Overview of HMN Financial’s Financial Performance

HMN Financial, the parent company of Home Federal Savings Bank, reported mixed financial results for the second quarter and first half of 2024. While the company saw declines in net income compared to the prior year periods, it continued to maintain a strong balance sheet and credit quality.

For the second quarter of 2024, HMN reported net income of $1.0 million, down from $1.4 million in the same period of 2023. Diluted earnings per share were $0.22, compared to $0.32 a year earlier. The decrease was primarily due to higher expenses, including a goodwill impairment charge and merger-related costs, as well as a decline in net interest income.

Over the first six months of 2024, net income was $2.3 million, down from $3.1 million in the first half of 2023. Diluted earnings per share fell to $0.52 from $0.70 in the prior year period. Again, the lower profitability was driven by higher expenses and a narrower net interest margin.

Revenue and Profit Trends

HMN’s net interest income, which is the difference between interest earned on loans and investments versus interest paid on deposits and borrowings, declined in both the second quarter and first half of 2024 compared to the prior year periods.

In the second quarter, net interest income fell 3.1% to $7.5 million, as the average yield on interest-earning assets increased by 60 basis points to 4.54% but the average rate paid on interest-bearing liabilities and deposits rose even faster, up 88 basis points to 2.01%. This compression in the net interest margin, from 2.90% to 2.70%, was the primary driver of the lower net interest income.

A similar dynamic played out over the first six months, with net interest income declining 6.6% to $14.7 million as the net interest margin contracted from 3.00% to 2.67%. The increase in funding costs outpaced the rise in asset yields.

On the positive side, HMN saw an increase in non-interest income, which rose 12.0% to $2.2 million in the second quarter and 5.5% to $4.1 million in the first half. This was largely due to higher gains on loan sales, as the company sold more of the mortgages it originated.

However, these revenue gains were more than offset by higher expenses. Non-interest expense increased 16.2% to $8.7 million in the second quarter and 7.0% to $16.2 million in the first half, driven by a goodwill impairment charge, merger-related professional fees, and higher data processing costs.

The combination of lower net interest income and higher expenses resulted in the declines in net income and earnings per share compared to the prior year periods.

Strengths and Weaknesses

One of HMN’s key strengths is its strong credit quality. The company’s allowance for credit losses equaled 353.92% of non-performing loans as of June 30, 2024, up from 309.69% at the end of 2023. Non-performing assets made up just 0.29% of total assets, down from 0.34% at year-end.

This solid credit performance allowed HMN to reduce its provision for credit losses by $0.6 million in the second quarter and $0.7 million in the first half of 2024 compared to the prior year periods. The lower provisioning helped offset some of the pressure on profitability from the narrower net interest margin.

Another positive is HMN’s ample liquidity, with the ability to borrow an additional $278.9 million from the Federal Home Loan Bank based on the collateral value of its loan portfolio. The company also has $101.7 million in additional borrowing capacity from the Federal Reserve Bank. This liquidity provides a buffer against potential deposit outflows or other funding needs.

However, a key weakness for HMN is its reliance on higher-cost funding sources like brokered deposits and certificates of deposit. These funding sources have contributed to the rise in the company’s average cost of funds, squeezing its net interest margin. Reducing the company’s dependence on these higher-cost liabilities could help improve profitability.

Additionally, HMN faces the challenge of rising interest rates, which have increased its funding costs faster than the yields on its interest-earning assets. The company’s interest rate risk modeling shows that a 100 basis point increase in rates would reduce its projected net interest income over the next 12 months by 1.13%.

Outlook and Pending Merger

Looking ahead, HMN faces both opportunities and risks. On the positive side, the company expects to benefit from the proposed merger with Alerus Financial Corporation, which was announced in May 2024. Under the terms of the agreement, HMN shareholders will receive 1.25 shares of Alerus stock for each HMN share.

The merger is expected to close in the fourth quarter of 2024, subject to regulatory and shareholder approvals. HMN has already incurred $0.5 million in merger-related expenses, and expects to incur additional costs through the closing. However, the combination with the larger, more diversified Alerus could provide HMN with greater scale and resources to navigate the challenging interest rate environment.

On the risk side, HMN will need to manage the potential disruption and integration challenges associated with the merger. There is also uncertainty around the future value of the Alerus stock that HMN shareholders will receive, as that will depend on Alerus’ stock price at the time the deal closes.

Additionally, HMN faces ongoing interest rate risk, as further increases in funding costs could continue to pressure its net interest margin and profitability. The company’s ability to grow loans and non-interest income will be crucial to offsetting these margin headwinds.

Overall, HMN appears to be in a solid financial position, with strong credit quality and ample liquidity. However, the company’s profitability has been challenged by the narrowing net interest margin, and it will need to carefully manage the risks and opportunities presented by the pending merger with Alerus. Shareholders will want to monitor the company’s progress in integrating the two organizations and improving its earnings power in the face of the rising interest rate environment.