HFFC-2014.03.31-10Q

10-Q 1 hffc-20140331x10q.htm 10-Q HFFC-2014.03.31-10Q

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

_______________________________________________

FORM 10-Q



(Mark One)
ý		QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the Quarterly Period Ended March 31, 2014
OR
o		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 0-19972

_______________________________________________

HF FINANCIAL CORP.

(Exact name of registrant as specified in its charter)



Delaware (State or other jurisdiction of incorporation or organization)		46-0418532 (I.R.S. Employer Identification No.)
225 South Main Avenue, Sioux Falls, SD (Address of principal executive offices)		57104 (ZIP Code)

Registrant's telephone number, including area code: (605) 333-7556

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

Common Stock, par value $0.01 per share

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

None

Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act. Yes o No ý

Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Act. Yes o No ý

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or Section 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes ý No o

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 (§ 232.405 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 ý No o

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



Large accelerated filer o	Accelerated filer ý	Non-accelerated filer o (Do not check if a smaller reporting company)	Smaller reporting company ¨

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes o No ý

As of May 2, 2014, there were 7,055,440 shares of the registrant's common stock outstanding.

Quarterly Report on Form 10-Q

Table of Contents



		Page Number

PART I — FINANCIAL INFORMATION

Item 1.	Financial Statements:	3

	Consolidated Statements of Financial Condition At March 31, 2014 and June 30, 2013	3

	Consolidated Statements of Income Three and Nine Months Ended March 31, 2014 and 2013	4

	Consolidated Statements of Comprehensive Income Three and Nine Months Ended March 31, 2014 and 2013	5

	Consolidated Statements of Cash Flows Nine Months Ended March 31, 2014 and 2013	6

	Notes to Consolidated Financial Statements	7

Item 2.	Management’s Discussion and Analysis of Financial Condition and Results of Operations	36

Item 3.	Quantitative and Qualitative Disclosures about Market Risk	62

Item 4.	Controls and Procedures	64

PART II — OTHER INFORMATION

Item 1.	Legal Proceedings	64

Item 1A.	Risk Factors	64

Item 2.	Unregistered Sales of Equity Securities and Use of Proceeds	64

Item 3.	Defaults upon Senior Securities	64

Item 4.	Mine Safety Disclosures	64

Item 5.	Other Information	64

Item 6.	Exhibits	65

Form 10-Q	Signature Page	66

PART I - FINANCIAL INFORMATION

Item 1. Financial Statements

HF FINANCIAL CORP.

CONSOLIDATED STATEMENTS OF FINANCIAL CONDITION

(DOLLARS IN THOUSANDS, except share data)



	March 31, 2014			June 30, 2013
	(Unaudited)			(Audited)
ASSETS
Cash and cash equivalents	$	26,548		$	21,352
Investment securities available for sale	388,815			424,481
Investment securities held to maturity	19,150			—
Correspondent bank stock	7,439			8,936
Loans held for sale	3,204			9,169

Loans and leases receivable	754,819			695,771
Allowance for loan and lease losses	(10,346		)	(10,743		)
Loans and leases receivable, net	744,473			685,028

Accrued interest receivable	5,050			5,301
Office properties and equipment, net of accumulated depreciation	13,233			13,853
Foreclosed real estate and other properties	266			564
Cash value of life insurance	20,474			19,965
Servicing rights, net	11,458			10,987
Goodwill and intangible assets, net	4,857			4,938
Other assets	13,277			12,938
Total assets	$	1,258,244		$	1,217,512
LIABILITIES AND STOCKHOLDERS' EQUITY
Liabilities
Deposits	$	952,363		$	898,761
Advances from Federal Home Loan Bank and other borrowings	147,436			167,163
Subordinated debentures payable to trusts	24,837			24,837
Advances by borrowers for taxes and insurance	19,158			12,595
Accrued expenses and other liabilities	14,946			16,885
Total liabilities	1,158,740			1,120,241
Stockholders' equity
Preferred stock, $.01 par value, 500,000 shares authorized, none outstanding	—			—
Series A Junior Participating Preferred Stock, $1.00 stated value, 50,000 shares authorized, none outstanding	—			—
Common stock, $.01 par value, 10,000,000 shares authorized, 9,138,895 and 9,138,475 shares issued at March 31, 2014 and June 30, 2013, respectively	91			91
Additional paid-in capital	46,176			46,096
Retained earnings, substantially restricted	89,008			86,266
Accumulated other comprehensive (loss), net of related deferred tax effect	(4,874		)	(4,285		)
Less cost of treasury stock, 2,083,455 shares at March 31, 2014 and June 30, 2013	(30,897		)	(30,897		)
Total stockholders' equity	99,504			97,271
Total liabilities and stockholders' equity	$	1,258,244		$	1,217,512

See accompanying notes to unaudited consolidated financial statements.

HF FINANCIAL CORP.

CONSOLIDATED STATEMENTS OF INCOME

(DOLLARS IN THOUSANDS, except share data)

(Unaudited)



	Three Months Ended				Nine Months Ended
	March 31,				March 31,
	2014		2013		2014		2013
Interest, dividend and loan fee income:
Loans and leases receivable	$	8,781	$	8,082	$	25,740	$	25,892
Investment securities and interest-earning deposits	1,716		1,561		4,099		3,826
	10,497		9,643		29,839		29,718
Interest expense:
Deposits	960		1,111		2,996		3,716
Advances from Federal Home Loan Bank and other borrowings	1,212		1,432		3,955		4,384
	2,172		2,543		6,951		8,100
Net interest income	8,325		7,100		22,888		21,618
Provision (benefit) for losses on loans and leases	260		—		279		(172		)
Net interest income after provision for losses on loans and leases	8,065		7,100		22,609		21,790
Noninterest income:
Fees on deposits	1,472		1,361		4,727		4,921
Loan servicing income, net	703		406		2,132		(84		)
Gain on sale of loans	344		1,151		1,759		3,584
Earnings on cash value of life insurance	201		200		613		611
Trust income	229		209		642		593
Commission and insurance income	404		177		1,035		496
Gain on sale of securities, net	233		146		591		1,968
Other	98		5		295		(1,256		)
	3,684		3,655		11,794		10,833
Noninterest expense:
Compensation and employee benefits	5,298		5,258		16,025		14,973
Occupancy and equipment	1,058		1,096		3,140		3,167
FDIC insurance	220		195		661		606
Check and data processing expense	784		677		2,297		2,256
Professional fees	502		484		1,633		1,663
Marketing and community investment	315		106		935		778
Foreclosed real estate and other properties, net	50		16		306		325
Other	691		716		2,027		2,057
	8,918		8,548		27,024		25,825
Income before income taxes	2,831		2,207		7,379		6,798
Income tax expense	858		802		2,257		2,283
Net income	$	1,973	$	1,405	$	5,122	$	4,515

Basic earnings per common share	$	0.28	$	0.20	$	0.73	$	0.64
Diluted earnings per common share	0.28		0.20		0.73		0.64
Dividend declared per common share	0.11		0.11		0.34		0.34

See accompanying notes to unaudited consolidated financial statements.

