HMN FINANCIAL INC (Form: 10-K, Received: 03/09/2018 15:41:44)

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UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

Form 10-K

[x]

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

For the fiscal year ended December 31, 20 17

[ ]

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 Northwest	55901
Rochester , Minnesota	(Zip Code)
(Address of principal executive offices)

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

Securities registered pursuant to Section 12(b) of the Act:

Title of each class		Name of each exchange on which registered
Common Stock, par value $.01 per share		N asdaq Global Market

Securities registered pursuant to section 12(g) of the Act:

None

(Title of class)

Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act.

YES [ ] NO [ X ]

Indicate by check mark if the registrant is not required to file report s pursuant to Section 13 or Section 15(d) of the Exchange Act.

YES [ ] NO [ X ]

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 requirements for the past 90 days.

YES [ X ] 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 (§229.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).

YES [ X ] NO [ ]

Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K (§232.405 of this chapter) is not contained herein, and will not be contained, to the best of registrant’s knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K. [ X ]

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, a smaller reporting company, or 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 [ X ]
(Do not check if a smaller reporting company)	Emerging growth company [ ]

If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act. [ ]

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

YES [ ] NO [ X ]

As of June 30 , 2017, the aggregate market value of the registrant’s common stock held by non-affiliates of the registrant was $61.9 million based on the closing stock price of $17.55 on such date as reported on the Nasdaq Global Market.

As of February 19, 2018, the number of outstanding shares of common stock of the registrant was 4,504,234.

DOCUMENTS INCORPORATED BY REFERENCE

Portions of the registrant’s annual report to stockholders for the year ended December 31, 2017 (Annual Report), are incorporated by reference in Parts I and II of this Form 10-K. Portions of the registrant’s definitive proxy statement to be filed with the Securities and Exchange Commission pursuant to Regulation 14A not later than 120 days after the close of the registrant’s fiscal year ended December 31, 2017 are incorporated by reference in Part III of this Form 10- K.

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TABLE OF CONTENTS

		Page
PART I

Item 1.	Business	5
Item 1A.	Risk Factors	30
Item 1B.	Unresolved Staff Comments	39
Item 2.	Properties	40
Item 3.	Legal Proceedings	40
Item 4.	Mine Safety Disclosures	40

PART II

Item 5.	Market for Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities	40
Item 6.	Selected Financial Data	40
Item 7.	Management’s Discussion and Analysis of Financial Condition and Results of Operations	40
Item 7A.	Quantitative and Qualitative Disclosures About Market Risk	40
Item 8.	Financial Statements and Supplementary Data	41
Item 9.	Changes in and Disagreements With Accountants on Accounting and Financial Disclosure	41
Item 9A.	Controls and Procedures	41
Item 9B.	Other Information	42

PART III

Item 10.	Directors, Executive Officers and Corporate Governance	42
Item 11.	Executive Compensation	42
Item 12.	Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters	43
Item 13.	Certain Relationships and Related Transactions, and Director Independence	42
Item 14.	Principal Accounting Fees and Services	42

PART IV

Item 15.	Exhibits, Financial Statement Schedules	43
Item 16.	Form 10-K Summary	43
Index to Exhibits		44
Signatures		47

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Forward-Looking Statements

The information presented or incorporated by reference in this Form 10-K contains forward-looking statements within the meaning of Section 21E of the Securities Exchange Act of 1934 (the Exchange Act). These statements are often identified by such forward-looking terminology as “expect,” “intend,” “look,” “believe,” “anticipate,” “estimate,” “project,” “seek,” “may,” “will,” “would,” “could,” “should,” “trend,” “target,” and “goal” or similar statements or variations of such terms and include, but are not limited to, those relating to growing our core deposit relationships and loan balances, enhancing the financial performance of our core banking operations, maintaining credit quality, reducing non-performing assets, and generating improved financial results (including profitability); the extent of the positive impact of the lower federal tax rate on future earnings; 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; anticipated future levels of the provision for loan losses; future losses on non-performing assets; the amount and composition of interest-earning assets; the amount of yield enhancements relating to non-accruing and purchased loans; the amount and composition of non-interest and interest-bearing liabilities; the availability of alternate funding sources; the payment of dividends by HMN; the future outlook for the Company; the amount of deposits that will be withdrawn from checking and money market accounts and how the withdrawn deposits will be replaced; the projected changes in net interest income based on rate shocks; the range that interest rates may fluctuate over the next twelve months; the net market risk of interest rate shocks; the future outlook for the issuer of the trust preferred securities held by the Bank; the ability of the Bank to pay dividends to HMN; the ability to remain well capitalized; the impact of new accounting pronouncements, and compliance by the Bank with regulatory standards generally (including the Bank’s status as “well-capitalized”) and other supervisory directives or requirements to which the Company or the Bank are or may become expressly subject, specifically, and possible responses of the Office of the Comptroller of the Currency (OCC), Board of Governors of the Federal Reserve System (FRB), the Bank, and the Company to any failure to comply with any such regulatory standard, directive or requirement.

A number of factors could cause actual results to differ materially from the Company ’s assumptions and expectations. These include but are not limited to the adequacy and marketability of real estate and other collateral securing loans to borrowers; federal and state regulation and enforcement; possible legislative and regulatory changes, including additional changes to regulatory capital rules; the ability of the Bank to comply with other applicable regulatory capital requirements; enforcement activity of the OCC and FRB in the event of our non-compliance with any applicable regulatory standard or requirement; adverse economic, business and competitive developments such as shrinking interest margins, reduced collateral values, deposit outflows, changes in credit or other risks posed by the Company’s loan and investment portfolios; changes in costs associated with alternate funding sources, including changes in collateral advance rates and policies of the Federal Home Loan Bank (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; our ability to attract and retain employees; or other significant uncertainties. For additional discussion of the risks and uncertainties applicable to the Company, see the “Risk Factors” section of this Form 10-K. All forward-looking statements are qualified by, and should be considered in conjunction with, such cautionary statements.

All statements in this Form 10-K, 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 Form 10-K.

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PART I

ITEM 1. BUSINESS

General

HMN Financial, Inc. (HMN and, together with its subsidiaries, the Company) is a stock savings bank holding company that owns 100 percent of Home Federal Savings Bank (the Bank). The Bank has a community banking philosophy and operates retail banking and loan production facilities in Minnesota, Iowa and Wisconsin. The Bank has two wholly owned subsidiaries, Osterud Insurance Agency, Inc. (OIA), which does business as Home Federal Investment Services and offers financial planning products and services, and HFSB Property Holdings, LLC (HPH), which is currently inactive, but has acted in the past as an intermediary for the Bank in holding and operating certain foreclosed properties. HMN was incorporated in Delaware in 1994.

As a community-oriented financial institution, the Company seeks to serve the financial needs of communities in its market area. The Company’s business involves attracting deposits from the general public and businesses and using such deposits to originate or purchase single family residential, commercial real estate and multi-family mortgage loans as well as consumer, construction and commercial business loans. The Company also invests in mortgage-backed and related securities, U.S. government agency obligations and other permissible investments. The executive offices of the Company are located at 1016 Civic Center Drive Northwest, Rochester, Minnesota 55901. Its telephone number at that address is (507) 535-1200. The Company’s website is www.hmnf.com. Information contained on the Company’s website is expressly not incorporated by reference into this Form 10-K.

Market Area

The Company serves the southern Minnesota counties of Dodge, Fillmore, Freeborn, Houston, Mower, Olmsted and Winona and portions of Goodhue, Steele and Wabasha through its corporate office located in Rochester, Minnesota and its eleven branch offices located in Albert Lea, Austin, Kasson (2), La Crescent, Rochester (4), Spring Valley and Winona, Minnesota. The portion of the Company’s southern Minnesota market area consisting of Rochester and the contiguous communities is composed of primarily urban and suburban communities, while the balance of the Company's southern Minnesota market area consists primarily of rural areas and small towns. Primary industries in the Company's southern Minnesota market area include manufacturing, agriculture, health care, wholesale and retail trade, service industries and education. Major employers include the Mayo Clinic, Hormel Foods (a food processing company) and IBM. The Company's market area is also the home of Winona State University, Rochester Community and Technical College, University of Minnesota - Rochester, Winona State University - Rochester Center and Austin’s Riverland Community College.

The Company serves Dakota County, in the southern portion of the Minneapolis and St. Paul metropolitan area, from its office located in Eagan, Minnesota. Major employers in this market area include Delta Airlines, Patterson Companies (dental and animal health), UTC (aerospace systems), CHS Cooperative, Flint Hills Resources LP (oil refinery), Unisys Corp (computer software), Blue Cross Blue Shield of Minnesota and West Group, a Thomson Reuters business (legal research).

The Company serves the Iowa county of Marshall through its branch office located in Marshalltown, Iowa. Major employers in the area include Swift & Company (pork processors), Emerson (automation solutions, and commercial and residential solutions), Lennox Industries (furnace and air conditioner manufacturing), Iowa Veterans Home (hospital care), Marshall Community School District (education) and UnityPoint Health (hospital care).

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Based upon information obtained from the U.S. Census Bureau for 201 6 (the last year for which information is available), the population of the seven primary counties in the Company’s southern Minnesota market area was estimated as follows: Dodge – 20,506; Fillmore – 21,003; Freeborn – 30,446; Houston – 18,814; Mower – 39,163; Olmsted – 153,102; and Winona – 50,948. For these same seven counties, the median household income from the U.S. Census Bureau for 2012-2016 ranged from $48,827 to $69,308. The population of Dakota County was 417,486 and the median household income was $77,321. With respect to Iowa, the population of Marshall County was 40,312 and the median household income was $54,193.

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Lending Activities

General. Historically, the Company has originated 15 and 30 year fixed rate mortgage loans secured by single family residences for its loan portfolio. Over the past 20 years, the Company has focused on managing interest rate risk and improving interest margins by increasing its investment in shorter term and generally higher yielding commercial real estate, commercial business and construction loans, while reducing its investment in longer term single family real estate loans. The Company continues to originate 15 and 30 year fixed rate mortgage loans and some shorter term fixed rate loans. The shorter term fixed rate loans and adjustable rate loans are generally placed into portfolio, while the majority of the 15 and 30 year fixed rate mortgage loans are sold in the secondary mortgage market. Mortgage interest rates continued to be at relatively low levels in 2017 and very few 15 and 30 year loans were placed into portfolio, as most were sold into the secondary market in order to manage the Company’s interest rate risk position. The Company also offers an array of consumer loan products that include both open and closed end home equity loans. Home equity lines of credit have adjustable interest rates based upon the prime rate, as published in the Wall Street Journal, plus a margin. Refer to “ Note 5 Loans Receivable, Net ” and “ Note 6 Allowance for Loan Losses and Credit Quality Information ” in the Notes to Consolidated Financial Statements in the Annual Report for more information on the loan portfolio (incorporated by reference in Item 8 of Part II of this Form 10-K).

The following table shows the composition of the Company's loan portfolio by fixed and adjustable rate loans as of December 31:

	20 17						20 16						20 15						20 14					20 13

(Dollars in thousands)	Amount			Percent			Amount			Percent			Amount			Percent			Amount		Percent			Amount		Percent
Fixed rate Loans
Real e state:
Single family	$	53,869			9.06	%	$	55,143			9.83	%	$	55,226			11.68	%	$	46,288		12.39	%	$	47,377		11.96	%
Multi-family		20,254			3.40			29,171			5.20			8,045			1.70			10,919		2.92			7,687		1.94
Commercial		179,755			30.22			159,195			28.38			117,790			24.91			104,178		27.89			109,387		27.62
Construction		26,715			4.49			13,438			2.40			27,381			5.79			7,361		1.97			2,645		0.67
Total real estate loans		280,593			47.17			256,947			45.81			208,442			44.08			168,746		45.17			167,096		42.19
Consumer loans:
Automobile		2,894			0.49			3,036			0.54			2,885			0.61			1,124		0.30			971		0.25
Home equity		8,315			1.40			9,744			1.74			10,231			2.16			10,711		2.87			11,629		2.94
Recreational vehicle		13,181			2.21			7,553			1.35			2,650			0.56			0		0.00			0		0.00
Other		4,270			0.72			5,447			0.97			4,635			0.99			4,091		1.09			4,174		1.05
Total consumer loans		28,660			4.82			25,780			4.60			20,401			4.32			15,926		4.26			16,774		4.24
Commercial business loans		55,642			9.36			53,019			9.46			39,197			8.29			32,147		8.61			40,122		10.13
Total non-real estate loans		84,302			14.18			78,799			14.06			59,598			12.61			48,073		12.87			56,896		14.37
Total fixed rate loans		364,895			61.35			335,746			59.87			268,040			56.69			216,819		58.04			223,992		56.56

Adjustable rate Loans
Real estate:
Single family		53,136			8.93			48,112			8.58			35,719			7.55			23,553		6.31			29,090		7.34
Multi-family		8,395			1.41			7,606			1.36			4,279			0.90			4,781		1.28			426		0.11
Commercial		79,269			13.33			71,760			12.80			79,136			16.74			59,187		15.84			69,099		17.45
Construction		19,729			3.32			17,910			3.19			10,722			2.27			5,242		1.40			5,206		1.31
Total real estate loans		160,529			26.99			145,388			25.93			129,856			27.46			92,763		24.83			103,821		26.21
Consumer:
Home equity line		36,869			6.20			40,476			7.22			38,561			8.16			36,832		9.86			36,178		9.13
Home equity		7,508			1.26			6,558			1.17			4,970			1.05			1,709		0.46			0		0.00
Other		730			0.12			469			0.08			483			0.10			458		0.12			471		0.12
Total consumer loans		45,107			7.58			47,503			8.47			44,014			9.31			38,999		10.44			36,649		9.25
Commercial business loans		24,267			4.08			32,157			5.73			30,909			6.54			24,975		6.69			31,587		7.98
Total non-real estate loans		69,374			11.66			79,660			14.20			74,923			15.85			63,974		17.13			68,236		17.23
Total adjustable rate loans		229,903			38.65			225,048			40.13			204,779			43.31			156,737		41.96			172,057		43.44
Total loans		594,798			100.00	%		560,794			100.00	%		472,819			100.00	%		373,556		100.00	%		396,049		100.00	%
Less
Unamortized discounts		19						20						16						14					33
Net deferred loan (costs) fees		(463	)					(300	)					(91	)					97					0
Allowance for losses on loans		9,311						9,903						9,709						8,332					11,401
Total loans receivable, net	$	585,931					$	551,171					$	463,185					$	365,113				$	384,615

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The following table illustrates the interest rate maturities of the Company's loan portfolio at December 31, 20 17. Loans which have adjustable or renegotiable interest rates are shown as maturing in the period during which the contract is due. Scheduled repayments of principal are reflected in the year in which they are scheduled to be paid. The schedule does not reflect the effects of possible prepayments or enforcement of due-on-sale clauses.

	Real Estate
(Dollars in thousands)	Single family					Multi-family and Commercial					Construction					Consumer					Commercial Business					Total

Due During Years Ending December 31,	Amount		Weighted Average Rate			Amount		Weighted Average Rate			Amount		Weighted Average Rate			Amount		Weighted Average Rate			Amount		Weighted Average Rate			Amount		Weighted Average Rate

2018 ⁽¹⁾	$	8,806		4.26	%	$	48,712		4.56	%	$	24,686		3.91	%	$	7,395		5.74	%	$	43,473		4.88	%	$	133,072		4.59	%
2019		9,239		4.09			39,359		4.55			1,684		4.78			5,302		5.67			10,656		4.68			66,240		4.60
2020		9,358		4.05			48,517		4.43			3,254		4.26			4,183		5.48			10,309		4.58			75,621		4.45
2021 through 2022		16,321		4.11			78,765		4.50			6,040		4.12			6,795		5.34			14,358		4.42			122,279		4.47
2023 through 2027		24,528		3.96			63,051		4.48			8,526		4.51			11,865		5.41			1,033		5.04			109,003		4.47
2028 through 2042		33,329		3.99			9,050		5.07			2,254		4.67			37,904		4.83			22		5.26			82,559		4.51
2043 and thereafter		5,424		3.67			219		5.69			0		0.00			323		0.00			58		0.00			6,024		3.51
	$	107,005				$	287,673				$	46,444				$	73,767				$	79,909				$	594,798

⁽¹⁾

Includes demand loans, loans having no stated maturity, and overdraft loans.

Th e total amount of loans due after December 31, 2018 which have predetermined interest rates is $283.1 million, while the total amount of loans due after such date which have floating or adjustable interest rates is $178.6 million. Construction or development loans at December 31, 2017 were $23.1 million for single family dwellings, $11.6 million for multi-family and $11.7 million for nonresidential.

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The aggregate amount of loans and extensions of credit that the Bank is permitted to make to any one borrower is generally limited to 15% of unimpaired capital and surplus. In addition to the 15% limit, the Bank is permitted to lend an additional amount equal to 10% of unimpaired capital and surplus if the additional amount is fully secured by “readily marketable collateral” having a current market value of at least 100% of the loan or extension of credit. Similarly, the Bank is permitted to lend additional amounts equal to the lesser of 30% of unimpaired capital and surplus, or $30 million, for certain residential development loans. Applicable law establishes a number of rules for combining loans to separate borrowers. Loans or extensions of credit to one person may be attributed to other persons if: (i) the proceeds of a loan or extension of credit are used for the direct benefit of the other person; or (ii) a common enterprise is deemed to exist between persons. At December 31, 2017, based upon the 15% limitation, the Bank's regulatory limit for loans to one borrower was approximately $12.8 million and no loans to any one borrower exceeded this amount. At December 31, 2017, the Bank’s largest aggregate amount of loans to one borrower totaled $11.6 million. All of the loans for the largest borrower were performing in accordance with their terms as of December 31, 2017 and the borrower had no affiliation with the Bank other than its relationship as a borrower.

All of the Bank's lending is subject to its written underwriting standards and to loan origination procedures. Decisions on loan requests are made on the basis of detailed applications and property valuations determined by an independent appraiser. The loan applications are designed primarily to determine the borrower's ability to repay. The more significant items on the application are verified through the use of credit reports, financial statements, tax returns or confirmations.

Single family loans are originated either for inclusion in the loan portfolio under the Bank ’s Portfolio First loan program or for sale in the secondary market to the Federal National Mortgage Association (FNMA) on a servicing retained basis or to other third party investors on a servicing released basis. The limit for retail mortgages originated for sale on the secondary market was $424,100 and $417,000 for 2017 and 2016, respectively, and these loans require the approval of a designated secondary market underwriter.

Three levels of approval authority have been established for loans originated under the Portfolio First loan program. The three levels of authority include Approved Portfolio First Lenders, Market Presidents and Credit Administration positions with Portfolio First approval authority. Approved Portfolio First Lenders are select mortgage loan officers recommended for the Portfolio First program approval authority by their Market President and are approved by the Chief Operating Officer. The Credit Administration positions with Portfolio First approval authority include the Rochester Market President, Director of Retail Lending and Loan Servicing, Vice President of Credit Administration, Chief Credit Officer and the Chief Operating Officer.

Loans less than $350,000 require the approval of the Portfolio First Lender, t he Market President and one Credit Administration individual with Portfolio First approval authority. Loans over $350,000 require the approval of the Portfolio First Lender, the Market President and two Credit Administration individuals with Portfolio First approval authority. Loans where the total aggregate amount of all loan obligations owed or guaranteed to the Bank plus the new obligation is greater than $2.0 million require the approval of a majority of the Senior Loan Committee, which is comprised of the Bank’s most experienced lending staff.

Loans that meet the underwriting guidelines of secondary market investors are approved by designated Credit Administration positions. The Credit Administration position s with secondary market approval authority include Retail Loan Underwriters, Director of Retail Lending and Servicing, Vice President of Credit Administration, Chief Credit officer and the Chief Operating Officer. Approval level authorities are granted by the Chief Credit Officer or Chief Operating Officer and confirmed by the Executive Loan Committee on an annual basis. Loans are originated based on the specific guidelines established by the secondary market investor.

The Bank generally requires title insurance on its mortgage loans , as well as fire and extended coverage casualty insurance in amounts at least equal to the principal amount of the loan or the value of improvements on the property. The Bank also requires flood insurance to protect the property securing its interest when the property is located in a flood plain.

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Single Family Residential Real Estate Lending . At December 31, 2017, the Company's single family real estate loans, consisting of both fixed rate and adjustable rate loans, totaled $107.0 million, an increase of $3.7 million from $103.3 million at December 31, 2016. The increase in the single family loans in 2017 is the result of an increased emphasis on originating shorter term fixed rate and adjustable rate mortgage loans that were placed into the portfolio during 2017. The majority of the longer term loans that were originated during the year continued to be sold into the secondary market in order to manage the Company’s interest rate risk position.

The Company offers conventional fixed rate single family loans that have maximum terms of 30 years. In order to manage interest rate risk, the Company typically sells the majority of fixed rate loan originations with terms to maturity of 15 years or greater that are eligible for sale in the secondary market. The interest rates charged on the fixed rate loan products are based on the secondary market delivery rates, as well as other competitive factors. The Company also originates fixed rate loans with terms up to 30 years that are insured by the Federal Housing Administration (FHA), Veteran’s Administration (VA), Minnesota Housing Finance Agency, Iowa Finance Authority or United States Department of Agriculture-Guaranteed Housing (RD).

The Company also offers one year adjustable rate mortgages (ARMs) at a margin (generally 400 to 600 basis points) over the yield on the Average Weekly One Year U.S. Treasury Constant Maturity Index for terms of up to 30 years. The ARMs offered by the Company allow the borrower to select (subject to pricing) an initial period of one to seven years between the loan origination and the date the first interest rate change occurs. The ARMs generally have a 200 basis point annual interest rate change cap and a lifetime cap of 600 basis points over or under the initial rate. The Company’s originated ARMs do not permit negative amortization of principal, generally do not contain prepayment penalties and are not convertible into fixed rate loans. Because of the low interest rate environment that has existed over the last few years, a limited number of ARM loans have been originated as consumers have generally opted for longer term fixed rate loans.

In underwriting single family residential real estate loans, the Company evaluates the borrower's credit history, ability to make principal, interest and escrow payments, the value of the property that will secure the loan and debt-to-income ratios. Properties securing single family residential real estate loans made by the Company are appraised by independent appraisers. The Company originates residential mortgage loans with loan-to-value ratios up to 100% for owner-occupied homes and up to 85% for non-owner-occupied homes; however, private mortgage insurance is generally required to reduce the Company's exposure to 80% or less of the value on most loans. The Company generally seeks to underwrite its loans in accordance with secondary market, FHA, VA or RD standards. However, the Company does originate shorter term fixed rate and adjustable rate single family loans for its portfolio that do not meet certain secondary market guidelines.

The Company's residential mortgage loans customarily include due-on-sale clauses giving it the right to declare the loan immediately due and payable in the event that, among other things, the borrower sells or otherwise disposes of the property subject to the mortgage.

At both December 31, 2017 and December 31, 2016, $0.9 million of the single family residential loan portfolio were non-performing.

Commercial Real Estate and Multi-Family Lending . The Company originates permanent commercial real estate and multi-family loans secured by properties located primarily in its market area. It also purchases a limited amount of participations in commercial real estate and multi-family loans originated by third parties. The commercial real estate and multi-family loan portfolio includes loans secured by motels, hotels, apartment buildings, churches, manufacturing plants, land developments, office buildings, business facilities, shopping malls, nursing homes, golf courses, restaurants, warehouses, convenience stores and other non-residential building properties primarily located in the upper Midwestern portion of the United States. At December 31, 2017, the Company’s commercial and multi-family real estate loans totaled $287.7 million, an increase of $20.0 million from $267.7 million at December 31, 2016.

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Permanent commercial real estate and multi-family loans are generally originated for a maximum term of 1 0 years and may have longer amortization periods with balloon maturity features. The interest rates may be fixed for the term of the loan or have adjustable features that are tied to the prime rate or another published index. Commercial real estate and multi-family loans are generally written in amounts up to 80% of the lesser of the appraised value of the property or the purchase price and generally have a debt service coverage ratio of at least 120%. The debt service coverage ratio is the ratio of net cash from operations to debt service payments. The Company may originate construction loans secured by commercial or multi-family real estate, or may purchase participation interests in third party originated construction loans secured by commercial or multi-family real estate.

Appraisals on commercial real estate and multi-family real estate properties are performed by independent appraisers prior to the time the loan is made. For transactions less than $250,000, the Company may use an internal valuation. All appraisals on commercial and multi-family real estate are reviewed and approved by a qualified Bank employee or independent third party. The Bank's underwriting procedures require verification of the borrower's credit history, income and financial statements, banking relationships and income projections for the property. The commercial loan policy generally requires personal guarantees from the proposed borrowers. An initial on-site inspection is generally required for all collateral properties for loans with balances in excess of $250,000. Independent annual reviews are performed for aggregate commercial lending relationships that exceed $500,000. The reviews cover financial performance, documentation completeness and accuracy of loan risk ratings.

Multi-family and commercial real estate loans generally present a higher level of risk than loans secured by single family residences. This greater risk is due to several factors, including the concentration of principal in a limited number of loans and borrowers, the effects of general economic conditions on income producing properties and the increased difficulty of evaluating and monitoring these types of loans. Furthermore, the repayment of loans secured by multi-family and commercial real estate is typically dependent upon the successful operation of the related real estate project. If the cash flow from the project is reduced (for example, if leases are not obtained or renewed), the borrower's ability to repay the loan may be impaired. At December 31, 2017 and 2016, $1.4 million of loans in the commercial real estate portfolio were non-performing. The largest non-performing lending relationship in this category as of December 31, 2017 was a $1.2 million loan secured by a manufacturing facility located in the Bank’s primary market area.

Construction Lending. The Company makes construction loans to individuals for the construction of their residences and to builders for the construction of single family residences. It also makes a limited number of loans to builders for houses built on speculation. Construction loans also include commercial real estate loans.

Almost all loans to individuals for the construction of their residences are structured as permanent loans. These loans are made on the same terms as residential loans, except that during the construction phase, which typically lasts up to twelve months, the borrower pays interest only. Generally, the borrower also pays a construction fee at the time of origination plus other costs associated with processing the loan. Residential construction loans are underwritten pursuant to the same guidelines used for originating residential loans on existing properties.

Construction loans to builders or developers of single family residences generally carry terms of one year or less.

Construction loans to owner occupants are generally made in amounts up to 95% of the lesser of cost or appr aised value, but no more than 90% of the loan proceeds can be disbursed until the building is completed. The Company generally limits the loan-to-value ratios on loans to builders to 80%. Prior to making a commitment to fund a construction loan, the Company requires a valuation of the property, financial data and verification of the borrower's income. The Company obtains personal guarantees for substantially all of its construction loans to builders. Personal financial statements of guarantors are also obtained as part of the loan underwriting process. Construction loans are generally located in the Company's market area.

Construction loans are obtained principally through continued business from builders and developers who have previously borrowed from the Bank, as well as referrals from existing clients and walk-in clients. The application process includes a submission to the Bank of accurate plans, specifications and costs of the project to be constructed. These items are one factor utilized in the determination of the appraised value of the subject property to be built.

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At December 31, 201 7, construction loans totaled $46.4 million, an increase of $15.1 million from $31.3 million at December 31, 2016. Total construction loans included $23.1 million and $21.9 million of single family residential, $11.6 million and $2.6 million of multi-family residential and $11.7 million and $6.8 million of commercial real estate loans at December 31, 2017 and 2016, respectively. The nature of construction loans makes them more difficult to evaluate and monitor than loans on existing buildings. The risk of loss on a construction loan is dependent largely upon the accuracy of the initial estimate of the property's value upon completion of the project, experience of the builder and the estimated cost (including interest) of the project. If the estimate of value proves to be inaccurate, the Company may be confronted, at or prior to the maturity of the loan, with a project having a value that is insufficient to assure full repayment or the possibility of having to make substantial investments to complete and sell the project. Because defaults in repayment may not occur during the construction period, it may be difficult to identify problem loans at an early stage. In these cases, the Company may be required to modify the terms of the loan. At both December 31, 2017 and December 31, 2016, $0.1 million of construction loans in the commercial real estate portfolio were non-performing. The non-performing construction loans are loans to parties related through common ownership to construct model homes that when sold, or subject to a purchase agreement, are converted to performing loans and the interest is recognized.

Consumer Lending. The Company originates a variety of consumer loans, including home equity loans (open-end and closed-end), automobile, recreational vehicles, mobile home, lot loans, loans secured by deposit accounts and other loans for household and personal purposes. At December 31, 2017, the Company’s consumer loans totaled $73.8 million, an increase of $0.5 million from $73.3 million at December 31, 2016.

Consumer loan terms vary according to the type and value of collateral, length of contract and creditworthiness of the borrower. The Company's consumer loans are made at fixed or adjustable interest rates, with terms up to 20 years for secured loans and up to five years for unsecured loans.

The Company's home equity loans are written so that the total commitment amount, when combined with the balance of any other outstanding mortgage liens, generally does not exceed 90% of the appraised value of the property or an internally established market value. Internal market values are established using current market data, including recent sales data, and are typically lower than third party appraised values. The closed-end home equity loans are written with fixed or adjustable rates with terms up to 15 years. The open-end home equity lines are written with an adjustable rate and a 2 to 10 year draw period that requires interest only payments followed by a 10 year repayment period that fully amortizes the outstanding balance. The consumer may access the open-end home equity line by making a withdrawal at the Bank, transferring funds through our online or mobile banking products or writing a check on the home equity line of credit account. Open and closed-end equity loans, which are generally secured by second mortgages on the borrower’s principal residence, represented 71.4% of the Company’s consumer loan portfolio at December 31, 2017.

The underwriting standards employed by the Company for consumer loans include a determination of the applicant's payment history on other debts and their ability to meet existing obligations and payments on the proposed loan. Although creditworthiness of the applicant is of primary consideration, the underwriting process also includes a comparison of the value of the security, if any, in relation to the proposed loan amount. Consumer loans may entail greater credit risk than do residential mortgage loans, particularly in the case of consumer loans that are unsecured or are secured by rapidly depreciable assets, such as automobiles, recreational vehicles or mobile homes. In these cases, any repossessed collateral for a defaulted consumer loan may not provide an adequate source of repayment of the outstanding loan balance as a result of the greater likelihood of damage, loss or depreciation. In addition, consumer loan collections are dependent on the borrower's continuing financial stability, and thus are more likely to be affected by adverse personal circumstances. Furthermore, the application of various federal and state laws, including bankruptcy and insolvency laws, may limit the amount that can be recovered on such loans. At both December 31, 2017 and December 31, 2016 the consumer loan portfolio had $0.6 million of non-performing loans.

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Commercial Business Lending. The Company maintains a portfolio of commercial business loans to borrowers associated with the real estate industry as well as to retail, manufacturing operations and professional firms. The Company's commercial business loans generally have terms ranging from six months to five years and may have either fixed or variable interest rates. The Company's commercial business loans generally include personal guarantees and are usually, but not always, secured by business assets such as inventory, equipment, leasehold interests in equipment, fixtures, real estate and accounts receivable. The underwriting process for commercial business loans includes consideration of the borrower's financial statements, tax returns, projections of future business operations and inspection of the subject collateral, if any. The Company may also purchase a limited amount of participation interests in commercial business loans originated outside of the Company’s market area from third party originators. These loans generally have underlying collateral of inventory or equipment and repayment periods of less than ten years. At December 31, 2017, the Company’s commercial business loans totaled $79.9 million, a decrease of $5.3 million from $85.2 million at December 31, 2016.

Unlike residential mortgage loans, which generally are made on the basis of the borrower's ability to make repayment from his or her income, and which are secured by real property with more easily ascertainable value, commercial business loans are of higher risk and typically are made on the basis of the borrower's ability to make repayment from the cash flow of the borrower's business. As a result, the availability of funds for the repayment of commercial business loans may be substantially dependent on the success of the business itself. Furthermore, the collateral securing the loans may depreciate over time, may be difficult to appraise and may fluctuate in value based on the success of the business. At December 31, 2017 and 2016, $0.3 million of loans in the commercial business loan portfolio were non-performing.

Originations, Purchases and Sales of Loans and Mortgage-Backed and Related Securities

Real estate loans are generally originated by the Company's salaried loan officers. Mortgage and consumer loan officers may also receive a commission in addition to their base salary for meeting production and other branch goals. Loan applications are taken in all branch and loan production offices.

The Company originates both fixed and adjustable rate loans, however, its ability to originate loans is dependent upon the relative client demand for loans in its markets. Demand for adjustable rate loans is affected by the interest rate environment. The number of adjustable rate loans remained low in 2017 due to the low long term fixed mortgage rates that existed during the year. The Company originated for its portfolio $7.8 million of single family adjustable rate loans during 2017, a decrease of $10.6 million from $18.4 million in 2016. The Company also originated for its portfolio $25.0 million of fixed rate single family loans during 2017, a decrease of $1.9 million from $26.9 million for 2016. The changes in the adjustable rate single family loans that were placed into the loan portfolio in 2017 are the result of customer’s preference to lock in fixed rate loans due to the low interest rate environment and the increased expectation of increased mortgage rates in the future. The slight decrease in fixed rate loans originated in 2017 compared to 2016 is the result of lower originations of fixed rate loans that did not meet secondary market criteria between the periods.

During the past several years, the Company has focused its portfolio loan origination efforts on commercial real estate , commercial business and consumer loans because these loans have terms to maturity and adjustable interest rate characteristics that are generally more beneficial to the Company in managing interest rate risk than traditional single family fixed rate conventional loans. The Company originated $148.3 million of multi-family and commercial real estate, commercial business and consumer loans (which excludes commercial real estate loans for construction or development) during 2017, an increase of $7.8 million from originations of $140.5 million for 2016. The increase in originations primarily reflects the $18.6 million and $9.3 million increase in commercial business and commercial real estate loans, respectively, in 2017 compared to 2016. Multi-family loan originations decreased $16.5 million and consumer loan originations decreased $3.6 million between the periods.

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In order to supplement loan demand in the Company's market area and geographically diversify its loan portfolio, the Company, from time to time, purchases participations in real estate loans from selected sellers, with yields based upon then-current market rates. The Company reviews and underwrites all loans purchased to ensure that they meet the Company's underwriting standards, and the seller generally continues to service the loans. The Company has generally not experienced higher losses or credit quality issues with purchased participations than other loans originated by the Company. The Company purchased $7.2 million of loans during 2017, a decrease of $9.1 million from $16.3 million purchased during 2016. All of the loans purchased have terms and interest rates that are similar in nature to the Company's originated single family, commercial real estate, construction and development and commercial business portfolios. See “ Note 5 Loans Receivable, Net ” and “Note 6 Allowance for Loan Losses and Credit Quality Information” in the Notes to Consolidated Financial Statements in the Annual Report for more information on purchased loans (incorporated by reference in Item 8 of Part II of this Form 10-K).

The Company did not acquire any loans through an acquisition in 2017 but acquired loans totaling $12.0 million in an acquisition that occurred in the second quarter of 2016.

The Company has mortgage-backed and related securities that are held, based on investment intent, in the "available for sale" portfolio. The Company did not acquire any mortgage-backed securities in 2017 or 2016 through an acquisition. The Company purchased $5.1 million of mortgage-backed securities in 2017 and none were purchased in 2016. The limited amount of mortgage-backed securities purchased is because debt instruments issued by federal agencies, such as FNMA and the Federal Home Loan Mortgage Corporation (FHLMC), continued to be more appealing to purchase due to their shorter duration given the low interest rate environment that continued to exist in 2017. In 2017, the Company did not sell any mortgage backed securities and in 2016 it sold $30,000 of mortgage-backed securities that were previously acquired in an acquisition. The securities were sold due primarily to the small lot size of the individual securities. See “Investment Activities” below.

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The following table shows the loan and mortgage-backed and related securities origination, purchase, acquisition, sale and repayment activities of the Company for the periods indicated.

