HMN Financial, Inc. Announces Second Quarter Results

HMN Financial, Inc. (HMN) (NASDAQ:HMNF):
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Second Quarter Highlights

         -- Net income of $2.9 million, up $444,000, or 17.8%, over 
            second quarter 2005
         -- Diluted earnings per share of $0.73, up $0.11, over second
            quarter of 2005
         -- Net interest income up $1.0 million, or 11.5%, over second
            quarter of 2005
         -- Net interest margin of 4.08%, up 38 basis points over 
            second quarter of 2005
         -- Income tax expense up $436,000, or 31.3%, over second 
            quarter of 2005

Year to Date Highlights

         -- Net income of $5.7 million, up $369,000, or 6.9%, over 
            first six months of 2005
         -- Diluted earnings per share of $1.41, up $0.08, over first 
            six months of 2005
         -- Net interest income up $1.7 million, or 9.9%, over first 
            six months of 2005
         -- Net interest margin of 4.09%, up 34 basis points over 
            first six months of 2005
         -- Income tax expense up $760,000, or 27.6%, over first six 
            months of 2005


Earnings Summary
                      Three months ended         Six months ended
                           June 30,                  June 30,
                   ------------------------- -------------------------
                       2006         2005         2006         2005
                   ------------ ------------ ------------ ------------
Net income          $2,943,370    2,499,453   $5,683,776    5,314,517
Diluted earnings
 per share                0.73         0.62         1.41         1.33
Return on average
 assets                   1.18%        1.01%        1.16%        1.09%
Return on average
 equity                  12.34%       11.38%       12.08%       12.29%
Book value per
 share                  $21.38       $19.64       $21.38       $19.64
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   HMN Financial, Inc. (HMN) (NASDAQ:HMNF), the $1 billion holding
company for Home Federal Savings Bank (the Bank), today reported net
income of $2.9 million for the second quarter of 2006, up $444,000, or
17.8%, over net income of $2.5 million for the second quarter of 2005.
Diluted earnings per common share for the second quarter of 2006 were
$0.73, up $0.11, or 17.7%, from $0.62 for the second quarter of 2005.

   Second Quarter Results

   Net Interest Income

   Net interest income was $9.7 million for the second quarter of
2006, an increase of $1.0 million, or 11.5%, compared to $8.7 million
for the second quarter of 2005. Interest income was $17.0 million for
the second quarter of 2006, an increase of $2.2 million, or 15.2%,
from $14.8 million for the same period in 2005. Interest income
increased because of an increase in the average interest rates earned
on loans and investments. Interest rates increased primarily because
of the 200 basis point increase in the prime interest rate between the
periods. Increases in the prime rate, which is the rate that banks
charge their prime business customers, generally increase the rates on
adjustable rate consumer and commercial loans in the portfolio and on
new loans originated. The increase in interest income due to increased
rates was partially offset by a $37 million decrease in the average
outstanding loan portfolio balances between the periods. The average
yield earned on interest-earning assets was 7.11% for the second
quarter of 2006, an increase of 86 basis points from the 6.25% average
yield for the second quarter of 2005.
   Interest expense was $7.3 million for the second quarter of 2006,
an increase of $1.3 million, or 20.5%, compared to $6.0 million for
the second quarter of 2005. Interest expense increased because of the
higher interest rates paid on deposits which were caused by the 200
basis point increase in the federal funds rate between the periods.
Increases in the federal funds rate, which is the rate that banks
charge other banks for short term loans, generally increase the rates
banks pay for deposits. The average interest rate paid on
interest-bearing liabilities was 3.23% for the second quarter of 2006,
an increase of 53 basis points from the 2.70% average interest rate
paid in the second quarter of 2005. Net interest margin (net interest
income divided by average interest earning assets) for the second
quarter of 2006 was 4.08%, an increase of 38 basis points, compared to
3.70% for the second quarter of 2005.