HF FINANCIAL CORP.

CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME

(DOLLARS IN THOUSANDS, except share data)

(Unaudited)



	Three Months Ended						Nine Months Ended
	March 31,						March 31,
	2014			2013			2014			2013
Net income	$	1,973		$	1,405		$	5,122		$	4,515
Other comprehensive income (loss), net of tax:
Investment securities available for sale:
Change in unrealized gains (losses) on other securities	1,013			(593		)	(792		)	145
Reclassification adjustment:
Security (gains) recognized in earnings	(233		)	(146		)	(591		)	(1,968		)
Income tax (expense) benefit	(297		)	281			525			693
Other comprehensive income (loss) on investment securities available for sale	483			(458		)	(858		)	(1,130		)
Cash flow hedging activities-interest rate swap contracts:
Net unrealized gains	156			223			408			521
Reclassification adjustment:
Hedge losses recognized in earnings	—			—			—			1,456
Income tax (expense)	(53		)	(76		)	(139		)	(734		)
Other comprehensive income on cash flow hedging activities-interest rate swap contracts	103			147			269			1,243
Total other comprehensive income (loss)	586			(311		)	(589		)	113
Comprehensive income	$	2,559		$	1,094		$	4,533		$	4,628

See accompanying notes to unaudited consolidated financial statements.

HF FINANCIAL CORP.

CONSOLIDATED STATEMENTS OF CASH FLOWS

(DOLLARS IN THOUSANDS, except share data)

(Unaudited)



	Nine Months Ended
	March 31,
	2014			2013
Cash Flows From Operating Activities
Net income	$	5,122		$	4,515
Adjustments to reconcile net income to net cash provided by (used in) operating activities
Provision (benefit) for losses on loans and leases	279			(172		)
Provision (benefit) for allowance on servicing rights	(1,249		)	750
Depreciation	1,297			1,324
Amortization of intangible assets	81			—
Amortization of discounts and premiums on investment securities and other	5,416			5,710
Stock-based compensation	80			313
Net change in loans held for resale	7,724			11,281
(Gain) on sale of loans	(1,759		)	(3,584		)
Realized (gain) on sale of investment securities, net	(591		)	(1,968		)
Loss (gain) and provision for losses on foreclosed real estate and other properties, net	48			(42		)
Loss on disposal of office properties and equipment, net	8			89
Change in other assets and liabilities	(2,118		)	3,073
Net cash provided by operating activities	14,338			21,289
Cash Flows From Investing Activities
Net change in loans and leases outstanding	(60,370		)	1,336
Purchases of investment securities	(127,372		)	(209,680		)
Proceeds from sales, maturities and repayments of investment securities	139,104			160,043
Purchases of correspondent bank stock	(21,107		)	(6,935		)
Proceeds from redemption of correspondent bank stock	22,604			7,259
Purchases of office properties and equipment	(686		)	(887		)
Proceeds from sale of office properties and equipment	—			172
Proceeds from sale of foreclosed real estate and other properties	627			737
Purchases of servicing rights from external sources	—			(3		)
Net cash (used in) investment activities	(47,200		)	(47,958		)
Cash Flows From Financing Activities
Net increase in deposits	53,602			3,356
Proceeds of advances from Federal Home Loan Bank and other borrowings	545,800			160,841
Payments on advances from Federal Home Loan Bank and other borrowings	(565,527		)	(168,110		)
Increase in advances by borrowers	6,563			5,561
Proceeds from issuance of common stock	—			42
Cash dividends paid	(2,380		)	(2,381		)
Net cash provided by (used in) financing activities	38,058			(691		)
Increase (decrease) in cash and cash equivalents	5,196			(27,360		)
Cash and Cash Equivalents
Beginning	21,352			50,334
Ending	$	26,548		$	22,974

Supplemental Disclosure of Cash Flows Information
Cash payments for interest	$	7,497		$	8,497
Cash payments for income and franchise taxes	3,136			470

See accompanying notes to unaudited consolidated financial statements.

HF FINANCIAL CORP.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(DOLLARS IN THOUSANDS, except share data)

(Unaudited)

NOTE 1—SELECTED ACCOUNTING POLICIES

Basis of Financial Statement Presentation

The consolidated financial information of HF Financial Corp. (the “Company”) and its wholly-owned subsidiaries included in this Quarterly Report on Form 10-Q is unaudited. Interim consolidated financial statements and the notes have been prepared pursuant to the rules and regulations of the Securities and Exchange Commission (“SEC”) for quarterly reports on Form 10-Q and do not include certain information and footnote disclosures required by U.S. generally accepted accounting principles (“GAAP”) for complete annual financial statements. Accordingly, these financial statements should be read in conjunction with the audited consolidated financial statements and notes thereto included in the Company's Annual Report on Form 10-K for the fiscal year ended June 30, 2013 (“fiscal 2013”), filed with the SEC.

The accompanying consolidated balance sheet as of June 30, 2013, which has been derived from audited financial statements, and the unaudited consolidated interim financial statements have been prepared in accordance with GAAP and reflect all adjustments that are, in the opinion of management, necessary for the fair presentation of the financial position and results of operations for the periods presented. All such adjustments are of a normal recurring nature. The results of operations for the nine months ended March 31, 2014 are not necessarily indicative of the results that may be expected for the year ending June 30, 2014.

The interim consolidated financial statements include the accounts of the Company, its wholly-owned subsidiaries, Home Federal Bank (the “Bank”), HF Financial Group, Inc. (“HF Group”) and HomeFirst Mortgage Corp. (the “Mortgage Corp.”), and the Bank’s wholly-owned subsidiaries, Mid America Capital Services, Inc. (“Mid America Capital”) and Hometown Investment Services, Inc. (“Hometown”). The interim consolidated financial statements reflect the deconsolidation of the wholly-owned subsidiary trusts of the Company: HF Financial Capital Trust III (“Trust III”), HF Financial Capital Trust IV (“Trust IV”), HF Financial Capital Trust V (“Trust V”) and HF Financial Capital Trust VI (“Trust VI”). See Note 12 of “Notes to Consolidated Financial Statements.” All intercompany balances and transactions have been eliminated in consolidation.