LOANS HELD FOR INVESTMENT
	Year Ended December 31,
(Dollars in thousands)	20 17			20 16			20 15
Originations by type:
Adjustable rate:
Real estate -
- single family	$	7,833			18,442			12,111
- multi-family		1,167			9,246			0
- commercial		23,818			14,591			21,489
- construction or development		30,799			40,132			19,920
Non-real estate -
- consumer		11,585			15,481			18,852
- commercial business		3,428			10,353			19,538
Total adjustable rate		78,630			108,245			91,910

Fixed rate:
Real estate -
- single family		25,016			26,948			27,612
- multi-family		3,718			12,107			4,042
- commercial		42,203			42,176			47,306
- construction or development		16,559			19,181			38,299
Non-real estate -
- consumer		16,639			16,335			11,610
- commercial business		45,767			20,196			18,281
Total fixed rate		149,902			136,943			147,150
Total loans originated		228,532			245,188			239,060

Purchases:
Real estate -
- single family		203			0			2,800
- multi-family		0			750			0
- commercial		500			1,130			7,501
- construction or development		4,740			2,500			5,500
Non-real estate -
- commercial business		1,756			11,949			2,600
Total loans purchased		7,199			16,329			18,401

Acquisition :
Real estate -
- single family		0			146			4,985
- multi-family		0			0			100
- commercial		0			5,808			7,712
Non-real estate -
- consumer		0			3,536			5,226
- commercial business		0			2,546			6,037
Total loans acquired		0			12,036			24,060

Sales, participations and repayments :
Real estate -
- multi-family		0			4,500			0
- commercial		10,565			9,002			4,504
- construction or development		3,221			13,765			14,602
Non-real estate -
- consumer		834			719			516
- commercial business		53,240			634			154
Total sales		67,860			28,620			19,776
Transfers to loans held for sale		9,047			15,002			8,125
Principal repayments		123,912			140,944			154,054
Total reductions		200,819			184,566			181,955
Decrease in other items, net		(908	)		(1,012	)		(303	)
Net increase	$	34,004			87,975			99,263

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LOANS HELD FOR SALE

	Year Ended December 31,
(Dollars in thousands)	201 7			201 6			201 5
Originations by type :
Fixed rate:
Real estate -
- single family		78,751			79,783			69,941
Total fixed rate		78,751			79,783			69,941
Total loans originated		78,751			79,783			69,941

Sales and repayments :
Real estate -
- single family		83,475			88,355			71,992
Total sales		83,475			88,355			71,992
Transfers from loans held for investment		(4,558	)		(6,822	)		(3,778	)
Principal repayments		6			20			24
Total reductions		78,923			81,553			68,238
Net (decrease) increase	$	(172	)		(1,770	)		1,703

MORTGAGE-BACKED AND RELATED SECURITIES

	Year Ended December 31,
(Dollars in thousands)	201 7			201 6			201 5

Purchases :
Fixed rate mortgage-backed securities	$	5,055			0			2,343
CMOs and REMICs ⁽¹⁾		0			0			3,116
Total purchases		5,055			0			5,459

Sales :
Fixed rate mortgage-backed securities		0			0			2,174
CMOs and REMICs		0			30			2,021
Total sales		0			30			4,195

Principal repayments		(993	)		(1,247	)		(1,890	)
Net increase (decrease)	$	4,062			(1,277	)		(626	)

(1) Collateralized mortgage obligations and real estate mortgage investment conduits

Classified Assets and Delinquencies

Classification of Assets . Federal regulations require that each savings institution evaluate and classify its assets on a regular basis. In addition, in connection with examinations of savings institutions, the OCC and the Federal Deposit Insurance Corporation (FDIC) examiners may identify problem assets and, if appropriate, require them to be classified with an adverse rating. There are three adverse classifications: substandard, doubtful, and loss. Assets classified as substandard have one or more defined weaknesses and are characterized by the distinct possibility that the Bank will sustain some loss if the deficiencies are not corrected. Assets 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. An asset classified as loss is considered uncollectible and of such little value that continuance as an asset on the balance sheet of the institution is not warranted. Assets classified as substandard or doubtful require the institution to establish prudent specific allowances for loan losses. If an asset, or portion thereof, is classified as a loss, the institution charges off such amount. If an institution does not agree with an OCC or FDIC examiner's classification of an asset, it may appeal the determination to the OCC District Director or the appropriate FDIC personnel. On the basis of management's review of its assets, at December 31, 2017, the Bank classified a total of $17.3 million of its loans and real estate as follows:

(Dollars in thousands)	Single Family		Real Estate Construction or Development		Commercial and Multi-family		Consumer		Commercial Business		Real Estate		Total
Substandard	$	2,154		120		7,950		631		5,506		627		16,988
Doubtful		44		0		0		119		0		0		163
Loss		0		0		0		130		0		0		130
Total	$	2,198		120		7,950		880		5,506		627		17,281

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The Bank's classified assets consist of non-performing loans and loans and other assets of concern discussed in Management’s Discussion and Analysis of Financial Condition and Results of Operations (incorporated by reference in Item 7 of Part II of this Form 10-K). See “ Note 6 Allowance for Loan Losses and Credit Quality Information” in the Notes to Consolidated Financial Statements in the Annual Report (incorporated by reference in Item 8 of Part II of this Form 10-K) for more information on classified assets. At December 31, 2017, these asset classifications were materially consistent with those of the OCC and FDIC.

Delinquency Procedures. Generally, the following procedures apply to delinquent single family real estate loans. When a borrower fails to make a required payment on a loan, the Company attempts to cure the delinquency by contacting the borrower. A late notice is sent on all loans over 16 days delinquent. Additional written and verbal contacts are made with the borrower between 30 and 60 days after the due date. If the loan is contractually delinquent 90 days, the Company sends a 30-day demand letter to the borrower and after the loan is contractually delinquent 120 days, institutes appropriate action to foreclose on the property. If foreclosed, the property is sold at a sheriff’s sale and may be purchased by the Company. Delinquent commercial real estate and commercial business loans are generally handled in a similar manner. The Company's procedures for repossession and sale of consumer collateral are subject to various requirements under state consumer protection laws.

Real estate acquired by the Company as a result of foreclosure is typically classified as real estate in judgment for six to twelve months and thereafter as real estate owned until it is sold. When property is acquired by foreclosure or deed in lieu of foreclosure, it is recorded as real estate owned at the estimated fair value less the estimated cost of disposition. After acquisition, all costs incurred in maintaining the property are expensed. Costs relating to the development and improvement of the property, however, are capitalized to the extent of fair value less disposition cost.

The following table sets forth the Company's loan delinquencies by loan type, amount and percentage of type at December 31, 20 17 for loans past due 60 days or more.

	Loans Delinquent For:														Total Delinquent
	60-89 Days							90 Days and Over							Loans
(Dollars in thousands)	Number		Amount		Percent of Loan Category			Number		Amount		Percent of Loan Category			Number		Amount		Percent of Loan Category

Single family real estate		6	$	294		0.27	%		8	$	669		0.63	%		14	$	963		0.89	%
Consumer		7		117		0.16			7		235		0.32			14		352		0.48
Commercial business		0		0		0.00			2		180		0.23			2		180		0.23
Total		13	$	411		0.07	%		17	$	1,084		0.18	%		30	$	1,495		0.25	%

Loans delinquent for 90 days and over are generally non-accruing and are included in the Company’s non-performing asset total at December 31, 2017.

Investment Activities

The Company utilizes the available for sale securities portfolio in virtually all aspects of asset/liability management. In making investment decisions, the Investment-Asset/Liability Committee considers, among other things, the yield and interest rate objectives, the credit risk position and the Bank's liquidity and projected cash flow requirements.

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Securities. Federally chartered savings institutions have the authority to invest in various types of liquid assets, including United States Treasury obligations, securities of various federal agencies, certain certificates of deposit of insured banks and savings institutions, certain bankers' acceptances, repurchase agreements and federal funds. Subject to various restrictions, the holding company of a federally chartered savings institution may also invest its assets in commercial paper, investment grade corporate debt securities and mutual funds whose assets conform to the investments that a federally chartered savings institution is otherwise authorized to make directly.

The investment strategy of the Company has been directed toward a mix of high-quality assets (primarily government callable agency obligations) with steps and short and intermediate terms to maturity. At December 31, 2017, the Company did not own any investment securities of a single issuer that exceeded 10% of the Company's stockholders’ equity other than U.S. government agency obligations.

The Bank invests a portion of its liquid assets in interest-earning overnight deposits of the FHLB of Des Moines and the Federal Reserve Bank of Minneapolis. Other investments include high grade municipal bonds, corporate preferred stock, corporate equity securities and medium-term (up to five years) federal agency notes. HMN invests in the same type of investment securities as the Bank. See “ Note 4 Securities Available For Sale” in the Notes to Consolidated Financial Statements in the Annual Report for additional information regarding the Company's securities portfolio (incorporated by reference in Item 8 of Part II of this Form 10-K).

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The following table set s forth the composition of the Company's securities portfolio, excluding mortgage-backed and related securities, at the dates indicated.

	December 31, 2017										December 31, 2016										December 31, 2015
(Dollars in thousands)	Amortized		Adjusted			Fair		% of			Amortized		Adjusted			Fair		% of			Amortized		Adjusted			Fair		% of
	Cost		To			Value		Total			Cost		To			Value		Total			Cost		To			Value		Total
Securities available for sale:
U.S. Government agency obligations	$	69,962		(1,201	)		68,761		64.0	%	$	74,979		(1,063	)		73,916		72.2	%	$	105,003		(61	)		104,942		71.4	%
Municipal obligations		2,699		(6	)		2,693		2.5			2,819		(20	)		2,799		2.7			3,991		11			4,002		2.8
Corporate obligations		234		(1	)		233		0.2			290		2			292		0.3			340		(6	)		334		0.2
Corporate preferred stock		700		(140	)		560		0.5			700		(350	)		350		0.3			700		(350	)		350		0.2
Corporate equity ⁽¹⁾		58		99			157		0.1			58		57			115		0.1			58		5			63		0.0
Subtotal		73,653					72,404		67.3			78,846					77,472		75.6			110,092					109,691		74.6
Federal Home Loan Bank stock ⁽¹⁾		817					817		0.8			770					770		0.8			691					691		0.5
Total investment securities and Federal Home Loan Bank stock		74,470					73,221		68.1			79,616					78,242		76.4			110,783					110,382		75.1

Average remaining life of investment securities excluding Federal Home Loan Bank stock (years)	2.61										2.52										1.48

Other interest earning assets:
Cash equivalents	$	34,265					34,265		31.9		$	24,140					24,140		23.6		$	36,570					36,570		24.9
Total	$	108,735					107,486		100.0	%	$	103,756					102,382		100.0	%	$	147,353					146,952		100.0	%
Average remaining life or term to repricing of investment securities and other interest earning assets, excluding Federal Home Loan Bank stock (years)	1.78										1.72										1.11

⁽¹⁾ Average life assigned to holdings is five years.

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The composition and maturities of the investment securities portfolio, excluding F HLB stock, mortgage-backed and related securities, are indicated in the following table.

	December 31, 201 7
	1 Year or Less			After 1 through 5 Years			After 5 through 10 Years			Over 10 Years			No stated maturity			Total Securities
(Dollars in thousands)	Amortized Cost			Amortized Cost			Amortized Cost			Amortized Cost			Amortized Cost			Amortized Cost			Adjusted To			Fair Value
Securities available for sale:
U.S. government agency securities ⁽¹⁾	$	55,000			14,962			0			0			0			69,962			(1,201	)		68,761
Municipal obligations		311			2,388			0			0			0			2,699			(6	)		2,693
Corporate obligations		0			234			0			0			0			234			(1	)		233
Corporate preferred stock		0			0			0			700			0			700			(140	)		560
Corporate equity		0			0			0			0			58			58			99			157
Total	$	55,311			17,584			0			700			58			73,653			(1,249	)		72,404

Weighted average yield		1.35	%		1.74	%		0.00	%		5.52	%		1.80	%		1.48	%

⁽¹⁾ Callable U.S. government agency securities maturity date based on first available call date that the security is anticipated to be called.

Mortgage-Backed and Related Securities . In order to supplement loan production and achieve its asset/liability management goals, the Company invests in mortgage-backed and related securities. All of the mortgage-backed and related securities owned by the Company are issued, insured or guaranteed either directly or indirectly by a U.S. Government Agency and are considered to be investment grade securities. The Company had $5.1 million of mortgage-backed and related securities all classified as “available for sale” at December 31, 2017, compared to $1.0 million of mortgage-backed and related securities classified as available for sale at December 31, 2016. The Company purchased $5.1 million in mortgage-backed securities in 2017 and did not purchase any i n 2016.

The contractual maturities of the mortgage-backed and related securities portfolio without any prepayment assumptions at Dec ember 31, 2017 are as follows:

(Dollars in thousands)	5 Years or Less			5 to 10 Years			10 to 20 Years			Over 20 Years			Dec. 31, 20 17 Balance Outstanding
Securities available for sale:
Federal Home Loan Mortgage Corporation	$	93			0			0			0			93
Federal National Mortgage Association		54			0			4,703			0			4,757
Collateralized Mortgage Obligations		0			0			0			218			218
Total	$	147			0			4,703			218			5,068

Weighted average yield		4.41	%		0.00	%		2.02	%		3.03	%		2.13	%

At December 31, 2017, the Company did not have any non-agency mortgage-backed or related securities in excess of 10% of its stockholders' equity.

Mortgage-backed and related securities can serve as collateral for borrowings and, through sales and repayments, as a source of liquidity. In addition, mortgage-backed and related securities available for sale can be sold to respond to changes in economic conditions.

Sources of Funds

General. The Bank's primary sources of funds are retail, commercial, internet and brokered deposits, payments of loan principal, interest earned on loans and securities, repayments and maturities of securities, borrowings and other funds provided from operations.

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Deposits. The Bank offers a variety of deposit accounts to retail and commercial clients having a wide range of interest rates and terms. The Bank's deposits consist of savings, negotiable order of withdrawal (NOW), non-interest bearing checking, money market and certificate accounts (including individual retirement accounts). The Bank relies primarily on competitive pricing policies and client service to attract and retain these deposits.

The variety of deposit accounts offered by the Bank has allowed it to be competitive in obtaining funds and to respond with flexibility to changes in consumer demand. As clients have become more interest rate conscious, the Bank has become more susceptible to short-term fluctuations in deposit flows. The Bank manages the pricing of its deposits in keeping with its asset/liability management, profitability and growth objectives. Based on its experience, the Bank believes that its savings and NOW accounts are relatively stable sources of deposits. However, the ability of the Bank to attract and maintain certificates of deposit and money market accounts, and the rates paid on these deposits, has been and will continue to be significantly affected by market conditions. The increase in deposits in 2017 relates primarily to the $35.9 million in commercial deposit growth and the $6.9 million in retail deposit growth that was experienced. The increase in commercial deposits in 2017 includes $9.0 million in wholesale commercial deposits acquired through an internet bulletin board service and $3.6 million in growth from clients in the alternative energy industry. The increase in deposits in 2016 related to commercial deposits from clients in the alternative energy industry. The deposits in 2016 also increased $19.0 million as a result of a branch acquisition that occurred in the second quarter of 2016. The increase in deposits in 2015 related primarily to the $47.3 million in deposits that were acquired in an acquisition in the third quarter of 2015.

The following table sets forth the savings flows at the Bank during the periods indicated.

	Year Ended December 31,
(Dollars in thousands)	201 7			201 6			201 5
Opening balance	$	592,811			559,387			496,750
Deposits		4,500,620			4,323,445			4,084,845
Deposits acquired in acquisitions		0			18,977			47,280
Withdrawals		(4,458,537	)		(4,309,719	)		(4,070,087	)
Interest credited		707			721			599
Ending balance		635,601			592,811			559,387
Net increase	$	42,790			33,424			62,637
Percent increase		7.22	%		5.98	%		12.61	%

Th e following table sets forth the dollar amount of deposits in the various types of deposit products offered by the Bank as of December 31:

(Dollars in thousands)			20 17					20 16					20 15
Transaction and Savings Deposits ⁽¹⁾ :			Amount		Percent of Total			Amount		Percent of Total			Amount		Percent of Total
Noninterest checking			$	172,007		27.1	%	$	158,024		26.7	%	$	151,737		27.1	%
NOW – 0.05% ⁽²⁾				90,599		14.3			92,670		15.6			82,425		14.7
Savings – 0.08% ⁽³⁾				75,255		11.8			74,238		12.5			66,421		11.9
Money market – 0.40% ⁽⁴⁾				186,937		29.4			165,179		27.9			159,959		28.6
Total n on-certificates			$	524,798		82.6	%	$	490,111		82.7	%	$	460,542		82.3	%

Certificates :
0.00	-	0.99%	$	58,444		9.2	%	$	79,628		13.4	%	$	85,391		15.3	%
1.00	-	1.99%		43,691		6.9			22,958		3.9			12,611		2.3
2.00	-	2.99%		8,550		1.3			0		0.0			733		0.1
3.00	-	3.99%		118		0.0			114		0.0			110		0.0
Total Certificates				110,803		17.4	%		102,700		17.3	%		98,845		17.7	%
Total Deposits			$	635,601		100.0	%	$	592,811		100.0	%	$	559,387		100.0	%

⁽¹⁾

Reflects weighted average rates paid on transaction and savings deposits at December 31, 2017.

⁽²⁾

The weighted average rate on NOW Accounts for 2016 was 0.07% and for 2015 was 0.04%.

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⁽³⁾

The weighted average rate on Savings Accounts for 2016 was 0.08% and for 2015 was 0.09%.

⁽⁴⁾

The weighted average rate on Money Market Accounts for 2016 was 0.25% and for 2015 was 0.22%.

The following table shows rate and maturity information for the Bank ’s certificates of deposit as of December 31, 2017.

(Dollars in thousands)		0.00- 0.99%		1.00- 1.99%		2.00- 2.99%		3.00- 3.99%		Total			Percent of Total
Certificate accounts maturing in quarter ending:
March 31, 201 8	$	9,406		1,276		0		0			10,682			9.64	%
June 30, 2018		13,876		2,786		789		0			17,451			15.75
September 30, 201 8		14,673		2,931		4,613		0			22,217			20.05
December 31, 2018		7,291		5,427		2,386		118			15,222			13.74
March 31, 2019		3,289		2,177		0		0			5,466			4.93
June 30, 2019		2,894		3,083		0		0			5,977			5.39
September 30, 201 9		1,900		4,749		0		0			6,649			6.00
December 31, 2019		1,588		2,832		0		0			4,420			3.99
March 31, 2020		833		2,090		0		0			2,923			2.64
June 30, 2020		560		5,307		100		0			5,967			5.39
Septemb er 30, 2020		654		3,963		561		0			5,178			4.67
December 31, 2020		932		1,802		68		0			2,802			2.53
Thereafter		548		5,268		33		0			5,849			5.28
Total	$	58,444		43,691		8,550		118			110,803			100.00	%

Percent of total		52.74	%	39.43	%	7.72	%	0.11	%		100.00	%

The following table indicates the amount of the Bank's certificates of deposit and other deposits by time remaining until m aturity as of December 31, 2017.

	Maturity
(Dollars in thousands)	3 Months or Less		Over 3 to 6 Months		Over 6 to 12 Months		Over 12 M onths		Total
Certi ficates of deposit less than $250,000	$	10,376		16,264		32,340		42,618		101,598
Certificates of deposit of $25 0,000 or more		0		0		5,044		2,522		7,566
Public funds less than $25 0,000 ⁽¹⁾		306		27		55		91		479
Public funds of $25 0,000 or more ⁽¹⁾		0		1,160		0		0		1,160
Total certificates of deposit	$	10,682		17,451		37,439		45,231		110,803
Checking and savings accounts of $250,000 or more	$	195,467		0		0		0		195,467
Accounts of $25 0,000 or more		195,467		1,160		5,044		2,522		204,193

_______________

⁽¹⁾ Deposits from governmental and other public entities.

For additional information regarding the composition of the Bank's deposits, see “ Note 1 1 Deposits” in the Notes to Consolidated Financial Statements in the Annual Report (incorporated by reference in Item 8 of Part II of this Form 10-K). For additional information on certificate maturities and the impact on the Company's liquidity see “Management’s Discussion and Analysis of Financial Condition and Results of Operations - Liquidity and Capital Resources” of the Annual Report (incorporated by reference in Item 7 of Part II of this Form 10-K).

Borrowings. The Bank's other available sources of funds include advances from the FHLB and borrowings from the Federal Reserve Bank of Minneapolis. As a member of the FHLB of Des Moines, the Bank is required to own capital stock in the FHLB and is authorized to apply for advances. Each FHLB credit program has its own interest rate, which may be fixed or variable, and range of maturities. The FHLB may prescribe the acceptable uses for these advances, as well as limitations on the size of the advances and repayment provisions. Consistent with its asset/liability management strategy, the Bank has utilized FHLB advances from time to time to fund loan demand and extend the term to maturity of its liabilities. The Bank may also use short-term FHLB and Federal Reserve Bank borrowings to offset short term cash needs due to deposit outflows or loan fundings. At December 31, 2017, the Bank had no FHLB advances and no Federal Reserve Bank borrowings outstanding. On such date, the Bank had a collateral pledge arrangement with the FHLB pursuant to which the Bank may borrow up to $106.3 million for liquidity purposes, subject to approval from the FHLB. The Bank also had the ability to borrow $77.9 million from the Federal Reserve Bank based upon the loans that were pledged as collateral at December 31, 2017. 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 with an interest rate of 6.50% per annum. On February 17, 2015 the Company took a one time advance on the note of $10.0 million and used the proceeds to retire the final $10.0 million of Preferred Stock. This note was paid in full on August 31, 2017.

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Refer to the information on pages 18 and 19 under the caption “Management’s Discussion and Analysis of Financial Condition and Results of Operations - Liquidity and Capital Resources” in the Annual Report and “ Note 1 2 FHLB Advances and Other Borrowings” in the Notes to Consolidated Financial Statements in the Annual Report for more information on FHLB advances and other borrowings (incorporated by reference in Items 7 and 8 of Part II of this Form 10-K).

S ervice Corporations of the Bank

As a federally chartered savings bank, the Bank is permitted by OCC regulations to invest up to 2% of its assets in the stock of, or loans to, service corporation subsidiaries, and may invest an additional 1% of its assets in service corporations where these additional funds are used for inner-city or community development purposes. In addition to investments in service corporations, federal institutions are permitted to invest an unlimited amount in operating subsidiaries engaged solely in activities in which a federal savings bank may engage directly.

OIA is one of two subsidiaries of the Bank. OIA is a Minnesota corporation that was organized in 1983 and operated as an insurance agency until 1986 when its assets were sold. OIA remained inactive until 1993 when it began offering credit life insurance, annuity and mutual fund products to the Bank's clients and others. OIA currently offers a variety of financial planning products and services. HPH is the Bank’s other subsidiary and was organized as a limited liability company in Minnesota in 2013. It was inactive in 2017 but has operated as an intermediary for the Bank in holding and operating certain foreclosed properties.

Competition

The Bank faces strong competition both in originating real estate, commercial and consumer loans and in attracting deposits. Competition in originating loans comes primarily from mortgage bankers, commercial banks, credit unions and other savings institutions which have offices in the Bank's market area and those that operate through Internet banking operations throughout the United States. The Bank competes for loans principally on the basis of the interest rates and loan fees it charges, the types of loans it originates and the quality of services it provides to borrowers.

Competition for deposits is pr incipally from mutual funds, securities firms, commercial banks, credit unions and other savings institutions located in the same communities and those that operate through Internet banking operations throughout the United States. The ability of the Bank to attract and retain deposits depends on its ability to provide an investment opportunity that satisfies the requirements of investors as to rate of return, liquidity, risk, convenience and other factors. The Bank competes for these deposits by offering a variety of deposit accounts at competitive rates, convenient business hours and a client oriented staff.

Other Corporations Owned by the Company

The Bank was HMN ’s sole direct subsidiary at December 31, 2017.

Employees

A t December 31, 2017, the Company had a total of 196 employees, which equated to 187 full-time equivalent employees. None of the employees of the Company are represented by any collective bargaining unit. Management considers its employee relations to be good.

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Regulation and Supervision

The banking industry is highly regulated. As a savings and loan holding company (SLHC), HMN is subject to regulation, supervision and examination by the FRB. The Bank, a federally-chartered savings association, is also subject to regulation, supervision and examination by the OCC, which is the Bank’s primary federal regulator. The FDIC also has authority to regulate the Bank. Subsidiaries of HMN and the Bank may also be subject to state regulation and/or licensing in connection with certain insurance and investment activities. The Company is subject to numerous laws and regulations. These laws and regulations impose restrictions on activities, set minimum capital requirements, impose lending and deposit restrictions and establish other restrictions. References in this section to applicable statutes and regulations are brief and incomplete summaries only. You should consult the statutes, regulations and related policies and interpretive guidance for a full understanding of the details of their operation. Changes in statutes, regulations or regulatory policies applicable to the Company, including interpretation or implementation thereof, could have a material effect on the Company’s business.

The Dodd-Frank Wall Street Reform and Consumer Protection Act

The Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010 (Dodd-Frank Act) significantly changed the regulatory structure for financial institutions and their holding companies, including with respect to lending, deposit, investment, trading and operating activities. Federal banking regulators and other agencies including, among others, the FRB, the OCC and the Consumer Financial Protection Bureau (CFPB), have been engaged in extensive rule-making efforts under the Dodd-Frank Act.

Holding Company Regulation

As a savings and loan holding company, HMN is subject to regulation and supervision by the FRB. FRB regulations require holding companies to act as a source of strength to their subsidiary depository institutions by providing capital, liquidity, and other support in times of financial stress.

Acquisitions by Savings and Loan Holding Companies. Acquisition of a savings association or a savings and loan holding company is generally subject to FRB approval and the public must have an opportunity to comment on the proposed acquisition. Without prior approval from the FRB, HMN may not acquire, directly or indirectly, control of another savings association.

Examination and Reporting. Under the Home Owners’ Loan Act and FRB regulations, HMN, as a SLHC, must file periodic reports with the FRB. In addition, HMN must comply with FRB record keeping requirements and is subject to holding company supervision and examination by the FRB. The FRB may take enforcement action if the activities of a SLHC constitute a risk to the financial safety, soundness or stability of a subsidiary savings association.

Affiliate Transactions. The Bank, as a holding company subsidiary that is a depository institution, is subject to both qualitative and quantitative limitations on transactions with the Company. See “Bank Regulation - Transactions with Affiliates and Insiders” below.

Capital Adequacy. The Bank is subject to various capital requirements, which, effective since January 1, 2015, have been modified under rules promulgated by the FRB and the OCC implementing the Dodd-Frank Act and the Basel III reforms of the Basel Committee on Banking Supervision of the Bank for International Settlements (Basel III Rules).

Under the Basel III Rules, certain SLHCs for the first time in 2015 became subject to formal regulatory capital requirements. In the second quarter of 2015, the FRB amended its Small Bank Holding Company Policy Statement (Policy Statement), which exempted small bank holding companies from the above capital requirements, by raising the asset size threshold for determining applicability from $500 million to $1 billion. The Policy Statement was also expanded to include savings and loan holding companies that meet the Policy Statement’s qualitative requirements for exemption. The Company meets the qualitative exemption requirements, and therefore, is exempt from the Basel III holding company capital requirements. See “Bank Regulation – Capital Requirements and Prompt Corrective Action Requirements; Basel III Rules” below.

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Dividends. Federal law also limits the ability of a savings and loan holding company, such as HMN, to pay dividends or make other capital distributions. FRB guidance applicable to holding companies sets out factors that should be taken into account when considering dividends or distributions, including, among other things, current and prospective earnings and liquidity, and the holding company’s ability to serve as an ongoing source of financial and managerial strength to insured depository institution subsidiaries such as the Bank.

B ank Regulation

As a federally-chartered savings association, the Bank is subject to regulation and supervision by the OCC. Federal law authorizes the Bank, as a federal savings association, to conduct, subject to various conditions and limitations, business activities that include: accepting deposits and paying interest on them; making and buying loans secured by residential and other real estate; making a limited amount of consumer loans; making a limited amount of commercial loans; investing in corporate obligations, government debt securities, and other securities; and offering various banking, trust, securities and insurance agency services to its clients.

Savings associations are expected to conduct lending activities in a prudent, safe and sound manner. The OCC regulates the safety and soundness of the Bank by enforcing statutory limits on the Bank ’s lending and investment powers. OCC regulations set aggregate limits on certain types of loans including commercial business, commercial real estate and consumer loans. OCC regulations also establish limits on loans to a single borrower. As of December 31, 2017, the Bank’s lending limit to one borrower was approximately $12.8 million.

A federal savings association generally may not invest in noninvestment-grade debt securities. A federal savings association may establish subsidiaries to conduct any activity the association is authorized to conduct and may establish service corporation subsidiaries for limited preapproved activities.

Qualified Thrift Lender Test. Savings associations, including the Bank, must be qualified thrift lenders (QTLs). A savings association generally satisfies the QTL requirement if at least 65% of a specified asset base consists of assets such as loans to small businesses and loans to purchase or improve domestic residential real estate. Savings associations may qualify as QTLs in other ways. Savings associations that do not qualify as QTLs are subject to significant restrictions on their operations. If the Bank fails to meet QTL requirements, the Company would face certain limitations, including potential enforcement action by the OCC and, as a result of the Dodd-Frank Act, a statutory bar to the payment by the Bank of dividends except under prescribed conditions including approval by the OCC. As of December 31, 2017, the Bank met the QTL test.

OCC Assessments. The OCC is authorized by statute to charge assessments to cover the costs of examining the financial institutions it regulates and to fund its operations. The Bank’s OCC assessments for the year ended December 31, 2017 were approximately $185,000. The FRB does not currently assess HMN for examination fees.

Transactions with Affiliates and Insiders. Savings associations, like banks, are subject to affiliate and insider transaction restrictions. The restrictions prohibit or limit a savings association from extending credit to, or entering into certain covered transactions with affiliates, principal stockholders, directors and executive officers of the savings association and its affiliates. The term “affiliate” generally includes a holding company, such as HMN, and any company under common control with the savings association. Federal law limits covered transactions between the Bank and any one affiliate to 10% of the Bank’s capital and surplus and with all affiliates in the aggregate to 20%. In addition, the federal law governing unitary savings and loan holding companies prohibits the Bank from making any loan to any affiliate whose activity is not permitted for a subsidiary of a bank holding company. This law also prohibits the Bank from making any equity investment in any affiliate that is not its subsidiary. The Bank is currently in compliance with these requirements. The Dodd-Frank Act expanded the limitations on transactions with affiliates to cover transactions that create credit risk. Covered transactions now include derivatives and the borrowing and lending of securities. Repurchase agreements with affiliates are now subject to collateralization requirements.

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Dividend Restrictions. Federal law limits the ability of a depository institution, such as the Bank, to pay dividends or make other capital distributions. The Bank, as a subsidiary of a savings and loan holding company, must file a notice with the FRB before payment of a dividend or approval of a proposed capital distribution by its board of directors and must obtain prior approval from the FRB if it fails to meet certain regulatory conditions.

During 201 7, the Bank paid dividends to HMN of $6.0 million to pay the principal and interest on the third party note payable and fund the ongoing operating expenses of the Company. HMN did not declare or distribute any dividends to its common shareholders in 2017.

Deposit Insurance. The FDIC insures the deposits of the Bank through the Deposit Insurance Fund (DIF). The DIF is funded by assessments of FDIC members such as the Bank. The FDIC applies a risk-based system for setting deposit insurance assessments. Under the risk-based assessment system, an institution’s insurance assessments vary according to the level of capital the institution holds and the degree to which it is the subject of supervisory concern.

The Dodd-Frank Act instituted significant changes that modified the way that the DIF is managed by the FDIC and is capitalized. The Dodd-Frank Act altered the assessment base for deposit insurance assessments from a deposit to an asset base. It also increased the DIF reserve ratio from 1.15% to 1.35%. The Dodd Frank Act also requires that FDIC assessments be set in a manner that offsets the cost of the assessment increases for institutions with consolidated assets of less than $10 billion (meaning that assessments on larger institutions will be responsible for the 20 basis point increase). During 2017, the Bank was assessed approximately $203,000 for the DIF. The Dodd-Frank Act also permanently increased deposit insurance coverage from $100,000 per account ownership type to $250,000.

In addition to deposit insurance assessments, the FDIC is authorized to collect assessments against insured deposits to be paid to the Financing Corporation (FICO) to service the FICO debt incurred in the 1980 ’s. The FICO assessment rate is adjusted quarterly. In 2017, the Bank paid a FICO assessment of approximately $31,000.

Capital Requirements and Prompt Corrective Action Requirements; Basel III Rules. The Bank is subject to various regulatory capital requirements administered by the federal banking agencies. 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 the Bank’s assets, liabilities and certain off-balance sheet items as calculated under regulatory accounting practices. Quantitative measures established by regulations to ensure capital adequacy required the Bank to maintain minimum amounts and ratios of Common Tier 1 Risk-based capital, Total Tier 1 capital (Tier 1 leverage ratio), Tier 1 capital to Risk-based assets, and Risk-based capital to total assets (in each case as defined in the regulations). The Bank’s capital amounts and classification are also subject to qualitative judgments by the regulators about components, risk weightings and other factors.

The Federal Deposit Insurance Corporation Improvement Act of 1991 (FDICIA) established five capital categories: 1) well capitalized; 2) adequately capitalized; 3) undercapitalized; 4) significantly undercapitalized; and 5) critically undercapitalized. The activities in which a depository institution may engage and regulatory responsibilities of federal bank regulatory agencies vary depending upon whether an institution is well-capitalized, adequately capitalized or undercapitalized. Undercapitalized institutions are subject to various restrictions such as limitations on dividends and growth. A depository institution’s prompt corrective action capital category depends upon where its capital levels are in relation to relevant capital measures, which include risk-based capital measures and certain other factors.

In addition to the capital categories, the Basel III Rules established a “capital conservation buffer” above the minimum capital ratios otherwise required by the prompt corrective action framework. The capital conservation buffer requirement for 2017 was 1.25% of risk-weighted assets and will increase incrementally each year until January 2019 when the entire 2.50% capital conservation buffer will be fully phased in. An institution will be subject to limitations on paying dividends, engaging in share repurchases and paying discretionary bonuses if its capital level falls below the buffer amount.

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At December 31, 2017, the Bank’s capital amounts and ratios are presented for (a) actual capital and (b) required capital and ratios under the prompt corrective actions regulations to which the Bank is currently subject:

						Prompt Corrective Action Regulations
	Actual					Required to be Adequately Capitalized					Required to be Well Capitalized
(Dollars in thousands)	Amount		Percent of Assets ⁽¹⁾			Amount		Percent of Assets ⁽¹⁾			Amount		Percent of Assets ⁽¹⁾
December 31, 201 7
Common equity Tier 1 capital	$	76,279		12.45	%	$	27,561		4.50	%	$	39,810		6.50	%
Tier 1 leverage		76,279		10.68			28,569		4.00			35,711		5.00
Tier 1 risk-based capital		76,279		12.45			36,748		6.00			48,997		8.00
Total risk-based capital		83,957		13.71			48,997		8.00			61,246		10.00

⁽¹⁾	Based upon the Bank ’s adjusted total assets for the purpose of the Tier 1 or core capital ratios and risk-weighted assets for the purpose of the risk-based capital ratios.

Management believes that, as of December 31, 2017, the Bank’s capital ratios were in excess of those quantitative capital ratio standards set forth under the prompt corrective action regulations described above and was “well capitalized” within the meaning of those prompt corrective action regulations. However, there can be no assurance that the Bank will continue to maintain such status in the future. In addition, the OCC has extensive discretion in its supervisory and enforcement activities, including the ability to downgrade the Bank’s prompt corrective action capital category by one level under certain conditions.

Under applicable banking regulations, the failure to comply with capital rules or other applicable requirements as they arise, could subject HMN, the Bank and their directors and officers to such restrictions, legal actions or sanctions as the FRB or the OCC considers appropriate. Possible sanctions include among others (i) the imposition of one or more cease and desist orders requiring corrective action, which are enforceable directives that may address any aspect of the Company’s management, operations or capital, including requirements to change management, raise equity capital, dispose of assets or effect a change of control; (ii) civil money penalties; and (iii) downgrades in the capital adequacy status of the Bank. These regulatory actions may significantly restrict the ability of the Company to take operating and strategic actions that may be in the best interests of stockholders or compel the Company to take operating and strategic actions that are not potentially in the best interests of stockholders.

Other Regulations and Examination Authority. The FDIC has adopted regulations to protect the DIF and depositors, including regulations governing the deposit insurance of various forms of accounts. Federal regulation of depository institutions is intended for the protection of depositors, and not for the protection of stockholders or other creditors. In addition, federal law requires that in any liquidation or other resolution of any FDIC-insured depository institution, claims for administrative expenses of the receiver and for deposits in U.S. branches (including claims of the FDIC as subrogee of the insured institution) shall have priority over the claims of general unsecured creditors.

The OCC may sanction any OCC-regulated bank that does not operate in accordance with OCC regulations, policies and directives. The FDIC has additional authority to terminate insurance of accounts, after notice and hearing, upon a finding that the insured institution is or has engaged in any unsafe or unsound practice that has not been corrected, is operating in an unsafe or unsound condition, or has violated any applicable law, regulation, rule, or order of or condition imposed by the FDIC.

Federal Home Loan Bank (FHLB) System. The Bank is a member of the FHLB of Des Moines, which is one of the 11 regional Federal Home Loan Banks (FHBs). The primary purpose of the FHBs is to provide funding to their saving association members in support of the home financing credit function of the members. Each FHB serves as a reserve or central bank for its members within its assigned region. FHBs are funded primarily from proceeds derived from the sale of consolidated obligations of the FHLB System. FHBs make loans or advances to members in accordance with policies and procedures established by the board of directors of the FHB. These policies and procedures are subject to the regulation and oversight of the Federal Housing Financing Board. All advances from a FHB are required to be fully secured by sufficient collateral as determined by the FHB. Long-term advances are required to be used for residential home financing and small business and agricultural loans.