   Provision for Loan Losses

   The provision for loan losses was $980,000 for the second quarter
of 2006, an increase of $73,000, or 8.0%, from $907,000 for the second
quarter of 2005. The provision for loan losses increased primarily
because $10.0 million of related commercial real estate loans were
downgraded and classified as non-accruing during the quarter. These
loans are collateralized by real estate and are guaranteed by the
borrowers. The increase in the provision related to the commercial
loan risk rating downgrades was partially offset by a decrease in the
provision related to the $11 million reduction in the commercial loan
portfolio in the second quarter of 2006 compared to the $12 million in
growth that was experienced in the second quarter of 2005. The
reduction in loan growth was the result of management's decision not
to pursue long-term, low fixed-rate commercial loans in an environment
of rising short-term interest rates. Total non-performing assets were
$13.5 million at June 30, 2006, an increase of $9.6 million from $3.9
million at December 31, 2005. Non-performing loans increased $10.0
million, foreclosed and repossessed assets decreased $275,000 and
other non performing assets decreased $106,000 during the period.

   Non-Interest Income and Expense

   Non-interest income was $1.8 million for the second quarter of
2006, an increase of $191,000, or 12.2%, from $1.6 million for the
same period in 2005. Fees and service charges increased $110,000
between the periods primarily because of increased retail deposit
account activity and fees. Security gains increased $48,000 due to
increased security sales. Gain on sale of loans decreased $22,000
between the periods due to a decrease in the number of single-family
mortgage loans sold and a decrease in the profit margins realized on
the loans that were sold. Competition in the single-family loan
origination market has increased as the overall market has slowed and
profit margins have been lowered in order to remain competitive and
maintain origination volumes. Other non-interest income increased
$59,000 primarily because of increased revenues from the sale of
uninsured investment products.
   Non-interest expense was $5.8 million for the second quarter of
2006, an increase of $242,000, or 4.4%, from $5.6 million for the same
period of 2005. Compensation expense increased $333,000 primarily
because of annual payroll increases and increased pension costs.
Occupancy expense increased $62,000 due primarily to additional costs
associated with new branch and loan origination offices opened in
Rochester in the first quarter of 2006. Data processing costs
increased $42,000 due to increases in the internet and other banking
services provided by the Bank's third party processor between the
periods. Other non-interest expense decreased $152,000 primarily
because of decreased mortgage loan expenses and professional fees
incurred during the second quarter of 2006. Income tax expense
increased $436,000 between the periods due to an increase in taxable
income and an effective tax rate that increased from 35.8% for the
second quarter of 2005 to 38.3% for the second quarter of 2006. The
increase in the effective tax rate was primarily the result of state
tax law changes that were enacted in the third quarter of 2005.

   Return on Assets and Equity

   Return on average assets for the second quarter of 2006 was 1.18%,
compared to 1.01% for the second quarter of 2005. Return on average
equity was 12.34% for the second quarter of 2006, compared to 11.38%
for the same quarter in 2005. Book value per common share at June 30,
2006 was $21.38, compared to $19.64 at June 30, 2005.

   Six Month Period Results

   Net Income

   Net income was $5.7 million for the six month period ended June
30, 2006, an increase of $369,000, or 6.9%, compared to $5.3 million
for the six month period ended June 30, 2005. Diluted earnings per
share for the six month period in 2006 were $1.41, up $0.08, or 6.0%,
from $1.33 for the same period in 2005.

   Net Interest Income

   Net interest income was $19.1 million for the first six months of
2006, an increase of $1.7 million, or 9.9%, from $17.4 million for the
same period in 2005. Interest income was $33.0 million for the six
month period ended June 30, 2006, an increase of $4.0 million, or
13.9%, from $29.0 million for the same six month period in 2005.
Interest income increased because of an increase in the average
interest rates earned on loans and investments. Interest rates
increased primarily because of the 200 basis point increase in the
prime interest rate between the periods. The increase in interest
income due to increased rates was partially offset by a $30 million
decrease in the average outstanding loan portfolio balance between the
periods. The average yield earned on interest-earning assets was 7.05%
for the first six months of 2006, an increase of 82 basis points from
the 6.23% average yield for the first six months of 2005.
   Interest expense was $13.9 million for the first six months of
2006, an increase of $2.3 million, or 19.9%, compared to $11.6 million
for the first six months of 2005. Interest expense increased because
of the higher interest rates paid on deposits which were caused by the
200 basis point increase in the federal funds rate between the
periods. The average interest rate paid on interest-bearing
liabilities was 3.15% for the first six months of 2006, an increase of
52 basis points from the 2.63% average interest rate paid in the first
six months of 2005. Net interest margin (net interest income divided
by average interest earning assets) for the first six months of 2006
was 4.09%, an increase of 34 basis points, compared to 3.75% for the
first six months of 2005.