Management has evaluated subsequent events for potential disclosure or recognition through May 9, 2014, the date of the filing of the consolidated financial statements with the Securities and Exchange Commission.

Reclassification

Certain balances in the consolidated financial statements from prior periods have been reclassified to conform to the current period's presentation.

NOTE 2—REGULATORY CAPITAL

The following table summarizes the Bank's compliance with its minimum regulatory capital requirements at March 31, 2014:



	Amount		Percent
Tier I (core) capital (to adjusted total assets):
Required	$	62,708	5.00	%
Actual	119,282		9.51
Excess over required	56,574		4.51

Total risk-based capital (to risk-weighted assets):
Required	84,876		10.00
Actual	129,577		15.27
Excess over required	44,701		5.27

HF FINANCIAL CORP.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)

(DOLLARS IN THOUSANDS, except share data)

(Unaudited)

NOTE 3—EARNINGS PER SHARE

Basic earnings per common share is computed by dividing income available to common stockholders (the numerator) by the weighted-average number of common shares outstanding (the denominator) during the period. Shares outstanding include the nonvested shares of the Company. See Note 11 “Stock-Based Compensation Plans” for additional information related to the nonvested share activity. Shares issued during the period and shares reacquired during the period are weighted for the portion of the period they were outstanding.

Diluted earnings per common share is similar to the computation of basic earnings per common share except the denominator is increased to include the number of additional common shares that would have been outstanding if the dilutive options outstanding had been exercised.

Following is a reconciliation of the income available to common shareholders and common stock share amounts used in the calculation of basic and diluted EPS for the periods presented:



	Three Months Ended				Nine Months Ended
	March 31,				March 31,
	2014		2013		2014		2013
Net income	$	1,973	$	1,405	$	5,122	$	4,515

Basic EPS:
Weighted average number of common shares outstanding	7,055,440		7,054,902		7,055,256		7,053,880
Basic earnings per common share	$	0.28	$	0.20	$	0.73	$	0.64

Diluted EPS:
Weighted average number of common shares outstanding	7,055,440		7,054,902		7,055,256		7,053,880
Common share equivalents—Stock Options / Stock Appreciation Rights (SARs) under employee compensation plans/warrant	2,513		2,084		2,640		2,487
Weighted average number of common shares and common share equivalents	7,057,953		7,056,986		7,057,896		7,056,367
Diluted earnings per common share	$	0.28	$	0.20	$	0.73	$	0.64

HF FINANCIAL CORP.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)

(DOLLARS IN THOUSANDS, except share data)

(Unaudited)

NOTE 4—INVESTMENT SECURITIES

The amortized cost and fair value of investments in securities classified as available for sale and held to maturity according to management's intent, are as follows:



	March 31, 2014
	Adjusted Carrying Cost		Gross Unrealized Gains		Gross Unrealized (Losses)			Fair Value
Investment securities available for sale:
Debt securities:
U.S. government agencies	$	15,780	$	9	$	(99	)	$	15,690
Municipal bonds	10,743		83		(44		)	10,782
	26,523		92		(143		)	26,472
Equity securities:
FNMA⁽¹⁾	—		—		—			—
Federal Ag Mortgage	7		7		—			14
Other investments	253		—		—			253
	260		7		—			267
Agency residential mortgage-backed securities	365,649		944		(4,517		)	362,076
Total investment securities available for sale	$	392,432	$	1,043	$	(4,660	)	$	388,815

Investment securities held to maturity:
Municipal bonds	$	17,179	$	154	$	(46	)	$	17,287
Agency residential mortgage-backed securities	1,971		—		(21		)	1,950
Total investment securities held to maturity	$	19,150	$	154	$	(67	)	$	19,237

___________________________________________________________

⁽¹⁾ $8 amortized cost and $8 total other-than-temporary impairment recognized in Accumulated Other Comprehensive Income.



	June 30, 2013
	Adjusted Carrying Cost		Gross Unrealized Gains		Gross Unrealized (Losses)			Fair Value
Investment securities available for sale:
Debt securities:
U.S. government agencies	$	5,502	$	—	$	(137	)	$	5,365
Municipal bonds	11,879		155		(111		)	11,923
	17,381		155		(248		)	17,288
Equity securities:
FNMA⁽¹⁾	—		—		—			—
Federal Ag Mortgage	7		5		—			12
Other investments	253		—		—			253
	260		5		—			265
Agency residential mortgage-backed securities	409,075		2,112		(4,259		)	406,928
Total investment securities available for sale	$	426,716	$	2,272	$	(4,507	)	$	424,481

___________________________________________________________

⁽¹⁾ $8 amortized cost and $8 total other-than-temporary impairment recognized in Accumulated Other Comprehensive Income.

HF FINANCIAL CORP.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)

(DOLLARS IN THOUSANDS, except share data)

(Unaudited)

Management determines the appropriate classification of securities at the date individual securities are acquired and evaluates the appropriateness of such classifications at each statement of financial condition date. Investment securities classified as held to maturity are those debt securities that management has the positive intent and ability to hold to maturity, are reported at amortized cost and adjusted for amortization of premiums and accretion of discounts using a method that approximates level yield. Investment securities classified as available for sale are those debt securities that the Company intends to hold for an indefinite period of time, but may not hold necessarily to maturity, and all equity securities.

Management has a process to identify securities that could potentially have a credit impairment that is other-than-temporary. This process involves evaluating the length of time and extent to which the fair value has been less than the amortized cost basis, reviewing available information regarding the financial position of the issuer, monitoring the rating of the security, and projecting cash flows. Management also determines if it is more likely than not the Company will be required to sell the security before the recovery of its amortized cost which, in some cases, may extend to maturity. To the extent the Company determines that a security is deemed to be other-than-temporarily impaired, an impairment loss is recognized.

For all securities that are considered temporarily impaired, the Company does not intend to sell these securities (has not made a decision to sell) and it is not more likely than not that the Company will be required to sell the security before recovery of its amortized cost, which may occur at maturity. The Company believes that it will collect all principal and interest due on all investments that have amortized cost in excess of fair value that are considered only temporarily impaired.