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As a member, the Bank is required to purchase and maintain stock in the FHLB of Des Moines. As of December 31, 2017, the Bank had $0.8 million in FHLB stock, which was in compliance with this requirement. The Bank receives dividends on its FHLB stock. The FHLB’s dividend philosophy is to differentiate dividend rates between membership and activity-based capital stock. Based on the FHLB’s most recent quarterly filing on Form 10-Q for the nine months ended September 30, 2017, the effective combined annualized dividend rate paid on both subclasses of its capital stock during the nine months ended September 30, 2017 and 2016 was 5.50% and 4.25%, respectively.

Other Regulation. Under FRB regulations, the Bank is required to maintain reserves against transaction accounts (primarily interest-bearing and noninterest-bearing checking accounts). Historically, reserves generally have been maintained in cash or in noninterest-bearing accounts, thereby effectively increasing an institution’s cost of funds. These regulations generally require that the Bank maintain reserves against net transaction accounts. The reserve levels are subject to adjustment by the FRB and prior to October 6, 2008, the policy was to not pay interest on reserves. The FRB now pays interest and utilizes the rate of interest paid on reserves to conduct monetary policy. A savings association, like other depository institutions maintaining reservable accounts, may, under certain conditions, borrow from the Federal Reserve Bank discount window.

Numerous other regulations promulgated by the FRB, the OCC, the CFPB and other agencies and other governmental authorities affect the business operations of the Bank. These include but are not limited to regulations relating to privacy, equal credit access, mortgage lending and foreclosure practices, electronic fund transfers, collection of checks, lending and savings disclosures and availability of funds. The CFPB has broad authority to develop new rules and interpretations with respect to consumer financial products and services, even though its examination and enforcement authority currently do not extend to the Bank.

The CFPB ’s rule-making activities include, among other things, the issuance in January 2013 of final rules implementing the Dodd-Frank Act mortgage lending requirements, including the “ability-to-repay” requirement for mortgage lending together with certain safe harbors and rebuttable presumptions of compliance associated with “qualified mortgages.”

Community Reinvestment Act. The Community Reinvestment Act (CRA) requires financial institutions regulated by the federal financial supervisory agencies to ascertain and help meet the credit needs of their delineated communities, including low to moderate income neighborhoods within those communities, while maintaining safe and sound banking practices. The regulatory agency assigns one of four possible ratings to an institution’s CRA performance and is required to make public an institution’s rating and written evaluation. The four possible ratings of meeting community credit needs are outstanding, satisfactory, needs improvement and substantial noncompliance. Under regulations that apply to all current CRA performance evaluations, many factors play a role in assessing a financial institution’s CRA performance. The institution’s regulator must consider its financial capacity and size, legal impediments, local economic conditions and demographics, including the competitive environment in which it operates. The evaluation does not rely on absolute standards, and the institutions are not required to perform specific activities or to provide specific amounts or types of credit. The Bank maintains a CRA statement for public viewing, as well as an annual CRA highlights document. These documents describe the Bank’s credit programs and services, community outreach activities, public comments and other efforts to meet community credit needs. The Bank’s last CRA exam was January 3, 2017 and the Bank received a “satisfactory” rating under the Intermediate Small Savings Association criteria.

Bank Secrecy Act. The Bank Secrecy Act (BSA) requires financial institutions to verify the identity of clients, keep records and file reports that are determined to have a high degree of usefulness in criminal, tax and regulatory matters, and to implement anti-money laundering programs and compliance procedures. The impact on Bank operations from the BSA depends on the types of clients served by the Bank.

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Troubled Asset Relief Program – Capital Purchase Program

On October 3, 2008, the federal government enacted the Emergency Economic Stabilization Act of 2008 (EESA). The EESA was enacted to provide liquidity to the U.S. financial system and lessen the impact of accelerating economic problems. The EESA included broad authority. The centerpiece of the EESA was the Troubled Asset Relief Program (TARP). The EESA’s broad authority was interpreted to allow the Treasury to purchase equity interests in both healthy and troubled financial institutions. The equity purchase program is commonly referred to as the Capital Purchase Program (CPP). The Company elected to participate in the CPP and sold shares of its Fixed Rate Cumulative Perpetual Preferred Stock, Series A (the Preferred Stock) to the Treasury in December 2008, along with a warrant to purchase 833,333 shares of HMN common stock at $4.68 per share (the Warrants).

On February 8, 2013, the Treasury sold the Preferred Stock to unaffiliated third party investors in a private transaction for $18.8 million. The Company received no proceeds from the sale and it had no effect on the Company’s capital, financial condition or results of operations. The Company has redeemed all of the outstanding Preferred Stock with the final $10 million being redeemed on February 17, 2015.

On May 21, 2015, the Treasury sold the Warrant s 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 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.

Executive Officers of the registrant

Executive o fficers are chosen by and serve at the discretion of the Board of Directors of HMN and the Bank. There are no family relationships among any of the directors or officers of HMN and the Bank. The business experience of each executive officer of both HMN and the Bank is set forth below.

Bradley C. Krehbiel , age 5 9 . Mr. Krehbiel has been a director of HMN and President of the Bank since 2009, President of HMN since 2010, and Chief Executive Officer of HMN and the Bank since 2012. Prior to that, he had been the Executive Vice President of the Bank since 2004. Mr. Krehbiel joined the Bank as Vice President of Business Banking in 1998. Prior to his employment at the Bank, Mr. Krehbiel held several positions in the financial services industry.

Jon J. Eberle , age 5 2 . Mr. Eberle is Chief Financial Officer, Senior Vice President and Treasurer of HMN and the Chief Financial Officer, Executive Vice President and Treasurer of the Bank. Mr. Eberle has held the Chief Financial Officer and Treasurer positions since 2003 and the Executive Vice President position since 2012. Prior to that he served as a Vice President since 2000 and as the Controller since 1998. From 1994 to 1998, he served as the Director of Internal Audit for HMN and the Bank. Prior to his employment at the Bank, Mr. Eberle worked as a certified public accountant for a national accounting firm.

Lawrence D. McGraw , age 5 4 . Mr. McGraw has served as the Chief Operating Officer and Executive Vice President of the Bank since 2012. Prior to that he served as Chief Credit Officer and Senior Vice President since 2010. Prior to his employment at the Bank, Mr. McGraw served as Regional President and Chief Banking Officer of a Minnesota community bank from 2005 until 2010. From 2001 to 2005 he served as the President and Chief Executive Officer of a branch location of the same community bank. Prior to his tenure at the Minnesota community bank, Mr. McGraw held various positions at two other community banks and the FDIC.

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Available Information

The Company ’s website is www.hmnf.com. The Company makes available, free of charge, through its website its annual report on Form 10-K, quarterly reports on Form 10-Q, current reports on Form 8-K and amendments to those reports filed or furnished pursuant to Section 13(a) of the Exchange Act, as soon as reasonably practicable after it electronically files these materials with, or furnishes them to, the Securities and Exchange Commission (the SEC). Information contained on the Company’s website is expressly not incorporated by reference into this Form 10-K.

ITEM 1A. RISK FACTORS

Like all financial companies, the Company ’s business and results of operations are subject to a number of risks, many of which are outside of the Company’s control. In addition to the other information in this report, readers should carefully consider that the following important factors, among others, could materially impact the Company’s business and future results of operations.

Risks Related to our Business

Our capital may not be adequate to meet all our needs and requirements in the future and we may need to take steps to meet our capital needs. These actions may reduce our base of earning assets and core deposits and may dilute our shareholders or result in a change of control of the Company or the Bank. There can be no assurance that we will satisfactorily meet our required future capital needs.

We are required by federal regulatory authorities to maintain adequate levels of capital to support our operations and protect depositors of the Bank. Depending upon the operating performance of the Bank and our other liquidity and capital needs, we may find it prudent , subject to prevailing market conditions and other factors, to raise additional capital through the issuance of additional shares of our common stock or other equity securities. Additional capital would potentially allow the Bank to grow its assets more aggressively. Depending on circumstances, if we were to raise capital, we may deploy it to the Bank for general banking purposes, or may retain some or all of such capital 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, dilute the Company’s earnings per share, and, if issued at a price less than the Company’s book value, dilute the per share book value of our 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 our current stockholders which may adversely impact our current stockholders. Our ability to raise additional capital through the issuance of equity securities, if deemed prudent, would depend on conditions in the capital markets at that time, which are outside of our control, and on our financial performance. A significant investment by a person or group may also necessitate an amendment to our Certificate of Incorporation, which would require stockholder approval. Accordingly, we may not be able to raise additional capital, if needed, at all, on favorable economic terms, or other terms acceptable to us.

The Bank may not be able to meet its cash flow needs on a timely basis at a reasonable cost, and its cost of funds for banking operations may significantly increase as a result of general economic conditions, interest rates and competitive pressures . HMN , on an unconsolidated basis , has limited capital resources and liquidity to assist the Bank with its liquidity and capital requirements.

Liquidity is the ability to meet cash flow needs on a timely basis and at a reasonable cost. The liquidity of the Bank is used to pay expenses, make loans and to repay deposit and borrowing liabilities as they become due or are demanded by clients and creditors. Many factors affect the Bank’s ability to meet liquidity needs, including variations in the markets served by its network of offices, its composition of assets and liabilities, reputation and standing in the marketplace and general economic conditions.

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The Bank ’s primary source of funding is retail deposits, gathered through its network of thirteen banking offices. Wholesale funding sources principally consist of borrowing lines from the FHLB of Des Moines and the Federal Reserve Bank of Minneapolis and brokered and internet certificates of deposit obtained from the national market. Borrowings from the FHLB are subject to the FHLB’s credit policies and procedures relating to the valuation of the loans securing advances as well as the amount of funds the FHLB will loan to the Bank. The current collateral pledged to secure advances may become unacceptable, the formulas for determining the excess pledged collateral may change or the Bank’s credit rating with the FHLB could decrease. In these cases, the Bank may not have sufficient collateral to pledge or have the borrowing capacity to meet its funding needs and may be required to rely upon alternate funding sources, such as the Federal Reserve Bank, which bear higher borrowing costs. The Bank’s securities and loan portfolios also provide a source of contingent liquidity that could be accessed in a reasonable time period through sales.

Significant changes in general economic conditions, market interest rates, competitive pressures or otherwise, could cause the Bank ’s deposits to decrease relative to overall banking operations, and it would have to rely more heavily on brokered and Internet deposits or borrowings in the future, which are typically more expensive than retail deposits.

The Bank actively manages its liquidity position and monitors it using cash flow forecasts. Changes in economic conditions, including consumer savings habits and availability or access to borrowed funds and the brokered and Internet deposit markets could potentially have a significant impact on the Company’s liquidity position, which in turn could materially impact its financial condition, results of operations and cash flows.

HMN ’s primary source of cash is dividends from the Bank, and the Bank is restricted from paying dividends to HMN unless certain conditions are met under bank regulatory requirements. At December 31, 2017, HMN had $2.1 million in cash and other assets that could readily be turned into cash. Primarily, HMN requires cash for the payment of holding company level expenses, including director and management fees, legal expenses and regulatory costs. HMN does not anticipate that it will have on an ongoing stand-alone basis adequate liquid resources to make all of the required cash payments for these items in the future. To meet these payment requirements or other potential HMN liquidity or capital needs would require dividends from the Bank or external capital. Failure to meet regulatory requirements for any future dividends from the Bank to HMN, or to receive dividends in amounts deemed satisfactory by HMN, could cause HMN to require other sources of liquidity for its needs in 2018 and beyond. Further information about HMN’s liquidity position is available on page 18 in the “Management’s Discussion and Analysis of Financial Condition and Results of Operations – Liquidity and Capital Resources” section of the Annual Report incorporated by reference in Part II, Item 7 of this Form 10-K.

Our allowance for loan losses may prove to be insufficient to absorb losses or appropriately reflect , at any given time , the inherent risk of loss in our loan portfolio.

Our non-performing assets were at $3.8 million, or 0.52% of total assets, at December 31, 2017. Classified loans at December 31, 2017 were $36.7 million, or 6.2% of total loans. Classified loans represent special mention, performing substandard and non-performing loans. The decreased level of our classified loans is primarily due to the economic recovery we are experiencing. If the economic recovery does not continue these assets may not perform according to their terms and the value of the collateral may be insufficient to pay any remaining loan balance. If this occurs, we may experience losses or an increased risk of loss in our loan portfolio, which could have a negative effect on our results of operations. Like all financial institutions, we maintain an allowance for loan losses to provide for loans in our portfolio that may not be repaid in their entirety. Our allowance for loan losses may not be sufficient to cover actual loan losses or the inherent risk of loss in our loan portfolio, and future provision for loan losses could materially adversely affect our operating results.

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In evaluating the appropriateness of our allowance for loan losses, we consider numerous factors, including but not limited to, specific occurrences of loan impairment, our historical charge-off experience, 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. In addition, we use information about specific borrower situations, including their financial position and estimated collateral values, to estimate the risk and amount of loss for those borrowers. Our estimates of the risk of loss and amount of loss on any loan are complicated by the significant uncertainties surrounding our borrowers’ abilities to successfully execute their business models through changing economic environments, competitive challenges and other factors. Because of the degree of uncertainty and susceptibility of these factors to change, our actual losses and estimates of risk of loss inherent in our loan portfolio have varied and are likely to continue to vary from our current estimates. Such variances may materially and adversely affect our financial condition and results of operations.

Federal regulators, as an integral part of their examination process, periodically review our allowance for loan losses and may require us to increase our allowance for loan losses by recognizing additional provisions for loan losses charged to expense, or to decrease our allowance for loan losses by recognizing loan charge-offs. Any such additional provisions for loan losses or charge-offs, as required by these regulatory agencies, could have a material adverse effect on our financial condition and results of operations.

The Company has concentrations in commercial business and commercial real estate loans, increasing the risk in its loan portfolio.

In order to enhance the yield and shorten the term-to-maturity of its loan portfolio, the Company continues to maintain its commercial business and commercial real estate lending and these categories of loans represented approximately 70% of the total loans receivable at December 31, 2017. Some of the Company’s commercial real estate portfolio is in land development loans, while many of the Company’s commercial business loans were made to borrowers associated with the real estate industry. Commercial business and commercial real estate loans generally, and land development loans in particular, present a higher level of risk than loans secured by single family residences. This greater risk is due to several factors, including the concentration of principal in a limited number of loans and borrowers, the effects of general economic conditions on income producing properties and the increased difficulty of evaluating and monitoring these types of loans.

Furthermore, the repayment of loans secured by commercial real estate is typically dependent upon the successful operation of the related real estate project. If the cash flow from the project is reduced (for example, if leases are not obtained or renewed or properties intended for resale are not developed and sold), the borrower’s ability to repay the loan and the underlying collateral may be impaired. Commercial business loans to businesses that are dependent on the cash flow generated by the sale or leasing of real estate are similarly impacted. The Company’s commercial business and commercial real estate loan portfolios have experienced difficulties in the past, which has adversely affected the Company’s results of operations and financial condition. At December 31, 2017, the Company classified $3.1 million of loans as non-performing, of which $1.6 million related to commercial business and commercial real estate loans. At December 31, 2017, total classified loans included $33.5 million of commercial business and commercial real estate loans. The Company may experience actual losses in respect of these classified loans and further increases in the level of classified loans in our loan portfolio that may require further increases in our provision for loan losses.

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Regional economic changes in the Company ’s markets have in the past adversely impacted, and may in the future adversely impact, results from operations.

Like all financial institutions, the Company is subject to the effects of any economic downturn, and in particular a significant decline in home values and reduced commercial development in the Company ’s markets has had a negative effect on results of operations in the past. The Company’s success depends primarily on the general economic conditions in the counties in which the Company conducts business, and in the southern Minnesota, northern Iowa and eastern Wisconsin areas in general. Unlike larger financial institutions that are more geographically diversified, the Company provides banking and financial services to clients primarily in the southern Minnesota counties of Dodge, Fillmore, Freeborn, Houston, Mower, Olmsted and Winona and portions of Goodhue, Steele and Wabasha counties, as well as Marshall county in Iowa. It also originates loans in the Milwaukee, Wisconsin area through a loan production office located in Waukesha county in Wisconsin. The local economic conditions in these market areas have a significant impact on the Company’s ability to originate loans, the ability of the borrowers to repay these loans and the value of the collateral securing these loans. A significant decline in the general economic conditions caused by inflation, recession, unemployment or other factors beyond the Company’s control can affect and has in the past affected these local economic conditions and can adversely affect and has in the past adversely affected the Company’s financial condition and results of operations. The Company has a significant amount of commercial business and commercial real estate loans and decreases in tenant occupancy and development home sales can have, and in the past have had, a negative effect on the ability of many of the Company’s borrowers to make timely repayments of their loans and the value of the collateral held as security for these loans, which can have, and in the past has had, an adverse impact on the Company’s earnings.

Because of the asset size of the Company, adverse performance affecting a few large loans or lending relationships can cause significant volatility in earnings.

Due to the Company ’s asset size, the provision for loan losses or charge offs associated with individual loans can be large relative to the Company’s earnings for a particular period. If one or a few relatively large loans become non-performing in a period and the Company is required to increase its loss reserves, or to write off principal or interest relative to such loans, the operating results for that period could be significantly adversely affected. The effect on results of operations for any given period from a change in the performance of a small number of loans may be disproportionately larger than the impact of such loans on the quality of the Company’s overall loan portfolio. The Company’s current internal lending limit is $7.5 million and the regulatory lending limit was $12.8 million at December 31, 2017. The Bank’s largest borrowing relationship had outstanding loans totaling $11.6 million and was performing at December 31, 2017.

The Company operate s in a highly regulated environment and may be adversely affected by changes in federal and state laws and regulations.

The Company is and will continue to be subject to extensive examination, supervision and comprehensive regulation by federal bank regulatory agencies. Banking regulations are primarily intended to protect depositors’ funds, federal deposit insurance funds, and the banking system and the financial system as a whole, and not holders of our common stock. These regulations affect our lending practices, capital structure, investment practices, dividend policy, and growth, among other things. See Item 1 “Business – Regulation and Supervision” of this Form 10-K for information regarding regulation affecting the Company.

The Dodd-Frank Act continue s to change the bank regulatory structure and to affect the lending, deposit, investment, trading and operating activities of financial institutions and their holding companies, including the Company. The Dodd-Frank Act requires various federal agencies, including the FRB, the OCC and the CFPB, to adopt a broad range of new implementing rules and regulations. The federal agencies were given significant discretion in drafting the implementing rules and regulations, and many of the requirements called for in the Dodd-Frank Act are being implemented over the course of several years. The full impact of changes resulting from the Dodd-Frank Act on our operations is ongoing. These changes and other changes in the regulatory landscape may significantly impact the profitability of business activities, require material changes to certain business practices, impose more stringent capital, liquidity and leverage requirements or otherwise adversely affect our business.

The FRB assess es the condition, performance and activities of savings and loan holding companies in a manner that is consistent with its established risk-based approach regarding bank holding company supervision to ensure that savings and loan holding companies are effectively supervised and can serve as a source of strength for, and do not threaten the soundness of, subsidiary depository institutions such as the Bank.

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The CFPB has broad authority to develop new rules and interpretations with respect to consumer financial products and services even though its examination and enforcement authority do not currently extend to the Bank.

Congress and federal regulatory agencies continually r eview banking laws, regulations and policies for possible changes. Changes to statutes, regulations, or regulatory policies, including changes in interpretation or implementation of statutes, regulations, or policies, could affect us in substantial and unpredictable ways. Such changes could subject us to additional costs, limit the types of financial services and products we may offer, restrict mergers and acquisitions, investments, access to capital, the location of banking offices, or increase the ability of non-banks to offer competing financial services and products, among other things. Failure, or alleged failure, to comply with laws, regulations or policies could result in sanctions by regulatory agencies, civil or criminal penalties or money damages in connection with actions or proceedings on behalf of regulators or consumers, and/or reputational damage, any of which could have a material adverse effect on our business, financial condition and results of operations. While we have policies and procedures designed to prevent any such violations and to reduce the likelihood of such actions or proceedings, there can be no assurance that such violations will not occur or that such actions or proceedings will not be brought.

Changes to laws and regulations, including changes in interpretation or implementation, may also limit the Bank ’s flexibility on financial products and fees which could result in additional operational costs and a reduction in our non-interest income.

Further, our regulators have significant discretion and authority to prevent or remedy unsafe or unsound practices or violations of laws by financial institutions and holding companies in the performance of their supervisory and enforcement duties. Examples include limits on payment of dividends by banks and regulations governing compensation. Regulation of dividends may limit the liquidity of the Company and restrictions on compensation may adversely affect our ability to attract and retain employees.

We are subject to the CRA and fair lending laws, and failure to comply with these laws could lead to material penalties.

The CRA and fair lending laws and regulations impose nondiscriminatory lending requirements on financial institutions. The Department of Justice, the CFPB and other federal agencies are responsible for enforcing these laws and regulations. A successful challenge to an institution’s performance under the CRA or fair lending laws and regulations could result in a wide variety of sanctions, including the required payment of damages and civil money penalties, injunctive relief, imposition of restrictions on mergers and acquisitions activity, and restrictions on expansion activity. Private parties may also have the ability to challenge an institution’s performance under fair lending laws in private class action litigation. The Bank has implemented policies and procedures designed to ensure compliance with such laws and regulations, but any noncompliance could lead to regulatory actions that could result in material penalties or sanctions.

The USA PATRIOT Act and Bank Secrecy Act may subject us to large fines for non-compliance.

The USA PATRIOT Act and the Bank Secrecy Act require financial institutions to develop programs to prevent financial institutions from being used for money laundering and terrorist activities. If these activities are detected, financial institutions are obligated to file suspicious activity reports with the U.S. Treasury Department’s Office of Financial Crimes Enforcement Network. These rules require financial institutions to establish procedures for identifying and verifying the identity of clients seeking to open new financial accounts. Failure to comply with these regulations could result in fines or sanctions. In recent years, several banking institutions have received large fines for non-compliance with these laws and regulations. Although the Bank has developed policies and procedures designed to ensure compliance, regulators may take enforcement action against the Bank in the event of noncompliance.

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Changes in interest rates could negatively impact the Company ’s results of operations.

The earnings of the Company are primarily dependent on net interest income, which is the difference between interest earned on loans and investments and interest paid on interest-bearing liabilities such as deposits and borrowings. Interest rates are highly sensitive to many factors, including government monetary and fiscal policies and domestic and international economic and political conditions. Conditions such as inflation, recession, unemployment, money supply, government borrowing and other factors beyond management’s control may also affect interest rates. If the Company’s interest-earning assets mature, reprice or prepay more quickly than interest-bearing liabilities in a given period, a decrease in market interest rates could adversely affect net interest income. Likewise, if interest-bearing liabilities mature or reprice, or, in the case of deposits, are withdrawn by the accountholder, more quickly than interest-earning assets in a given period, an increase in market interest rates could adversely affect net interest income. Given the Company’s assets and liability composition as of December 31, 2017, a falling interest rate environment would negatively impact the Company’s results of operations. The effect on our deposits of decreases in interest rates generally lags the effect on our assets. The lagging effect of deposit rate changes is primarily due to the Bank’s deposits that are in the form of certificates of deposit, which do not re-price immediately when the federal funds rate changes.

Fixed rate loans increase the Company ’s exposure to interest rate risk in a rising rate environment because interest-bearing liabilities would be subject to repricing before assets become subject to repricing. Adjustable rate loans decrease the risks to a lender associated with changes in interest rates but involve other risks. As interest rates rise, the payment by the borrower rises to the extent permitted by the terms of the loan, and the increased payment increases the potential for default. At the same time, for secured loans, the marketability of the underlying collateral may be adversely affected by higher interest rates. In a declining interest rate environment, there is likely to be an increase in prepayment activity on loans as the borrowers refinance their loans at lower interest rates. Under these circumstances, the Company’s results of operations could be negatively impacted.

Changes in interest rates also can affect the value of loans, investments and other interest-rate sensitive assets including mortgage servicing rights, and the Company ’s ability to realize gains on the sale or resolution of assets. This type of income can vary significantly from quarter-to-quarter and year-to-year based on a number of different factors, including the interest rate environment. An increase in interest rates that adversely affects the ability of borrowers to pay the principal or interest on loans may lead to an increase in non-performing assets and increased loan loss reserve requirements that could have a material adverse effect on the Company’s results of operations.

Changes in interest rates or prepayment speeds could negatively impact the value of capitalized mortgage servicing rights.

The capitalization, amortization and impairment of mortgage servicing rights are subject to significant estimates. These estimates are based upon loan types, note rates and prepayment speed assumptions. Changes in interest rates or prepayment speeds may have a material effect on the net carrying value of mortgage servicing rights. In a declining interest rate environment, prepayment speed assumptions will increase and result in an acceleration in the amortization of the mortgage servicing rights as the assumed underlying portfolio declines and also may result in impairment as the value of the mortgage servicing rights declines.

The extended disruption or compromise of vital infrastructure, including the Company ’s technology systems, could negatively impact the Company’s results of operations and financial condition.

The Company ’s business depends on its ability to process, record and monitor a large number of transactions. The Company’s technological and physical infrastructures, which include its financial, accounting and other data processing systems, are vital to its operation. Extended disruption or compromise of its vital infrastructure by fire, power loss, natural disaster, telecommunications failure, computer hacking and viruses, terrorist activity or the domestic and foreign response to such activity, or other events outside of the Company’s control, could cause the Company to suffer regulatory consequences, reputational damage and financial losses, any of which could have a material adverse effect either on the financial services industry as a whole, or on the Company’s business, financial condition and results of operations.

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The Company faces cybersecurity and other external data security risks that could adversely affect the reputation of the Company and that could have a material adverse effect on the Company ’s financial condition and results of operations.

The Company’s business is dependent upon the transmission and storage of confidential information in digital technologies, computer and email systems, software and networks. The Company has security systems in place and regularly monitors its computer systems and network infrastructure. The Company does not believe that it has experienced a material cybersecurity breach, but it has experienced immaterial threats to its data and systems, including computer virus and malware attacks and other attempted unauthorized access to our systems. Cyber threats are rapidly evolving and the Company may not be able to anticipate or prevent all future attacks. Other financial institutions have been, and continue to be, the target of various evolving and adaptive cyberattacks, including malware and denial of service, as part of an effort to disrupt the operations of financial institutions, potentially test their cybersecurity capabilities, or obtain confidential, proprietary, or other information. As cybersecurity threats continue to evolve, the Company may incur increasing costs in an effort to minimize these risks. In addition, the Company could be held liable for, and could suffer reputational damage as a result of, any security breach or loss, which could have a material adverse effect on the Company’s financial condition and results of operations.

Third parties with which the Company does business or that facilitate its business activities, including vendors and retailers, could also be sources of operational and information security risk to the Company. There have been increasingly sophisticated and large-scale efforts on the part of third parties to breach data security with respect to financial transactions, including intercepting account information at locations where clients make purchases, as well as the use of social engineering schemes such as “phishing.” For example, large retailers have reported data breaches resulting in the loss of client information. In the event that third parties are able to misappropriate financial information of the Bank’s clients, even if such breaches take place due to weaknesses in other parties' internal data security procedures, the Company could suffer reputational or financial losses which could have a material adverse effect on its financial condition and results of operations.

Strong competition within the Company’s market area may limit profitability or generate losses.

The Company faces significant competition both in attracting deposits and in the origination of loans. Mortgage bankers, commercial banks, credit unions and other savings institutions, which have offices in the Bank ’s market area have historically provided most of the Company’s competition for deposits and loans; however, the Company also competes with financial institutions that operate through Internet banking operations throughout the United States. In addition, and particularly in times of high interest rates, the Company faces additional and significant competition for funds from money market and mutual funds, and securities firms located in the same communities and those that operate through Internet banking operations throughout the United States. Many competitors have substantially greater financial and other resources than the Company. Finally, credit unions do not pay federal or state income taxes and are subject to fewer regulatory constraints than savings banks and as a result, they may enjoy a competitive advantage over the Company. The Bank competes for loans principally on the basis of the interest rates and loan fees it charges, the types of loans it originates and the quality of services it provides to borrowers. This competitive strategy places significant competitive pressure on the prices of loans and deposits.

Loss of large checking and money market deposit client s could increase cost of funds and have a negative effect on results of operations.

The Company has a number of large deposit clients that maintain balances in checking and money market accounts at the Bank. At December 31, 2017, there were $77.0 million in checking and money market accounts of clients in the alternative energy and other industries that have relationship balances greater than $5 million. The ability to attract and retain these types of deposits has a positive effect on the Company’s net interest margin as they provide a relatively low cost of funds to the Company compared to certificates of deposits or advances. If these depositors were to withdraw these funds and the Bank was not able to replace them with similar types of deposits, the Banks cost of funds would increase and the Company’s results of operation would be negatively impacted.

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We may decide to continue to grow our business through acquisitions, which may disrupt or harm our business and dilute stockholder value.

The Company completed acquisitions in the second quarter of 2016 and the third quarter of 2015. The Company continues to regularly monitor acquisition opportunities and conducts due diligence activities related to possible transactions with banks and other financial institutions. Negotiations may take place and future acquisitions may occur at any time. Our ability to grow through acquisitions will depend, in part, on the availability of suitable acquisition targets at acceptable prices, terms and conditions; our ability to compete effectively for these acquisition candidates; and the availability of capital and personnel to complete such acquisitions and run the acquired business effectively. These risks could be heightened if we complete a large acquisition or multiple acquisitions within a relatively short period of time.

The benefits of an acquisition may take more time than expected to develop or integrate into our operations and we cannot guarantee that any acquisition will ultimately produce any benefits. Acquiring other banks, businesses, or branches involves various risks, such as potential disruption of the Company ’s business, including diversion of management’s attention; difficulty in valuing the target company; potential exposure to undisclosed, contingent, or other liabilities or problems, unanticipated costs associated with an acquisition, and an inability to recover or manage such liabilities and costs; exposure to potential asset quality issues of the target company; volatility in reported income as goodwill and other impairment losses could occur irregularly and in varying amounts; difficulty and expense of integrating the operations and personnel of the target company or in realizing projected efficiencies, revenue increases, cost savings, increased market presence, or other projected benefits; potential loss of key employees or clients of the Company or the target company; dilution to existing stockholders if securities are issued as part of transaction consideration or to fund transaction consideration; and potential changes in banking or tax laws or regulations that may affect the target company. Any of the foregoing factors could have a material adverse effect on the Company’s financial condition and results of operations.

Risks related to our Common Stock

The price of our common stock has been volatile and could continue to fluctuate in the future.

During the year ended December 31, 201 7, the price of our common stock on The Nasdaq Global Market ranged from $16.60 to $19.45 per share, and over the period from January 1, 2013 to December 31, 2017 it has ranged from $2.99 to $19.45. Our closing sale price on December 31, 2017 was $19.10 per share and on February 16, 2018 it was $18.75 per share. Our stock generally trades in relatively low volumes and its price may fluctuate in response to a number of events and factors, including, but not limited to, variations in operating results, litigation or governmental and regulatory proceedings, market perceptions of our financial reporting, changes in financial estimates and recommendations by securities analysts, the operating and stock price performance of other companies that investors may deem comparable to us, and news reports relating to trends in our markets or general economic conditions.

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We may issue additional stock, or reissue shares of treasury stock, without shareholder consent.

We have authorized 16,000,000 shares of common stock . As of December 31, 2017, 9,128,662 shares were issued and outstanding (including 4,631,124 shares that were held as treasury stock) and 6,871,338 shares were unissued. Of the unissued shares of common stock 833,333 were reserved for issuance pursuant to outstanding warrants, 49,229 shares were reserved for issuance pursuant to outstanding options and 415,292 shares were reserved for issuance pursuant to our equity incentive plans. The board of directors has authority, without action or vote of the stockholders, to issue all or part of the authorized but unissued shares and to reissue all of the treasury shares. Additional shares may be issued, or treasury shares reissued, in connection with future financing, acquisitions, employee stock plans or otherwise. Any such issuance, or reissuance, will dilute the percentage ownership of existing stockholders. We are also currently authorized to issue up to 500,000 shares of preferred stock and as of December 31, 2017, there were no preferred stock shares issued and outstanding. Under our certificate of incorporation, our board of directors can issue additional preferred stock in one or more series and fix the terms of such stock without shareholder approval. Preferred stock may include the right to vote as a series on particular matters, preferences as to dividends and liquidation, conversion and redemption rights and sinking fund provisions. The issuance of preferred stock could adversely affect the rights of the holders of common stock and reduce the value of the common stock. In addition, specific rights granted to holders of preferred stock could be used to restrict our ability to merge with or sell our assets to a third party.

Future sale of shares of our common stock in the public market upon exercise of the outstanding warrant s could depress our stock price.

Shares issuable upon exercise of the outstanding warrants represented beneficial ownership of approximately 14% of our common stock as of December 31, 2017. The warrants, or shares issuable upon exercise of the warrants, may be eligible for sale publicly under Rule 144 under the Securities Act of 1933 in certain circumstances. Sales of substantial amounts of our common stock, whether upon exercise of the warrants or otherwise, or the perception that those sales could occur, may adversely affect the market price of our common stock.

Our ability to pay dividends on or repurchase our common stock is restricted . W e have not paid a dividend on our common stock during the last nine years .

We are a stock savings bank holding company and our operations are conducted primarily by the Bank. Since we receive substantially all of our revenue from dividends from the Bank, our ability to pay dividends on our common stock depends on our receipt of dividends from the Bank. Dividend payments from the Bank are subject to legal and regulatory limitations. The ability of the Bank to pay dividends to us is also subject to its profitability, financial condition, capital needs and other cash flow requirements. There is no assurance that the Bank will be able to pay dividends to us in the future or that we will generate adequate cash flow to pay dividends in the future. The inability to receive dividends from the Bank could have an adverse effect on our business and financial condition.

Provisions of our certificate of incorporation and bylaws, as well as Delaware and federal law, may discourage, delay or prevent an acquisition of control of us, even in situations that may be viewed as desirable by our stockholders.

Provisions included in our certificate of incorporation and bylaws, as well as provisions of the Delaware General Corporation Law and federal law (including banking regulations), may discourage, delay or prevent potential acquisitions of control of us, particularly when attempted in a transaction that is not negotiated directly with and approved by our board of directors, despite perceived short-term benefits to our stockholders (such as an increase in the trading price of our common stock).

Specifically, our certificate of incorporation and bylaws include provisions that:

	•	limit the voting power of shares held by a stockholder beneficially owning in excess of 10% of the outstanding shares of our common stock;

	•	require that, with limited exceptions, business combinations between us and a stockholder beneficially owning in excess of 10% of the voting power of the outstanding shares of our stock entitled to vote in the election of directors, be approved by at least 80% of the total number of our outstanding voting shares;

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	•	require that prior to acquiring publicly traded equity securities from a stockholder that owns 5% or more of our publicly traded voting stock, with limited exception, holders of 80% or more of our voting stock outstanding, other than shares held by the selling stockholder, must approve the transaction;

	•	divide our board of directors, other than directors who may be elected by a class or series of preferred stock, into three classes serving staggered three-year terms and provide that a director may only be removed prior to the expiration of a term for cause by the affirmative vote of the holders of at least 80% of the voting power of all of the outstanding shares of capital stock entitled to vote in an election of directors;

	•	require that a special meeting of stockholders be called pursuant to a resolution adopted by a majority of our board of directors;

	•	require advance notice of nominations of directors to be made, or business to be brought, by stockholders at our annual meetings;

	•	authorize the issuance of preferred stock with such designations, rights and preferences as may be determined from time to time by our board of directors; and

	•	require that amendments to (i) our certificate of incorporation be approved by a two-thirds vote of our board of directors and by a majority of the outstanding shares of our voting stock or, with respect to the amendment of certain provisions (regarding, among other things, provisions relating to number, classification, election and removal of directors, amendment of the bylaws, call of special stockholder meetings, acquisitions of control, director liability, and certain business combinations), by 80% of the outstanding shares of our voting stock, and (ii) our bylaws be approved by a majority vote of our board of directors or the affirmative vote of at least 80% of the total votes eligible to be voted at a duly constituted meeting of stockholders.