   Provision for Loan Losses

   The provision for loan losses was $1.5 million for the first six
months of 2006, a decrease of $48,000, from $1.5 million for the same
six month period in 2005. The provision for loan losses decreased
primarily because of the $23 million reduction in the commercial loan
portfolio in the first six months of 2006 compared to the $52 million
in growth that was experienced in the first six months of 2005. The
reduction in loan growth was the result of management's decision not
to pursue long-term, low fixed-rate commercial loans in an environment
of rising short-term interest rates. The decrease in the provision
related to the reduced loan growth was partially offset by an increase
in the provision due to increased commercial loan risk rating
downgrades in the first six months of 2006 when compared to the same
period of 2005. Total non-performing assets were $13.5 million at June
30, 2006, an increase of $9.6 million from $3.9 million at December
31, 2005. Non-performing loans increased $10.0 million, foreclosed and
repossessed assets decreased $275,000 and other non performing assets
decreased $106,000 during the period.

   Non-Interest Income and Expense

   Non-interest income was $3.3 million for the first six months of
2006, an increase of $251,000, or 8.4%, from $3.0 million for the same
period in 2005. Fees and service charges increased $223,000 between
the periods primarily because of increased retail deposit account
activity and fees. Security gains increased $48,000 due to increased
security sales. Gain on sale of loans decreased $69,000 between the
periods due to a decrease in the number of single-family mortgage
loans sold and a decrease in the profit margins realized on the loans
that were sold. Competition in the single-family loan origination
market has increased as the overall market has slowed and profit
margins have been lowered in order to remain competitive and maintain
origination volumes. Other non-interest income increased $42,000
primarily because of increased revenues from the sale of uninsured
investment products.
   Non-interest expense was $11.7 million for the first six months of
2006, an increase of $891,000, or 8.2%, from $10.8 million for the
same period of 2005. Compensation expense increased $818,000 primarily
because of annual payroll increases and increased pension costs.
Occupancy expense increased $167,000 due primarily to additional costs
associated with new branch and loan origination offices opened in
Rochester in the first quarter of 2006. Data processing costs
increased $93,000 due to increases in the internet and other banking
services provided by the Bank's third party processor between the
periods. Other non-interest expense decreased $172,000 primarily
because of a decrease in mortgage loan expenses and professional fees.
Income tax expense increased $760,000 between the periods due to an
increase in taxable income and an effective tax rate that increased
from 34.1% for the first six months of 2005 to 38.2% for the first six
months of 2006. The increase in the effective tax rate was primarily
the result of state tax law changes that were enacted in the third
quarter of 2005.

   Return on Assets and Equity

   Return on average assets for the six month period ended June 30,
2006 was 1.16%, compared to 1.09% for the same period in 2005. Return
on average equity was 12.08% for the six month period ended in 2006,
compared to 12.29% for the same period in 2005.

   President's Statement

   "Net earnings continued to improve despite the challenging
interest rate environment," said HMN President, Mike McNeil. "The
increase in net income was primarily the result of an improved net
interest margin that reflected an improved deposit mix. We believe
that actively managing our net interest margin will continue to have a
positive effect on earnings."