HF FINANCIAL CORP.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)

(DOLLARS IN THOUSANDS, except share data)

(Unaudited)

The following tables present the fair value and age of gross unrealized losses by investment category:



	March 31, 2014
	Less than 12 Months					12 Months or More					Total
	Fair Value		Gross Unrealized (Losses)			Fair Value		Gross Unrealized (Losses)			Fair Value		Gross Unrealized (Losses)
Investment securities available for sale:
Debt securities:
U.S. government agencies	$	8,755	$	(99	)	$	—	$	—		$	8,755	$	(99	)
Municipal bonds	3,101		(27		)	805		(17		)	3,906		(44		)
	11,856		(126		)	805		(17		)	12,661		(143		)
Agency residential mortgage-backed securities	207,652		(2,652		)	74,241		(1,865		)	281,893		(4,517		)
Total investment securities available for sale	$	219,508	$	(2,778	)	$	75,046	$	(1,882	)	$	294,554	$	(4,660	)

Investment securities held to maturity:
Municipal bonds	$	5,284	$	(46	)	$	—	$	—		$	5,284	$	(46	)
Agency residential mortgage-backed securities	1,950		(21		)	—		—			1,950		(21		)
Total investment securities held to maturity	$	7,234	$	(67	)	$	—	$	—		$	7,234	$	(67	)



	June 30, 2013
	Less than 12 Months					12 Months or More					Total
	Fair Value		Gross Unrealized (Losses)			Fair Value		Gross Unrealized (Losses)			Fair Value		Gross Unrealized (Losses)
Investment securities available for sale:
Debt securities:
U.S. government agencies	$	5,365	$	(137	)	$	—	$	—		$	5,365	$	(137	)
Municipal bonds	5,643		(111		)	70		—			5,713		(111		)
	11,008		(248		)	70		—			11,078		(248		)
Agency residential mortgage-backed securities	271,404		(4,161		)	8,937		(98		)	280,341		(4,259		)
Total investment securities available for sale	$	282,412	$	(4,409	)	$	9,007	$	(98	)	$	291,419	$	(4,507	)

The unrealized losses reported for U.S. government agencies relate to three securities issued by the Federal National Mortgage Association (“FNMA”), two securities issued by the Federal Home Loan Bank ("FHLB") and one security issued by the Federal Home Loan Mortgage Corporation ("FHLMC"). The unrealized losses are primarily attributable to changes in interest rates and the contractual cash flows of these investments which are guaranteed by an agency of the U.S. government. Management does not believe the unrealized losses at March 31, 2014 represents an other-than-temporary impairment for these investments. The Company does not have the intent to sell these securities (has not made a decision to sell) and has assessed that it is not more likely than not that the Company will be required to sell these securities before anticipated recovery of fair value.

HF FINANCIAL CORP.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)

(DOLLARS IN THOUSANDS, except share data)

(Unaudited)

The unrealized losses reported for municipal bonds relate to 19 available for sale and 19 held to maturity municipal general obligation or revenue bonds. The unrealized losses are primarily attributed to changes in credit spreads or market interest rate increases since the securities were originally acquired, rather than due to credit or other causes. Management does not believe any individual unrealized losses as of March 31, 2014, represent an other-than-temporary impairment for these investments. The Company does not have the intent to sell these securities (has not made a decision to sell) and has assessed that it is not more likely than not that the Company will be required to sell these securities before anticipated recovery of fair value.

The unrealized losses reported for agency residential mortgage-backed securities relate to 131 available for sale and one held to maturity security issued by Federal National Mortgage Association ("FNMA"), the Government National Mortgage Association ("GNMA"), or the Federal Home Loan Mortgage Corporation ("FHLMC"). These unrealized losses are primarily attributable to changes in interest rates and the contractual cash flows of those investments which are guaranteed by an agency of the U.S. government. Management does not believe any of these unrealized losses as of March 31, 2014, represent an other-than-temporary impairment for those investments. The Company does not have the intent to sell these securities (has not made a decision to sell) and has assessed that it is not more likely than not that the Company will be required to sell these securities before anticipated recovery of fair value.

The following table presents the amounts recognized in the Consolidated Statements of Income for other-than-temporary impairments charged to net income:



	Nine Months Ended
	March 31,
	2014		2013
Beginning balance of credit losses on securities held as of July 1 for which a portion of other-than-temporary impairment was recognized in other comprehensive income⁽¹⁾	$	8	$	8
Credit losses for which an other-than-temporary impairment was not previously recognized	—		—
Increases to the amount related to the credit losses for which other-than-temporary was previously recognized	—		—
Sale of securities which previously had recorded a credit loss for other-than-temporary impairment	—		—
Ending balance of credit losses on securities held as of March 31 for which a portion of other-than-temporary impairment was recognized in other comprehensive income⁽¹⁾	$	8	$	8

_____________________________________


⁽¹⁾	Includes $8 of other-than-temporary impairment related to Fannie Mae common stock.

The amortized cost and fair values of available for sale and held to maturity debt securities as of March 31, 2014, by contractual maturity, are shown below. Expected maturities will differ from contractual maturities because the borrowers may have the right to call or prepay obligations with or without call or prepayment penalties.



	Available for Sale				Held to Maturity
	Amortized Cost		Fair Value		Amortized Cost		Fair Value
Due in one year or less	$	1,316	$	1,328	$	—	$	—
Due after one year through five years	17,731		17,726		2,212		2,219
Due after five years through ten years	7,169		7,121		12,902		12,965
Due after ten years	307		297		2,065		2,103
	26,523		26,472		17,179		17,287
Agency residential mortgage-backed securities	365,649		362,076		1,971		1,950
	$	392,172	$	388,548	$	19,150	$	19,237

Equity securities have been excluded from the maturity table above because they do not have contractual maturities associated with debt securities.

HF FINANCIAL CORP.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)

(DOLLARS IN THOUSANDS, except share data)

(Unaudited)

Proceeds from the sale of securities available for sale for the three months ended March 31, 2014 were $26,914 and resulted in gross gains and gross losses of $239 and $6, respectively. There were $18,386 proceeds from the sales of securities for the three months ended March 31, 2013 and resulted in gross gains and gross losses of $166 and $20, respectively.

Proceeds from the sale of securities available for sale for the first nine months of fiscal 2014 were $61,708 and resulted in gross gains and gross losses of $604 and $13, respectively. Proceeds from the sale of securities available for sale for the first nine months of fiscal 2013 were $91,418 and resulted in gross gains and gross losses of $1,988 and $20, respectively.