We are subject to the provisions of Section 203 of the Delaware General Corporation Law, which prohibits a publicly-held Delaware corporation from engaging in a “business combination” with an “interested stockholder” for a period of three years after the date of the transaction in which the person became an interested stockholder, unless the business combination is approved in a prescribed manner. For purposes of Section 203, a “business combination” includes a merger, asset sale or other transaction resulting in a financial benefit to the interested stockholder, and an “interested stockholder” is a person who, either alone or together with affiliates and associates, owns (or within the past three years, did own) 15% or more of the corporation ’s voting stock. For purposes of Section 203, “voting stock” means stock of any class or series entitled to vote generally in the election of directors. Furthermore, federal law requires FRB or OCC approval prior to any direct or indirect acquisition of control (as defined in regulations) of HMN or the Bank, respectively, including, with respect to the Bank, any indirect acquisition of control through an acquisition of control of HMN.

ITEM 1B. UNRESOLVED STAFF COMMENTS

None.

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ITEM 2. PROPERTIES

The Company leases its corporate office in Rochester, Minnesota and owns the buildings and land for ten of its thirteen full service branches. The remaining three full service branches and three loan origination offices are leased. These leased branches are located at 1016 Civic Center Drive NW, Rochester, Minnesota; 100 1 ^st Ave Bldg., Suite 200, Rochester, Minnesota; and 2805 Dodd Road, Suite 160, Eagan, Minnesota. The leased loan origination offices are located at 50 14 ^th Avenue East, Suite 100, Sartell, Minnesota; 1850 Austin Road, Suite 103, Owatonna, Minnesota; and 3960 Hillside Drive, Suite 206, Delafield, Wisconsin. The Bank uses all properties and they are all located in Minnesota, except for one full service branch located in Iowa and one loan origination office located in Wisconsin.

I TEM 3. LEGAL PROCEEDINGS

From time to time, the Company is party to legal proceedings arising out of its lending and deposit operations. The Company is, and expects to become, engaged in a number of foreclosure proceedings and other collection actions as part of its collection activities. Based on our current understanding of these pending legal proceedings, management does not believe that judgments or settlements arising from pending or threatened litigation 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 4. M INE SAFETY DISCLOSURES

Not applicable.

PART II

ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY, RELATED STOCKHOLDER MATTERS AND ISSUER PURCHASES OF EQUITY SECURITIES

The information on page 20 under the caption “Dividends”, “ Note 16 Stockholders’ Equity ” of the Notes to Consolidated Financial Statements, on page 55, page 65 under the caption “Common Stock Information” and the inside back cover page of the Annual Report is incorporated herein by reference.

ITEM 6. SELECTED FINANCIAL DATA

The information on page 5 under the caption “Five Year Consolidated Financial Highlights” of the Annual Report is incorporated herein by reference.

ITEM 7. MANAGEMENT ’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

The table on page 8 and the tables regarding investment maturities on page 20 of Part 1 Item 1 of this Form 10-K, as well as the information on pages 6 through 24 under the caption “Management Discussion and Analysis” (other than the section captioned “Market Risk”) of the Annual Report is incorporated herein by reference.

ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURE S ABOUT MARKET RISK

Not applicable.

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ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA

The financial statements (including the Notes to Consolidated Financial Statements) on pages 29 through 62 of the Annual Report, are incorporated herein by reference.

ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE

None .

ITEM 9A. CONTROLS AND PROCEDURES

Evaluation of disclosure controls and procedures. An evaluation was carried out under the supervision and with the participation of the Company’s management, including the Bank’s President (our Principal Executive Officer) and our Chief Financial Officer (our Principal Financial Officer) of the effectiveness of the design and operation of the Company’s disclosure controls and procedures (as defined in Rule 13a-15(e) under the Exchange Act as of the end of the period covered by this report. Based on that evaluation, the Principal Executive Officer and Principal Financial Officer have 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 SEC rules and forms.

Management's Annual Report on Internal Control over Financial Reporting. The Company’s management is responsible for establishing and maintaining adequate internal control over financial reporting, as such term is defined in Exchange Act Rule 13a-15(f). Internal control over financial reporting is a process designed 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.

Internal control over financial reporting includes those policies and procedures that pertain to the maintenance of records that in reasonable detail accurately and fairly reflect the transactions and dispositions of the assets of the Company; provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the Company are only being made in accordance with authorizations of management and directors of the Company; and provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the Company ’s assets that could have a material effect on the financial statements.

Any control system, no matter how well conceived and operated, can provide only reasonable, not absolute, assurance that the objectives of the control system are met. The design of a control system inherently has limitations, and the benefits of controls must be weighed against their costs. Additionally, controls can be circumvented by the individual acts of some persons by collusion of two or more people, or by management override of the control. Therefore, no assessment of a cost-effective system of internal controls can provide absolute assurance that all control issues and instances of fraud, if any, will be detected.

Under the supervision and with the participation of management, including the Principal Executive Officer and Principal Financial Officer, the Company conducted an evaluation of the effectiveness of its internal control over financial reporting based on the framework in the 2013 Internal Control-Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission. Based on the Company’s evaluation under this framework, the Company’s management concluded that the Company’s internal control over financial reporting was effective as of December 31, 2017. The Company has not included an attestation report of our independent registered public accounting firm regarding internal control over financial reporting. Our independent registered public accounting firm is not required to attest to management's report pursuant to Item 308(b) of Regulation S-K because the Company is not an accelerated filer or large accelerated filer.

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Changes in internal controls. No change in the Company’s internal control over financial reporting was identified in connection with the evaluation required by Rule 13a-15(d) of the Exchange Act that occurred during the period covered by this report and that has materially affected, or is reasonably likely to materially affect, the Company’s internal control over financial reporting.

ITEM 9b. OTHER INFORMATION

None.

PART III

ITEM 10. DIRECTORS, EXECUTIVE OFFICERS AND CORPORATE GOVERNANCE

The information required by this Item is incorporated by reference from the information under the caption “Executive Officers of the Registrant” in Part I , Item 1, of this report and under the captions “Proposal 1 – Election of Directors - Board of Directors,” “Corporate Governance - Committees of the Board of Directors” and “Section 16(a) Beneficial Ownership Reporting Compliance” in the Company’s definitive proxy statement to be filed with the SEC pursuant to Regulation 14A not later than 120 days after the close of the Company’s fiscal year ended December 31, 2017 (the 2018 Proxy Statement).

The Company has adopted a Code of Ethics that applies to its principal executive officer, principal financial and accounting officer, controller and other persons performing similar functions. The Company has posted the Code of Ethics on its website located at www.hmnf.com. The Company intends to post on its website any amendment to , or a waiver from, a provision of the Code of Ethics that applies to its principal executive officer, principal financial and accounting officer, controller or other persons performing similar functions within four business days following the date of such amendment or waiver.

ITEM 11. EXECUTIVE COMPENSATION

The information required by this Item is incorporated by reference from the information under the caption “201 7 Executive Compensation” and “2017 Director Compensation” in the 2018 Proxy Statement.

ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIA L OWNERS AND MANAGEMENT AND RELATED STOCKHOLDER MATTERS

The information required by this Item is incorporated by reference from the information under the captions “Security Ownership of Management and Certain Beneficial Owners” and “Other Equity Compensation Plan Information” in the 2018 Proxy Statement.

ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS, AND DIRECTOR INDEPENDENCE

The information required by this Item is incorporated by reference from the information under the captions “Corporate Governance – Committees of the Board of Directors; - Director Independence; - Related Person Transaction Approval Policy; and - Certain Transactions” in the 2018 Proxy Statement.

ITEM 14. PRINCIPAL ACCOUNT ing FEES AND SERVICES

The information required by this Item is incorporated by reference from the information under the captions “Corporate Governance - Independent Registered Public Accounting Firm Fees” and “ -Approval of Independent Registered Public Accounting Firm Services and Fees” in the 2018 Proxy Statement.

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PART IV

ITEM 15. EXHIBITS , FINANCIAL STATEMENT SCHEDULES

Financial Statements

The following financial statements appearing in the Company's Annual Report, are incorporated herein by reference.

	Pages in
Annual Report Section	2017 Annual Report
Consolidated Balance Sheets -- December 31, 2017 and 2016	25

Consolidated Statements of Comprehensive Income -- Each of the Years in the Three-Year Period Ended December 31, 2017	26

Consolidated Statements of Stockholders’ Equity -- Each of the Years in the Three-Year Period Ended December 31, 2017	27

Consolidated Statements of Cash Flows -- Each of the Years in the Three-Year Period Ended December 31, 2017	28

Notes to Consolidated Financial Statements	29

Report of Independent Registered Public Accounting Firm	63

Financial Statement Schedules

All financial statement schedules have been omitted as this information is not required under the related instructions, is not applicable or has been included in the Notes to Consolidated Financial Statements.

3. Exhibits

The exhibits filed with this report are set forth on the Index of Exhibits filed as part of this report immediately preceeding the signatures.

ITEM 1 6. FORM 10-K SUMMARY

None.

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INDEX TO EXHIBITS

Exhibit Number	Exhibit	Filing Status
3.1	Certificate of Incorporation (Amended and Restated through July 28, 2015)	Incorporated by Reference (1)

3.2	Amended and Restated By-laws	Incorporated by Reference (2)

4.1	Form of Common Stock Certificate	Incorporated by Reference (3)

4.2	Form of Warrant to Purchase Common Stock	Incorporated by Reference (4)

10.1 †	Form of Change in Control Agreement with executive officers	Incorporated by Reference (5 )

10.2 †	Directors Deferred Compensation Plan	Incorporated by Reference (6 )

10.3†	Non-Employee Director Stock Purchase Plan	Incorporated by Reference (7 )

10.4†	Descrip tion of annual awards to non-employee directors under the 2009 Equity Incentive Plan and form of Restricted Stock Agreement (approved April 28, 2015)	Incorporated by Reference (8 )

10.5 †	HMN Financial, Inc. Employee Stock Ownership Plan ( Amended and Restated January 1, 2016)	Incorporated by Reference (9 )

10.6 †	HMN Financial, Inc. 2009 Equity Incentive Plan	Incorporated by Reference (10 )

10.7 †	Form of Restricted Stock Agreement under HMN Financial, Inc. 2009 Equity Incentive Plan	Incorporated by Reference (11 )

10.8 †	Form of Restricted Stock Agreement under HMN Financial, Inc. 2009 Equity Incentive Plan (Approved April 28, 2015)	Incorporated by Reference (12 )

10.9 †	Form of Incentive Stock Option Agreement under HMN Financial, Inc. 2009 Equity Incentive Plan (Approved January 26, 2016)	Incorporated by Reference (13 )

10.10 †	Form of Non-Statutory Stock Option Agreement under HMN Financial, Inc. 2009 Equity Incentive Plan	Incorporated by Refere nce (14)

10.11 †	Amendment to the January 2014 Restricted Stock Award Agreements (Amended January 26, 2016)	Incorporated by Reference (15)

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Exhibit Number	Exhibit	Filing Status
10.12 †	Executive Management Incentive Plan (Amended and Restated January 31, 2017)	Incorporated by Reference (16)

10.13 †	HMN Financial, Inc. 2017 Equity Incentive Plan	Incorporated by Reference (17)

10.14 †	Form of Directors ’ Restricted Stock Agreement for awards granted to directors under the HMN Financial, Inc. 2017 Equity Incentive Plan	Incorporated by Reference (18)

10.15 †	Form of Executives ’ Restricted Stock Agreement for awards granted to executives under the HMN Financial, Inc. 2017 Equity Incentive Plan	Filed Electronically

10.16 †	Executive Severance Agreement, dated May 23, 2017, among the Company, the Bank and Bradley C. Krehbiel	Incorporated by Reference (19)

13	Portions of Annual Report to Security Holders incorporated by reference	Filed Electronically
21	Subsidiaries of Registrant	Filed Electronically
23 .1	Consent of CliftonLarsonAllen LLP	Filed Electronically
24	Powers of Attorney	Included with Signatures
31.1	Rule 13a-14(a)/15d-14(a) Certification of Chief Executive Officer	Filed Electronically
31.2	Rule 13a-14(a)/15d-14(a) Certification of Chief Financial Officer	Filed Electronically
32	Section 1350 Certifications	Filed Electronically
101	Financial Statements of the Company from the Annual Report on Form 10-K for the year ended December 31, 2017, formatted in Extensible Business Reporting Language (XBRL): (i) the Consolidated Balance Sheets, (ii) the Consolidated Statement of Comprehensive Income, (iii) the Consolidated Statements of Stockholders ’ Equity, (iv) the Consolidated Statements of Cash Flows and (v) Notes to Consolidated Financial Statements.	Filed Electronically
† Management contract or compensatory arrangement.

1	Incorporated by reference to Exhibit 3.1 to the Company’s Quarterly Report on Form 10-Q for the period ended September 30, 2015 (File No. 000-24100).

2	Incorporated by reference to Exhibit 3.1 to the Company’s Current Report on Form 8-K, dated March 5, 2012 (File No. 000-24100).

3	Incorporated by reference to the same numbered exhibit to the Company’s Registration Statement on Form S-1 dated April 1, 1994 (File No. 33-77212).

4	Incorporated by reference to Exhibit 4.1 to the Company’s Current Report on Form 8-K dated December 19, 2008, filed on December 23, 2008 (File No. 000-24100).

5	Incorporated by reference to Exhibit 10.1 to the Company’s Current Report on Form 8-K dated May 27, 2014, filed on June 2, 2014 (File No. 000-24100).

6	Incorporated by reference to the same numbered exhibit to the Company’s Annual Report on Form 10-K for the period ended December 31, 1994 (File No. 000-24100).

7	Incorporated by reference to Exhibit 10.1 to the Company’s Quarterly Report on Form 10-Q for the period ended March 31, 2015 (File No. 000-24100).

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8	Incorporated by reference to Exhibit 10.2 to the Company’s Quarterly Report on Form 10-Q for the period ended March 31, 2015 (File No. 000-24100).

9	Incorporated by reference to Exhibit 10. 5 to the Company’s Annual Report on Form 10-K for the period ended December 31, 2015 (File No. 000-24100).

10	Incorporated by reference to Exhibit A to the Company’s Proxy Statement for its Annual Meeting of Stockholders held on April 28, 2009 (File No. 000-24100).

11	Incorporated by reference to Exhibit 99.1 to the Company’s Current Report on Form 8-K dated May 6, 2009, filed on May 12, 2009 (File No. 000-24100).

12	Incorporated by reference to Exhibit 10.8 to the Company’s Annual Report on Form 10-K for the period ended December 31, 2015 (File No. 000-24100).

13	Incorporated by reference to Exhibit 10.9 to the Company’s Annual Report on Form 10-K for the period ended December 31, 2015 (File No. 000-24100).

14	Incorporated by reference to Exhibit 99.3 to the Company’s Current Report on Form 8-K dated May 6, 2009, filed on May 12, 2009 (File No. 000-24100).

15	Incorporated by reference to Exhibit 10.12 to the Company’s Annual Report on Form 10-K for the period ended December 31, 2015 (File No. 000-24100).

16	Incorporated by reference to Exhibit 10.11 to the Company’s Annual Report on Form 10-K for the period ended December 31, 2016 (File No. 000-24100).

17	Incorporated by reference to Exhibit 10.1 to the Company’s Quarterly Report on Form 10-Q for the period ended March 31, 2017 (File No. 000-24100).

18	Incorporated by reference to Exhibit 10.2 to the Company’s Quarterly Report on Form 10-Q for the period ended March 31, 2017 (File No. 000-24100).

19	Incorporated by reference to Exhibit 10.1 to the Company’s Current Report on Form 8-K dated May 23, 2017, filed on May 30, 2017 (File 000-24100).

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SIGNATURES

Pursuant to the requirements of Section 13 or 15(d) 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.
Date: March 9, 2018	By:	/s/Bradley Krehbiel
		Bradley Krehbiel,
		President and CEO

Each of the undersigned hereby appoints Hugh Smith and Jon Eberle, and each of them (with full power to act alone), as attorneys and agents for the undersigned, with full power of substitution, for and in the name, place and stead of the undersigned, to sign and file with the Securities and Exchange Commission under the Securities Act of 1934, as amended, any and all amendments and exhibits to this Form 10-K and any and all applications, instruments, and other documents to be filed with the Securities and Exchange Commission pertaining to this Form 10-K or any amendments thereto, with full power and authority to do and perform any and all acts and things whatsoever requisite and necessary or desirable. Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed by the following persons on behalf of the registrant and in the capacities indicated on March 9, 2018.

Name		Title
/s/ Bradley Krehbiel		President and CEO
Bradley Krehbiel		(Principal Executive Officer)

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

/s/ Hugh Smith		Chairman of the Board
Hugh Smith

/s/ Allen Berning		Director
Allen Berning

/ s/ M ichael B ue		Director
Michael Bue

/s/ Bernard Nigon		Director
Bernard Nigon

/s/ Wendy Shannon		Director
Wendy Shannon

/s/ Patricia Simmons		Director
Patricia Simmons

/ s/ M ark U tz		Director
Marl Utz

/ s/ H ans Z ietlow		Director
Hans Zietlow

Exhibit 10.15

HMN FINANCIAL, INC .

201 7 EQUITY INCENTIVE PLAN

Restricted Stock A greement
(Executives)

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 to satisfaction of service-based conditions (the “Restricted Shares”). The terms and conditions of this Restricted Stock Award are set forth in this Restricted Stock Award 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 is amended.

Full Name of Participant:
N umber of Restricted Shares Granted:		Grant Date:
Vesting Schedule:

Vesting Date s	Number of Restricted Shares that Vest

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:
			Title:

HMN Financial , Inc.

201 7 Equity Incentive Plan

Restricted Stock Agreement

Terms and Conditions

Grant of Restricted S hares . 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 9(b) and 9(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 vest 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.

	(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 . If you remain a Service Provider to the Company (or any Affiliate) continuously from the Grant Date specified on the cover page of this Agreement, then the Restricted Shares will vest in the number(s) and on the date(s) specified in the Vesting Schedule on the cover page of this Agreement.

(b) Accelerated Vesting . Notwithstanding Section 4(a), the Restricted Shares will vest in full upon the earlier to occur of (i) the termination of your Service to the Company and its Affiliates because of your death or Disability, or (ii) a Change in Control that occurs while you continue to be a Service Provider.

5 .

Release of Unrestricted Shares . Upon the vesting of Restricted Shares and the corresponding lapse of the transfer restrictions, and after the Company has determined that all conditions to the release of unrestricted Shares to you, including compliance with all applicable legal requirements, have been satisfied, it shall release to you the unrestricted 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.

Forfeiture of Restricted Shares . Subject to Section 4(b), if your Service to the Company or any Affiliate 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.

83(b) Election . You may make and file with the Internal Revenue Service an election under Section 83(b) of the Code with respect to the grant of the Restricted Shares hereunder, electing to include in your gross income as of the Grant Date the Fair Market Value of the Restricted Shares as of the Grant Date. You shall promptly provide a copy of such election to the Company. If you make and file such an election, you shall make such arrangements in accordance with Section 8 as are satisfactory to the Committee to provide for the timely payment of all applicable withholding taxes.

Withholding Taxes . You hereby authorize the Company (or any Affiliate) to withhold from payroll or other amounts payable to you any sums required to satisfy any federal, state, local or foreign withholding taxes that may be due as a result of the receipt or vesting of Restricted Shares, and the Company may defer the release to you of any and all unrestricted Shares until you have made arrangements acceptable to the Company for payment of all such withholding taxes in accordance with the provisions of Section 14 of the Plan. If you wish to satisfy some or all of such withholding tax obligations by delivering Shares you already own or by having the Company retain a portion of the unrestricted Shares that would otherwise be released to you, you must notify the Company prior to vesting of the Restricted Shares.

9 .	Restrictive Legend s 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.

1 0 .

No Right to C ontinued 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.

1 1 .

Interpretation of This Agreement . All decisions and interpretations made by the Committee 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.

1 2 .

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.

1 3 .

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 4 .

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 5 .

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 6 .

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.

Exhibit 13

Financial Highlights	1
Letter to Shareholders and Clients	2
Board of Directors	4
Five-year Consolidated Financial Highlights	5
Management Discussion and Analysis	6
Consolidated Financial Statements	26
Notes to Consolidated Financial Statements	30
Report of Independent Registered Public Accounting Firm	67
Other Financial Data	68
Common Stock Information	69
Selected Quarterly Financial Data	70
Corporate and Shareholder Information	Inside Back Cover
Directors and Officers	Inside Back Cover

HMN Financial, Inc. and Home Federal Savings Bank are headquartered in Rochester, Minnesota. Home Federal Savings Bank operates twelve full service offices in Minnesota located in Albert Lea, Austin, Eagan, Kasson (2), La Crescent, Rochester (4), Spring Valley and Winona; one full service office in Marshalltown, Iowa; two loan origination offices in Minnesota located in Sartell and Owatonna; and one loan origination office in Delafield, Wisconsin.

FINANCIAL HIGHLIGHTS

	At or For the Year Ended
Operating Results:	December 31,						Percentage
(Dollars in thousands, except per share data)	201 7			201 6			Change
Total interest income	$	27,680			27,349			1.2	%
Total interest expense		1,797			1,593			12.8
Net interest income		25,883			25,756			0.5
Provision for loan losses		(523	)		(645	)		18.9
Net interest income after provision for loan losses		26,406			26,401			0.0
Fees and service charges		3,354			3,427			(2.1	)
Loan servicing fees		1,202			1,108			8.5
Gain on sales of loans		2,138			2,618			(18.3	)
Other non-interest income		960			1,048			(8.4	)
Total non-interest income		7,654			8,201			(6.7	)
Total non-interest expense		25,254			24,130			4.7
Income before income tax expense		8,806			10,472			(15.9	)
Income tax expense		4,402			4,122			6.8
Net income	$	4,404			6,350			(30.6	)

Per Common Share Information:
Earnings per common share and common share equivalents :
Basic	$	1.04			1.52
Diluted		0.90			1.34
Stock price (for the year) :
High	$	19.45			18.55
Low		16.60			10.81
Close		19.10			17.50
Book value per common share		17.97			16.91
Closing price to book value		106.29	%		103.49	%

Financial Ratios:
Return on average assets		0.63	%		0.96	%		(34.4	)%
Return on average stockholders ’ equity		5.52			8.71			(36.6	)
Net interest margin		3.86			4.11			(6.1	)
Operating expenses to average assets		3.62			3.66			(1.1	)
Average stockholders ’ equity to average assets		11.43			11.07			3.3
Stockholders ’ equity to total assets at year end		11.18			11.13			0.4
Non-performing assets to total assets		0.52			0.57			(8.8	)
Efficiency ratio		75.30			71.06			6.0

Balance Sheet Data:	December 31,						Percentage
(Dollars in thousands)	2017			201 6			Change
Total assets	$	722,685			682,023			6.0	%
Securities available for sale		77,472			78,477			(1.3	)
Loans held for sale		1,837			2,009			(8.6	)
Loans receivable, net		585,931			551,171			6.3
Deposits		635,601			592,811			7.2
Federal Home Loan Bank advances and other borrowings		0			7,000			(100.0	)
Stockholders ’ equity		80,818			75,919			6.5
Home Federal Savings Bank regulatory capital ratios:
Common equity Tier 1 capital		12.45	%		13.42	%		(7.2	)%
Tier 1 leverage		10.68			11.55			(7.5	)
Tier 1 risk-based capital		12.45			13.42			(7.2	)
Total risk-based capital		13.71			14.68			(6.6	)

Letter to Shareholders and Clients

I am pleased to present you with our 2017 Annual Report. Our focus during the year to improve core balance sheet and earnings growth is reflected throughout this report.

Balance Sheet

By year-end 2017, total assets had grown by $41 million. This growth was comprised primarily of increases in our highest yielding assets- mortgage and commercial real estate loans. By design, our investment portfolio remained level throughout the year as management worked to deploy excess liquidity. It is important to note that this loan growth reflects loans made and serviced directly by Home Federal, and not loans purchased from third party originators. While we regularly participate with other community banks, the outstanding balances of participations purchased declined $8.5 million during the year to $20.1 million. We believe organic loan growth offers us the best opportunity to develop long-term multi-product relationships with our clients.

Deposits also exhibited growth during the year with commercial accounts leading the way increasing by $35.9 million. Retail accounts over the same period grew by $6.9 million. This growth can be attributed to management’s efforts to solicit more local deposits and the improving financial condition of our commercial clients. We have also experienced success in attracting new clients with special affiliation accounts like our Jubilee Program, for clients 55 and older and obtaining larger deposit relationships by providing insurance coverage for deposits over FDIC limits using the insured cash sweep (ICS) and Certificate of Deposit Account Registry Service (CDARS) programs offered through a third party vendor.

During the year, we prepaid the remaining $7 million balance of the $ 10 million term loan secured in 2014 to repurchase the remaining HMN Preferred shares issued in connection with the Troubled Asset Relief Program (TARP). At a rate of 6.5%, this obligation represented our single most expensive source of funds and was an excellent opportunity to deploy excess balance sheet liquidity and capital of the Company.

In spite of our growth, our capital level remains strong. While it might appear to some that we hold more capital than is necessary, I firmly believe that our disciplined approach to capital planning will position our Company to capitalize on growth opportunities as they arise- in good times or in bad-, prudently fund organic growth and weather adverse economic conditions when they arise.

Income Statement

Net income for 2017 was $4.4 million, a decline of $ 2.0 million from 2016. The decline in income between the periods is partially because of the $1.1 million increase in income tax expense as a result of tax reform legislation that was enacted in the fourth quarter of 2017. The decline relating to our core operating results was centered in lower commercial loan sale gains- a result of increased competition from conventional lenders- and a decline in gain on sale of non-performing assets. It is important to note that as our asset quality has improved, the opportunities to recognize yield enhancements as problem assets are collected have diminished as well. These assets include our own recession-era legacy assets as well as purchased assets that are collected in excess of our book value.

The continuing low interest rate environment caused a 0.23% decline in our yield on average earning assets. Fortunately, the aforementioned loan growth along with a nominal increase in our cost of funds enabled us to report higher net interest income compared with the prior year.

Asset Quality

Non-performing asset levels remained flat during the year- further evidence of our improved asset quality and more normalized operations. Our past due ratio as of year -end remained very low at 0.30%, while our reserve for problem loans remained a healthy 1.57% of total loans. Our improved asset quality allowed us to record a reverse provision for loan losses during the year of $0.5 million.

Markets

I continue to be pleased by our growth in nearly all of our markets. While some of this growth can be attributed to the overall improvement in the economy, we believe it is a reflection of our approach to community banking, one which empowers qualified managers to make local decisions in their own markets. Late in the year, we announced plans to open our first new branch in over ten years. Located in Owatonna, Minnesota, this branch is the logical next step for our Business Development Office we established there in 2015. We are using this opportunity to utilize the latest developments in a branch floor plan design and technology while continuing to meet the market’s sales and service expectations.

The pricing expectations of community banks contemplating a sale increased dramatically throughout the year. While acquisitions remain an important component of our growth strategy, we must remain disciplined in our approach to deal pricing. During the year, our acquisitions team considered a number of potential acquisition opportunities in new markets. Unfortunately, we were unable to negotiate the terms and conditions we felt necessary to ensure sufficient earnings accretion and the enhancement in long-term shareholder value. We continue to aggressively look for new opportunities for growth through acquisition.

Summary

As I review this annual report, I am particularly pleased with the increase in the core operating results of the Bank. It is a reflection of our commitment to enhancing long-term franchise and shareholder value- a commitment to doing what is in the long-term best interest of our Company and its shareholders. I want to thank each and every one of you for your support over the past year and especially thank our dedicated employees and board members for their work in helping to accomplish our mission.

Best Regards,

Brad Krehbiel

President/CEO

FIVE-YEAR CONSOLIDATED FINANCIAL HIGHLIGHTS

Selected Operations Data:	Year Ended December 31,
(Dollars in thousands, except per share data)	2017			2016			2015			2014			2013
Total interest income	$	27,680			27,349			21,453			20,613			22,983
Total interest expense		1,797			1,593			1,507			1,211			3,289
Net interest income		25,883			25,756			19,946			19,402			19,694
Provision for loan losses		(523	)		(645	)		(164	)		(6,998	)		(7,881	)
Net interest income after provision for loan losses		26,406			26,401			20,110			26,400			27,575
Fees and service charges		3,354			3,427			3,316			3,458			3,513
Loan servicing fees		1,202			1,108			1,046			1,058			1,029
Gain on sales of loans		2,138			2,618			1,964			1,828			2,102
Other non-interest income		960			1,048			1,327			940			668
Total non-interest income		7,654			8,201			7,653			7,284			7,312
Total non-interest expense		25,254			24,130			23,196			21,403			22,623
Income before income tax expense		8,806			10,472			4,567			12,281			12,264
Income tax expense (benefit)		4,402	⁽¹⁾		4,122			1,611			4,902			(14,406	) ⁽²⁾
Net income		4,404			6,350			2,956			7,379			26,670
Preferred stock dividends and discount		0			0			(108	)		(1,710	)		(2,068	)
Net income available to common shareholders	$	4,404			6,350			2,848			5,669			24,602

Basic earnings per common share	$	1.04			1.52			0.69			1.40			6.15
Diluted earnings per common share		0.90			1.34			0.61			1.23			5.71

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

⁽² ⁾ Relates to the elimination of the deferred tax asset valuation reserve at December 31, 2013.

Selected Financial Condition Data:	December 31,
(Dollars in thousands, except per share data)	2017			2016			2015			2014			2013
Total assets	$	722,685			682,023			643,161			577,426			648,622
Securities available for sale		77,472			78,477			111,974			137,834			107,956
Loans held for sale		1,837			2,009			3,779			2,076			1,502
Loans receivable, net		585,931			551,171			463,185			365,113			384,615
Deposits		635,601			592,811			559,387			496,750			553,930
Federal Home Loan Bank advances and other borrowings		0			7,000			9,000			0			0
Stockholders ’ equity		80,818			75,919			69,645			76,013			85,675
Book value per common share		17.97			16.91			15.54			14.77			13.49

Number of full service offices		13			13			13			11			11
Number of loan origination offices		3			3			3			2			1

Key Ratios : ⁽³ ⁾
Stockholders ’ equity to total assets at year end		11.18	%		11.13	%		10.83	%		13.16	%		13.21	%
Average stockholders ’ equity to average assets		11.43			11.07			11.70			13.25			10.77
Return on stockholders ’ equity (ratio of net income to average equity)		5.52			8.71			4.27			9.12			42.22
Return on assets (ratio of net income to average assets)		0.63			0.96			0.50			1.21			4.55

⁽³ ⁾ Average balances were calculated based upon amortized cost without the market value impact of ASC 320.

^{See accompanying notes to consolidated financial statements.}

This Annual Report, other reports filed by the Company with the Securities and Exchange Commission, and the Company ’s proxy statement may contain forward-looking statements within the meaning of the safe harbor provisions of the Private Securities Litigation Reform Act of 1995. These statements are often identified by such forward-looking terminology as “expect,” “intend,” “look,” “believe,” “anticipate,” “estimate,” “project,” “seek,” “may,” “will,” “would,” “could,” “should,” “trend,” “target,” and “goal” or similar statements or variations of such terms and include, but are not limited to, those relating to growing our core deposit relationships and loan balances, enhancing the financial performance of our core banking operations, maintaining credit quality, reducing non-performing assets, and generating improved financial results (including profitability); the extent of the positive impact of the lower federal tax rate on future earnings; 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; anticipated future levels of the provision for loan losses; future losses on non-performing assets; the amount and composition of interest-earning assets; the amount of yield enhancements relating to non-accruing and purchased loans; the amount and composition of non-interest and interest-bearing liabilities; the availability of alternate funding sources; the payment of dividends by HMN; the future outlook for the Company; the amount of deposits that will be withdrawn from checking and money market accounts and how the withdrawn deposits will be replaced; the projected changes in net interest income based on rate shocks; the range that interest rates may fluctuate over the next twelve months; the net market risk of interest rate shocks; the future outlook for the issuer of the trust preferred securities held by the Bank; the ability of the Bank to pay dividends to HMN; the ability to remain well capitalized; the impact of new accounting pronouncements, and compliance by the Bank with regulatory standards generally (including the Bank’s status as “well-capitalized”) and other supervisory directives or requirements to which the Company or the Bank are or may become expressly subject, specifically, and possible responses of the Office of the Comptroller of the Currency (OCC), Board of Governors of the Federal Reserve System (FRB), the Bank, and the Company to any failure to comply with any such regulatory standard, directive or requirement.

A number of factors could cause actual results to differ materially from the Company ’s assumptions and expectations. These include but are not limited to the adequacy and marketability of real estate and other collateral securing loans to borrowers; federal and state regulation and enforcement; possible legislative and regulatory changes, including additional changes to regulatory capital rules; the ability of the Bank to comply with other applicable regulatory capital requirements; enforcement activity of the OCC and FRB in the event of our non-compliance with any applicable regulatory standard or requirement; adverse economic, business and competitive developments such as shrinking interest margins, reduced collateral values, deposit outflows, changes in credit or other risks posed by the Company’s loan and investment portfolios; changes in costs associated with alternate funding sources, including changes in collateral advance rates and policies of the Federal Home Loan Bank ( 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; 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 and 10-Q with the Securities and Exchange Commission (SEC) . 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, 2017.

All statements in this Annual Report, including forward-looking statements, speak only as of the date hereof, and we undertake no duty to update any of the forward-looking statements after the date of this Annual Report.

Overview

HMN Financial, Inc. (HMN or the Company) is the stock savings bank holding company for Home Federal Savings Bank (the Bank) , which operates community banking and loan production offices in Minnesota, Iowa and Wisconsin. The earnings of the Company are primarily dependent on the Bank's net interest income, which is the difference between interest earned on loans and investments, and the interest paid on interest-bearing liabilities such as deposits and other borrowings. The difference between the average rate of interest earned on assets and the average rate paid on liabilities is the "interest rate spread". Net interest income is produced when interest-earning assets equal or exceed interest-bearing liabilities and there is a positive interest rate spread. Net interest income and net interest rate spread are affected by changes in interest rates, the volume and composition of interest-earning assets and interest-bearing liabilities, and the level of non-performing assets. The Company's net earnings are also affected by the generation of non-interest income, which consists primarily of gains from the sale of loans and real estate owned, fees for servicing loans, commissions on the sale of uninsured investment products, and service charges on deposit accounts. The Bank incurs expenses in addition to interest expense in the form of compensation and benefits, occupancy and equipment expenses, provisions for loan losses, professional services, deposit insurance, amortization expense on mortgage servicing assets, data processing costs and income taxes. The earnings of financial institutions, such as the Bank, are also significantly affected by prevailing economic and competitive conditions, particularly changes in interest rates, government monetary and fiscal policies, and regulations of various regulatory authorities. Lending activities are influenced by the demand for and supply of business credit, single family and commercial properties, competition among lenders, the level of interest rates and the availability of funds. Deposit flows and costs of deposits are influenced by prevailing market rates of interest on competing investments, account maturities and the levels of personal income and savings.

Critical Accounting Estimates

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

Allowance for Loan Losses and Related Provision

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

The appropriateness of the allowance for loan losses is dependent upon management ’s estimates of variables affecting valuation, appraisals of collateral, evaluations of performance and status, and the amounts and timing of future cash flows expected to be received on impaired loans. Such estimates, appraisals, evaluations and cash flows may be subject to adjustments due to changing economic prospects of borrowers or properties. The fair market value of collateral dependent loans 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 by receiving recoveries of previously charged off loans. The Company decreases its allowance by crediting the provision for loan losses. The current year activity in the allowance resulted in a credit to the loan loss provision. The methodology for establishing the allowance for loan losses takes into consideration probable losses that have been identified in connection with specific loans as well as losses in the loan portfolio that have not been specifically identified. Although management believes that based on current conditions the allowance for loan losses is maintained at an appropriate amount to provide for probable loan losses inherent in the portfolio as of the balance sheet dates, future conditions may differ substantially from those anticipated in determining the allowance for loan losses and adjustments may be required in the future.

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 differenc es, the largest of which relates to the allowance for loan and real estate losses. For tax purposes only the net charge-offs are deductible while the entire provision for loan losses is used to determine book income. A deferred tax asset is created because of the timing difference of when the expense is recognized for book and tax purposes. Under 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. The Company could not currently identify any negative evidence. It is possible that future conditions may differ substantially from those anticipated in determining that no valuation allowance was required on deferred tax assets and adjustments may be required in the future.

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

Results of Operations

Comparison of 201 7 with 201 6

Net income was $4.4 million for 2 017, a decrease of $2.0 million compared to net income of $6.4 million for 2016. Diluted earnings per share for the year ended December 31, 2017 was $0.90, a decrease of $0.44 per share compared to diluted earnings per share of $1.34 for the year ended December 31, 2016. The decrease in net income for 2017 is due primarily to a $0.5 million decrease in the gain on sales of loans because of a decrease in commercial government guaranteed loan sales and a $0.5 million decrease in the gains on real estate owned because of fewer sales between the periods. Net income also decreased $0.4 million due to an increase in other non-interest expenses primarily related to advertising expenses, $0.3 million due to an increase in income tax expense, $0.2 million because of an increase in compensation and benefits and $0.1 million due to an increase in the loan loss provision between the periods. The increase in income tax expense is due primarily to the $1.1 million decrease in the Company’s net deferred tax asset as a result of the reduction in the corporate federal tax rate in connection with the enactment of the Tax Cuts and Jobs act in the fourth quarter of 2017. These decreases in net income were partially offset by an increase in net interest income of $0.1 million as a result of an increase in the average interest-earning assets and a change in the composition of the average interest-earning assets held between the periods.

