and 7(c). Your right to receive this Restricted Stock Award is conditioned upon your execution and delivery to the Company of any instruments of assignment that may be necessary to permit transfer to the Company of all or a portion of the Restricted Shares if such Restricted Shares are forfeited in whole or in part.

3 . Applicable Restrictions .

(a) Beginning on the Grant Date, you shall have all rights and privileges of a stockholder of the Company with respect to the Restricted Shares except as follows:

(i)

Dividends and other distributions declared and paid with respect to the Restricted Shares before they vest shall be subject to Section 3(c).

(ii)

None of the Restricted Shares may be sold, transferred, assigned, pledged or otherwise encumbered, subjected to a levy or attachment or disposed of before they have become Vested Shares (as defined in Section 4(a)) other than a transfer upon your death in accordance with your will, by the laws of descent and distribution or, if and to the extent permitted under the Plan, pursuant to a beneficiary designation submitted to the Company. In addition, for so long as your Service as a Non-Employee Director continues after such time as the Restricted Shares have become Vested Shares, such Vested Shares shall remain subject to the foregoing transfer restrictions. Such transfer restrictions shall cease to apply to Vested Shares if your Service with the Company terminates due to death or Disability, or if a Change in Control occurs. To the extent such transfer restrictions do apply to Vested Shares, such restrictions will lapse as to one-third of the Vested Shares on the date your Service as a Non-Employee Director ends, and on each of the two succeeding anniversaries of such date.

-2-

(iii)

All or a portion of the Restricted Shares may be forfeited under the circumstances specified in Section 6.

(b) Any attempt to transfer or dispose of any Restricted Shares in a manner contrary to the transfer restrictions shall be void and of no effect.

(c) Any dividends or distributions, including regular cash dividends, payable or distributable with respect to or in exchange for outstanding but unvested Restricted Shares, including any shares of Company common stock or other property or securities distributable as the result of any equity restructuring or other change in corporate capitalization described in Section 16 of the Plan, shall be delivered to, retained and held by the Company subject to the same restrictions, vesting conditions and other terms of this Agreement to which the underlying unvested Restricted Shares are subject. At the time the underlying Restricted Shares vest, the Company shall deliver to you (without interest) the portion of such retained dividends and distributions that relate to the Restricted Shares that have vested. You agree to execute and deliver to the Company any instruments of assignment that may be necessary to permit transfer to the Company of all or any portion of any dividends or distributions subject to this Section 3(c) that may be forfeited.

4 .	Vesting of Restricted Shares .

(a)

Scheduled Vesting. So long as your Service continues, the Restricted Shares will cease to be subject to possible forfeiture on the Vesting Date specified in the table at the beginning of this Agreement, or at such earlier time as may be specified in subsections (b) and (c) of this Section 4. Restricted Shares that have so ceased to be subject to forfeiture restrictions are sometimes referred to as “vested” or as “Vested Shares” in this Agreement.

( b )

Death or Disability . If your Service with the Company terminates because of death or Disability prior to the Vesting Date of this Award, all Restricted Shares subject to this Award will vest and become Vested Shares, and shall no longer be subject to the transfer restrictions set forth in Subsection 3(a)(ii), as of the date of your termination of Service.

(c)

Change in Control. If a Change in Control occurs prior to the Vesting Date of this Award and while your Service continues, all Restricted Shares subject to this Award will vest and become Vested Shares, and shall no longer be subject to the transfer restrictions set forth in Subsection 3(a)(ii), as of the date of the Change in Control.

5 .

Release of Vested Shares . Following the vesting of Restricted Shares and the corresponding lapse of the transfer restrictions as to those Vested Shares, and after the Company has determined that all conditions to the release of Vested Shares to you, including compliance with all applicable legal requirements, have been satisfied, it shall release to you such Vested Shares, as evidenced by issuance to you of a stock certificate without restrictive legend, by electronic delivery of such Shares to a brokerage account designated by you, or by an unrestricted book-entry registration of such Shares with the Company’s transfer agent.

-3-

Forfeiture of Restricted Shares . Subject to Sections 4(b) and 4(c), if your Service with the Company terminates before all of the Restricted Shares have vested, or if you attempt to transfer Restricted Shares in a manner contrary to the transfer restrictions, you will immediately forfeit all unvested Restricted Shares. Any Restricted Shares that are forfeited shall be returned to the Company for cancellation.