NOTE 5—LOANS AND LEASES RECEIVABLE

Loans and leases receivable by classes within portfolio segments, consist of the following:



	March 31, 2014				June 30, 2013
	Amount		Percent		Amount		Percent
Residential:
One-to four-family	$	44,617	5.9	%	46,738		6.7	%
Construction	3,826		0.5		2,360		0.4
Commercial:
Commercial business ⁽¹⁾	69,585		9.2		75,555		10.9
Equipment finance leases	918		0.1		1,633		0.2
Commercial real estate:
Commercial real estate	272,390		36.1		239,057		34.4
Multi-family real estate	77,112		10.2		49,217		7.1
Construction	23,833		3.2		12,879		1.8
Agricultural:
Agricultural real estate	77,264		10.2		77,334		11.1
Agricultural business	107,243		14.2		100,398		14.4
Consumer:
Consumer direct	18,006		2.4		21,219		3.1
Consumer home equity	57,253		7.6		66,381		9.5
Consumer overdraft & reserve	2,771		0.4		2,995		0.4
Consumer indirect	1		—		5		—
Total loans and leases receivable ⁽²⁾	$	754,819	100.0	%	$	695,771	100.0	%

_____________________________________


⁽¹⁾	Includes $1,774 and $2,024 tax exempt leases at March 31, 2014 and June 30, 2013, respectively.


⁽²⁾	Exclusive of undisbursed portion of loans in process and net of deferred loan fees and discounts.

HF FINANCIAL CORP.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)

(DOLLARS IN THOUSANDS, except share data)

(Unaudited)

The following tables summarize the activity in the allowance for loan and lease losses by portfolio segment for the three months ended:



March 31, 2014
	Residential			Commercial			Commercial Real Estate			Agricultural			Consumer			Total
Balance at beginning of period	$	268		$	1,279		$	2,626		$	4,576		$	1,856		$	10,605
Charge-offs	—			(7		)	(31		)	(393		)	(132		)	(563		)
Recoveries	—			17			—			—			27			44
Provisions	(30		)	(255		)	969			(184		)	(240		)	260
Balance at end of period	$	238		$	1,034		$	3,564		$	3,999		$	1,511		$	10,346

March 31, 2013
	Residential			Commercial			Commercial Real Estate			Agricultural			Consumer			Total
Balance at beginning of period	$	298		$	1,698		$	2,159		$	4,355		$	2,270		$	10,780
Charge-offs	—			(13		)	—			—			(176		)	(189		)
Recoveries	—			12			—			8			53			73
Provisions	33			105			(96		)	(63		)	21			—
Balance at end of period	$	331		$	1,802		$	2,063		$	4,300		$	2,168		$	10,664

The following tables summarize the activity in the allowance for loan and lease losses by portfolio segment for the nine months ended:



March 31, 2014
	Residential			Commercial			Commercial Real Estate			Agricultural			Consumer			Total
Balance at beginning of period	$	203		$	1,558		$	2,373		$	4,637		$	1,972		$	10,743
Charge-offs	(7		)	(125		)	(41		)	(491		)	(430		)	(1,094		)
Recoveries	1			313			—			13			91			418
Provisions	41			(712		)	1,232			(160		)	(122		)	279
Balance at end of period	$	238		$	1,034		$	3,564		$	3,999		$	1,511		$	10,346

March 31, 2013
	Residential			Commercial			Commercial Real Estate			Agricultural			Consumer			Total
Balance at beginning of period	$	347		$	977		$	2,063		$	4,493		$	2,686		$	10,566
Charge-offs	(1		)	(34		)	(7		)	(395		)	(782		)	(1,219		)
Recoveries	20			289			—			976			204			1,489
Provisions	(35		)	570			7			(774		)	60			(172		)
Balance at end of period	$	331		$	1,802		$	2,063		$	4,300		$	2,168		$	10,664

HF FINANCIAL CORP.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)

(DOLLARS IN THOUSANDS, except share data)

(Unaudited)

The following tables summarize the related statement balances by portfolio segment:



	March 31, 2014
	Residential		Commercial		Commercial Real Estate		Agricultural		Consumer		Total
Allowance for loan and lease losses:
Individually evaluated for impairment	$	17	$	168	$	28	$	250	$	255	$	718
Collectively evaluated for impairment	221		866		3,536		3,749		1,256		9,628
Total allowance for loan and lease losses	$	238	$	1,034	$	3,564	$	3,999	$	1,511	$	10,346
Loans and leases receivable:
Individually evaluated for impairment	$	165	$	4,435	$	1,277	$	15,332	$	1,744	$	22,953
Collectively evaluated for impairment	48,278		66,068		372,058		169,175		76,287		731,866
Total loans and leases receivable	$	48,443	$	70,503	$	373,335	$	184,507	$	78,031	$	754,819

	June 30, 2013
	Residential		Commercial		Commercial Real Estate		Agricultural		Consumer		Total
Allowance for loan and lease losses:
Individually evaluated for impairment	$	8	$	665	$	148	$	1,481	$	161	$	2,463
Collectively evaluated for impairment	195		893		2,225		3,156		1,811		8,280
Total allowance for loan and lease losses	$	203	$	1,558	$	2,373	$	4,637	$	1,972	$	10,743
Loans and leases receivable:
Individually evaluated for impairment	$	277	$	5,129	$	1,360	$	16,295	$	1,320	$	24,381
Collectively evaluated for impairment	48,821		72,059		299,793		161,437		89,280		671,390
Total loans and leases receivable	$	49,098	$	77,188	$	301,153	$	177,732	$	90,600	$	695,771

Credit Quality Indicators

The Company categorizes loans into risk categories based on relevant information about the ability of borrowers to service their debt such as: current financial information, historical payment experience, credit documentation, public information and current economic trends, among other factors. For loans other than residential and consumer, the Company analyzes loans individually, by classifying the loans as to credit risk. This analysis includes non-term loans, regardless of balance and term loans with an outstanding balance greater than $100. Each loan is reviewed annually, at a minimum. Specific events applicable to the loan may trigger an additional review prior to its scheduled review, if such event is determined to possibly modify the risk classification. The summary of the analysis for the portfolio is calculated on a monthly basis. The Company uses the following definitions for risk ratings:

HF FINANCIAL CORP.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)

(DOLLARS IN THOUSANDS, except share data)

(Unaudited)

Pass—Loans classified as pass represent loans that are evaluated and are performing under the stated terms. Pass rated assets are analyzed by the pay capacity, the current net worth, and the value of the loan collateral of the obligor.

Special Mention—Loans classified as special mention possess potential weaknesses that require management attention, but do not yet warrant adverse classification. While the status of a loan put on this list may not technically trigger their classification as Substandard or Doubtful, it is considered a proactive way to identify potential issues and address them before the situation deteriorates further and does result in a loss for the Company.