Net Interest Income

Net interest income was $25.9 million for 2017, an increase of $0.1 million, or 0.5%, from $25.8 million for the same period of 2016. Interest income was $27.7 million for 2017, an increase of $0.4 million, or 1.2%, from $27.3 million for the same period of 2016. Interest income increased $2.4 million 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 6 basis point increase in the average yields earned between the periods. While the average interest-earning assets increased $43.2 million between the periods, the average interest-earning assets held in higher yielding loans increased $58.8 million and the amount of average interest-earning assets held in lower yielding cash and investments decreased $15.6 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 increase in interest income as a result of these items was partially offset by a decrease in interest income as a result of recognizing a lower amount of yield enhancements between the periods. Interest income decreased $2.1 million due to a decrease in the amount of yield enhancements recognized from loan prepayment penalties, yield adjustments on purchased loans, and the interest payments received on non-accruing and previously charged off commercial real estate loans. This resulted in a 29 basis point decrease in the average yield between the periods. It is anticipated that the yield enhancements relating to these items will be lower in subsequent periods as the pool of non-accruing and purchased loans continues to decline. The average yield earned on interest-earning assets was 4.13% for 2017, a decrease of 23 basis points from 4.36% for 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 $1.8 million for 2017, an increase of $0.2 million, or 12.8%, compared to $1.6 million for 2016. The average interest rate paid on non-interest and interest-bearing liabilities was 0.29% for 2017, an increase of 1 basis point from 0.28% for 2016. The average rate paid increased between the periods due to an increase in the rates paid on certain money market and certificate of deposit accounts. This increase was partially offset by a decrease in the interest paid on other borrowings due to a decrease in the average borrowings outstanding between the periods. The average non-interest and interest-bearing liabilities increased $34.6 million between the periods, the average amount held in lower rate checking, savings, and money market accounts increased $10.4 million, the average amount held in higher rate premium money market accounts increased $22.5 million, and the average amount held in higher rate borrowings and certificates of deposit increased $1.7 million between the periods.

The following table presents the total dollar amount of interest income from average interest-earning assets and the resultant yields, as well as the interest expense on average interest-bearing liabilities, expressed both in dollars and rates. Non-accruing loans have been included in the average outstanding loan balance in the table as loans carrying a zero yield.

	Year Ended December 31,
	201 7								20 16								20 15
(Dollars in thousands)	Average Outstanding Balance		Interest Earned/ Paid			Average Yield/ Rate			Average Outstanding Balance		Interest Earned/ Paid			Average Yield/ Rate			Average Outstanding Balance		Interest Earned/ Paid			Average Yield/ Rate
Interest-earning assets :
Securities available for sale:
Mortgage-backed and related securities	$	2,524		57			2.26	%	$	1,631		58			3.56	%	$	3,274		116			3.54	%
Other marketable securities		74,035		1,103			1.49			84,528		1,289			1.52			130,806		1,881			1.44
Loans held for sale		1,905		94			4.93			3,046		126			4.14			2,507		87			3.47
Loans receivable, net ^{(1) (2)}		573,894		26,274			4.58			513,974		25,774			5.01			394,086		19,302			4.90
FHLB stock		874		12			1.37			770		6			0.78			734		4			0.54
Other, including cash equivalents		17,214		140			0.81			23,337		96			0.41			28,544		63			0.22
Total interest-earning assets	$	670,446		27,680			4.13		$	627,286		27,349			4.36		$	559,951		21,453			3.83

Interest-bearing liabilities:
NOW accounts	$	87,416		77			0.09	%	$	85,440		50			0.06	%	$	76,136		17			0.02	%
Passbooks		76,592		63			0.08			71,728		62			0.09			55,273		42			0.08
Money market accounts		179,675		560			0.31			164,522		366			0.22			153,441		347			0.23
Certificate accounts		106,006		770			0.73			100,942		524			0.52			96,600		528			0.55
FHLB advances and other borrowings		6,335		327			5.16			9,374		591			6.30			9,225		573			6.21
Total interest-bearing liabilities	$	456,024							$	432,006							$	390,675
Noninterest checking		156,149								145,450								124,342
Other non-interest-bearing liabilities		1,279								1,434								985
Total interest-bearing liabilities and noninterest-bearing deposits	$	613,452		1,797			0.29	%	$	578,890		1,593			0.28	%	$	516,002		1,507			0.29	%
Net interest income				25,883								25,756								19,946
Net interest rate spread							3.84	%							4.08	%							3.54	%
Net earning assets	$	56,994							$	48,396							$	43,949
Net interest margin							3.86	%							4.11	%							3.56	%
Average interest-earning assets to average interest-bearing liabilities and noninterest-bearing deposits				109.29	%							108.36	%							108.52	%

⁽¹ ⁾ Tax exempt income was not material; therefore, the yield was not presented on a tax equivalent basis for any of the years presented.

⁽²⁾ Calculated net of deferred loan fees, loan discounts, loans in process and loss reserves.

Net interest margin decreased 25 basis points to 3.86% in 2017 from 4.11% in 2016 primarily because of a $2.1 million, or 29 basis point decrease in the yield enhancements recognized between the periods. Average net earning assets increased from $48.4 million in 2016 to $57.0 million in 2017. The $8.6 million increase in net earning assets is due to the net income earned in 2017 adjusted for non-cash items including the expenses incurred related to deferred tax asset changes and depreciation.

The following table presents the dollar amount of changes in interest income and interest expense for major components of interest-earning assets and interest-bearing liabilities. It quantifies the changes in interest income and interest expense related to changes in the average outstanding balances (volume) and those changes caused by fluctuating interest rates. For each category of interest-earning assets and interest-bearing liabilities, information is provided on changes attributable to (i) changes in volume (i.e., changes in volume multiplied by old rate) and (ii) changes in rate (i.e., changes in rate multiplied by current volume).

	Year Ended December 31,
	2017 vs. 201 6									2016 vs. 2015
	Increase (Decrease) Due to									Increase (Decrease) Due to
(Dollars in thousands)	Volume ⁽¹⁾			Rate ⁽¹⁾			Total Increase (Decrease)			Volume ⁽¹⁾			Rate ⁽¹⁾			Total Increase (Decrease)
Interest-earning assets:
Securities available for sale:
Mortgage-backed and related securities	$	32			(33	)		(1	)		(58	)		0			(58	)
Other marketable securities		(160	)		(26	)		(186	)		(665	)		73			(592	)
Loans held for sale		(47	)		15			(32	)		19			20			39
Loans receivable, net		3,091			(2,591	)		500			5,824			648			6,472
Cash equivalents		(25	)		69			44			(12	)		45			33
FHLB stock		1			5			6			0			2			2
Total interest-earning assets	$	2,892			(2,561	)		331			5,108			788			5,896
Interest-bearing liabilities:
NOW accounts	$	3			24			27			1			32			33
Passbooks		4			(3	)		1			12			8			20
Money market accounts		39			155			194			18			1			19
Certificates of deposit		77			169			246			26			(30	)		(4	)
FHLB advances and other borrowings		(275	)		11			(264	)		16			2			18
Total interest-bearing liabilities		(152	)		356			204			73			13			86
Increase (d ecrease) in net interest income	$	3,044			(2,917	)		127			5,035			775			5,810

⁽¹⁾ For purposes of this table, changes attributable to both rate and volume which cannot be segregated have been allocated proportionately to the

change due to volume and the change due to rate.

The following table sets forth the weighted average yields on the Company's interest-earning assets, the weighted average interest rates on interest-bearing liabilities and the interest rate spread between the weighted average yields and rates as of the date indicated. Non-accruing loans have been included in the average outstanding loan balances in the table as loans carrying a zero yield.

At December 31, 20 17
Weighted average yield on:			Weighted average rate on:
Securities available for sale:
Mortgage-backed and related securities	2.04	%	NOW accounts	0.05	%
Other marketable securities	1.61		Passbooks	0.08
Loans held for sale	5.06		Money market accounts	0.38
Loans receivable, net	4.78		Certificates of deposit	0.94
Federal Home Loan Bank stock	1.50		Combined weighted average rate on interest-bearing liabilities	0.30
Other interest-earnings assets	1.50		Interest rate spread	3.97
Combined weighted average yield on interest-earning assets	4.27

Provision for Loan Losses

The provision for loan losses was ($0.5) million for the year ended December 31, 2017, an increase of $0.1 million, from ($0.6) million for the year ended December 31, 2016. The provision for loan losses increased between the periods primarily because of the increase in the reserves required on certain commercial loans due to a deterioration of their credit quality.

A reconciliation of the allowance for loan losses for 201 7 and 2016 is summarized as follows:


( Dollars in thousands)	201 7			201 6
Balance at January 1	$	9,903			9,709
Provision		(523	)		(645	)
Charge offs:
Commercial		(311	)		(180	)
Commercial real estate		(50	)		(67	)
Consumer		(288	)		(108	)
Single family		(6	)		(66	)
Recoveries		586			1,260
Balance at December 31	$	9,311			9,903

Specific allowance	$	1,073			988
General allowance		8,238			8,915
	$	9,311			9,903

Non-Interest Income

Non-interest income was $7.7 million for the year ended December 31, 2017, a de crease of $0.5 million, from $8.2 million for the year ended December 31, 2016. The following table presents the components of non-interest income:

	Year ended December 31,						Percentage Increase (Decrease)
(Dollars in thousands)	2017		2016		2015		2017/2016			2016/2015
Fees and service charges	$	3,354		3,427		3,316		(2.1	) %		3.3	%
Loan servicing fees		1,202		1,108		1,046		8.5			5.9
Gain on sales of loans		2,138		2,618		1,964		(18.3	)		33.3
Other non-interest income		960		1,048		1,327		(8.4	)		(21.0	)
Total non-interest income	$	7,654		8,201		7,653		(6.7	)		7.2

The decrease in non-interest income is primarily related to the $0.5 million decrease in the gain on sales of loans due to a decrease in commercial government guaranteed loan sales between the periods. Fees and service charges decreased $0.1 million between the periods due primarily to a decrease in overdraft fees. Other non-interest income decreased $0.1 million because of a decrease in the revenue earned on the sale of uninsured investment products between the periods. These decreases in non-interest income were partially offset by a $0.1 million increase in loan servicing fees earned due to an increase in the loans being serviced for others between the periods.

Non-Interest Expense

Non-interest expense was $25.3 million for the year ended December 31, 20 17, an increase of $1.2 million, from $24.1 million for the year ended December 31, 2016. The following table presents the components of non-interest expense:

	Year ended December 31,								Percentage Increase (Decrease)
(Dollars in thousands)	2017			2016			2015		2017/2016			2016/2015
Compensation and benefits	$	15,007			14,764			13,733		1.6	%		7.5	%
(G ains) losses on real estate owned		(72	)		(596	)		218		87.9			(373.4	)
Occupancy and equipment		4,068			4,041			3,722		0.7			8.6
Data processing		1,106			1,161			1,020		(4.7	)		13.8
Professional services		1,285			1,257			1,108		2.2			13.4
Other		3,860			3,503			3,395		10.2			3.2
Total non-interest expense	$	25,254			24,130			23,196		4.7			4.0

Gains on real estate owned decreased $0.5 million between the periods due to the gains that were recognized on the sale of two commercial properties in 2016. Other non-interest expense increased $0.4 million primarily due to an increase in advertising expense between the periods. Compensation expense increased $0.2 million between the periods due to normal annual salary increases. Occupancy and equipment expense increased slightly because of increased software and equipment expenses. Professional services expense increased slightly due to an increase in legal expenses between the periods. These increases in non-interest expense were partially offset by a $0.1 million decrease in data processing expense due to a decrease in debit card costs between the periods.

Income Taxes

Comparison of 201 6 with 201 5

Net income was $6.4 million for 2016, an increase of $3.4 million compared to net in come of $3.0 million for 2015. Net income available to common shareholders was $6.4 million for 2016, an increase of $3.6 million compared to net income available to common shareholders of $2.8 million for 2015. Diluted earnings per share for the year ended December 31, 2016 was $1.34, an increase of $0.73 per share compared to diluted earnings per share of $0.61 for the year ended December 31, 2015. The increase in net income for 2016 was due primarily to a $5.9 million increase in interest income as a result of an increase in the average interest-earning assets and a change in the composition of the average interest-earning assets held between the periods. Gain on sales of loans increased $0.7 million due to an increase in single family mortgage loan production and sales between the periods. The provision for loan losses decreased $0.5 million between the periods due to improvements in the credit quality of the commercial loan portfolio. These increases in income were partially offset by a $1.0 million increase in compensation expense due to annual increases in compensation and an increase in the number of employees related to the increased loan production. Income tax expense increased $2.5 million because of the increase in pre-tax income between the periods.

Net Interest Income

Net interest income was $25.8 million for 2016, an increase of $5.9 million, or 29.1% , from $19.9 million for 2015. Interest income was $27.3 million for 2016, an increase of $5.8 million, or 27.5%, from $21.5 million for 2015. Interest income increased between the periods 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 an increase in the average yields earned between the periods. While the average interest-earning assets increased $67.3 million between the periods, the average interest-earning assets held in higher yielding loans increased $120.4 million and the amount of average interest-earning assets held in lower yielding cash and investments decreased $53.1 million between the periods. The yield on average interest-earning assets was also enhanced by $2.2 million, or 30 basis points, due to loan prepayment penalties, yield adjustments recognized on purchased loans, and interest payments received on non-accruing and previously charged off loans during 2016. 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. Average outstanding loans also increased $18.6 million between the periods as a result of the acquisitions that occurred in the third quarter of 2015 and the second quarter of 2016. The average yield earned on interest-earning assets was 4.36% for 2016, an increase of 53 basis points from 3.83% for 2015.

Interest expense was $1.6 million for 2016 , an increase of $0.1 million, or 5.7%, compared to $1.5 million for 2015. Interest expense increased because of an increase in the average outstanding interest-bearing liabilities. The average rate paid on interest-bearing liabilities decreased 1 basis point between the periods because of the change in the composition of the average interest-bearing liabilities. While the average interest-bearing liabilities increased $62.9 million between the periods, the average amount held in lower rate checking and money market accounts increased $58.0 million and the average amount held in higher rate certificates of deposits and other borrowings increased $4.9 million between the periods. The increase in the average outstanding deposits between the periods was primarily due to the $42.9 million increase as a result of the acquisitions that occurred in the third quarter of 2015 and the second quarter of 2016. The average interest rate paid on interest-bearing liabilities was 0.28% for 2016 compared to 0.29% for 2015. Net interest margin (net interest income divided by average interest-earning assets) for 2016 was 4.11%, an increase of 55 basis points compared to 3.56% for 2015.

Net interest margin increased to 4.11% in 2016 from 3.56% in 2015 primarily because of a change in the composition of average interest-earning assets held, which resulted in an increase in the average yields earned between the periods. The increase in the average yields earned was due to having larger average balances of higher earning loans and smaller average balances of lower earning cash and investments during 2016 when compared to 2015. The yield on average interest-earning assets was also enhanced $2.2 million, or 30 basis points, in 2016 due to loan prepayment penalties, yield adjustments recognized on purchased loans, and interest payments received on non-accruing and previously charged off loans. Average net earning assets increased from $43.9 million in 2015 to $48.4 million in 2016. The $4.5 million increase in net earning assets was due primarily to the net income earned in 2016.

The provision for loan losses was ($0.6) million for the year ended December 31, 2016, a decrease of $0.4 million, from ($0.2) million for the year ended December 31, 2015. The provision for loan losses decreased between the periods primarily because of the decrease in the reserve percentages applied to certain risk rated loan categories as a result of an internal analysis performed.

Non-interest income was $8.2 million for the year ended December 31, 2016, an increase of $0.5 million from $7.7 million for the year ended December 31, 2015 . The increase in non-interest income was primarily related to the $0.7 million increase in the gain on sales of loans due to an increase in single family loan originations and sales between the periods. Fees and service charges increased $0.1 million between the periods due primarily to an increase in debit card income. Loan servicing fees increased $0.1 million due to an increase in the loans serviced for others between the periods. These increases were partially offset by a $0.3 million decrease in other non-interest income because of a decrease in the gains realized on acquisitions between the periods.

Non-interest expense was $24.1 million for the year ended December 31, 2016, an increase of $0.9 million from $23.2 million for the year ended December 31, 2015. Compensation expense increased $1.0 million between the periods due to annual increases in compensation and an increase in the number of employees between the periods because of the increased loan production. Occupancy and equipment expense increased $0.3 million because of increased software and equipment expenses. Other non-interest expense increased $0.1 million due primarily to an increase in loan related expenses as a result of the increase in loans originated between the periods. Data processing expense increased $0.1 million between the periods due to increased mobile and on-line banking costs. Other professional expenses increased $0.1 million primarily due to expenses related to the acquisition that occurred in the second quarter of 2016. These increases in non-interest expenses were partially offset by a $0.8 million increase in the gains on real estate owned between the periods primarily because of the gains that were recognized on the sale of two commercial properties during 2016.

The Company considers the calculation of current and deferred income taxes to be a critical accounting policy that is subject to significant estimates . Income tax expense was $4.1 million for the year ended December 31, 2016, an increase of $2.5 million, from $1.6 million for the year ended December 31, 2015. The increase in income tax expense between the periods was primarily related to the increase in pre-tax income in 2016 when compared to 2015.

Net income available to common shareholders was $6.4 million for 2016, an increase of $3.6 million from the $2.8 million net income available to common shareholders for 2015. Basic earnings per common share for the year ended December 31, 2016 was $1.52, an increase of $0.83 from the basic earnings per common share of $0.69 for the year ended December 31, 2015. Diluted earnings per common share for the year ended December 31, 2016 was $1.34, an increase of $0.73 from diluted earnings per common share of $0.61 for the year ended December 31, 2015. Net income available to common shareholders and the basic and diluted earnings per common share increased primarily because of the increase in net income and a reduction in the dividends required to be paid on the outstanding Fixed Rate Cumulative Perpetual Preferred Stock Series A (the “Preferred Stock”) between the periods. On February 17, 2015 the Company redeemed the final 10,000 shares of its outstanding Preferred Stock and, as a result, no dividends were required to be paid on the Preferred Stock after that date.

Financial Condition

Loans Receivable, Net

The following table sets forth the information on the Company's loan po rtfolio in dollar amounts and percentages before deductions for deferred fees and discounts and allowances for losses as of the dates indicated:

							December 31,
	20 1 7						20 16						20 15						201 4					20 13
(Dollars in thousands)	Amount			Percent			Amount			Percent			Amount			Percent			Amount		Percent			Amount		Percent
Real Estate Loans:
Single family	$	107,005			17.99	%	$	103,255			18.41	%	$	90,945			19.24	%	$	69,841		18.70	%	$	76,467		19.31	%
Multi-family		28,649			4.81			36,777			6.56			12,324			2.61			15,700		4.20			8,113		2.05
Commercial		259,024			43.55			230,955			41.18			196,926			41.65			163,365		43.73			178,486		45.06
Construction or development		46,444			7.81			31,348			5.59			38,103			8.05			12,603		3.37			7,851		1.98
Total real estate loans		441,122			74.16			402,335			71.74			338,298			71.55			261,509		70.00			270,917		68.40
Other Loans:
Consumer Loans:
Automobile		2,894			0.49			3,036			0.54			2,885			0.61			1,124		0.30			971		0.25
Home equity line		36,869			6.20			40,476			7.22			38,980			8.24			36,832		9.86			36,178		9.13
Home equity		15,823			2.66			16,302			2.91			14,782			3.13			12,420		3.33			11,629		2.94
Recreational vehicle s		13,181			2.21			7,553			1.35			2,650			0.56			0		0.00			0		0.00
Other		5,000			0.84			5,916			1.05			5,118			1.08			4,549		1.22			4,645		1.17
Total consumer loans		73,767			12.40			73,283			13.07			64,415			13.62			54,925		14.71			53,423		13.49
Commercial business loans		79,909			13.44			85,176			15.19			70,106			14.83			57,122		15.29			71,709		18.11
Total other loans		153,676			25.84			158,459			28.26			134,521			28.45			112,047		30.00			125,132		31.60
Total loans		594,798			100.00	%		560,794			100.00	%		472,819			100.00	%		373,556		100.00	%		396,049		100.00	%
Less:
Unamortized discounts		19						20						16						14					33
Net deferred loan (costs) fees		(463	)					(300	)					(91	)					97					0
Allowance for losses		9,311						9,903						9,709						8,332					11,401
Total loans receivable, net	$	585,931					$	551,171					$	463,185					$	365,113				$	384,615

The increase in the loan portfolio in 2017 was primarily because there were fewer loan prepayments than originations. Based on current economic conditions and the projected loan origination and prepayment amounts, i t is anticipated that our overall loan portfolio growth will be less in 2018 than the growth experienced in 2017.

Single family real estate loans were $107.0 million at December 31, 2017, an increase of $3.7 million, compared to $103.3 million at December 31, 2016. The mortgage loan portfolio increased in 2017 due to an increased emphasis on originating shorter term and adjustable rate mortgage loans that were placed into the portfolio. The majority of the longer term mortgage loans that were originated during the year were sold into the secondary market and were not placed in the loan portfolio in order to manage the Company’s interest rate risk position.

Multi-family real estate loans were $ 28.6 million at December 31, 2017, a decrease of $8.2 million, compared to $36.8 million at December 31, 2016. The decrease in multi-family real estate loans is primarily because newly originated loans were less than the $15.6 million in loans that were paid off or transferred to other loan categories during 2017.

Commercial real estate loans were $ 259.0 million at December 31, 2017, an increase of $28.0 million, compared to $231.0 million at December 31, 2016. Commercial real estate loan balances increased in 2017 as loan originations exceeded loan payoffs during the year. Commercial business loans were $79.9 million at December 31, 2017, a decrease of $5.3 million, compared to $85.2 million at December 31, 2016. The decrease in commercial business loans is because there were more loan payoffs in 2017 when compared to 2016.

Construction or development loans were $ 46.4 million at December 31, 2017, an increase of $15.1 million, compared to $31.3 million at December 31, 2016. The increase was primarily related to an increase in multi-family and commercial construction loans between the periods. The increase was the result of the following activity during 2017: $26.8 million in new construction loans originated, $13.2 million in paid off loans, $9.7 million in advances on existing loans and $8.2 million of loans moved to a permanent loan classification upon completion of a project.

Home equity line s of credit were $36.9 million at December 31, 2017, a decrease of $3.6 million, compared to $40.5 million at December 31, 2016. The open-end home equity lines are generally written with an adjustable rate and a 10 year draw period which requires interest only payments followed by a 10 year repayment period which fully amortizes the outstanding balance. Closed-end home equity loans are written with fixed or adjustable rates with terms up to 15 years. Home equity loans were $15.8 million at December 31, 2017, a decrease of $0.5 million, compared to $16.3 million at December 31, 2016. The decrease in the open-end equity lines and closed-end equity loans is related primarily to an increase in loan payoffs as borrowers continued to refinance their homes and roll outstanding equity loan balances into their first mortgage.

Recreational vehicle loans were $ 13.2 million at December 31, 2017, an increase of $5.6 million, compared to $7.6 million at December 31, 2016. These loans have been made primarily to finance the recreational vehicle sales of a single dealer within the Bank’s market area and the increase in balances between the periods is due to an increase in originations.

Allowance for Loan Losses

The determination of the allowance for loan losses and the related provision is a critical accounting policy of the Company that is subject to significant estimates. The current level of the allowance for loan losses is a result of management ’s assessment of the risks within the portfolio based on the information obtained through the credit evaluation process. The Company utilizes a risk-rating system on non-homogeneous commercial real estate and commercial business loans that includes regular credit reviews to identify and quantify the risk in the commercial portfolio. Management conducts quarterly reviews of the entire loan portfolio and evaluates the need to adjust the allowance balance on the basis of these reviews.

Management actively monitor s asset quality and, when appropriate, charges off loans against the allowance for loan losses. Although management believes it uses the best information available to make determinations with respect to the allowance for loan losses, future adjustments may be necessary if economic conditions differ substantially from the economic conditions in the assumptions used to determine the size of the allowance for loan losses.

The al lowance for loan losses was $9.3 million, or 1.57% of gross loans at December 31, 2017, compared to $9.9 million, or 1.77% of gross loans at December 31, 2016. The allowance for loan losses decreased primarily due the lower reserve percentages used for certain risk rated commercial loans as a result of an internal analysis of the most recent charge-off history that was performed during the year. This decrease was partially offset by an increase in reserves due to a $34 million increase in the loan portfolio during the year, as well as increased specific reserves for non-performing commercial loans.

The following table reflects the activity in the allowance for loan losses and selected statistics:

	December 31,
(Dollars in thousands)	201 7			201 6			201 5			201 4			201 3
Balance at beginning of year	$	9,903			9,709			8,332			11,401			21,608
Provision for losses		(523	)		(645	)		(164	)		(6,998	)		(7,881	)
Charge-offs:
Single family		(6	)		(66	)		(19	)		(92	)		(200	)
Consumer		(288	)		(108	)		(105	)		(131	)		(484	)
Commercial business		(311	)		(180	)		(69	)		(55	)		(651	)
Commercial real estate		(50	)		(67	)		0			(936	)		(3,711	)
Recoveries		586			1,260			1,734			5,143			2,720
Net (charge-offs) recoveries		(69	)		839			1,541			3,929			(2,326	)
Balance at end of year	$	9,311			9,903			9,709			8,332			11,401
Year end allowance for loan losses as a percent of year end gross loan balance		1.57	%		1.77	%		2.05	%		2.23	%		2.88	%
Ratio of net loan recoveries (charge-offs) to average loans outstanding		(0.01	)		0.16			0.36			1.02			(0.53)

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

	December 31,
	20 1 7						20 16						20 15						20 14						20 13
	Allocated A llowance as a % of Loan C ategory			Percent of Loans in Each Category to Total L oans			Allocated Allowance as a % of Loan C ategory			Percent of Loans in Each Category to Total L oans			Allocated Allowance as a % of Loan C ategory			Percent of Loans in Each Category to Total L oans			Allocated Allowance as a % of Loan C ategory			Percent of Loans in E ach Category to Total Loans			Allocated Allowance as a % of Loan C ategory			Percent of Loans in Each Category to Total L oans
Single family		0.84	%		17.99	%		1.15	%		18.41	%		1.09	%		19.24	%		1.57	%		18.70	%		2.13	%		19.31	%
Commercial real estate		1.52			56.17			1.66			53.33			2.46			52.31			2.62			51.30			3.32			49.09
Consumer		2.21			12.40			2.20			13.07			1.86			13.62			1.84			14.71			2.07			13.49
Commercial business		2.14			13.44			2.53			15.19			2.05			14.83			2.11			15.29			3.08			18.11
Total		1.57			100.00	%		1.77			100.00	%		2.05			100.00	%		2.23			100.00	%		2.88			100.00	%

The allocated reserve percentages for single family, commercial real estate, and commercial business loans decreased in 2017 due to the general improvement in the credit quality of these loan portfolios. The allocation of the allowance for loan losses for consumer loans increased due to an increase in the outstanding balances and changes in the types of loans held in these categories between the periods.

Allowance for Real Estate Losses

Real estate properties acquired or expected to be acquired through loan foreclosures are initially recorded at fair value less estimated selling costs. Management periodically performs valuations and an allowance for losses is established if the carrying value of a property exceeds its fair value less estimated selling costs. There was no allowance for real estate losses at December 31, 2017 and the balance of the allowance was $0.7 million at December 31, 2016.

Non-performing Assets

Loans are reviewed at least quarterly and if the collectability of any loan is doubtful, it is placed on non-accrual status. Loans are placed on non-accrual status when either principal or interest is 90 days or more past due, unless, in the judgment of management, the loan is well collateralized and in the process of collection. Interest accrued and unpaid at the time a loan is placed on non-accrual status is charged against interest income. Subsequent payments are either applied to the outstanding principal balance or recorded as interest income, depending on the assessment of the ultimate collectability of the loan. Restructured loans include the Bank's troubled debt restructurings (TDRs) that involved forgiving a portion of interest or principal or making a loan at a rate materially less than the market rate to borrowers whose financial condition has deteriorated. Foreclosed and repossessed assets include assets acquired in settlement of loans. Total non-performing assets were $3.8 million at December 31, 2017, a decrease of $0.1 million, or 3.3%, from $3.9 million at December 31, 2016. Non-performing loans decreased $0.1 million and foreclosed and repossessed assets were the same between the periods. The following table sets forth the amounts and categories of non-performing assets (non-accrual loans and foreclosed and repossessed assets) in the Company’s portfolio:


	December 31,
(Dollars in thousands)	201 7			201 6			201 5			20 14			20 13
Non- performing loans:
Single family	$	949			916			1,655			1,564			1,602
Commercial real estate		1,364			1,384			1,694			8,750			14,549
Consumer		553			630			786			486			737
Commercial business		278			343			46			120			608
Total		3,144			3,273			4,181			10,920			17,496
Foreclosed and repossessed assets:
Single family		0			0			48			50			0
Commercial real estate		627			611			1,997			3,053			6,898
Consumer		0			16			0			0			0
Total		627			627			2,045			3,103			6,898
Total non-performing assets	$	3,771			3,900			6,226			14,023			24,394
Total as a percentage of total assets		0.52	%		0.57	%		0.97	%		2.43	%		3.76	%
Total non-performing loans	$	3,144		$	3,273		$	4,181		$	10,920		$	17,496
Total as a percentage of total loans receivable, net		0.54	%		0.59	%		0.90	%		2.99	%		4.55	%
Allowance for loan losses to non-performing loans		296.11	%		302.56	%		232.22	%		76.30	%		65.17	%

G ross interest income which would have been recorded had the non-accruing loans been current in accordance with their original terms amounted to $0.3 million, $0.6 million and $0.4 million for the years ended December 31, 2017, 2016 and 2015, respectively. The amounts that were included in interest income on a cash basis for these loans were $0.1 million, $0.4 million and $0.2 million, respectively.

At December 31, 2017, 2016 and 2015, there were loans included in loans receivable, net, with terms that had been modified in a TDR totaling $3.0 million, $3.3 million and $2.5 million, respectively. Had the loans performed in accordance with their original terms throughout 2017, 2016 and 2015, the Company would have recorded gross interest income of $0.4 million, $0.6 million and $0.4 million, respectively. During 2017, 2016 and 2015 the Company recorded gross interest income of $0.2 million, $0.4 million and $0.2 million, respectively.

For the loans that were modified in 2017, $0.6 million were unclassified and performing and $0.4 million were non-performing at December 31, 2017. The decrease in TDRs in 2017 relates primarily to one commercial relationship totaling $0.5 million that had performed according to the restructured terms and met the criteria to be upgraded to non-TDR status during the year.

Of the loans that were modified in 2017 and outstanding at December 31, 2017, $0.8 million related to loans secured by first or second mortgages on a single family property and the remaining modifications related to other consumer or commercial business loans.

For the loans that were modified in 2016 , $0.2 million were unclassified and performing, and $1.7 million were non-performing at December 31, 2016. The increase in TDRs in 2016 related primarily to one commercial relationship totaling $1.3 million that was downgraded from performing to non-performing status and was restructured during the year. Of the loans that were modified in 2016 and outstanding at December 31, 2016, $1.3 million related to loans secured by commercial real estate, $0.4 million related to first or second mortgages on a single family property and the remaining modifications related to other consumer or commercial business loans.

For the loans that were modified in 2015, $0.5 million were unclassified and performing, and $0.7 million were non-performing at December 31, 2015. The decrease in TDRs in 2015 related primarily to a group of commercial development loans totaling $6.0 million that were upgraded to performing status and met the criteria to be removed from TDR classification during the year. Of the loans that were modified in 2015 and outstanding at December 31, 2015, $0.8 million related to loans secured by first or second mortgages on single family properties and the remaining modifications related to other consumer or commercial business loans.

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


	December 31,
(Dollars in thousands)	201 7		201 6		201 5		201 4		201 3
Single family	$	685		448		647		368		840
Commercial real estate		1,210		1,774		725		7,956		14,781
Consumer		758		709		732		571		697
Commercial business		391		369		415		555		1,074
Total TDRs	$	3,044		3,300		2,519		9,450		17,392

TDRs on accrual status	$	1,129		1,297		1,618		7,414		3,780
TDRs on non-accrual status		1,915		2,003		901		2,036		13,612
Total	$	3,044		3,300		2,519		9,450		17,392

In addition to the TDRs and the non-performing loans set forth in the previous table of all non-performing assets, the Company may identify other potential problem loans. Potential problem loans are loans that are not in non-performing status, however, there are circumstances present to create doubt as to the ability of the borrower to comply with present repayment terms. The decision of management to include performing loans in potential problem loans does not necessarily mean that the Company expects losses to occur but that management recognized a higher degree of risk associated with these loans. The level of potential problem loans is another predominant factor in determining the relative level of the allowance for loan losses. There was one potential problem loan relationship totaling $7.5 million identified by the Company as of December 31, 2017. These loans are secured primarily by multi-family properties and other business assets. There were no potential problem loans identified by the Company as of December 31, 2016. The four loan relationships that were reported as potential problem loans at December 31, 2015 were $6.0 million in loans to two unrelated trucking companies and $0.5 million in loans secured by agricultural assets to two unrelated individuals.

Liquidity and Capital Resources

The Company attempts to manage its liquidity position so that the funding needs of borrowers and depositors are met timely and in a cost effective manner. Asset liquidity is the ability to convert assets to cash through the maturity or sale of the asset. Liability liquidity is the ability of the Bank to obtain retail, internet, or brokered deposits or to borrow funds from third parties such as the FHLB or the Federal Reserve Bank of Minneapolis.

The primary investing activities are the origination of loans and the purchase of securities. Principal and interest payments on loans and securities , along with the proceeds from the sale of loans held for sale, are the primary sources of cash for the Bank. Additional cash can be obtained by selling securities from the available for sale portfolio or by selling loans or mortgage servicing rights. Unpledged securities could also be pledged and used as collateral for additional borrowings with the FHLB or Federal Reserve Bank of Minneapolis to generate additional cash.

The primary financing activity is the attraction of retail , commercial, and internet deposits. The Bank also has the ability to borrow additional funds from the FHLB or Federal Reserve Bank of Minneapolis by pledging additional securities or loans, subject to applicable borrowing base and collateral requirements. See “ Note 1 2 FHLB Advances and Other Borrowings” in the Notes to Consolidated Financial Statements for more information on additional advances that could be drawn based upon existing collateral levels with the FHLB and the Federal Reserve Bank of Minneapolis.

The Bank's most liquid assets are cash and cash equivalents, which consist of short-term highly liquid investments with original maturities of less than three months that are readily convertible to known amounts of cash and interest-bearing deposits. The level of these assets is dependent on the operating, financing and investing activities during any given period.

Cash and cash equivalents at December 31, 20 17 were $37.6 million, an increase of $10.0 million, compared to $27.6 million at December 31, 2016. Net cash provided by operating activities during 2017 was $17.0 million. The Company conducted the following major investing activities during 2017: principal payments and maturity proceeds received on securities available for sale and FHLB stock were $25.0 million; purchases of securities available for sale and FHLB stock were $24.0 million; and the proceeds from the sale of premises and other real estate were $0.3 million. The Company also purchased premises and equipment of $1.0 million and net loans receivable increased $43.2 million. Net cash used by investing activities during 2017 was $42.9 million. The Company conducted the following major financing activities during 2017: repaid borrowings of $106.2 million, received proceeds from borrowings of $99.2 million, and deposits increased $42.8 million. Net cash provided by financing activities was $35.9 million for 2017.

The Bank has certificates of deposits from customers with outstanding balances of $65.6 million that mature during 2018. Based upon past experience, management anticipates that the majority of the deposits will renew for another term. The Company believes that deposits that do not renew will be replaced with deposits from other customers or FHLB advances. Proceeds from the sale of securities could also be used to fund unanticipated outflows of deposits.

The Bank has deposits of $77.0 million in checking and money market accounts of six customers that have individual relationship balances greater than $5.0 million. These funds may be withdrawn at any time, however, management anticipates that the majority of these deposits will remain on deposit with the Bank over the next twelve months. If these deposits are withdrawn, it is anticipated that they would be funded with available cash or replaced with deposits from other customers or FHLB advances. Proceeds from the sale of securities could also be used to fund unanticipated outflows of deposits.

D ividends from the Bank have been the Company’s primary source of cash. The Bank is restricted under applicable federal banking law from paying dividends to the Company without prior notice to and non-objection of the applicable regulator. During 2017, the Bank paid dividends to the Company of $6.0 million and at December 31, 2017, the Company had $2.1 million in cash and other assets that could readily be turned into cash.