   General Information

   HMN Financial, Inc. and Home Federal Savings Bank are
headquartered in Rochester, Minnesota. The Bank operates ten full
service offices in southern Minnesota located in Albert Lea, Austin,
LaCrescent, Rochester, Spring Valley and Winona and two full service
offices in Iowa located in Marshalltown and Toledo. Home Federal
Savings Bank also operates loan origination offices located in Sartell
and Rochester, Minnesota. Eagle Crest Capital Bank, a division of Home
Federal Savings Bank, operates branches in Edina and Rochester,
Minnesota.

   Safe Harbor Statement

   This press release may contain forward-looking statements within
the meaning of the Private Securities Litigation Reform Act of 1995.
These statements include, but are not limited to those relating to the
Company's financial expectations for earnings and revenues and the
management of net interest margin. A number of factors could cause
actual results to differ materially from the Company's assumptions and
expectations. These factors include possible legislative changes and
adverse economic, business and competitive developments such as
shrinking interest margins; deposit outflows; reduced demand for
financial services and loan products; changes in accounting policies
and guidelines, changes in monetary and fiscal policies of the federal
government, or changes in tax laws. Additional factors that may cause
actual results to differ from the Company's assumptions and
expectations include those set forth in the Company's most recent
filings with the Securities and Exchange Commission. All
forward-looking statements are qualified by, and should be considered
in conjunction with, such cautionary statements.
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                 HMN FINANCIAL, INC. AND SUBSIDIARIES
                     Consolidated Balance Sheets

----------------------------------------------------------------------
                                             June 30,     December 31,
                                               2006           2005
----------------------------------------------------------------------
                                            (unaudited)
                 Assets

Cash and cash equivalents................    $62,608,169   47,268,795
Securities available for sale:
   Mortgage-backed and related securities
    (amortized cost $7,055,100 and
     $7,428,504).........................      6,267,160    6,879,756
    Other marketable securities
     (amortized cost $139,615,255 and
      $113,749,841)......................    138,953,180  112,778,813
                                          --------------- ------------
                                             145,220,340  119,658,569
                                          --------------- ------------

Loans held for sale......................      7,128,570    1,435,141
Loans receivable, net....................    757,621,273  785,678,461
Accrued interest receivable..............      4,396,521    4,460,014
Real estate, net.........................      1,101,060    1,214,621
Federal Home Loan Bank stock, at cost....      8,400,700    8,364,600
Mortgage servicing rights, net...........      2,296,433    2,653,635
Premises and equipment, net..............     12,025,027   11,941,863
Investment in limited partnerships.......        125,489      141,048
Goodwill.................................      3,800,938    3,800,938
Core deposit intangible, net.............        162,831      219,760
Prepaid expenses and other assets........      2,530,750    1,854,948
Deferred tax asset.......................      2,516,800    2,544,400
                                          --------------- ------------
    Total assets......................... $1,009,934,901  991,236,793
                                          =============== ============


  Liabilities and Stockholders' Equity

Deposits.................................   $748,355,396  731,536,560
Federal Home Loan Bank advances..........    160,900,000  160,900,000
Accrued interest payable.................      1,568,173    2,085,573
Advance payments by borrowers for taxes
 and insurance...........................        779,722    1,038,575
Accrued expenses and other liabilities...      4,707,906    4,947,816
                                          --------------- ------------
    Total liabilities....................    916,311,197  900,508,524
                                          --------------- ------------
Commitments and contingencies
Stockholders' equity:
    Serial preferred stock ($.01 par
     value):
     authorized 500,000 shares; issued
      and outstanding none...............              0            0
    Common stock ($.01 par value):
     authorized 11,000,000; issued shares
      9,128,662..........................         91,287       91,287
Additional paid-in capital...............     57,689,740   58,011,099
Retained earnings, subject to certain
 restrictions............................    102,784,471   98,951,777
Accumulated other comprehensive (loss)...       (875,415)    (917,577)
Unearned employee stock ownership plan
 shares..................................     (4,254,285)  (4,350,999)
Unearned compensation restricted stock
 awards..................................              0     (182,521)
Treasury stock, at cost 4,748,698 and
 4,721,402 shares........................    (61,812,094) (60,874,797)
                                          --------------- ------------
    Total stockholders' equity...........     93,623,704   90,728,269
                                          --------------- ------------
Total liabilities and stockholders'
 equity.................................. $1,009,934,901  991,236,793
                                          =============== ============