Substandard—Loans classified as substandard are inadequately protected by the current net worth, paying capacity of the obligor, or by the collateral pledged. Substandard loans must have a well-defined weakness or weaknesses that jeopardize the repayment of the debt as originally contracted. They are characterized by the distinct possibility that the Company will sustain a loss if the deficiencies are not corrected.

Doubtful—Loans classified as doubtful have the weaknesses of those classified as substandard, with the added characteristic that the weaknesses make collection or liquidation in full, on the basis of currently existing facts, conditions and values, highly questionable and improbable. Loans that fall into this class are deemed collateral dependent and an individual impairment analysis is performed on all relationships. Loans in this category are allocated a specific reserve if the estimated discounted cash flows from the loan (or collateral value less cost to sell for collateral dependent loans) does not support the outstanding loan balance or charged off if deemed uncollectible.

The following tables summarize the credit quality indicators used to determine the credit quality by class within the portfolio segments:

Credit risk profile by internally assigned grade—Commercial, Commercial real estate and Agricultural portfolio segments



	March 31, 2014								June 30, 2013
	Pass		Special Mention		Substandard		Doubtful		Pass		Special Mention		Substandard		Doubtful
Commercial:
Commercial business	$	64,650	$	97	$	4,905	$	122	$	65,931	$	2,253	$	7,077	$	510
Equipment finance leases	917		—		1		—		1,553		—		80		—
Commercial real estate:
Commercial real estate	259,767		—		12,608		18		226,417		—		12,994		92
Multi-family real estate	75,524		992		596		—		48,802		—		415		—
Construction	23,833		—		—		—		12,879		—		—		—
Agricultural:
Agricultural real estate	68,016		92		8,949		207		59,807		3,964		12,327		1,366
Agricultural business	105,690		57		1,478		30		98,449		60		1,998		86
	$	598,397	$	1,238	$	28,537	$	377	$	513,838	$	6,277	$	34,891	$	2,054

HF FINANCIAL CORP.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)

(DOLLARS IN THOUSANDS, except share data)

(Unaudited)

Credit risk profile based on payment activity—Residential and Consumer portfolio segments



	March 31, 2014				June 30, 2013
	Performing		Nonperforming		Performing		Nonperforming
Residential:
One-to four- family	$	44,491	$	126	$	46,502	$	236
Construction	3,826		—		2,360		—
Consumer:
Consumer direct	17,985		21		21,204		15
Consumer home equity	56,255		998		65,363		1,018
Consumer OD & reserves	2,771		—		2,995		—
Consumer indirect	1		—		5		—
	$	125,329	$	1,145	$	138,429	$	1,269

The following table summarizes the aging of the past due financing receivables by classes within the portfolio segments and related accruing and nonaccruing balances:



March 31, 2014	Accruing and Nonaccruing Loans										Nonperforming Loans
	30 - 59 Days Past Due		60 - 89 Days Past Due		Greater Than 89 Days		Total Past Due		Current⁽²⁾		Recorded Investment >90 Days and Accruing⁽¹⁾		Nonaccrual Balance		Total
Residential:
One-to four-family	$	149	$	—	$	126	$	275	$	44,342	$	—	$	125	$	125
Construction	—		—		—		—		3,826		—		—		—
Commercial:
Commercial business	192		336		180		708		68,877		—		3,932		3,932
Equipment finance leases	—		—		—		—		918		—		—		—
Commercial real estate:
Commercial real estate	110		—		208		318		272,072		—		1,214		1,214
Multi-family real estate	—		—		27		27		77,085		—		27		27
Construction	—		—		—		—		23,833		—		—		—
Agricultural:
Agricultural real estate	—		—		181		181		77,083		—		8,172		8,172
Agricultural business	—		547		—		547		106,696		—		4,063		4,063
Consumer:
Consumer direct	17		3		3		23		17,983		—		21		21
Consumer home equity	222		44		421		687		56,566		—		999		999
Consumer OD & reserve	5		—		—		5		2,766		—		—		—
Consumer indirect	—		—		—		—		1		—		—		—
Total	$	695	$	930	$	1,146	$	2,771	$	752,048	$	—	$	18,553	$	18,553

_____________________________________


⁽¹⁾	Loans accruing and delinquent greater than 90 days have either government guarantees or acceptable loan-to-value ratios.


⁽²⁾	Net of deferred loan fees and discounts and exclusive of undisbursed portion of loans in process.

HF FINANCIAL CORP.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)

(DOLLARS IN THOUSANDS, except share data)

(Unaudited)



June 30, 2013	Accruing and Nonaccruing Loans										Nonperforming Loans
	30 - 59 Days Past Due		60 - 89 Days Past Due		Greater Than 89 Days		Total Past Due		Current⁽²⁾		Recorded Investment >90 Days and Accruing⁽¹⁾		Nonaccrual Balance		Total
Residential:
One-to four-family	$	128	$	—	$	236	$	364	$	46,374	$	—	$	236	$	236
Construction	—		—		—		—		2,360		—		—		—
Commercial:
Commercial business	122		460		17		599		74,956		—		4,365		4,365
Equipment finance leases	4		35		—		39		1,594		—		35		35
Commercial real estate:
Commercial real estate	76		—		451		527		238,530		—		1,180		1,180
Multi-family real estate	—		—		27		27		49,190		—		27		27
Construction	—		—		—		—		12,879		—		—		—
Agricultural:
Agricultural real estate	—		10		—		10		77,324		—		11,634		11,634
Agricultural business	37		58		—		95		100,303		—		4,113		4,113
Consumer:
Consumer direct	33		—		15		48		21,171		—		15		15
Consumer home equity	282		55		510		847		65,534		—		1,018		1,018
Consumer OD & reserve	7		—		—		7		2,988		—		—		—
Consumer indirect	—		—		—		—		5		—		—		—
Total	$	689	$	618	$	1,256	$	2,563	$	693,208	$	—	$	22,623	$	22,623

_____________________________________


⁽¹⁾	Loans accruing and delinquent greater than 90 days have either government guarantees or acceptable loan-to-value ratios.


⁽²⁾	Net of deferred loan fees and discounts and exclusive of undisbursed portion of loans in process.

At March 31, 2014, the Company had identified $22,953 of loans as impaired which includes performing troubled debt restructurings. A loan is identified as impaired when, based on current information and events, it is probable that the Bank will be unable to collect all amounts due according to the contractual terms of the loan agreement and thus are placed on non-accrual status. Interest income on impaired loans is recognized on a cash basis. The average carrying amount is calculated for each quarter by using the daily average balance, which is then averaged with the other quarters' averages to determine an annual average balance.