T he Company’s primary use of cash is the payment of holding company level expenses including the payment of director and management fees, legal expenses, and other regulatory costs. The Company plans to continue to fund its liquidity needs through dividends from the Bank, or if deemed prudent, by obtaining external capital.

Contractual Obligations and Commercial Commitments

The Company has certain obligations and commitments to make future payments under existing contracts. At December 31, 20 17, the aggregate contractual obligations (excluding bank deposits) and commercial commitments were as follows:


	Payments Due by Period
(D ollars in thousands)	Total		Less than 1 Year		1-3 Years		4-5 Years		More than 5 Years
Contractual Obligations:
Annual rental commitments under non-cancellable operating leases	$	5,740		888		1,740		1,679		1,433
Total contractual obligations	$	5,740		888		1,740		1,679		1,433

	Amount of Commitment s Expiring by Period
Other Commercial Commitments:
Commercial lines of credit	$	53,691	25,433	17,175	11,033	50
Commitments to lend		39,965	13,691	994	13,110	12,170
Standby letters of credit		1,867	1,546	321	0	0
Total other commercial commitments	$	95,523	40,670	18,490	24,143	12,220

Regulatory Capital Requirements

Effective January 1, 2015 the capital requirements of the Company and the Bank were changed to implement the regulatory requirements of the Basel III capital reforms. The 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 the capital ratios and buffer requirements which will be phased in incrementally, with full implementation scheduled for January 1, 2019. Failure by the Bank to meet minimum capital requirements can initiate certain mandatory and possibly additional discretionary actions by regulators that, if undertaken, could have a direct material effect on the Company's financial statements. Under capital adequacy guidelines and the regulatory framework for prompt corrective action, both the Company and the Bank must meet specific capital guidelines that involve quantitative measures of their assets, liabilities and certain off-balance sheet items as calculated under regulatory accounting practices. The capital amounts and classification are also subject to qualitative judgments by the regulators about components, risk weightings and other factors. Management believes that, as of December 31, 2017, the Bank’s capital ratios were in excess of those quantitative capital ratio standards set forth under the prompt corrective action regulations. However, there can be no assurance that the Bank will continue to maintain such status in the future. The OCC has extensive discretion in its supervisory and enforcement activities, and can further adjust the requirement to be “well-capitalized” in the future. See “ Note 1 7 Regulatory Capital” of the Notes to Consolidated Financial Statements for a table which reflects the Bank’s capital compared to these capital requirements.

In the second quarter of 2015, the FRB amended its Policy Statement, which exempted small bank holding companies from the above capital requirements, by raising the asset size threshold for determining applicability from $500 million to $1 billion. The Policy Statement was also expanded to include savings and loan holding companies that meet the Policy Statement’s qualitative requirements for exemption. The Company met the qualitative exemption requirements, and therefore, is exempt from the above capital requirements.

The Company also serves as a source of capital, liquidity and financial support to the Bank. Depending upon the operating performance of the Bank and the Company’s other liquidity and capital needs, the Company may find it prudent, subject to prevailing capital market conditions and other factors, to raise additional capital through issuance of its common stock or other equity securities. Additional capital would potentially permit the Company to implement a strategy of growing Bank assets. Depending on the circumstances, if it were to raise capital, the Company may deploy it to the Bank for general banking purposes, or may retain some or all of it for use by the Company.

If the Company raises capital through the issuance of additional shares of common stock or other equity securities, it would dilute the ownership interests of existing stockholders and, if issued at less than the Company’s book value would dilute the per share book value of the Company’s common stock, dilute the Company’s earnings per share, and could result in a change of control of the Company and the Bank. New investors may also have rights, preferences and privileges senior to the Company’s current stockholders which may adversely impact the Company’s current stockholders. The Company’s ability to raise additional capital through the issuance of equity securities, if deemed prudent, will depend on, among other factors, conditions in the capital markets at that time, which are outside of the Company’s control, and on the Company’s financial performance and plans. Accordingly, the Company may not be able to raise additional capital, if deemed prudent, on favorable economic terms, or other terms acceptable to it. If the Bank cannot satisfactorily address its capital needs as they arise, the Bank’s ability to maintain or expand its operations, maintain compliance with the regulatory capital requirements, to operate without additional regulatory or other restrictions, and its operating results, could be materially adversely affected.

Dividends

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

Under applicable federal banking laws and regulations, no dividends can be declared or paid by the Bank to the Company without notice to and non-objection from the applicable banking regulator. There is no assurance that the Bank and the Company would satisfy the applicable regulatory requirements necessary to effect any such dividends. The payment of dividends by the Company is dependent upon the Company having adequate cash or other assets that can be converted to cash to pay dividends to its stockholders. Further, any determination as to whether, when and in what amount to declare and pay any such dividends would be subject to the discretion of the board of directors of both the Bank and the Company and would depend on numerous factors including the results of operations, financial conditions, growth plans, and cash flow requirements of the Company and the Bank.

I mpact of Inflation and Changing Prices

The impact of inflation is reflected in the increased cost of operations. Unlike most industrial companies, nearly all of the assets and liabilities of the Company are monetary in nature. As a result, interest rates have a greater impact on the Company's performance than do the effects of general levels of inflation. Interest rates do not necessarily move in the same direction or to the same extent as the prices of goods and services.

New Accounting Pronouncements

In May 2014, the Financial Accounting Standards Board (FASB) issued Accounting Standards Update (ASU) 2014-09, R evenue from Contracts with Customers (Topic 606), with an original effective date for annual reporting periods beginning after December 15, 2016. In August 2015, the FASB issued ASU 2015-14, which deferred the effective date of ASU 2014-09 to annual and interim reporting periods in fiscal years beginning after December 15, 2017. This ASU is a converged standard between the FASB and the International Accounting Standards Board (IASB) that provides a single comprehensive revenue recognition model for all contracts with customers across transactions and industries. The primary objective of the ASU is revenue recognition that represents the transfer of promised goods or services to customers in an amount that reflects the consideration to which the entity expects to be entitled to in exchange for those goods or services. In March, April, May and December of 2016 and February and September of 2017, the FASB also issued ASU 2016-08, 2016-10, 2016-12, 2016-20, 2017-05, and 2017-13, respectively, related to Topic 606. The amendments in these subsequently issued ASUs do not change the core principles of the previously issued guidance, but instead provide more clarity and implementation guidance for certain aspects of the original ASU. The Company has completed its assessment of which revenue sources are within the scope of this ASU and evaluated the applicable contracts to assess and quantify accounting methodology changes resulting from the adoption of the standard. Based on this assessment, t he adoption of this ASU and the related amendments in the first quarter of 2018 did not have a material impact on the Company’s consolidated financial statements.

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 did not 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 Generally Accepted Accounting Principles (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 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 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 did not 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 ASUs 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 V entures (Topic 323); Accounting 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 did not 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 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 on a prospective basis and the entity is required to disclose the nature of and reason for the change in accounting principle upon transition. The Company early adopted this ASU in the fourth quarter of 2017 in order to reduce the complexity of the goodwill impairment calculation. The adoption of this ASU in the fourth quarter of 2017 did not have any impact on the Company’s consolidated financial statements.

In March 2017, the FASB issued ASU 2017-08, 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.

In May 2017, the FASB issued ASU 2017-09, C ompensation- Stock Compensation (Topic 718). The amendments in this ASU provide clarity about which changes to the terms or conditions of a share-based payment award require an entity to apply modification accounting. The ASU is effective for all entities for fiscal years beginning after December 15, 2017, including interim periods within those fiscal years with early adoption permitted. The adoption of this ASU in the first quarter of 2018 did not have any impact on the Company’s consolidated financial statements.

In February 2018, the FASB issued ASU 2018-01, Income Statement – Reporting Comprehensive Income (Topic 220): Reclassification of Certain Tax Effects from Accumulated Other Comprehensive Income. The amendments in this ASU require a reclassification from accumulated other comprehensive income to retained earnings for stranded tax effects resulting from the newly enacted federal corporate income tax rate. The amount of the reclassification is the difference between the historical corporate income tax rate and the newly enacted 21 percent corporate income tax rate. This ASU is effective for all entities for fiscal years beginning after December 15, 2018, and interim periods within those fiscal years. Early adoption is permitted, including adoption in any interim period, for public business entities such as the Company for reporting periods for which financial statement have not yet been issued. The Company opted to early adopt this ASU as of December 31, 2017. The impact on the December 31, 2017 financial statements was a $157,600 reclassification between other comprehensive income and retained earnings for the stranded tax effects as a result of the change in the federal corporate tax rate.

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 Management’s Discussion and Analysis 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 market value to the Company ’s interest-earning assets and interest-bearing liabilities based upon incremental 100 basis point changes in interest rates from interest rates in effect on December 31, 2017.

	Market Value
(Dollars in thousands) Basis point change in interest rates	-100			0			+100			+200
Total market-risk sensitive assets	$	726,656			714,097			701,330			687,808
Total market-risk sensitive liabilities		625,420			584,839			549,618			518,471
Off-balance sheet financial instruments		(184	)		0			(8	)		4
Net market risk	$	101,420			129,258			151,720			169,333
Percentage change from current market value		(21.54	%)		0.00	%		17.38	%		31.00	%

The preceding table was prepared utilizing the following assumptions (the Model Assumptions) regarding prepayment and decay ratios that were determined by management based upon its review of historical prepayment speeds and decay rates. Fixed rate loans were assumed to prepay at annual rates of between 2% and 42%, depending on the note rate and the period to maturity. Adjustable rate mortgages (ARMs) were assumed to prepay at annual rates of between 6% and 48%, depending on the note rate and the period to maturity. Mortgage-backed securities were projected to have prepayments based upon the underlying collateral securing the instrument. All loan prepayments vary based on the note rate and period to maturity of the individual loans. Certificate accounts were assumed not to be withdrawn until maturity. Retail money market and passbook accounts were assumed to decay at annual rates of 2% and 18%, respectively. Retail non-interest checking and negotiable order of withdrawal (NOW) accounts were assumed to decay at annual rates of 12% and 14%, respectively. Commercial non-interest checking and NOW accounts were assumed to decay at annual rates of 27% and 32%, respectively. Commercial money market demand accounts (MMDAs) were assumed to decay at annual rates of between 1% and 31%.

Certain shortcomings are inherent in the method of analysis presented in the foregoing table. The interest rates on certain types of assets and liabilities may fluctuate in advance of changes in market interest rates, while interest rates on other types of assets and liabilities may lag behind changes in market interest rates. The model assumes that the difference between the current interest rate being earned or paid compared to a treasury instrument or other interest index with a similar term to maturity (the interest spread) will remain constant over the interest changes disclosed in the table. Changes in interest spread could impact projected market value changes. Certain assets, such as ARMs, have features that restrict changes in interest rates on a short-term basis and over the life of the assets. The market value of the interest-bearing assets that are approaching their lifetime interest rate caps or floors could be different from the values calculated in the table. Certain liabilities, such as certificates of deposit, have fixed rates that restrict interest rate changes until maturity. In the event of a change in interest rates, prepayment and early withdrawal levels may deviate significantly from 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 the net interest income projected for the twelve months following December 31, 2017 to determine if its current level of interest rate risk is acceptable. The following table projects the estimated impact on net interest income during the twelve month period ending December 31, 2018 of immediate interest rate changes called rate shocks:


(Dollars in thousands)
Rate Shock in Basis Points	Net Interest Change			Percent Change
+200	$	3,089			11.35	%
+100		1,536			5.65
0		0			0.00
-100		(1,644	)		(6.04	)

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 because there are more loans that are anticipated to re-price to higher interest rates in the next twelve months than there are deposits that would re-price.

In an attempt to manage its exposure to changes in interest rates, management closely monitors interest rate risk. The Company has an Asset/Liability Committee that meets frequently to discuss changes in the interest rate risk position and projected profitability. The Committee makes adjustments to the asset-liability position of the Bank that are reviewed by the Board of Directors of the Bank. This Committee also reviews the Bank's portfolio, formulates investment strategies and oversees the timing and implementation of transactions as intended to assure attainment of the Bank's objectives in an effective manner. In addition, the Board reviews, on a quarterly basis, the Bank's asset/liability position, including simulations of the effect on the Bank's capital of various interest rate scenarios.

In managing its asset/liability mix, the Bank may, at times, depending on the relationship between long 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 focused its 30 year fixed rate single family residential lending program on loans that are saleable to third parties and generally places only adjustable rate or shorter term fixed rate loans that meet certain risk characteristics into its loan portfolio. In addition, a significant portion of the Bank’s commercial loan production is in short term fixed rate loans or adjustable rate loans that re-price every one, two, or three years.

Off-Balance Sheet Arrangements

The Company has no off-balance sheet arrangements other than commitments to originate and sell loans in the ordinary course of business . See “ Note 1 8 Financial Instruments with Off-Balance S heet Risk” in the Notes to Consolidated Financial Statements for additional information. Management believes that the Company has sufficient liquidity to satisfy its off-balance sheet obligations.

CONSOLIDATED BALANCE SHEETS

	December 31,			December 31,
(Dollars in thousands)	201 7			20 16

ASSETS
Cash and cash equivalents	$	37,564			27,561
Securities available for sale:
Mortgage-backed and related securities (amortized cost $5,148 and $993)		5,068			1,005
Other marketable securities (amortized cost $73,653 and $78,846)		72,404			77,472
		77,472			78,477

Loans held for sale		1,837			2,009
Loans receivable, net		585,931			551,171
Accrued interest receivable		2,344			2,626
Real estate, net		627			611
Federal Home Loan Bank stock, at cost		817			770
Mortgage servicing rights, net		1,724			1,604
Premises and equipment, net		8,226			8,223
Goodwill		802			802
Core deposit intangible, net		355			454
Prepaid expenses and other assets		1,314			1,768
Deferred tax asset, net		3,672			5,947
Total assets	$	722,685			682,023

LIABILITIES AND STOCKHOLDERS ’ EQUITY
Deposits	$	635,601			592,811
Other borrowings		0			7,000
Accrued interest payable		146			236
Customer escrows		1,147			1,011
Accrued expenses and other liabilities		4,973			5,046
Total liabilities		641,867			606,104

Commitments and contingencies
Stockholders ’ equity:
Serial-preferred stock ($.01 par value):
authorized 500,000 shares; issued shares 0		0			0
Common stock ($.01 par value):
authorized 16,000,000; issued shares 9,128,662		91			91
Additional paid-in capital		50,623			50,566
Retained earnings, subject to certain restrictions		91,448			86,886
Accumulated other comprehensive loss		(957	)		(820	)
Unearned employee stock ownership plan shares		(2,030	)		(2,223	)
Treasury stock, at cost 4,631,124 and 4,639,739 shares		(58,357	)		(58,581	)
Total stockholders’ equity		80,818			75,919
Total liabilities and stockholders ’ equity	$	722,685			682,023

See accompanying notes to consolidated financial statements.

Consolidated S tatement s of COMPREHENSIVE INCOME

Years ended December 31 ( Doll ars in thousands , except per share amounts )

201 7

201 6

201 5

Interest income:

Loans receivable

26,368

25,900

19,389

Securities available for sale:

Mortgage-backed and related

116

Other marketable

1,103

1,289

1,881

Cash equivalents

140

Other

Total interest income

27,680

27,349

21,453

Interest expense:

Deposits

1,470

1,002

934

Federal Home Loan Bank advances and other borrowings

327

591

573

Total interest expense

1,797

1,593

1,507

Net interest income

25,883

25,756

19,946

Provision for loan losses

(523

)

(645

)

(164

)

Net interest income after provision for loan losses

26,406

26,401

20,110

Non-interest income:

Fees and service charges

3,354

3,427

3,316

Loan servicing fees

1,202

1,108

1,046

Gain on sales of loans

2,138

2,618

1,964

Other

960

1,048

1,327

Total non-interest income

7,654

8,201

7,653

Non-interest expense:

Compensation and benefits

15,007

14,764

13,733

(Gains) losses on real estate owned

(72

)

(596

)

218

Occupancy and equipment

4,068

4,041

3,722

Data processing

1,106

1,161

1,020

Professional services

1,285

1,257

1,108

Other

3,860

3,503

3,395

Total non-interest expense

25,254

24,130

23,196

Income before income tax expense

8,806

10,472

4,567

Income tax expense

4,402

4,122

1,611

Net income

4,404

6,350

2,956

Preferred stock dividends

(108

)

Net income available to common shareholders

4,404

6,350

2,848

Other comprehensive (loss) income, net of tax

(137

)

(606

)

204

Comprehensive income available to common shareholders

4,267

5,744

3,052

Basic earnings per common share

1.04

1.52

0.69

Diluted earnings per common share

0.90

1.34

0.61

See accompanying notes to consolidated financial statements.

Consolidated Statements of Stockholders ’ Equity

Unearned

Accumulated

Employee

Total

Additional

Other

Stock

Stock-

Preferred

Common

Paid-in

Retained

Comprehensive

Ownership

Treasury

holders ’

( D ollars in thousands)

Stock

Capital

Earnings

(Loss)

Plan

Stock

Equity

Balance, December 31, 2014

10,000

50,207

77,805

(418

)

(2,610

)

(59,062

)

76,013

Net income

2,956

Other comprehensive income

204

Redemption of preferred stock

(10,000

)

(10,000

)

Restricted stock awards

(332

)

332

Restricted stock awards forfeiture

)

Amortization of restricted stock awards

447

Preferred stock dividends

(225

)

(225

)

Earned employee stock ownership plan shares

193

250

Balance, December 31, 2015

50,388

80,536

(214

)

(2,417

)

(58,739

)

69,645

Net income

6,350

Other comprehensive loss

(606

)

(606

)

Stock compensation expense

Restricted stock awards

(158

)

158

Amortization of restricted stock awards

177

Earned employee stock ownership plan shares

194

274

Balance, December 31, 201 6

50,566

86,886

(820

)

(2,223

)

(58,581

)

75,919

Net income

4,404

Other comprehensive income

Reclassification of certain income tax effects from accumulated other comprehensive income

158

(158

)

Stock compensation expense

Restricted stock awards

(278

)

278

Stock awards withheld for tax withholding

(54

)

(54

)

Amortization of restricted stock awards

147

Earned employee stock ownership plan shares

147

193

340

Balance, December 31, 201 7

50,623

91,448

(957

)

(2,030

)

(58,357

)

80,818

See accompanying notes to consolidated financial statements.

CONSOLIDATED STATEMENTS OF CASH FLOWS

Years ended December 31 (Dollars in thousands)

201 7

201 6

201 5

Cash flows from operating activities:

Net income

4,404

6,350

2,956

Adjustments to reconcile net income to cash provided by operating activities:

Provision for loan losses

(523

)

(645

)

(164

)

Depreciation

949

850

706

Amortization of (discounts) premiums, net

)

Amortization of deferred loan fees

(240

)

(1,011

)

(964

)

Amortization of core deposit intangible

Amortization of purchased loan fair value adjustments

(85

)

(529

)

(657

)

Amortization of mortgage servicing rights

555

601

555

Capitalized mortgage servicing rights

(675

)

(706

)

(547

)

Deferred income tax expense

2,105

3,128

1,722

Reclassification of certain income tax effects from accumulated other comprehensive income

158

Securities losses (gains), net

)

Gain on sale of premises

)

(Gains) losses on s ales of real estate owned

(72

)

(596

)

218

Gain on sales of loans

(2,138

)

(2,618

)

(1,964

)

Proceeds from sales of loans held for sale

90,127

99,121

78,278

Disbursements on loans held for sale

(78,751

)

(79,783

)

(69,941

)

Amortization of restricted stock awards

147

177

447

Amortization of unearned ESOP shares

193

194

193

Earned ESOP shares priced above original cost

147

Stock option compensation expense

Decrease (increase) in accrued interest receivable

282

(265

)

(346

)

(Decrease) increase in accrued interest payable

(91

)

137

Decrease (increase) in other assets

417

(323

)

(239

)

(Decrease) increase in other liabilities

(62

)

999

302

Other, net

270

Net cash provided by operating activities

17,043

25,513

10,820

Cash flows from investing activities:

Proceeds from sales of securities available for sale

10,951

Principal collected on securities available for sale

953

1,245

1,694

Proceeds collected on maturity of securities available for sale

20,100

136,145

175,070

Purchases of securities available for sale

(20,035

)

(104,968

)

(144,069

)

Purchase of Federal Home Loan Bank stock

(3,999

)

(1,879

)

(2,152

)

Redemption of Federal Home Loan Bank stock

3,952

1,800

2,238

Proceeds from sales of real estate owned

309

2,369

1,127

Net increase in loans receivable

(43,194

)

(89,570

)

(80,447

)

Gain on acquisition

(289

)

Acquisition payment (net of cash acquired)

6,080

4,816

Proceeds from sale of premises

Purchases of premises and equipment

(1,011

)

(1,607

)

(803

)

Net cash used by investing activities

(42,917

)

(50,365

)

(31,864

)

Cash flows from financing activities:

Increase in deposits

42,794

14,468

15,375

Redemption of preferred stock

(10,000

)

Stock awards withheld for tax withholding

(54

)

Dividends paid to preferred stockholders

(225

)

Proceeds from borrowings

99,200

45,000

65,000

Repayment of borrowings

(106,200

)

(47,000

)

(56,000

)

Increase in customer escrows

137

163

Net cash provided by financing activities

35,877

12,631

14,192

Increase (decrease) in cash and cash equivalents

10,003

(12,221

)

(6,852

)

Cash and cash equivalents, beginning of year

27,561

39,782

46,634

Cash and cash equivalents, end of year

37,564

27,561

39,782

Supplemental cash flow disclosures:

Cash paid for interest

1,887

1,599

1,358

Cash paid for income taxes

1,879

436

191

Supplemental noncash flow disclosures:

Loans transferred to loans held for sale

9,211

15,002

8,125

Loans held for sale transferred to loans

164

Transfer of loans to real estate

253

591

110

See accompanying notes to consolidated financial statements.

Notes to Consolidated Financial Statements

December 31, 20 1 7 , 20 1 6 and 20 1 5

NOTE 1 Description of the Business and Summary of Significant Accounting Policies

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

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

The Company evaluated subsequent events through the filing date of our annual 10 -K with the Securities and Exch ange Commission (SEC) on March 9, 2018.

Use of Estimates

In preparing the consolidated financial statements, management is required to make estimates and assumptions that affect the reported amounts of assets and liabilities as of the date of the balance sheet and revenues and expenses for the period. Actual results could differ from those estimates.

An e stimate that is particularly susceptible to change relates to the determination of the allowance for loan losses. Management believes that the allowance for loan losses is appropriate to cover probable losses inherent in the portfolio at the date of the balance sheet. While management uses available information to recognize losses on loans, future additions to the allowance may be necessary based on changes in economic conditions and other factors. In addition, various regulatory agencies, as an integral part of their examination process, periodically review the allowance for loan losses. Such agencies may require changes to the allowance based on their judgment about information available to them at the time of their examination.

Cash and Cash Equivalents

The Company considers highly liquid investments with original maturities of three months or less to be cash equivalents.

Securities

Securities are accounted for according to their purpose and holding period. The Company classifies its debt and equity securities in one of three categories:

Trading Securities

Securities held principally for resale in the near term are classified as trading securities and are recorded at their fair values. Unrealized gains and losses on trading securities are included in other income.

Securities Held to Maturity

Securities that the Company has the positive intent and ability to hold to maturity are reported at cost and adjusted for premiums and discounts that are recognized in interest income using the interest method over the period to maturity. Unrealized losses on securities held to maturity reflecting a decline in value judged to be other than temporary are charged to income and a new cost basis is established.

Securities Available for Sale

Securities available for sale consist of securities not classified as trading securities or a s securities held to maturity. They include securities that management intends to use as part of its asset/liability strategy or that may be sold in response to changes in interest rates, changes in prepayment risk, or similar factors. Unrealized gains and losses, net of income taxes, are reported as a separate component of stockholders’ equity until realized. Gains and losses on the sale of securities available for sale are determined using the specific identification method and recognized on the trade date. Premiums and discounts are recognized in interest income using the interest method over the period to maturity. Unrealized losses on securities available for sale reflecting a decline in value judged to be other than temporary are charged to income and a new cost basis is established.

Management monitors the investment security portfolio for impairment on an individual security basis and has a process in place to identify securities that could potentially have a credit impairment that is other than temporary. This process involves analyzing the length of time and extent to which the fair value has been less than the amortized cost basis, the market liquidity for the security, the financial condition and near-term prospects of the issuer, expected cash flows, and the Company's intent and ability to hold the investment for a period of time sufficient to recover the temporary loss, including determining whether it is more-likely-than- not that the Company will be required to sell the security prior to recovery. To the extent it is determined that a security is deemed to be other-than-temporarily impaired, an impairment loss is recognized.

Loans Held for Sale

Mortgage loans originated or purchased which are intended for sale in the secondary market are carried at the lower of cost or estimated market value in the aggregate. Net fees and costs associated with acquiring or originating loans held for sale are deferred and included in the basis of the loan in determining the gain or loss on the sale of the loans. Gains on the sale of loans are recognized on the settlement date. Net unrealized losses are recognized through a valuation allowance by charges to income.

Loans Receivable, n et

Loans receivable, net, are carried at amortized cost. Loan origination fees received, net of certain loan origination costs, are deferred as an adjustment to the carrying value of the related loans, and are amortized into income using the interest method over the estimated life of the loans.

Premiums and discounts on purchased participation loans are amortized into interest income using the interest method over the period to contractual maturity, adjusted for estimated prepayments.

The allowance for loan losses is based on a periodic analysis of the loan portfolio and is maintained at an amount considered to be appropriate by management to provide for probable losses inherent in the loan portfolio as of the balance sheet dates. In this analysis, management considers factors including, but not limited to, specific occurrences of loan impairment, actual and anticipated changes in the size of the portfolios, national and regional economic conditions (such as unemployment data, loan delinquencies, local economic conditions, demand for single family homes, demand for commercial real estate and building lots), loan portfolio composition, historical loss experience, and observations made by the Company's ongoing internal audit and regulatory exam processes. In connection with the determination of the allowance for loan losses, management obtains independent appraisals for significant properties or other collateral securing classified loans. Appraisals on collateral dependent commercial real estate and commercial business loans are obtained when it is determined that the borrower’s risk profile has deteriorated and the loan is classified as impaired. Subsequent new third party appraisals of properties securing impaired commercial real estate and commercial business loans are prepared at least every two years. For all land development loan types, a new third party appraisal is prepared on an annual basis where current activity is not consistent with the assumptions made in the most recent third party appraisal. Non-performing residential and consumer home equity loans and home equity lines may have a third party appraisal or an internal evaluation completed depending on the size of the loan and location of the property. These appraisals, or internal valuations, are generally completed when a residential or consumer home equity loan or home equity line of credit becomes 120 days past due and are typically updated after possession of the property is obtained. Valuations are reviewed on a quarterly basis and adjustments are made to the allowance for loan losses for temporary impairments and charge-offs are taken when the impairment is determined to be permanent. The fair market value of the properties for all loan types are adjusted for estimated selling costs in order to determine the net realizable value of the properties. The allowance for loan losses is established for known problem loans, as well as for loans which are not currently known to require an allowance. Loans are charged off to the extent they are deemed to be uncollectible. The appropriateness of the allowance for loan losses is dependent upon management’s estimates of variables affecting valuation, appraisals of collateral, evaluations of performance and status, and the amounts and timing of future cash flows expected to be received on impaired loans. Such estimates, appraisals, evaluations and cash flows may be subject to adjustments due to changing economic prospects of borrowers or properties. The fair market value of collateral dependent loans 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. The allowance is allocated to individual loan categories based upon the relative risk characteristics of the loan portfolios and the actual loss experience. The Company increases its allowance for loan losses by charging the provision for loan losses against income and decreases its allowance by crediting the provision for loan losses. The methodology for establishing the allowance for loan losses takes into consideration probable losses that have been identified in connection with specific loans as well as losses in the loan portfolio that have not been specifically identified.

Interest income is recognized on an accrual basis except when collectability is in doubt. When loans are placed on a non-accrual basis, generally when the loan is 90 days past due, previously accrued but unpaid interest is reversed from income. If the ultimate collectability of a loan is in doubt and the loan is placed in nonaccrual status, the cost recovery method is used and cash collected is applied to first reduce the principal outstanding. Generally, the Company returns a loan to accrual status when all delinquent interest and principal becomes current under the terms of the loan agreement and collectability of remaining principal and interest is no longer doubtful. Previously collected interest payments that were applied to principal when the loan was classified as non-accrual are recorded as interest income using the effective yield method over the estimated life of the loan, including expected renewal terms.

All impaired loans are valued at the present value of expected future cash flows discounted at the loan's initial effective interest rate. The fair value of the collateral of an impaired collateral-dependent loan or an observable market price, if one exists, may be used as an alternative to discounting. If the value of the impaired loan is less than the recorded investment in the loan, the impaired amount is charged off. A loan is considered impaired when, based on current information and events, it is probable that the Company will be unable to collect all amounts due according to the contractual terms of the loan agreement. Impaired loans include all loans which are on non-accrual, delinquent as to principal and interest for 90 days or more, or restructured in a troubled debt restructuring (TDR) involving a modification of terms. All non-accruing loans are reviewed for impairment on an individual basis.

Included in loans receivable, net, are certain loans that have been modified in order to maximize collection of the loan balances. The Company evaluates all loan modifications and if the Company, for legal or economic reasons related to the borrower's financial difficulties, grants a concession compared to the original terms and conditions of the loan that the Company would not otherwise consider, the modified loan is considered a TDR and is classified as an impaired loan. If the TDR loan was performing (accruing) prior to the modification, it typically will remain accruing after the modification as long as it continues to perform according to the modified terms. If the TDR loan was non-performing (non-accruing) prior to the modification, it will remain non-accruing after the modification for a minimum of six months. If the loan performs according to the modified terms for a minimum of six months, it typically will be returned to accruing status. In general, there are two conditions in which a TDR loan is no longer considered to be a TDR and potentially not classified as impaired. The first condition is whether the loan is refinanced with terms that reflect normal market terms for the type of credit involved. The second condition is whether the loan is repaid or charged off.

Purchased Loans Acquired Through Business Combinations

Purchased l oans acquired in a business combination, including loans that have evidence of deterioration of credit quality since origination and for which it is probable, at acquisition, that the Company will be unable to collect all contractually required payments, are initially recorded at fair value as determined by the present value of expected future cash flows with no valuation allowance. The difference between the undiscounted cash flows expected at acquisition and the investment in the loan is an accretable yield adjustment and is recognized as interest income using the effective yield method over the life of the loan. Contractually required payments for principal and interest that exceed the undiscounted cash flows expected at acquisition is a nonaccretable difference and is not recognized as a yield adjustment, loss accrual, or a valuation allowance. Increases in expected cash flows subsequent to the initial investment are recognized prospectively through an adjustment of the yield on the loan over its remaining life. Decreases in expected cash flows after the loan is acquired are recognized as an impairment and charged to the provision for loan losses.

Transfers of Financial Assets and Participating Interests

Transfers of an entire financial asset or a participating interest in an entire financial asset are accounted for as sales when control over the assets has been surrendered. Control over transferred assets is deemed to be surrendered when ( 1 ) the assets have been isolated from the Company, ( 2 ) the transferee obtains the right (free of conditions that constrain it from taking advantage of that right) to pledge or exchange the transferred assets, and ( 3 ) the Company does not maintain effective control over the transferred assets through an agreement to repurchase them before their maturity.

The transfer of a participating interest in an entire financial asset must also meet the definition of a participating interest. A participating interest in a financial asset has all of the following characteristics: ( 1 ) from the date of transfer, it must represent a proportionate (pro rata) ownership interest in the financial asset, ( 2 ) from the date of transfer, all cash flows received, except any cash flows allocated as any compensation for servicing or other services performed, must be divided proportionately among participating interest holders in the amount equal to their share ownership, ( 3 ) the rights of each participating interest holder must have the same priority, and ( 4 ) no party has the right to pledge or exchange the entire financial asset unless all participating interest holders agree to do so.

Real Estate, net

Real estate acquired through loan foreclosure or deed in lieu of foreclosure, is initially recorded at its fair value less estimated selling costs. Third party appraisals are obtained as soon as practical after obtaining possession of the property. Valuations are reviewed quarterly by management and an allowance for losses is established if the carrying value of a property exceeds its fair value less estimated selling costs.

Mortgage Servicing Rights , net

Mortgage servicing rights are capitalized at fair value and amortized in proportion to, and over the period of, estimated net servicing income. The Company evaluates its capitalized mortgage servicing rights for impairment each quarter. Loan type and note rate are the predominant risk characteristics of the underlying loans used to stratify capitalized mortgage servicing rights for purposes of measuring impairment. Any impairment is recognized through a valuation allowance.

Premises and Equipment , net

Land is carried at cost. Office buildings, improvements, furniture and equipment are carried at cost less accumulated depreciation. Depreciation is computed on a straight-line basis over estimated useful lives of 5 to 40 years for office buildings and improvements and 3 to 10 years for furniture and equipment.

Goodwill

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

Core Deposit Intangible , net

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

Impairment of Long-Lived Assets and for Long-Lived Assets to Be Disposed Of

The Company reviews long-lived assets and certain identifiable intangibles for impairment whenever events or changes in circumstances indicate that the carrying amount of an asset may not be recoverable.

Stock Based Compensation

T he Company recognizes the grant-date fair value of stock option and restricted stock awards issued as compensation expense, amortized over the vesting period.

Employee Stock Ownership Plan (ESOP)

The Company has an ESOP that borrowed funds from the Company and purchased shares of HMN common stock. The Company makes quarterly principal and interest payments on the ESOP loan. As the debt is repaid, ESOP shares that were pledged as collateral for the debt are released from collateral based on the proportion of debt service paid in the year and then allocated to eligible employees. The Company accounts for its ESOP in accordance with ASC 718, Employers' Accounting for Employee Stock Ownership Plans . Accordingly, the shares pledged as collateral are reported as unearned ESOP shares in stockholders' equity. As shares are determined to be ratably released from collateral, the Company reports compensation expense equal to the current market price of the shares, and the shares become outstanding for earnings per share computations.

Income Taxes

Deferred tax assets and li abilities are recognized for future tax consequences attributable to temporary differences between the financial statement carrying amounts of existing assets and liabilities and their respective tax basis. Deferred tax assets and liabilities are measured using enacted tax rates expected to apply to taxable income in the years in which those temporary differences are expected to be recovered or settled. The effect of a change in tax rates on deferred tax assets and liabilities is recognized in income in the period that includes the enactment date. A valuation allowance is required to be recognized if it is “more likely than not” that the deferred tax asset will not be realized. The determination of the realizability of the deferred tax asset is subjective and dependent upon judgment concerning management’s evaluation of both positive and negative evidence regarding the ultimate realizability of deferred tax assets.

Earnings per Common Share

Basic earnings per common share excludes dilution and is computed by dividing the income available to common stockholders by the weighted-average number of common shares outstanding for the period. Diluted earnings per common share reflects the potential dilution that could occur if securities or other contracts to issue common stock were exercised or converted into common stock or resulted in the issuance of common stock that shared in the earnings of the entity.

Comprehensive Income

Comprehensive income is defined as the change in equity during a period from transactions and other events from non-owner sources. Comprehensive income is the total of net income and other comprehensive income (loss), which for the Company is comprised of unrealized gains and losses on securities available for sale.

Segment Information

The amount of each segment item reported is the measure reported to the chief operating decision maker for purposes of making decisions about allocating resources to the segment and assessing its performance. Adjustments and eliminations made in preparing an enterprise ’s general-purpose financial statements and allocations of revenues, expenses, and gains or losses are included in determining reported segment profit or loss if they are included in the measure of the segment’s profit or loss that is used by the chief operating decision maker. Similarly, only those assets that are included in the measure of the segment’s assets that are used by the chief operating decision maker are reported for that segment.

New Accounting Pronouncement s

In May 2014, the Financial Accounting Standards Board (FASB) issued Accounting Standards Update (ASU) 2014 - 09, R evenue from Contracts with Customers (Topic 606 ), with an original effective date for annual reporting periods beginning after December 15, 2016. In August 2015, the FASB issued ASU 2015 - 14, which deferred the effective date of ASU 2014 - 09 to annual and interim reporting periods in fiscal years beginning after December 15, 2017. This ASU is a converged standard between the FASB and the International Accounting Standards Board (IASB) that provides a single comprehensive revenue recognition model for all contracts with customers across transactions and industries. The primary objective of the ASU is revenue recognition that represents the transfer of promised goods or services to customers in an amount that reflects the consideration to which the entity expects to be entitled to in exchange for those goods or services. In March, April, May and December of 2016 and February and September of 2017, the FASB also issued ASU 2016 - 08, 2016 - 10, 2016 - 12, 2016 - 20, 2017 - 05, and 2017 - 13, respectively, related to Topic 606. The amendments in these subsequently issued ASUs do not change the core principles of the previously issued guidance, but instead provide more clarity and implementation guidance for certain aspects of the original ASU. The Company has completed its assessment of which revenue sources are within the scope of this ASU and evaluated the applicable contracts to assess and quantify accounting methodology changes resulting from the adoption of the standard. Based on this assessment, t he adoption of this ASU and the related amendments in the first quarter of 2018 did not have a material impact on the Company’s consolidated financial statements.