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

                         Three Months Ended       Six Months Ended
                              June 30,                June 30,
                      ------------------------ -----------------------
                          2006        2005        2006        2005
                      ------------ ----------- ----------- -----------
Interest income:
   Loans receivable.. $15,081,511  13,769,340  29,784,291  27,102,359
   Securities
    available for
    sale:
      Mortgage-backed
       and related...      68,869      84,288     139,431     174,056
      Other
       marketable....   1,322,547     654,182   2,212,178   1,295,938
   Cash equivalents..     452,434     175,671     708,860     227,940
   Other.............      85,984      89,232     148,805     168,760
                      ------------ ----------- ----------- -----------
      Total interest
       income........  17,011,345  14,772,713  32,993,565  28,969,053
                      ------------ ----------- ----------- -----------

Interest expense:
   Deposits..........   5,516,428   4,199,791  10,384,109   7,902,422
   Federal Home Loan
    Bank advances....   1,744,879   1,826,501   3,470,735   3,649,192
                      ------------ ----------- ----------- -----------
      Total interest
       expense.......   7,261,307   6,026,292  13,854,844  11,551,614
                      ------------ ----------- ----------- -----------
      Net interest
       income........   9,750,038   8,746,421  19,138,721  17,417,439
Provision for loan
 losses..............     980,000     907,000   1,495,000   1,543,000
                      ------------ ----------- ----------- -----------
      Net interest
       income after
       provision for
       loan losses...   8,770,038   7,839,421  17,643,721  15,874,439
                      ------------ ----------- ----------- -----------

Non-interest income:
   Fees and service
    charges..........     795,808     685,357   1,510,586   1,287,954
   Mortgage servicing
    fees.............     301,259     303,363     604,934     596,343
   Securities gains,
    net..............      48,122           0      48,122           0
   Gains on sales of
    loans............     302,608     324,173     548,585     617,489
   Losses in limited
    partnerships           (9,059)     (6,500)    (15,559)    (14,210)
   Other.............     327,223     268,206     555,627     513,754
                      ------------ ----------- ----------- -----------
      Total non-
       interest
       income........   1,765,961   1,574,599   3,252,295   3,001,330
                      ------------ ----------- ----------- -----------

Non-interest expense:
   Compensation and
    benefits.........   3,117,702   2,784,578   6,376,573   5,558,682
   Occupancy.........   1,103,392   1,041,460   2,203,684   2,036,714
   Deposit insurance
    premiums.........      24,792      34,619      55,989      62,525
   Advertising.......     107,501     105,765     238,159     189,673
   Data processing        287,043     245,351     575,758     482,839
   Amortization of
    mortgage
    servicing rights,
    net..........         236,551     271,089     453,091     510,122
   Other.............     886,648   1,038,805   1,799,786   1,971,497
                      ------------ ----------- ----------- -----------
      Total non-
       interest
       expense.......   5,763,629   5,521,667  11,703,040  10,812,052
                      ------------ ----------- ----------- -----------
      Income before
       income tax
       expense.......   4,772,370   3,892,353   9,192,976   8,063,717
Income tax expense...   1,829,000   1,392,900   3,509,200   2,749,200
                      ------------ ----------- ----------- -----------
      Net income.....  $2,943,370   2,499,453   5,683,776   5,314,517
                      ============ =========== =========== ===========
Basic earnings per
 share...............       $0.77        0.65        1.48        1.39
                      ============ =========== =========== ===========
Diluted earnings per
 share...............       $0.73        0.62        1.41        1.33
                      ============ =========== =========== ===========


                 HMN FINANCIAL, INC. AND SUBSIDIARIES
             Selected Consolidated Financial Information
                             (unaudited)