HF FINANCIAL CORP.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)

(DOLLARS IN THOUSANDS, except share data)

(Unaudited)

The following table summarizes impaired loans by class of loans and the specific valuation allowance:



	March 31, 2014						June 30, 2013
	Recorded Investment		Unpaid Principal Balance⁽¹⁾		Related Allowance		Recorded Investment		Unpaid Principal Balance⁽¹⁾		Related Allowance
With no related allowance recorded:
One-to four-family	$	—	$	—	$	—	$	236	$	236	$	—
Commercial business	1,474		1,474		—		1,619		1,619		—
Commercial real estate	587		621		—		510		544		—
Multi-family real estate	27		27		—		27		27		—
Agricultural real estate	6,792		6,792		—		4,978		4,978		—
Agricultural business	3,515		3,515		—		3,730		3,730		—
Consumer direct	10		10		—		20		26		—
Consumer home equity	452		452		—		871		1,037		—
	12,857		12,891		—		11,991		12,197		—
With an allowance recorded:
One-to four-family	165		165		17		41		41		8
Commercial business	2,961		2,961		168		3,510		3,510		665
Commercial real estate	663		663		28		823		823		148
Agricultural real estate	4,477		4,477		220		7,204		7,204		1,381
Agricultural business	548		548		30		383		383		100
Consumer direct	14		14		14		—		—		—
Consumer home equity	1,268		1,268		241		429		435		161
	10,096		10,096		718		12,390		12,396		2,463
Total:
One-to four-family	165		165		17		277		277		8
Commercial business	4,435		4,435		168		5,129		5,129		665
Commercial real estate	1,250		1,284		28		1,333		1,367		148
Multi-family real estate	27		27		—		27		27		—
Agricultural real estate	11,269		11,269		220		12,182		12,182		1,381
Agricultural business	4,063		4,063		30		4,113		4,113		100
Consumer direct	24		24		14		20		26		—
Consumer home equity	1,720		1,720		241		1,300		1,472		161
	$	22,953	$	22,987	$	718	$	24,381	$	24,593	$	2,463

_____________________________________


⁽¹⁾	Represents the borrower's loan obligation, gross of any previously charged-off amounts.

HF FINANCIAL CORP.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)

(DOLLARS IN THOUSANDS, except share data)

(Unaudited)

The following table summarizes the Company's average recorded investment in impaired loans by class of loans and the related interest income recognized for the period indicated:



	Three Months Ended March 31,
	2014				2013
	Average Recorded Investment		Interest Income Recognized		Average Recorded Investment		Interest Income Recognized
One-to four-family	$	166	$	1	$	338	$	3
Commercial business	4,492		7		4,355		7
Commercial real estate	1,164		1		1,407		4
Multi-family real estate	27		—		27		—
Agricultural real estate	11,279		473		10,407		63
Agricultural business	3,848		—		2,659		31
Consumer direct	16		—		5		—
Consumer home equity	1,509		11		855		9
	$	22,501	$	493	$	20,053	$	117

The following table summarizes the Company's average recorded investment in impaired loans by class of loans and the related interest income recognized for the period indicated:



	Nine Months Ended March 31,
	2014				2013
	Average Recorded Investment		Interest Income Recognized		Average Recorded Investment		Interest Income Recognized
One-to four-family	$	232	$	2	$	286	$	12
Commercial business	4,752		23		3,115		60
Commercial real estate	1,166		5		1,400		17
Multi-family real estate	27		—		30		—
Agricultural real estate	11,492		473		10,987		84
Agricultural business	3,862		—		1,897		31
Consumer direct	15		—		3		—
Consumer home equity	1,439		26		495		18
	$	22,985	$	529	$	18,213	$	222

No additional funds are committed to be advanced in connection with impaired loans.

Modifications of terms for the Company's loans and their inclusion as troubled debt restructurings are based on individual facts and circumstances. Loan modifications that are included as troubled debt restructurings may involve reduction of the interest rate or renewing at an interest rate below current market rates, extension of the term of the loan and/or forgiveness of principal, regardless of the period of the modification.

Loans and leases that are considered troubled debt restructurings are factored into the determination of the allowance for loan and lease losses through impaired loan analysis and any subsequent allocation of specific valuation allowance, if applicable. The Company measures impairment on an individual loan and the extent to which a specific valuation allowance is necessary by comparing the loan's outstanding balance to either the fair value of the collateral, less the estimated cost to sell or the present value of expected cash flows, discounted at the loan's effective interest rate. During fiscal 2014, new TDRs consisted of one residential loan, three commercial business loans and seventeen consumer loans. Of these new TDRs, nineteen were evaluated for impairment based on collateral adequacy and three were evaluated based on discounted cash flows.

HF FINANCIAL CORP.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)

(DOLLARS IN THOUSANDS, except share data)

(Unaudited)

The following is a summary of the Company's performing troubled debt restructurings which are in-compliance with their modified terms:



March 31, 2014	Number of Contracts⁽¹⁾	Pre-Modification Recorded Balance		Post-Modification Outstanding Recorded Balance⁽¹⁾
Residential	2	$	166	$	166
Commercial business	6	3,675		3,675
Commercial real estate	4	734		700
Agricultural	7	11,124		11,124
Consumer	24	893		893
	43	$	16,592	$	16,558

June 30, 2013	Number of Contracts⁽²⁾	Pre-Modification Recorded Balance		Post-Modification Outstanding Recorded Balance⁽²⁾
Residential	1	$	41	$	41
Commercial business	5	4,372		4,372
Commercial real estate	5	974		940
Agricultural	9	14,769		14,769
Consumer	10	247		247
	30	$	20,403	$	20,369

_____________________________________


⁽¹⁾	Includes 19 customers, which are in compliance with their restructured terms, that are not accruing interest and have a recorded investment balance of $15,200.


⁽²⁾	Includes 14 customers, which are in compliance with their restructured terms, that are not accruing interest and have a recorded investment balance of $18,616.

Excluded from above, at March 31, 2014, the Company had four consumer relationships and one commercial real estate relationship with a recorded balances of $63 and $11, respectively, that were originally restructured in fiscal 2014. The consumer loans are not in compliance with their restructured terms and are in nonaccrual status, while the commercial real estate loan is not in compliance, but is in accruing status due to its overall collateralized position. At June 30, 2013, the Company had one agricultural relationship with a recorded balance of $9 that was originally restructured in fiscal 2012, two consumer relationships with a recorded balance of $44 that were originally restructured in fiscal 2013, and one residential relationship with a recorded balance of $84 that was originally restructured in fiscal 2013. Loans can retain their accrual status at the time of their modification if the restructuring is not a result of terminated loan payments. For nonaccruing loans, a minimum of six months of performance related to the restructured terms are required before a loan is returned to accruing status.