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 did not 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 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 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 did not 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 ASUs 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 V entures (Topic 323 ); Accounting 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 did not 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 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 on a prospective basis and the entity is required to disclose the nature of and reason for the change in accounting principle upon transition. The Company early adopted this ASU in the fourth quarter of 2017 in order to reduce the complexity of the goodwill impairment calculation. The adoption of this ASU in the fourth quarter of 2017 did not have any impact on the Company’s consolidated financial statements.

In March 2017, the FASB issued ASU 2017 - 08, 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.

In May 2017, the FASB issued ASU 2017 - 09, C ompensation- Stock Compensation (Topic 718 ). The amendments in this ASU provide clarity about which changes to the terms or conditions of a share-based payment award require an entity to apply modification accounting. The ASU is effective for all entities for fiscal years beginning after December 15, 2017, including interim periods within those fiscal years with early adoption permitted. The adoption of this ASU in the first quarter of 2018 did not have any impact on the Company’s consolidated financial statements.

In February 2018, the FASB issued ASU 2018 - 01, Income Statement – Reporting Comprehensive Income (Topic 220 ): Reclassification of Certain Tax Effects from Accumulated Other Comprehensive Income. The amendments in this ASU require a reclassification from accumulated other comprehensive income to retained earnings for stranded tax effects resulting from the newly enacted federal corporate income tax rate. The amount of the reclassification is the difference between the historical corporate income tax rate and the newly enacted 21 percent corporate income tax rate. This ASU is effective for all entities for fiscal years beginning after December 15, 2018, and interim periods within those fiscal years. Early adoption is permitted, including adoption in any interim period, for public business entities such as the Company for reporting periods for which financial statement have not yet been issued. The Company opted to early adopt this ASU as of December 31, 2017. The impact on the December 31, 2017 financial statements was a $157,600 reclassification between other comprehensive income and retained earnings for the stranded tax effects as a result of the change in the federal corporate tax rate.

Derivative Financial Instruments

The Company uses derivative financial instruments in order to manage the interest rate risk on residential loans held for sale and its commitments to extend credit for residential loans. The Company may also from time to time use interest rate swaps to manage interest rate risk. Derivative financial instruments include commitments to extend credit and forward mortgage loan sales commitments.

Reclassifications

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

NOTE 2 Acquisitions

The Company records purchased assets and liabilities at their fair market value at the time of purchase in accordance with the requirements of ASU 805 - Business Combinations . On April 8, 2016, the Bank completed the acquisition of loans and assumption of liabilities of the Deerwood Bank branch in Albert Lea, Minnesota. The transaction increased the Bank’s assets by $19.0 million, including increases in loans, cash, goodwill, and core deposit intangible of $11.9 million, $6.1 million, $0.8 million, and $0.2 million, respectively. The Bank also assumed deposit liabilities of $19.0 million. The acquired loans and deposits are being serviced from Home Federal’s existing branch location at 143 West Clark Street, Albert Lea, Minnesota.

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

D etermining the estimated fair value of the acquired assets and assumed liabilities required the Bank to estimate cash flows expected to result from those assets and liabilities and to discount those cash flows at appropriate rates of interest. The most significant of those determinations related to the fair valuation of the loans acquired. The fair value of the loans purchased was based on the present value of the expected cash flows. Periodic principal and interest cash flows were adjusted for expected losses and prepayments, then discounted to determine the present value and summed to arrive at the estimated fair value. For such loans, the excess of cash flows expected at acquisition over the estimated fair value is recognized as interest income over the remaining lives of the loans. The difference between contractually required payments at acquisition and the cash flows expected to be collected at acquisition reflects the impact of estimated credit losses and other factors, such as prepayments. In accordance with GAAP, there was no carry-over of previously established allowances for loan losses established on the seller’s records. As a result, standard industry coverage ratios with regard to the allowance for credit losses are less meaningful after the acquisitions. The purchased loans were 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 contractually required principal and interest payments on the loan. Subsequent decreases in the expected cash flows require the Bank to evaluate the need for additions to the allowance for credit losses. Subsequent improvements in expected cash flows generally result in a reduction of previously established allowance for credit losses or the recognition of additional interest income over the remaining lives of the loans.

NOTE 3 Other Comprehensive (Loss) Income

The components of other comprehensive (loss) income and the related tax effects were as follows:

	For the years ended December 31,
	2017								2016									2015
(Dollars in thousands )	Before Tax		Tax Effect			Net of Tax			Before Tax			Tax Effect			Net of Tax			Before Tax		Tax Effect		Net of Tax
Securities available for sale:
Gross unrealized gains (losses) arising during the period	$	33		12			21			(1,016	)		(404	)		(612	)		344		137		207
Less reclassification of net ( losses) gains included in net income		0		0			0			(10	)		(4	)		(6	)		6		3		3
Net unrealized gains (losses) arising during the period..		33		12			21			(1,006	)		(400	)		(606	)		338		134		204
Reclassification of certain income tax effects from accumulated other comprehensive income		0		(158	)		158			0			0			0			0		0		0
Other comprehensive (loss) income	$	33		170			(137	)		(1,006	)		(400	)		(606	)		338		134		204

NOTE 4 Securities Available for Sale

A summary of securities available for sale at December 31, 20 17 and 2016 is as follows:

(Dollars in thousands)	Amortized cost		Gross unrealized gains		Gross unrealized losses			Fair v alue
December 31 , 201 7
Mortgage-backed securities:
Federal Home Loan Mortgage Corporation (FHLMC)	$	91		2		0			93
Federal National Mortgage Association (FNMA)		4,834		1		(78	)		4,757
Collateralized mortgage obligations:
FNMA		223		0		(5	)		218
		5,148		3		(83	)		5,068
Other marketable securities:
U.S. Government agency obligations		69,962		0		(1,201	)		68,761
Municipal obligations		2,699		2		(8	)		2,693
Corporate obligations		234		0		(1	)		233
Corporate preferred stock		700		0		(140	)		560
Corporate equity		58		99		0			157
		73,653		101		(1,350	)		72,404
	$	78,801		104		(1,433	)		77,472


December 31 , 2016
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 Company did not sell any available for sale securities and did not recognize any gains or losses on investments in 2017. In 2016, the Company sold $20,000 of available for sale securities and recognized a loss of $10,000 on the sales. In 2015, the Company sold $11.0 million of available for sale securities and recognized a gain of $6,000 on the sales.

The following table presents the amortized cost and estimated fair value of securities available for sale at December 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. Actual maturities may differ from the maturities in the following table because obligors may have the right to call or prepay obligations with or without call or prepayment penalties:

(Dollars in thousands)	Amortized C ost		Fair V alue
Due one year or less	$	1,202		1,188
Due after one year through five years		74,950		73,706
Due after five years through ten years		1,780		1,752
Due after ten years		811		669
No stated maturity		58		157
Total	$	78,801		77,472

The allocation of mortgage-backed securities in the table above is based upon the anticipated future cash flow of the securities using estimated mortgage prepayment speeds.

The following table shows the gross unrealized losses and fair values for the securities available for sale portfolio aggregated by investment category and length of time that individual securities have been in a continuous unrealized los s position at December 31, 2017 and 2016:

	Less Than Twelve M onths							Twelve Months or M ore							Total
(Dollars in thousands)	# of Investments		Fair Value		Unrealized Losses			# of Investments		Fair Value		Unrealized Losses			Fair Value		Unrealized Losses
December 31, 201 7
Mortgage backed securities:
FNMA		2	$	4,703		(78	)		0	$	0		0		$	4,703		(78	)
Collateralized mortgage obligations:
FNMA		1		218		(5	)		0		0		0			218		(5	)
Other marketable securities:
U.S. Government agency obligations		2		9,819		(163	)		12		58,942		(1,038	)		68,761		(1,201	)
Municipal obligations		14		2,268		(8	)		0		0		0			2,268		(8	)
Corporate obligations		1		233		(1	)		0		0		0			233		(1	)
Corporate preferred stock		0		0		0			1		560		(140	)		560		(140	)
Total temporarily impaired securities		20	$	17,241		(255	)		13	$	59,502		(1,178	)	$	76,743		(1,433	)


December 31, 2016
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 on U.S. Government agency obligations are the result of changes in interest rates. The unrealized losses reported for the corporate preferred stock at December 31, 2017 relates to a single trust preferred security that was issued by the holding company of a small community bank. As of December 31, 2017 all payments were current on the trust preferred security and the issuer’s subsidiary bank was considered to be “well capitalized” based on its most recent regulatory filing. Based on a review of the issuer, it was determined that the trust preferred security was not other-than-temporarily impaired at December 31, 2017. The Company does not intend to sell the preferred stock and has the intent and ability to hold it for a period of time sufficient to recover the temporary loss. Management believes that the Company will receive all principal and interest payments contractually due on the security and that the decrease in the market value is primarily due to a lack of liquidity in the market for trust preferred securities. Management will continue to monitor the credit risk of the issuer and may be required to recognize other-than-temporary impairment charges on this security in future periods.

NOTE 5 Loans Receivable, Net

A summary of loans receivable at December 31, 2017 and 2016, is as follows:

(Dollars in thousands)	201 7			201 6
Residential real estate loans:
Single family conventional	$	106,881			103,125
Single family FHA		88			92
Single family VA		36			38
		107,005			103,255
Commercial real estate:
Lodging		55,675			43,285
Retail/office		64,780			53,935
Nursing home/health care		7,352			8,185
Land developments		21,058			24,240
Golf courses		1,112			1,560
Restaurant/bar/café		5,929			5,851
Warehouse		25,891			26,630
Construction:
Single family		23,090			21,944
Multi-family		11,649			2,610
Commercial real estate		11,705			6,794
Manufacturing		22,136			15,743
Churches/community service		12,734			10,199
Multi-family		28,649			36,777
Other		42,357			41,327
		334,117			299,080
Consumer:
Autos		2,894			3,036
Home equity line		36,869			40,476
Home equity		15,823			16,302
Other – secured		1,911			2,048
Recreational vehicles		13,181			7,553
Land/lot s		1,587			2,362
Other – unsecured		1,502			1,506
		73,767			73,283
Commercial business		79,909			85,176
Total loans		594,798			560,794
Less:
Unamortized discounts		19			20
Net deferred loan costs		(463	)		(300	)
Allowance for loan losses		9,311			9,903
Total loans receivable, net	$	585,931			551,171
Commitments to originate or purchase loans	$	24,692			47,220
Commitments to deliver loans to secondary market	$	5,629			9,595
Weighted average contractual rate of loans in portfolio		4.56	%		4.45	%

Included in total commitments to originate or purchase loans are fixed rate loans aggregating $18.1 million and $29.6 million as of December 31, 2017 and 2016, respectively. The interest rates on these loan commitments ranged from 3.375% to 5.210% at December 31, 2017 and from 2.75% to 5.125% at December 31, 2016.

The aggregate amount of loans to executive officers and directors of the Company was $0.1 million, $0.2 million and $2.7 million at December 31, 2017, 2016 and 2015, respectively. There was no activity during 2017 and 2016 on loans to executive officers and directors other than the $0.1 million and $2.5 million in loans that were reclassified during the respective periods due to a change in borrower classification. During 2015, repayments on loans to executive officers and directors were $0.1 million, new loans to executive officers and directors totaled $0.2 million, and loans paid off were $0.2 million. All loans were made in the ordinary course of business on normal credit terms, including interest rates and collateral, as those prevailing at the time for comparable transactions with unrelated parties.

At December 31, 2017, 2016 and 2015, the Company was servicing loans for others with aggregate unpaid principal balances of approximately $471.4 million, $425.5 million and $391.9 million, respectively.

The Company originates residential, commercial real estate and other loans primarily in Minnesota, Wisconsin, and Iowa. At December 31, 2017 and 2016, the Company had in its portfolio single family residential loans located in the following states:

201 7

201 6

(Dollars in thousands)

Amount

Percent

of Total

Amount

Percent

of Total

Iowa

3,605

3.4

4,470

4.3

Minnesota

90,345

84.4

87,135

84.4

Missouri

1,841

1.7

1,206

1.2

Wisconsin

9,894

9.3

8,779

8.5

Other states

1,320

1.2

1,665

1.6

Total

107,005

100.0

103,255

100.0

Amounts under one million dollars in both years are included in “Other states”.

At December 31, 20 17 and 2016, the Company had in its portfolio commercial real estate loans located in the following states:

2017

2016

(Dollars in thousands)

Amount

Percent

of Total

Amount

Percent

of Total

Alabama

1,742

0.5

1,902

0.7

Florida

2,790

0.9

3,781

1.3

Idaho

3,371

1.0

3,529

1.2

Indiana

3,374

1.0

2,189

0.7

Iowa

4,755

1.4

1,973

0.7

Minnesota

232,991

69.8

213,983

71.5

North Carolina

5,996

1.8

2,926

1.0

North Dakota

1,093

0.3

8,447

2.8

Ohio

1,680

0.5

0.0

Pennsylvania

2,056

0.6

0.0

Tennessee

0.0

1,036

0.3

Wisconsin

72,510

21.7

57,512

19.2

Other states

1,759

0.5

1,802

0.6

Total

334,117

100.0

299,080

100.0

Amounts under one million dollars in both years are included in “Other states”.

NOTE 6 Allowance for Loan Losses and Credit Quality Information

The allowance for loan losses is summarized as follows:

(Dollars in thousands)

Single

Family

Commercial

Real Estate

Consumer

Commercial

Business

Total

Balance, December 31, 2014

1,096

5,024

1,009

1,203

8,332

Provision for losses

(105

)

(427

)

254

114

(164

)

Charge-offs

(19

)

(105

)

(69

)

(193

)

Recoveries

1,481

193

1,734

Balance, December 31, 2015

990

6,078

1,200

1,441

9,709

Provision for losses

262

(1,788

)

481

400

(645

)

Charge-offs

(66

)

(67

)

(108

)

(180

)

(421

)

Recoveries

730

490

1,260

Balance, December 31, 2016

1,186

4,953

1,613

2,151

9,903

Provision for losses

(280

)

(75

)

263

(431

)

(523

)

Charge-offs

)

(50

)

(288

)

(311

)

(655

)

Recoveries

245

299

586

Balance, December 31, 201 7

900

5,073

1,630

1,708

9,311

Allocated to:

Specific reserves

235

248

434

988

General reserves

951

4,705

1,179

2,080

8,915

Balance, December 31, 2016

1,186

4,953

1,613

2,151

9,903

Allocated to:

Specific reserves

192

441

263

177

1,073

General reserves

708

4,632

1,367

1,531

8,238

Balance, December 31, 201 7

900

5,073

1,630

1,708

9,311

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

Loans receivable at December 31, 201 7 :

Individually reviewed for impairment

1,523

1,364

880

507

4,274

Collectively reviewed for impairment

105,482

332,753

72,887

79,402

590,524

Ending balance

107,005

334,117

73,767

79,909

594,798

The following table summarizes the amount of classified and unclassified loans at December 31 , 2017 and 2016:

December 31, 201 7

Classified

Unclassified

(Dollars in thousands)

Special

Mention

Substandard

Doubtful

Loss

Total

Total Loans

Single family

2,154

2,275

104,730

107,005

Commercial real estate:

Real estate rental and leasing

5,022

3,813

8,835

166,342

175,177

Other

9,135

4,257

13,392

145,548

158,940

Consumer

631

119

130

880

72,887

73,767

Commercial business:

Transportation industry

116

1,002

1,118

7,971

9,089

Other

5,665

4,504

10,169

60,651

70,820

20,015

16,361

163

130

36,669

558,129

594,798

December 31, 2016

Classified

Unclassified

(Dollars in thousands)

Special

Mention

Substandard

Doubtful

Loss

Total

Total Loans

Single family

457

2,130

2,661

100,594

103,255

Commercial real estate:

Real estate rental and leasing

1,577

3,156

4,733

148,610

153,343

Other

1,702

7,187

8,889

136,848

145,737

Consumer

531

110

299

940

72,343

73,283

Commercial business:

Transportation industry

4,065

6,444

10,509

Other

3,973

2,916

6,889

67,778

74,667

7,709

19,985

184

299

28,177

532,617

560,794

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

The aging of past due loans at December 31, 2017 and 2016 is summarized as follows:

(Dollars in thousands)

30-59

Days

Past Due

60-89

Days

Past Due

90 Days

or More

P ast Due

Total

P ast Due

Current

Loans

Total

L oans

Loans 90

Days or

M ore Past

Due and Still

Accruing

201 7

Single family

727

294

669

1,690

105,315

107,005

Commercial real estate:

Real estate rental and leasing

175,177

Other

158,940

Consumer

734

117

235

1,086

72,681

73,767

Commercial business:

Transportation industry

9,089

Other

180

214

70,606

70,820

1,495

411

1,084

2,990

591,808

594,798

2016

Single family

342

158

179

679

102,576

103,255

Commercial real estate:

Real estate rental and leasing

153,343

Other

145,737

Consumer

412

117

140

669

72,614

73,283

Commercial business:

Transportation industry

10,509

Other

274

359

74,308

74,667

839

275

593

1,707

559,087

560,794

I mpaired loans include loans that are non-performing (non-accruing) and loans that have been modified in a TDR. The following table summarizes impaired loans and related allowances for the years ended December 31, 2017 and 2016:

December 31, 201 7

(Dollars in thousands)

Recorded

Investment

Unpaid

Principal

Balance

Related

Allowance

Average

Recorded

Investment

Interest

Income

Recognized

Loans with no related allowance recorded:

Single family

415

414

Commercial real estate:

Real estate rental and leasing

Other

1,682

Consumer

414

406

Commercial business:

Other

100

Loans with an allowance recorded:

Single family

1,108

192

878

Commercial real estate:

Real estate rental and leasing

155

Other

1,304

441

1,715

Consumer

466

483

263

457

Commercial business:

Other

507

1,358

177

443

Total:

Single family

1,523

192

1,292

Commercial real estate:

Real estate rental and leasing

193

Other

1,329

2,986

441

1,741

Consumer

880

897

263

863

Commercial business:

Other

507

1,358

177

543

4,274

6,815

1,073

4,632

194

December 31, 2016

(Dollars in thousands)

Recorded

Investment

Unpaid

Principal

Balance

Allowance

Average

Recorded

Investment

Interest

Income

Recognized

Loans with no related allowance recorded:

Single family

217

567

Commercial real estate:

Real estate rental and leasing

122

Other

1,771

Consumer

312

449

Commercial business:

Other

274

356

Loans with an allowance recorded:

Single family

890

235

1,022

Commercial real estate:

Real estate rental and leasing

389

Other

1,814

248

1,856

229

Consumer

628

644

434

553

Commercial business:

Other

369

921

423

Total:

Single family

1,107

235

1,589

Commercial real estate:

Real estate rental and leasing

122

429

Other

1,840

3,585

248

1,885

326

Consumer

940

956

434

1,002

Commercial business:

Other

643

1,277

504

4,570

7,047

988

5,409

459

At December 31, 2017, 2016 and 2015, non-accruing loans totaled $3.2 million, $3.3 million and $4.2 million, respectively, for which the related allowance for loan losses was $0.9 million, $0.8 million and $0.7 million, respectively. Non-accruing loans for which no specific allowance has been recorded because management determined that the value of the collateral was sufficient to repay the loan totaled $0.4 million, $0.7 million and $1.4 million at December 31, 2017, 2016 and 2015, respectively. Had the non-accruing loans performed in accordance with their original terms, the Company would have recorded gross interest income on the loans of $0.3 million, $0.6 million and $0.4 million in 2017, 2016 and 2015, respectively. For the years ended December 31, 2017, 2016 and 2015, the Company recognized interest income on these loans of $0.1 million, $0.4 million and $0.2 million, respectively. All of the interest income that was recognized for non-accruing loans was recognized using the cash basis method of income recognition. Non-accrual loans also include some of the loans that have had terms modified in a TDR.

The following table summarizes non-accrual loans at December 31, 2017 and 2016:

(Dollars in thousands)	2017		2016
Single family	$	949		916
Commercial real estate:
Real estate rental and leasing		35		41
Other		1,329		1,343
Consumer		553		630
Commercial business:
Other		278		343
	$	3,144		3,273

Included in loans receivable, net, are certain loans that have been modified in order to maximize collection of loan balances. If the Company, for legal or economic reasons related to the borrower’s financial difficulties, grants a concession compared to the original terms and conditions of the loan, the modified loan is considered a TDR.

At December 31, 201 7, 2016 and 2015, there were loans included in loans receivable, net, with terms that had been modified in a TDR totaling $3.0 million, $3.3 million and $2.5 million, respectively. Had these loans been performing in accordance with their original terms throughout 2017, 2016 and 2015, the Company would have recorded gross interest income of $0.4 million, $0.6 million and $0.4 million, respectively. During 2017, 2016 and 2015, the Company recognized interest income of $0.2 million, $0.4 million and $0.2 million, respectively, on these loans. For the loans that were modified in 2017, $0.7 million are classified and performing and $0.4 million were non-performing at December 31, 2017.

The following table summarizes TDRs at December 31, 2017 and 2016:

(Dollars in thousands)	2017		2016
Single family	$	685		448
Commercial real estate:
Other		1,210		1,774
Consumer		758		709
Commercial business:
Other		391		369
	$	3,044		3,300

As of December 31, 201 7, the Bank had commitments to lend an additional $0.8 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. There were commitments to lend additional funds of $0.4 million to this same borrower at December 31, 2016.

TDR concessions can include reduction of interest rates, extension of maturity dates, forgiveness of principal and/or interest due, or acceptance of real estate or other assets in full or partial satisfaction of the debt. Loan modifications are not reported as TDRs after 12 months if the loan was modified at a market rate of interest for comparable risk loans, and the loan is performing in accordance with the terms of the restructured agreement. All loans classified as TDRs are considered to be impaired.

When a loan is modified as a TDR, there may be a direct, material impact on the loans within the Consolidated Balance Sheets, as principal balances may be partially forgiven. The financial effects of TDRs are presented in the following table and represent the difference between the outstanding recorded balance pre-modification and post-modification, for the periods ending December 31, 2017 and 2016:

Year ended December 31, 201 7

Year ended December 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 restructurings:

Single family

282

514

251

263

Commercial real estate:

Other

1,274

Consumer

588

591

382

384

Commercial business:

Other

416

116

257

201

Total

1,286

1,221

2,164

2,122

Loans that were restructured within the 12 months preceding December 31, 2017 and 2016 and defaulted during the year are presented in the table below:

	Year ended December 31, 201 7				Year ended December 31, 201 6
(Dollars in thousands)	Number of Contracts		Outstanding Recorded Investment		Number of Contracts		Outstanding Recorded Investment
Troubled debt restructurings that subsequently defaulted:
Commercial real estate:
Other		0	$	0		1	$	183
Consumer		1		65		1		4
Total		1	$	65		2	$	187

The Company considers a loan to have defaulted when it becomes 90 or more days past due under the modified terms, when it is placed in non-accrual status, when it becomes other real estate owned, or when it becomes non-compliant with some other material requirement of the modification agreement.

Loans that were non-accrual prior to modification remain non-accrual for at least six months following modification. Non-accrual TDR loans that have performed according to the modified terms for six months may be returned to accruing status. Loans 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 allocated reserves for TDRs was $0.9 million, or 9.8%, of the total $9.3 million in allowance for loan losses at December 31, 2017, and $0.6 million, or 6.2%, of the total $9.9 million in allowance for loan losses at December 31, 2016.

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

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

(Dollars in thousands)	Contractual Principal Receivable			Accretable Difference			Net Carrying Amount
Purchased Performing Loans:
Balance at December 31, 201 4	$	0			0			0

Loans acquired during the period	$	24,215			(793	)		23,422
Change due to payments/refinances		(5,676	)		334			(5,342	)
Balance at December 31, 201 5	$	18,539			(459	)		18,080

Loans acquired during the period	$	11,772			(211	)		11,561
Change due to payments/refinances		(13,413	)		340			(13,073	)
Change due to loan charge-off		(156	)		(2	)		(158	)
Balance at December 31, 201 6	$	16,742			(332	)		16,410

Change due to payments/refinances	$	(6,594	)		101			(6,493	)
Transferred to foreclosed assets		(2	)		0			(2	)
Change due to loan charge-off		(18	)		0			(18	)
Balance at December 31, 201 7	$	10,128			(231	)		9,897

(Dollars in thousands)

Contractual

Principal

Receivable

Non-Accretable

Difference

Net

Carrying

Amount

Purchased Credit Impaired Loans:

Balance at December 31, 2014

Loans acquired during the period

1,134

(497

)

637

Change due to payments/refinances

(260

)

(212

)

Change due to loan charge-off

(319

)

287

(32

)

Balance at December 31, 201 5

555

(162

)

393

Loans acquired during the period

329

(37

)

292

Change due to payments/refinances

(449

)

147

(302

)

Balance at December 31, 201 6

435

(52

)

383

Change due to payments/refinances

(33

)

(20

)

Balance at December 31, 201 7

402

(39

)

363

As a result of acquisitions, the Company has PCI loans for which there was, at acquisition, evidence of deterioration of credit quality since origination and for which it was probable at acquisition that all contractually required payments would not be collected. The carrying amount of those loans as of December 31, 2017 was $0.4 million.

No material provision for loan losses was recognized during the period ended December 31, 2017 related to acquired loans as there was no significant change to the credit quality of the loans.

NOTE 7 Accrued Interest Receivable

Accrued int erest receivable at December 31 is summarized as follows:

(Dollars in thousands)	201 7		201 6
Securities available for sale	$	352		400
Loans receivable		1,992		2,226
	$	2,344		2,626

NOTE 8 Intangible Assets

The Company ’s intangible assets consist of core deposit intangibles, goodwill, and mortgage servicing rights. A summary of mortgage servicing rights activity for 2017 and 2016 is as follows:

(Dollars in thousands)	2017			2016
Mortgage servicing rights:
Balance, beginning of year	$	1,604			1,499
Originations		675			706
Amortization		(555	)		(601	)
Balance, end of year		1,724			1,604
Valuation reserve		0			0
Mortgage servicing rights, net	$	1,724			1,604
Fair value of mortgage servicing rights	$	3,196			2,952

All of the single family loans sold where the Company continues to service the loans are serviced for Federal National Mortgage Association (FNMA) under the individual loan sale program. The following is a summary of the risk characteristics of the loans being serviced for FNMA at December 31, 2017:

(Dollars in thousands)

Loan

Principal

Balance

Weighted

Average

Interest Rate

Weighted

Average

Remaining Term

(months)

Number of

Loans

Original term:

30 year fixed rate

266,560

4.07

306

2,119

15 year fixed rate

102,957

3.10

136

1,084

Adjustable rate

3.25

281

The gross carrying amount of intangible assets and the associated accumulated amortization at December 31, 2017 and 2016 are presented in the following table. Amortization expense for intangible assets was $0.7 million, $0.7 million and $0.6 million for the years ended December 31, 2017, 2016 and 2015, respectively.

Gross

Unamortized

Carrying

Accumulated

Intangible

(Dollars in thousands)

Amount

Amortization

Assets

December 31, 20 1 7

Mortgage servicing rights

4,244

(2,520

)

1,724

Core deposit intangible

574

(219

)

355

Goodwill

802

Total

5,620

(2,739

)

2,881

December 31, 201 6

Mortgage servicing rights

3,954

(2,350

)

1,604

Core deposit intangible

574

(120

)

454

Goodwill

802

Total

5,330

(2,470

)

2,860

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

(Dollars in thousands)

Mortgage

Servicing

Rights

Core

Deposit

Intangible

Total

Amortizing
Intangible

Assets

Year ended December 31,

201 8

438

537

201 9

378

477

2020

305

404

202 1

256

303

202 2

191

202

Thereafter

156

1,724

355

2,079

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

Projections of am ortization are based on asset balances and the interest rate environment that existed at December 31, 2017. The Company’s actual experience may be significantly different depending upon changes in mortgage interest rates and other market conditions.

NOTE 9 Real Estate

A summary of real estate at December 31 , 2017 and 2016 is as follows:

	201 7						201 6

(Dollars in thousands)	Residential		Commercial & Other		Total		Residential		Commercial & Other			Total
Real estate in judgment subject to redemption	$	40		173		213		0		0			0
Real estate acquired through foreclosure		0		414		414		0		1,245			1,245
Real estate acquired through deed in lieu of foreclosure		0		0		0		0		28			28
		40		587		627		0		1,273			1,273
Allowance for losses		0		0		0		0		(662	)		(662	)
Real estate, net	$	40		587		627		0		611			611

NOTE 1 0 Premises and Equipment

A summary of premises and equipment at December 31 , 2017 and 2016 is as follows:

(Dollars in thousands)	201 7			201 6
Land	$	2,021			2,021
Office buildings and improvements		9,844			9,666
Furniture and equipment		12,507			12,478
		24,372			24,165
Accumulated depreciation		(16,146	)		(15,942	)
	$	8,226			8,223

N OTE 1 1 Deposits

Deposits and their weighted average interest rates at December 31 , 2017 and 2016 are summarized as follows:

20 1 7

20 16

(Dollars in thousands)

Weighted

Average

Rate

Amount

Percent

of Total

Weighted

Average

Rate

Amount

Percent

of Total

Noninterest checking

0.00

172,007

27.1

0.00

158,024

26.7

NOW accounts

0.05

90,599

14.3

0.07

92,670

15.6

Savings accounts

0.08

75,255

11.8

0.08

74,238

12.5

Money market accounts

0.40

186,937

29.4

0.25

165,179

27.9

524,798

82.6

490,111

82.7

Certificates by rate:

0-0.99%

58,444

9.2

79,628

13.4

1-1.99%

43,691

6.9

22,958

3.9

2-2.99%

8,550

1.3

0.0

3-3.99%

118

0.0

114

0.0

Total certificates

0.94

110,803

17.4

0.61

102,700

17.3

Total deposits

0.30

635,601

100.0

0.20

592,811

100.0

At December 31, 20 17 and 2016, the Company had $204.2 million and $172.6 million, respectively, of deposit accounts with balances of $250,000 or more. At December 31, 2017 and 2016, the Company had no certificate accounts that had been acquired through a broker.

Certificates had the following maturities at December 31 , 2017 and 2016:

20 1 7

20 16

(Dollars in thousands)

Amount

Weighted

A verage

R ate

Amount

Weighted

A verage

R ate

Remaining term to maturity

1-6 months

28,133

0.54

32,418

0.36

7-12 months

37,439

0.95

25,424

0.45

13-36 months

39,382

1.14

36,111

0.81

Over 36 months

5,849

1.28

8,747

1.18

110,803

0.94

102,700

0.61

At December 31, 20 17 and 2016, the Company had pledged mortgage loans and mortgage-backed and related securities with an amortized cost of approximately $18.9 million and $17.4 million, respectively, as collateral for certain deposits. An additional $1.0 million letter of credit from the Federal Home Loan Bank (FHLB) was pledged at December 31, 2016 as collateral on certain Bank deposits. This letter of credit matured in August of 2017 and was not renewed.

Interest expense on deposits is summarized as follows for the years ended December 31 , 2017, 2016 and 2015:

(Dollars in thousands)	2017		2016		2015
NOW accounts	$	77		50		17
Savings accounts		63		62		42
Money market accounts		560		366		347
Certificates		770		524		528
	$	1,470		1,002		934

NOTE 1 2 FHLB Advances and Other B orrowings

The Bank had no outstanding advances from the FHLB or borrowings from the Federal Reserve Bank of Minneapolis as of December 31, 2017 or December 31, 2016. At December 31, 2017 it had collateral pledged to the FHLB consisting of FHLB stock, mortgage loans, and investments with a borrowing capacity of approximately $106.3 million, subject to a requirement to purchase FHLB stock. The Bank also had the ability to draw additional borrowings of $77.9 million from the Federal Reserve Bank of Minneapolis, based upon the loans that were pledged to them as of December 31, 2017, subject to approval from the Board of Governors of the Federal Reserve System (FRB).

At December 31, 2016 it had collateral pledged to the FHLB consisting of FHLB stock, mortgage loans, and investments with an available borrowing capacity of approximately $104.7 million, subject to a requirement to purchase FHLB stock. The Bank also had the ability to draw additional borrowings of $85.8 million from the Federal Reserve Bank of Minneapolis, based upon the loans that were pledged to them as of December 31, 2016, subject to approval from the FRB.

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 6.50% per annum. The principal balance of the Note was 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. The Company had the option to 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, a $2.0 million payment on December 15, 2016, and on August 31, 2017 paid off the remaining principal balance of $7.0 million. There was no outstanding loan balance at December 31, 2017 and the loan balance was $7.0 million at December 31, 2016.

NOTE 1 3 Income Taxes

Income tax expense for the years ended December 31, 2017, 2016 and 2015 is as follows:

(Dollars in thousands)

2017

2016

2015

Current:

Federal

2,287

939

(87

)

State

(24

)

Total current

2,297

994

(111

)

Deferred:

Federal

1,412

2,322

1,393

State

693

806

329

Total deferred

2,105

3,128

1,722

Income tax expense

4,402

4,122

1,611

The reasons for t he difference between the expected income tax expense utilizing the federal corporate tax rate of 34% and the actual income tax expense are as follows:

(Dollars in thousands)

2017

2016

2015

Expected federal income tax expense

2,994

3,560

1,553

Items affecting federal income tax:

State income taxes, net of federal income tax deduction

529

622

259

Tax exempt interest

(16

)

(16

)

(44

)

Change in federal tax rate

1,062

Other, net

(167

)

(44

)

(157

)

Income tax expense

4,402

4,122

1,611

The tax effects of temporary differences that give rise to the deferred tax assets and deferred tax liabilities are as follows at December 31:

(Dollars in thousands)	2017		2016
Deferred tax assets:
Allowances for loan and real estate losses	$	2,602		4,186
Deferred compensation costs		166		262
Deferred ESOP loan asset		487		704
Nonaccruing loan interest		221		313
State net operating loss carryforward		824		1,366
Alternative minimum tax credit carryforward		175		118
Net unrealized loss on securities available for sale		372		542
Other		92		147
Total gross deferred tax assets		4,939		7,638

Deferred tax liabilities:
Deferred loan fees		37		100
Premises and equipment basis difference		380		126
Originated mortgage servicing rights		482		636
Federal tax liability on state net operating loss carryforwards		280		676
Other		88		153
Total gross deferred tax liabilities		1,267		1,691
Net deferred tax assets	$	3,672		5,947

The Company has no federal net operating loss carryforwards and $8.7 million of state net operating loss carryforwards at December 31, 2017 that expire beginning in 2023.

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

Retained earnings at December 31, 20 17 included approximately $8.8 million for which no provision for income taxes was made. This amount represents allocations of income to bad debt deductions for tax purposes. Reduction of amounts so allocated for purposes other than absorbing losses will create income for tax purposes, which will be subject to the then-current corporate income tax rate.

The Company considers the determination of the deferred tax asset amount and the need for any valuation reserve to be a critical accounting policy that requires significant judgment. The Company has, in its judgment, made reasonable assumptions and considered both positive and negative evidence relating to the ultimate realization of deferred tax assets. Positive evidence includes the cumulative net income generated over the prior three year period and the probability that taxable income will be generated in future periods. Based upon this evaluation, the Company determined that no valuation allowance was required with respect to the net deferred tax assets at December 31, 2017 and 2016.

NOTE 1 4 Employee Benefits

A ll eligible full-time employees of the Bank that were hired prior to 2002 were included in a noncontributory retirement plan sponsored by the Financial Institutions Retirement Fund (FIRF). The Home Federal Savings Bank (Employer #8006 ) plan participates in the Pentegra Defined Benefit Plan for Financial Institutions (the Pentegra DB Plan). The Pentegra DB Plan’s Employer Identification Number is 13 - 5645888 and the Plan number is 333. The Pentegra DB Plan operates as a multi-employer plan for accounting purposes under the Employee Retirement Income Security Act of 1974, as amended (ERISA), and the Internal Revenue Code. There are no collective bargaining agreements in place that require contributions to the Pentegra DB Plan.

The Pentegra DB Plan is a single plan under Internal Revenu e Code Section 413 (c) and, as a result, all of the assets stand behind all of the liabilities. Accordingly, under the Pentegra DB Plan, contributions made by a participating employer may be used to provide benefits to participants of other participating employers.