----------------------------------------------------------------------
SELECTED FINANCIAL DATA:                          Three Months Ended
                                                       June 30,
(dollars in thousands, except per share data)    2006             2005
----------------------------------------------------------------------
I.   OPERATING DATA:
      Interest income...........................   $17,011     14,773
      Interest expense..........................     7,261      6,027
      Net interest income.......................     9,750      8,746

II.   AVERAGE BALANCES:
       Assets (1)............................... 1,003,183    991,455
       Loans receivable, net....................   767,774    806,267
       Mortgage-backed and related securities
        (1).....................................     7,162      8,823
       Interest-earning assets (1)..............   959,477    948,304
       Interest-bearing liabilities.............   900,825    896,210
       Equity (1)...............................    95,690     88,100

 III. PERFORMANCE RATIOS: (1)
       Return on average assets (annualized)....      1.18%      1.01%
       Interest rate spread information:
          Average during period.................      3.88       3.55
          End of period.........................      3.92       3.65
       Net interest margin......................      4.08       3.70
       Ratio of operating expense to average....
         total assets (annualized)..............      2.30       2.23
       Return on average equity (annualized)....     12.34      11.38
       Efficiency...............................     50.05      53.50



----------------------------------------------------------------------
SELECTED FINANCIAL DATA:                           Six Months Ended
                                                       June 30,
(dollars in thousands, except per share data)      2006         2005
----------------------------------------------------------------------
I.   OPERATING DATA:
      Interest income...........................    32,994     28,969
      Interest expense..........................    13,855     11,552
      Net interest income.......................    19,139     17,417

II.   AVERAGE BALANCES:
       Assets (1)...............................   988,229    980,045
       Loans receivable, net                       772,993    803,334
       Mortgage-backed and related securities
        (1).....................................     7,261      9,056
       Interest-earning assets (1)..............   944,295    937,875
       Interest-bearing liabilities.............   886,081    886,447
       Equity (1)...............................    94,876     87,227

 III. PERFORMANCE RATIOS: (1)
       Return on average assets (annualized)....      1.16%     1.09 %
       Interest rate spread information:
          Average during period.................      3.89       3.60
          End of period.........................      3.92       3.65
       Net interest margin......................      4.09       3.75
       Ratio of operating expense to average....
         total assets (annualized)..............      2.39       2.22
       Return on average equity (annualized)....     12.08      12.29
       Efficiency...............................     52.27      52.95
                           
                             -----------------------------------------
                               June 30,    December 31,    June 30,
                                 2006          2005          2005
                             -----------------------------------------
IV.  ASSET QUALITY:
       Total non-performing
        assets..............      $13,491        3,883         12,475
       Non-performing assets
        to total assets.....         1.34%        0.39%          1.27%
       Non-performing loans
        to total loans
        receivable, net....          1.62%        0.30%          1.38%
      Allowance for loan
       losses.....                $10,216        8,778         10,223
      Allowance for loan
       losses to total loans
       receivable, net......         1.35%        1.11%          1.25%
      Allowance for loan
       losses to
         non-performing
          loans.............        82.93       376.88          90.26

V.   BOOK VALUE PER SHARE:
       Book value per share.       $21.38        20.59          19.64



                             -----------------------------------------
                              Six Months   Year Ended    Six Months
                                 Ended     Dec 31, 2005      Ended
                             June 30, 2006              June 30, 2005
                             -----------------------------------------
VI.  CAPITAL RATIOS:
       Stockholders' equity
        to total assets, at
        end of period.......         9.27%        9.15%          8.78%
       Average stockholders'
        equity to average
        assets (1)..........         9.60         9.05           8.90
       Ratio of average
        interest-earning
        assets to...........
         average interest-
          bearing
          liabilities (1)...       106.57       105.96         105.80

                             -----------------------------------------
                               June 30,    December 31,    June 30,
                                 2006          2005          2005
                             -----------------------------------------
VII. EMPLOYEE DATA:
       Number of full time
        equivalent employees          212          208            209


(1) Average balances were calculated based upon amortized cost without
the market value impact of SFAS 115
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