7 .	Restrictive Legends and Stop-Transfer Orders .

(a) Legends. Any certificate or certificates representing the Restricted Shares will bear the following legend (as well as any legends required by applicable state and federal corporate and securities laws) noting the existence of the restrictions set forth in this Agreement:

“THE SHARES REPRESENTED BY THIS CERTIFICATE MAY BE TRANSFERRED ONLY IN ACCORDANCE WITH THE TERMS OF A RESTRICTED STOCK AGREEMENT BETWEEN THE COMPANY AND THE PARTICIPANT, A COPY OF WHICH IS ON FILE WITH THE SECRETARY OF THE COMPANY.”

(b) Stop-Transfer Notices. You agree that, in order to ensure compliance with the restrictions referred to herein, the Company may issue appropriate “stop transfer” instructions to its transfer agent, if any, and that, if the Company transfers its own securities, it may make appropriate notations to the same effect in its own records.

(c) Refusal to Transfer. The Company will not be required (i) to transfer on its books any Shares subject to this Agreement that have been sold or otherwise transferred in violation of any of the provisions of this Agreement or (ii) to treat as owner of such Shares or to accord the right to vote or pay dividends to any purchaser or other transferee to whom the such Shares will have been so transferred.

8 .

No Right to Continued Service or Future Awards . This Agreement awards Restricted Stock to you, but does not impose any obligation on the Company to make any future grants or issue any future awards to you or otherwise continue your participation under the Plan. This Agreement will not give you a right to continued Service with the Company or any Affiliate, and the Company may terminate your Service and otherwise deal with you without regard to the effect it may have upon you under this Agreement

9 .

Tax Consequences . You understand that unless a proper and timely election under Section 83(b) of the Code has been made, at the time the Restricted Shares vest, you will be obligated to recognize ordinary income and be taxed in an amount equal to the Fair Market Value as of the date of vesting of the Restricted Shares then vesting. You shall be solely responsible for any tax obligations that may arise as a result of this Award. You understand that you may choose to file, within 30 days of the Grant Date, an election with the Internal Revenue Service electing pursuant to Section 83(b) to be taxed on the Fair Market Value of the Restricted Shares on the Grant Date. You acknowledge that it is your sole responsibility to timely file such an election, and that if such an election is made, you shall promptly provide the Company a copy.

-4-

10 .

Interpretation of This Agreement . All decisions and interpretations made by the Board with regard to any question arising hereunder or under the Plan will be binding and conclusive upon the Company and you. If there is any inconsistency between the provisions of this Agreement and the Plan, the provisions of the Plan will govern.

11 .	Binding Effect . This Agreement will be binding in all respects on your heirs, representatives, Successors and assigns, and any successor or assignee of the Company.

12 .	Choice of Law . This Agreement is entered into under the laws of the State of Delaware and will be construed and interpreted thereunder (without regard to its conflict-of-law principles).

1 3 .

Entire Agreement . This Agreement and the Plan set forth the entire agreement and understanding of the parties hereto with respect to the issuance and delivery of the Restricted Shares and the administration of the Plan and supersede all prior agreements, arrangements, plans, and understandings relating to the issuance and delivery of these Restricted Shares and the administration of the Plan.

1 4 .

Amendment and Waiver . Except as provided in the Plan, this Agreement may be amended, waived, modified, or canceled only by a written instrument executed by the parties or, in the case of a waiver, by the party waiving compliance.

1 5 .

Participant’s Rights Limited . You acknowledge that the Company and its Affiliates are subject to the supervisory authority of the Office of the Comptroller of the Currency (the “OCC”) as well as additional or successor financial regulators. Accordingly, the Company and its Affiliates may be bound by, and are subject to compliance with, any applicable order, rule or regulation of, memorandum of understanding with, or directive or consent, approval or no objection requirement of, the OCC or other supervisory authority or financial regulator.

-5-

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: May 5, 2017	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: May 5, 2017	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 March 31, 2017 as filed with the Securities and Exchange Commission on the date hereof (the "Report"), we, Bradley Krehbiel, President and Chief Executive Officer of 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: May 5, 2017		/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)