Effective September 1, 2002 , the accrual of benefits for existing participants was frozen and no new enrollments have been permitted into the plan. The actuarial present value of accumulated plan benefits and net assets available for benefits relating to the Bank's employees was not available at December 31, 2017 because such information is not accumulated for each participating institution. As of June 30, 2017, the Pentegra DB Plan valuation report reflected that the Bank was obligated to make a contribution totaling $0.1 million which was paid and expensed in 2017.

Funded status ( market value of plan assets divided by funding target) as of July 1 for the 2017, 2016, and 2015 plan years were 95.45%, 97.09% and 96.01%, respectively. Market value of plan assets reflects contributions received through June 30, 2017.

Total employer contributions made to the Pentegra DB Plan, as reported on Form 5500, equal $153.2 million, $163.1 million and $190.8 million for the plan years ended June 30, 2017, 2016 and 2015, respectively. The Bank’s contributions to the Pentegra DB Plan are not more than 5% of the total contributions to the Pentegra DB Plan. There is no funding improvement plan or rehabilitation plan as part of this multi-employer plan.

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

(Dollars in thousands)

201 7				201 6			201 5
Date Paid	Amount			Date Paid	Amount		Date Paid	Amount
1/6/2017	$	119	⁽¹⁾		$	0		$	0
10/15/2017		27		10/15/16		33	10/15/2015		42
12/27/2017		99				0	12/30/2015		151
Total	$	245			$	33		$	193

^(

1

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

The Company has a qualified, tax-exempt savings plan with a deferred feature qualifying under Section 401 (k) of the Internal Revenue Code (the 401 (k) Plan). All employees who have attained 18 years of age are eligible to participate in the 401 (k) Plan. Participants are permitted to make contributions to the 401 (k) Plan equal to the lesser of 50% of their annual salary or the maximum allowed by law, which was $18,000 for 2017, 2016 and 2015. The Company matches 25% of each participant’s contributions up to a maximum of 8% of their annual salary. Participant contributions and earnings are fully and immediately vested. The Company’s contributions are vested on a three year cliff basis, are expensed annually, and were $0.2 million in 2017, 2016 and 2015.

The Company has adopted an Employee Stock Ownership Plan (the ESOP) that meets the requirements of Section 4975 (e)( 7 ) of the Internal Revenue Code and Section 407 (d)( 6 ) of ERISA and, as such, the ESOP is empowered to borrow in order to finance purchases of the common stock of HMN. The ESOP borrowed $6.1 million from the Company to purchase 912,866 shares of common stock in the initial public offering of HMN in 1994. As a result of a merger with Marshalltown Financial Corporation (MFC), the ESOP borrowed $1.5 million in 1998 to purchase an additional 76,933 shares of HMN common stock to account for the additional employees and to avoid dilution of the benefit provided by the ESOP. The ESOP debt requires quarterly payments of principal plus interest at 7.52%. The Company has committed to make quarterly contributions to the ESOP necessary to repay the loans including interest. The Company contributed $0.5 million in 2017, 2016 and 2015.

As the debt is repaid, ESOP shares that were ple dged as collateral for the debt are released from collateral based on the proportion of debt service paid in the year and then allocated to eligible employees. The Company accounts for its ESOP in accordance with ASU 718, Employers' Accounting for Employee Stock Ownership Plans . Accordingly, the shares pledged as collateral are reported as unearned ESOP shares in stockholders' equity. As shares are determined to be ratably released from collateral, the Company reports compensation expense equal to the current market price of the shares and the shares become outstanding for earnings per common share computations. ESOP compensation expense was $0.4 million for 2017 and $0.3 million for both 2016 and 2015.

All employees of the Bank are eligible to participate in t he ESOP after they attain age 18 and complete one year of service during which they worked at least 1,000 hours. A summary of the ESOP share allocation is as follows for the years ended December 31:

2017

2016

2015

Shares held by participants beginning of the year

339,870

334,277

336,024

Shares allocated to participants

24,317

24,377

24,317

Shares distributed to participants

(7,052

)

(18,784

)

(26,064

)

Shares held by participants end of year

357,135

339,870

334,277

Unreleased shares beginning of the year

279,746

304,123

328,440

Shares released during year

(24,317

)

(24,377

)

(24,317

)

Unreleased shares end of year

255,429

279,746

304,123

Total ESOP shares end of year

612,564

619,616

638,400

Fair value of unreleased shares at December 31

4,878,694

4,895,555

3,512,621

In March 2001, the HMN Financial, Inc. 2001 Omnibus Stock Plan ( 2001 Plan) was adopted by the Company. In April 2009, this plan was superseded by the HMN Financial, Inc. 2009 Equity and Incentive Plan ( 2009 Plan) and options or restricted shares were no longer awarded from the 2001 Plan. As of December 31, 2017, all outstanding options under the 2001 Plan have expired.

In April of 2017, the 2009 Plan was superseded by the HMN Financial, Inc. 2017 Equity Incentive Plan ( 2017 Plan) and options or restricted shares were no longer awarded from the 2009 Plan. As of December 31, 2017 there were 26,409 vested and 22,820 unvested options outstanding under the 2009 Plan. These options expire 10 years from the date of grant and have an average exercise price of $9.25. There were also 14,881 shares of restricted stock previously granted to current employees that as of December 31, 2017 remain unvested. The 43,712 ungranted shares remaining in the 2009 Plan were transferred to the 2017 Plan upon its adoption and are available for grant under that plan.

The purpose of the 2017 Plan is to attract and retain the best available personnel for positions of responsibility with the Company, to provide additional incentives to them and align their interests with those of the Company’s stockholders, and to thereby promote the Company’s long-term business success. 375,000 shares of HMN common stock were initially available for distribution under the 2017 Plan in either restricted stock or options, subject to adjustment for future stock splits, stock dividends and similar changes to capitalization of the Company. Additionally, shares of restricted stock that are awarded are counted as 1.5 shares for purposes of determining the total shares available for issuance under the 2017 Plan. As of December 31, 2017, there were no options outstanding under the 2017 Plan. There were 2,280 shares of restricted stock granted to current employees during 2017 that remain unvested at December 31, 2017.

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

												Unvested options
	Shares Available For Grant			Unvested Restricted S hares O utstanding			Options O utstanding			Award Value/ Weighted Average Exercise P rice		Number			Weighted Average Grant Date Fair V alue		Vesting Period (in years)
2001 Plan
December 3 1, 2014		0			0			15,000		$	30.00		0
Forfeited/expired		0			0			(15,000	)		30.00		0
December 31, 2015		0			0			0			0.00		0
December 31, 2016		0			0			0			0.00		0
December 31, 2017		0			0			0			0.00		0

2009 Plan
December 31, 2014		96,405			84,858			15,000		$	4.77		0
Granted January 2 7, 2015		(11,903	)		9,919			0			N/A		0					3
Granted April 28, 2015		(3,158	)		2,632			0			N/A		0					1
Granted June 8, 2015		(398	)		332			0			N/A		0					1
Forfeited/expired		395			(329	)		0					0
Transferred from 2001 Plan		15,000			0			0					0
Vested		0			(58,526	)		0					0
December 31, 2015		96,341			38,886			15,000			4.77		0
Granted January 26, 2016		(4,087	)		3,406			0			N/A		0					3
Granted January 26, 2016		(34,229	)		0			34,229			11.21		34,229			4.04		3
Granted April 26, 2016		(3,149	)		2,624			0			N/A		0					1
Vested		0			(24,320	)		0					0
December 31, 2016		54,876			20,596			49,229			9.25		34,229			4.04
Granted January 31, 2017		(11,164	)		9,303			0			N/A							3
Transferred to 2017 Plan		(43,712	)		0			0			N/A
Vested		0			(15,018	)		0					(11,409	)		4.04
December 31, 2017		0			14,881			49,229		$	9.25		22,820		$	4.04

2017 Plan
April 25, 2017		375,000
Granted May 5 , 2017		(3,420	)		2,280			0			N/A							1
Transferred from 2009 Plan		43,712			0			0
December 31, 2017		415,292			2,280			0			N/A		0

Total all plans		415,292			17,161			49,229		$	9.25		22,820		$	4.04

The following table summarizes information about stock options outstanding at December 31, 2017:

Date of

Grant

Exercise

Price

Number

Outstanding

Weighted

Average

Remaining

Contractual

Life in Years

Number

Exercisable

Number

Unexercisable

Unrecognized Compensation

Expense

Weighted Average

Years Over Which Unrecognized Compensation will

be Recognized

May 6, 2009

4.77

15,000

1.4

15,000

N/A

January 26, 2016

11.21

34,229

8.1

11,409

22,820

18,062

1.1

49,229

26,409

22,820

18,062

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

In accordance with ASC 718, the Company recognizes compensation expense relating to stock options over the vesting period. The amount of the expense was determined under the fair value method. The fair value for each option grant is estimated on the date of the grant using the Black Scholes option valuation method. There were no options granted in 2017 or 2015.

The assumptions used in determining the fair value of the options granted during 2016 are as follows:

	201 6
Risk-free interest rate		2.10	%
Expected life (in years)		10
Expected volatility		22.83	%
Expected dividends		0.00	%

NOTE 1 5 Earnings per Common Share

The following table reconciles the weighted av erage shares outstanding and net income for basic and diluted earnings per common share:

Year ended December 31,

(Dollars in thousands, except per share data)

2017

2016

201 5

Weighted average number of common shares outstanding used in basic earnings per common share calculation

4,215,899

4,180,994

4,127,453

Net dilutive effect of :

Options and warrants

640,410

553,386

513,505

Restricted stock awards

11,662

13,367

34,959

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

4,867,971

4,747,747

4,675,917

Net income

4,404

6,350

2,956

Dividends on preferred stock

(108

)

Net income available to common shareholders

4,404

6,350

2,848

Basic earnings per common share

1.04

1.52

0.69

Diluted earnings per common share

0.90

1.34

0.61

NOTE 1 6 Stockholders' Equity

The Co mpany did not repurchase any shares of its common stock in the open market or pay any dividends on its common stock during 2017, 2016 or 2015. The Company did purchase 2,968 shares of common stock from employees to pay the income taxes on net exchanges of vested restricted stock in 2017.

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

O n February 17, 2015, the Company redeemed the final 10,000 shares of the outstanding Preferred Stock. On May 21, 2015, the Treasury sold the Warrant at an exercise price of $4.68 to three unaffiliated third party investors for an aggregate purchase price of $5.7 million. Two of the investors received a warrant to purchase 277,777.67 shares and one investor received a warrant to purchase 277,777.66 shares. All of the warrants were still outstanding as of December 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.

In order to grant a priority to eligible accountholders in the event of future liquidation, the Bank, at the time of conversion to a stock savings bank, established a liquidation account equal to its regulatory capital as of September 30, 1993. In the event of future liquidation of the Bank, an eligible accountholder who continues to maintain their deposit account shall be entitled to receive a distribution from the liquidation account. The total amount of the liquidation account will decrease as the balance of eligible accountholders is reduced subsequent to the conversion, based on an annual determination of such balance.

NOTE 1 7 Regulatory Capital

T he Company and the Bank are subject to 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 are being 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 their assets, liabilities and certain off-balance sheet items as calculated under regulatory accounting practices. The capital amounts and classification are also subject to qualitative judgments by the regulators about components, risk weightings and other factors.

T he FRB 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.

At December 31, 20 17 and 2016, the Bank's capital amounts and ratios are presented for actual capital, required capital and excess capital including amounts and ratios in order to qualify as being well capitalized under the prompt corrective action regulations:

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 ⁾

December 31, 201 7

C ommon equity T ier 1 capital

76,279

12.45

27,561

4.50

48,718

7.95

39,810

6.50

Tier 1 leverage

76,279

10.68

28,569

4.00

47,710

6.68

35,711

5.00

Tier 1 r isk-based capital

76,279

12.45

36,748

6.00

39,531

6.45

48,997

8.00

To tal risk-based capital

83,957

13.71

48,997

8.00

34,960

5.71

61,246

10.00

December 31, 2016

Common equity T ier 1 capital

77,634

13.42

26,032

4.50

51,602

8.92

37,601

6.50

Tier 1 leverage

77,634

11.55

26,876

4.00

50,758

7.55

33,595

5.00

Tier 1 risk-based capital

77,634

13.42

34,709

6.00

42,925

7.42

46,278

8.00

Total risk-based capital

84,900

14.68

46,278

8.00

38,622

6.68

57,848

10.00

⁽ ¹ ⁾ Based upon the Bank’s adjusted total assets for the purpose of the Tier 1 leverage capital ratio and risk-weighted assets for the purpose of the risk-based capital ratios.

T he 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 was 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 December 31, 201 7, the Bank’s capital ratios were in excess of those quantitative capital ratio standards applicable on that date, set forth under the 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 further adjust the requirement to be well-capitalized in the future.

NOTE 1 8 Financial Instruments with Off-Balance Sheet Risk

The Company is a party to financial instruments with off-balance sheet risk in the normal course of business to meet the financing needs of its customers. These financial instruments include commitments to extend credit. These commitments involve, to varying degrees, elements of credit and interest rate risk in excess of the amounts recognized in the balance sheet. The contract amounts of these instruments reflect the extent of involvement by the Company.

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

	December 31, Contract Amount
(Dollars in thousands)	2017		2016
Financial instruments whose contract amount represents credit risk:
Commitments to originate, fund or purchase loans:
Single family	$	3,792		7,587
Commercial real estate		12,968		33,953
Non-real estate commercial		6,495		420
Undisbursed balance of loans closed		44,712		39,841
Unused lines of credit		103,811		100,893
Letters of credit		1,867		1,902
Total commitments to extend credit	$	173,645		184,596
Forward commitments	$	5,629		9,595

Commitments to extend credit are agreements to lend to a customer , at the customer’s request, as long as there is no violation of any condition established in the contract. Commitments generally have fixed expiration dates or other termination clauses and may require payment of a fee. Since a portion of the commitments are expected to expire without being drawn upon, the total commitment amounts do not necessarily represent future cash requirements. The Bank evaluates each customer's creditworthiness on a case-by-case basis. The amount of collateral obtained, if deemed necessary by the Bank upon extension of credit, is based on the loan type and on management's credit evaluation of the borrower. Collateral consists primarily of residential and commercial real estate and personal property.

Forward c ommitments represent commitments to sell loans to a third party following the closing of the loan and are entered into in the normal course of business by the Bank.

The Bank issued standby letters of credit which guarantee the performance of customers to third parties. The standby letters of credit outstanding expire over the next 34 months and totaled $1.9 million at December 31, 2017 and December 31, 2016. The letters of credit are collateralized primarily with commercial real estate mortgages. Draws on standby letters of credit would be initiated by the secured party under the terms of the underlying obligation. Since the conditions under which the Bank is required to fund the standby letters of credit may not materialize, the cash requirements are expected to be less than the total outstanding commitments.

The Company has certain obligations and commitments to make future payments under existing contracts. At December 31, 201 7, the aggregate contractual obligations (excluding bank deposits) and commercial commitments were as follows:

Payments Due by Period

(Dollars in thousands)

Total

Less than 1

Year

1-3 Years

4-5 Years

More than 5 Years

Contractual Obligations:

Annual rental commitments under non-cancellable operating leases

5,740

888

1,740

1,679

1,433

Total contractual obligations

5,740

888

1,740

1,679

1,433

Amount of Commitments Expiring by Period

Other Commercial Commitments:

Commercial lines of credit

53,691

25,433

17,175

11,033

Commitments to lend

39,965

13,691

994

13,110

12,170

Standby letters of credit

1,867

1,546

321

Total other commercial commitments

95,523

40,670

18,490

24,143

12,220

NOTE 19 Derivative Instruments and Hedging Activities

The Company originates single-family residential loans for sale into the secondary market and enters into commitments to sell those loans in order to mitigate the interest rate risk associated with holding the loans until they are sold. The Company accounts for its commitments in accordance with ASC 815, Accounting for Derivative Instruments and Hedging Activities .

The Company ha d commitments outstanding to extend credit to future borrowers that had not closed prior to the end of the year, which is referred to as its mortgage pipeline. As commitments to originate loans enter the mortgage pipeline, the Company generally enters into commitments to sell the loans into the secondary market. The commitments to originate and sell loans are derivatives that are recorded at fair value. The marking of these derivatives to fair value for the periods ended December 31, 2017 and December 31, 2016 did not have a material impact on the Company’s consolidated financial statements.

As of December 31, 20 17 and 2016, the current commitments to sell loans held for sale are derivatives that do not qualify for hedge accounting. The loans held for sale that are not hedged are recorded at the lower of cost or market. The marking of these loans for the periods ended December 31, 2017 and December 31, 2016 did not have a material impact on the Company’s consolidated financial statements.

NOTE 2 0 Fair Value Measurement

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

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

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

Level 3 – Valuation is generated from model-based techniques that use significant assumptions not observable in the market and are used only to the extent 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 December 31, 2017 and 2016.

	Carrying Value at December 31, 201 7
*(Dollars in thousands)*	Total		Level 1		Level 2		Level 3
Securities available for sale	$	77,472		0		77,472		0
Mortgage loan commitments		28		0		28		0
Total	$	77,500		0		77,500		0

	Carrying V alue at December 31, 2016
(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

The Company may also be required, from time to time, to measure certain other financial assets at fair value on a nonrecurring basis in accordance with generally accepted accounting principles. These adjustments to fair value usually result from the appl ication of the lower-of-cost-or-market accounting or write downs of individual assets. For assets measured at fair value on a nonrecurring basis in 2017 and 2016 that were still held at December 31, the following table provides the level of valuation assumptions used to determine each adjustment and the carrying value of the related individual assets or portfolios at December 31, 2017 and 2016.

	Carrying Value at December 31, 201 7
*(Dollars in thousands)*	Total		Level 1		Level 2		Level 3		Year Ended December 31, 201 7 Total gains (losses)
Loans held for sale	$	1,837		0		1,837		0		1
Mortgage servicing rights, net		1,724		0		1,724		0		0
Loans ⁽¹⁾		3,201		0		3,201		0		(413	)
Real estate, net ⁽²⁾		627		0		627		0		0
Total	$	7,389		0		7,389		0		(412	)

	Carrying V alue at December 31, 2016
(Dollars in thousands)	Total		Level 1		Level 2		Level 3		Year E nded December 31, 201 6 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 specific reserves on loans for which adjustments are based on the appraised value of the collateral. The carrying value of loans fully charged-off is zero.

^(

2

)

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

NOTE 2 1 Fair Value of Financial Instruments

ASC 825 , Disclosures about Fair Values of Financial Instruments , requires disclosure of the estimated fair values of the Company's financial instruments, including assets, liabilities and off-balance sheet items for which it is practicable to estimate fair value. The fair value estimates are made as of December 31, 2017 and 2016 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 estimates are subjective in nature and involve uncertainties and matters of significant judgment and therefore cannot be determined with precision. Changes in assumptions could significantly affect the estimates.

Fair value estimates are based only on existing financial instruments without attempting to estimate the value of anticipated future business or the value of assets and liabilities that are not considered financial instruments. In addition, the tax ramifications related to the realization of the unrealized gains and losses can have a significant effect on the fair value estimates and have not been considered in any of the estimates.

The estimated fair value of the Company's financial instruments are shown below. Following the table, there is an explanation of the methods and assumptions used to estimate the fair value of each class of financial instruments.

December 31 , 201 7

December 31, 201 6

Fair value hierarchy

(Dollars in thousands)

Carrying

amount

Estimated

fair value

Level 1

Level 2

Level 3

Contract

amount

Carrying

amount

Estimated

fair value

Contract

a mount

Financial assets:

Cash and cash equivalents

37,564

27,561

Securities available for sale

77,472

78,477

Loans held for sale

1,837

2,009

Loans receivable, net

585,931

585,494

551,171

552,395

FHLB stock

817

770

Accrued interest receivable

2,344

2,626

Financial liabilities:

Deposits

635,601

635,905

592,811

593,297

Other borrowings

7,000

7,018

Accrued interest payable

146

236

Off-balance sheet financial instruments:

Commitments to extend credit

173,645

184,596

Commitments to sell loans

(11

)

(11

)

5,629

(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.

Loans Held for Sale

The fair values of loans held for sale were based upon quoted market prices for loans with similar interest rates and terms to maturity.

Loans Receivable

The fair values of loans receivable were estimated for groups of loans with similar characteristics. 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.

FHLB Stock

The carrying amount of FHLB stock approximates its fair value.

Accrued Interest Receivable

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

Deposits

T he 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.

FHLB Advances and Other Borrowings

The fair values of advances and 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.

NOTE 2 2 HMN Financial, Inc. Financial Information (Parent Company Only)

The following are the condensed financial statements for the parent company only as of December 31, 20 17 and 2016 and for the years ended December 31, 2017, 2016 and 2015.

(Dollars in thousands)

201 7

201 6

201 5

Condensed Balance Sheets

Assets:

Cash and cash equivalents

2,057

3,314

Investment in subsidiaries

77,006

78,108

Prepaid expenses and other assets

1,867

1,159

Deferred tax asset, net

141

756

Total assets

81,071

83,337

Liabilities and Stockholders' Equity:

Other borrowed money

7,000

Accrued expenses and other liabilities

253

418

Total liabilities

253

7,418

Common stock

Additional paid-in capital

50,623

50,566

Retained earnings

91,448

86,886

Net unrealized losses on securities available for sale

(957

)

(820

)

Unearned employee stock ownership plan shares

(2,030

)

(2,223

)

Tr easury stock, at cost, 4,631,124 and 4,639,739 shares

(58,357

)

(58,581

)

Total stockholders' equity

80,818

75,919

Total liabilities and stockholders' equity

81,071

83,337

Condensed Statements of Income

Interest income

Interest expense

(306

)

(589

)

(571

)

Equity income of subsidiaries

4,878

7,148

3,629

Compensation and benefits

(257

)

(264

)

(269

)

Occupancy

(30

)

(30

)

(30

)

Data processing

)

Professional services

(130

)

(138

)

(119

)

Other

(319

)

(329

)

(216

)

Income before income tax benefit

3,830

5,792

2,419

Income tax benefit

(574

)

(558

)

(537

)

Net income

4,404

6,350

2,956

Condensed Statements of Cash Flows

Cash flows from operating activities:

Net income

4,404

6,350

2,956

Adjustments to reconcile net income to cash used by operating activities:

Equity income of subsidiaries

(4,878

)

(7,148

)

(3,629

)

Deferred income tax benefit

615

244

Earned employee stock ownership shares priced above original cost

147

Stock option compensation

Amortization of restricted stock awards

147

177

447

Decrease in unearned ESOP shares

193

194

193

Increase in other assets

)

(11

)

(23

)

Dec rease in other liabilities

(866

)

(214

)

(692

)

Other, net

)

Net cash used by operating activities

(203

)

(250

)

(668

)

Cash flows from investing activities:

Decrease in loans receivable, net

900

Net cash provided by investing activities

900

Cash flows from financing activities:

Redemption of preferred stock

(10,000

)

Dividends to preferred stockholders

(225

)

Stock awards withheld for tax withholding

(54

)

Proceeds from borrowings

10,000

Repayments of borrowings

(7,000

)

(2,000

)

(1,000

)

Dividends received from Bank

6,000

3,000

Net cash (used) provided by financing activities

(1,054

)

1,000

1,775

(Decrease) increase in cash and cash equivalents

(1,257

)

750

2,007

Cash and cash equivalents, beginning of year

3,314

2,564

557

Cash and cash equivalents, end of year

2,057

3,314

2,564

NOTE 2 3 Business Segments

The Bank has been identified as a reportable operating segment in accordance with the provisions of ASC 280. HMN, the holding company, did not meet the quantitative thresholds for a reportable segment and therefore is included in the “Other” category. The Company evaluates performance and allocates resources based on the segment’s net income, return on average assets and return on average equity. Each corporation is managed separately with its own officers and board of directors.

The following table sets forth certain information about the reconciliations of reported net income and assets for each of the Company’s reportable segments.

(Dollars in thousands)

Home Federal

Savings Bank

Other

Eliminations

Consolidated

Total

At or for the year ended December 31, 201 7 :

Interest income – external customers

27,680

Non-interest income – external customers

7,654

Intersegment non-interest income

210

4,879

(5,089

)

Interest expense

1,491

306

1,797

Non-interest expense

24,722

742

(210

)

25,254

Income tax expense (b enefit )

4,976

(574

)

4,402

Net income

4,879

4,404

(4,879

)

4,404

Total assets

722,532

79,254

(79,101

)

722,685

At or for the year ended December 31, 2016:

Interest income – external customers

27,349

Non-interest income – external customers

8,201

Intersegment interest income

)

Intersegment non-interest income

210

7,148

(7,358

)

Interest expense

1,004

589

1,593

Non-interest expense

23,572

768

(210

)

24,130

Income tax expense (benefit)

4,680

(558

)

4,122

Net income

7,148

6,350

(7,148

)

6,350

Total assets

681,257

82,222

(81,456

)

682,023

At or for the year ended December 31, 201 5:

Interest income – external customers

21,453

Non-interest income – external customers

7,653

Intersegment interest income

)

Intersegment non-interest income

204

3,629

(3,833

)

Interest expense

937

571

)

1,507

Non-interest expense

22,760

640

(204

)

23,196

Income tax expense (benefit)

2,148

(537

)

1,611

Net income

3,629

2,956

(3,629

)

2,956

Total assets

642,151

78,162

(77,152

)

643,161

OTHER FINANCIAL DATA

The following table s set forth certain information as to the Bank’s Federal Home Loan Bank (FHLB) advances.

	Year Ended December 31,
(Dollars in thousands)	2017		2016		2015
Maximum Balance:
FHLB a dvances	$	18,800		15,500		16,000
FHLB short-term advances		18,800		15,500		16,000
Average Balance:
FHLB advances		1,693		468		551
FHLB short-term advances		1,693		468		551

See “ Note 1 2 FHLB Advances and O ther Borrowings” in the Notes to Consolidated Financial Statements for more information on the Bank’s FHLB advances and other borrowings.

COMMON STOCK INFORMATION

The common stock of the Company is listed on the Nasdaq Stock Market (Nasdaq) under the symbol HMNF. As of December 31, 2017, the Company had 9,128,662 shares of common stock issued and 4,631,124 shares in treasury stock. As of December 31, 2017, there were 507 stockholders of record and 1,067 estimated beneficial stockholders. The following table presents the stock price information for the Company as furnished by Nasdaq for each quarter for the last two fiscal years. On February 9, 2018, the last reported sale price of shares of our common stock on the Nasdaq was $18.50 per share. The Company has not paid a dividend on its common stock during the two year period ending December 31, 2017 and no common stock dividends are anticipated to be paid in 2018. See “ Liquidity and Capital Resources – Dividends” in the “M anagement Discussion and Analysis” section of this annual report for a description of restrictions on the ability of the Company and the Bank to pay dividends.

For the Quarter Ended

December 31 ,

201 7

September 30,

201 7

June 30,

201 7

March 31,

201 7

December 31,

201 6

September 30,

201 6

June 30,

201 6

March 31,

201 6

HIGH

19.45

18.95

18.50

18.70

18.55

15.00

14.44

11.80

LOW

17.80

16.61

16.60

17.48

13.58

13.25

11.25

10.81

19.10

17.85

17.55

18.05

17.50

14.16

13.58

11.26

The following graph and table compares the total cumulative stockholders ’ return on the Company’s common stock to the Nasdaq U.S. Stock Index (“Nasdaq Composite”), which includes all Nasdaq traded stocks of U.S. companies, and the SNL Bank Nasdaq Index. The graph and table assume that $100 was invested on December 31, 2012 and that all dividends were reinvested.

			Period Ending
Index	12/31/12		12/31/13		12/31/14		12/31/15		12/31/16		12/31/17
HMN Financial, Inc.		100.00		304.50		357.21		332.73		504.13		550.23
Nasdaq Composite Index		100.00		140.12		160.78		171.97		187.22		242.71
SNL Bank N asdaq Index		100.00		143.73		148.86		160.70		222.81		234.58

Selected Quarterly Financial Data

(Dollars in thousands, except per share data)

December 31, 2017

September 30, 2017

June 30, 2017

Selected Operations Data (3 months ended):

Interest income

6,767

7,255

6,999

Interest expense

435

493

461

Net interest income

6,332

6,762

6,538

Provision for loan losses

(581

)

269

Net interest income after provision for loan losses

6,273

7,343

6,269

Non -interest income:

Fees and service charges

837

848

845

Loan servicing fees

296

299

306

Gain on sales of loans

610

521

488

Other

216

241

267

Total non -interest income

1,959

1,909

1,906

Non -interest expense:

Compensation and benefits

3,641

3,642

3,780

Gains on real estate owned

(65

)

Occupancy and equipment

953

1,050

1,026

Data processing

311

243

260

Professional services

302

307

417

Other

1,002

1,082

957

Total non -interest expense

6,209

6,259

6,439

Income before income tax expense

2,023

2,993

1,736

Income tax expense

1,636

1,213

712

Net income

387

1,780

1,024

Basic earnings per common share

0.09

0.42

0.24

Diluted earnings per common share

0.08

0.37

0.21

Financial Ratios:

Return on average assets ⁽¹⁾

0.21

0.99

0.60

Return on average common equity ⁽¹⁾

1.88

8.78

5.19

Average equity to average assets

11.43

11.51

Net interest margin ⁽¹⁾⁽²⁾

3.64

3.92

3.98

(Dollars in thousands)

Selected Financial Condition Data (end of period) :

Total assets

722,685

716,610

725,183

Securities available for sale:

Mortgage-backed and related securities

5,068

5,450

613

Other marketable securities

72,404

72,901

78,034

Loans held for sale

1,837

2,594

2,061

Loans receivable, net

585,931

583,057

590,259

Deposits

635,601

628,971

634,101

FHLB advances and other borrowings

7,000

Stockholders ’ equity

80,818

80,632

78,723

⁽¹⁾ Annualized

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

March 31, 2017		December 31, 2016			September 30, 2016			June 30, 2016			March 31, 2016
6,659			6,711			6,954			7,159			6,525
408			420			404			395			374
6,251			6,291			6,550			6,764			6,151
(270	)		(374	)		80			381			(732	)
6,521			6,665			6,470			6,383			6,883

824			874			901			873			779
301			296			280			271			261
519			770			656			705			487
236			257			310			253			228
1,880			2,197			2,147			2,102			1,755

3,944			3,748			3,723			3,598			3,695
(6	)		(161	)		(11	)		(75	)		(349	)
1,039			1,047			998			1,006			990
292			308			299			281			273
259			386			252			368			251
819			877			940			855			831
6,347			6,205			6,201			6,033			5,691
2,054			2,657			2,416			2,452			2,947
841			973			1,002			974			1,173
1,213			1,684			1,414			1,478			1,774
0.29			0.40			0.34			0.35			0.43
0.25			0.35			0.30			0.31			0.38

0.73	%		0.99	%		0.84	%		0.91	%		1.12	%
6.35			8.93			7.55			8.23			10.12
11.49			11.07			11.10			11.07			11.11
3.91			3.89			4.10			4.36			4.09



680,981			682,023			685,667			653,385			638,156

797			1,005			1,306			1,641			1,984
77,751			77,472			78,810			73,924			103,844
2,430			2,009			5,879			3,159			4,467
565,040			551,171			540,583			530,425			490,260
591,376			592,811			592,243			563,060			551,506
7,000			7,000			9,000			9,000			9,000
77,400			75,919			74,834			73,337			71,687

HMN Financial, Inc.

1016 Civic Center Drive NW

Rochester, MN 55901

(507) 535-1200

Annual Meeting

The annual meeting of shareholders w ill be held on Tuesday, April 24, 2018 at 10:00 a.m. (Central Time) at the Rochester Golf and Country Club, 3100 West Country Club Road, Rochester, Minnesota.

Legal Counsel

Faegre Baker Daniels LLP

2200 Wells Fargo Center

90 South Seventh Street

Minneapolis, MN 55402-3901

Independent Registered Public Accounting Firm

CliftonLarsonAllen LLP

220 South Sixth Street, Suite 300

Minneapolis, MN 55402-1436

Investor Information and Form 10-K

HMN ’s Form 10-K, filed with the Securities and Exchange Commission, is available without charge upon written request from:

HMN Financial, Inc.

Attn: Cindy Hamlin, Investor Relations

1016 Civic Center Drive NW

Rochester, MN 55901

or at www.hmnf.com

Transfer Agent and Registrar

Inquiries regarding change of address, transfer requirements, and lost certificates should be directed to HMN ’s transfer agent:

Equiniti Trust Company

EQ Shareowner Services

1110 Centre Pointe Curve, Suite 101

Mendota Heights, MN 55120

www.shareowneronline.com

(800) 468-9716

Directors

Dr. Hugh C. Smith

Chairman of the Board

HMN and Home Federal Savings Bank

Retired Professor of Medicine, Mayo Clinic College of Medicine and Consultant in Cardiovascular Division, Mayo Clinic

Allen J. Berning

Chief Executive Officer

Ambient Clinical Analytics

Michael A. Bue

Retired President and Chief Executive Officer

Security State Bank of Lewiston

Bradley C. Krehbiel

President and Chief Executive Officer

HMN and Home Federal Savings Bank

Bernard R. Nigon

Retired Audit Partner with RSM US LLP (formerly McGladrey & Pullen, LLP)

Dr. Wendy S. Shannon

Assistant Professor, Winona State University

Dr. Patricia S. Simmons

Retired Professor of Pediatric and Adolescent Medicine, Mayo Clinic College of Medicine

Mark E. Utz

Attorney at law, Wendland Utz, Ltd.

Hans K. Zietlow

Director of Real Estate for Kwik Trip, Inc.

Executive Officers Who Are Not

Directors

Jon J. Eberle

Senior Vice President, Chief Financial Officer

and Treasurer of HMN and Executive Vice

President, Chief Financial Officer and Treasurer of Home Federal Savings Bank

Lawrence D. McGraw

Executive Vice President and

Chief Operating Officer

Home Federal Savings Bank

Branch Offices of Bank

Albert Lea

143 West Clark Street

Albert Lea, MN 56007

(507) 379-2551

Austin

201 Oakland Avenue West

Austin, MN 55912

(507) 434-2500

Eagan

2805 Dodd Road, Suite 160

Eagan, MN 55121

(651) 405-2000

Kasson

203 West Main
Kasson, MN 55944

(507) 634-7022

502 South Mantorville Avenue
Kasson, MN 55944

(507) 634-4141

La Crescent

208 South Walnut

La Crescent, MN 55947

(507) 895-9200

Marshalltown

303 West Main Street

Marshalltown, IA 50158

(641) 754-6198

Rochester

1201 South Broadway

Rochester, MN 55901

(507) 536-2416

1016 Civic Center Drive NW

Rochester, MN 55901

(507) 535-1309

100 1 ^st Avenue Bldg., Suite 200

Rochester, MN 55902

(507) 280-7256

2048 Superior Drive NW, Suite 400

Rochester, MN 55901

(507) 226-0800

Spring Valley

715 North Broadway

Spring Valley, MN 55975

(507) 346-9709

Winona

175 Center Street

Winona, MN 55987

(507) 453-6460

Loan Production Offices

Sartell

50 14 ^th Ave E, Suite 100
Sartell, MN 56377

(320) 654-4020

Owatonna

1850 Austin Road, Suite 103

Owatonna, MN 55060
(507) 413-6420

Delafield

3960 Hillside Drive, Suite 206
Delafield, WI 53018

(262) 337-9511

1016 Civic Center Drive NW

Rochester , Minnesota 55901

507.535.1200

www.hmnf.com

E XHIBIT 21

Subsidiaries of Registrant

Name & Address	Year & State Inc.

Home Federal Savings Bank 1016 Civic Center Drive NW Rochester , MN 55901	1934 Federal Charter

Osterud Insurance Agency, Inc. DBA Home Federal Investment Svcs. 1016 Civic Center Drive NW Rochester, MN 55901	1983 MN

HF SB Property Holdings, LLC 1016 Civic Center Drive NW Rochester, MN 55901	2013 MN

Exhibit 23.1

EXHIBIT 31.1

CERTIFICATIONS

I, Bradley Krehbiel , certify that:

1. I have reviewed this annual report on Form 10-K 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: March 9, 2018	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 annual report on Form 10-K 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: March 9, 2018

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 Annual Report of HMN Financial, Inc. (the "Company") on Form 10-K for the period ending December 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 HMN Financial, Inc. (the “Company”) (Principal Executive Officer of the Company), and Jon Eberle, Senior Vice President, Chief Financial Officer and Treasurer of the Company (Principal Financial Officer of the Company), certify, pursuant to 18 U.S.C. § 1350, as adopted pursuant to § 906 of the Sarbanes-Oxley Act of 2002, that:

(1)

The Report fully complies with the requirements of section 13(a) or 15(d) of the Securities Exchange Act of 1934; and

(2)

The information contained in the Report fairly presents, in all material respects, the financial condition and results of operations of the Company.

Date: March 9, 2018		/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)