HF FINANCIAL CORP.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)

(DOLLARS IN THOUSANDS, except share data)

(Unaudited)

New TDRs initially classified as a TDR during the nine months ended March 31, were as follows:



	2014					2013
	Number of Contracts	Pre-Modification Recorded Balance		Post-Modification Outstanding Recorded Balance		Number of Contracts	Pre-Modification Recorded Balance		Post-Modification Outstanding Recorded Balance
Residential	1	$	126	$	126	2	$	125	$	125
Commercial business	3	152		152		2	134		134
Commercial real estate	1	11		11		—	—		—
Consumer	17	702		702		7	140		140
	22	$	991	$	991	11	$	399	$	399

22 TDRs were added during the first nine months of fiscal 2014. 18 TDRs were negotiated to extend a loan maturity without reducing the interest rate below market rate and four were due to bankruptcy. Four of the new TDRs defaulted during the first nine months of fiscal 2014. All of the TDRs added during the first nine months of fiscal 2014 that were due to loan maturity extensions granted, did not received reduce interest rates below the market rate. Four TDRs defaulted during the first nine months of fiscal 2014.

NOTE 6—LOAN SERVICING

Mortgage loans serviced for others (including the South Dakota Housing Development Authority) are not included in the accompanying consolidated statements of financial condition.



	Three Months Ended						Nine Months Ended
	March 31,						March 31,
	2014			2013			2014			2013
Mortgage servicing rights, beginning	$	11,739		$	12,649		$	12,236		$	12,820
Additions	135			415			638			1,486
Amortization⁽¹⁾	(416		)	(627		)	(1,416		)	(1,869		)
Mortgage servicing rights, ending	$	11,458		$	12,437		$	11,458		$	12,437

Valuation allowance, beginning	$	(374	)	$	(1,858	)	$	(1,249	)	$	(888	)
(Additions) / reductions ⁽¹⁾	374			220			1,249			(750		)
Valuation allowance, ending	$	—		$	(1,638	)	$	—		$	(1,638	)

Mortgage servicing rights, net	$	11,458		$	10,799		$	11,458		$	10,799

Servicing fees received	$	745		$	813		$	2,299		$	2,535
Balance of loans serviced at:
Beginning of period	1,086,992			1,164,496			1,123,012			1,187,900
End of period	1,071,627			1,151,376			1,071,627			1,151,376

_____________________________________


⁽¹⁾	Changes to carrying amounts are reported net of loan servicing income on the statements of income for the periods presented.

Amortization of servicing rights is adjusted each quarter based upon analysis of portfolio attributes and factors, including an evaluation of historical prepayment activity and prospective industry consensus rates. For the quarters ended March 31, 2014 and 2013, the constant prepayment rates (CPR) used to calculate the amortization was 9.4% and 16.4%, respectively. For valuation purposes, management utilized a discount rate of 10.0% and 9.0% at March 31, 2014 and 2013, respectively.

HF FINANCIAL CORP.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)

(DOLLARS IN THOUSANDS, except share data)

(Unaudited)

Prepayment speeds utilized at March 31, 2014 and 2013 were 8.6% and 15.8%, respectively, which are used in the calculation of the amortization expense for the subsequent quarter. Prepayment speeds are analyzed and adjusted each quarter.

NOTE 7—GOODWILL AND INTANGIBLE ASSETS, NET

The components of goodwill and intangible assets, net, are as follows:



	Three Months Ended				Nine Months Ended
	March 31,				March 31,
	2014		2013		2014		2013
Goodwill⁽¹⁾	$	4,366	$	4,366	$	4,366	$	4,366

Amortizable intangible assets
Customer base⁽³⁾	$	479	$	—	$	479	$	—
Covenant not to compete⁽⁴⁾	119		—		119		—
Total amortizable intangible assets	598		—		598		—

Accumulated amortization, beginning	81		—		26		—
Amortization expense	26		—		81		—
Accumulated amortization, ending	107		—		107		—

Amortizable intangible assets, net⁽²⁾	$	491	$	—	$	491	$	—

Goodwill and intangible assets, net	$	4,857	$	4,366	$	4,857	$	4,366

^{_______________________________________________________________}

⁽¹⁾Banking segment related goodwill.

⁽²⁾ Other segment related intangible assets.

⁽³⁾ Amortization life of 10.0 years.

⁽⁴⁾ Amortization life of 2.0 years.

NOTE 8—SEGMENT REPORTING

Operating segments are defined as components of an enterprise for which discrete financial information is available that is evaluated regularly by the chief operating decision makers in deciding how to allocate resources and in assessing performance. The Company’s reportable segments are “banking” (including leasing activities) and “other”. The “banking” segment is conducted through the Bank and Mid America Capital and the “other” segment is composed of smaller non-reportable segments, the Company and intersegment eliminations.

The management approach is used as the conceptual basis for identifying reportable segments and is based on the way that management organizes the segments within the enterprise for making operating decisions, allocating resources and monitoring performance, which is primarily based on products.

HF FINANCIAL CORP.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)

(DOLLARS IN THOUSANDS, except share data)

(Unaudited)

The following tables summarize segment reporting information:



	Three Months Ended March 31,
	2014									2013
	Banking			Other			Total			Banking			Other			Total
Net interest income	$	8,638		$	(313	)	$	8,325		$	7,497		$	(397	)	$	7,100
(Provision) benefit for losses on loans and leases	(260		)	—			(260		)	—			—			—
Noninterest income	3,291			393			3,684			3,371			284			3,655
Intersegment noninterest income	73			(69		)	4			328			(185		)	143
Noninterest expense	(8,381		)	(537		)	(8,918		)	(8,119		)	(429		)	(8,548		)
Intersegment noninterest expense	—			(4		)	(4		)	—			(143		)	(143		)
Income (loss) before income taxes	$	3,361		$	(530	)	$	2,831		$	3,077		$	(870	)	$	2,207
Total assets at March 31⁽¹⁾⁽²⁾	$	1,255,298		$	2,946		$	1,258,244		$	1,192,492		$	4,680		$	1,197,172


⁽¹⁾	Included in total assets were goodwill and intangible assets, net totaling $4,366 and $491 for the banking segment and other segment, respectively, at March 31, 2014.

⁽²⁾ Included in total assets were goodwill and intangible assets, net totaling $4,366 for the banking segment at March 31, 2013.



	Nine Months Ended March 31,
	2014									2013
	Banking			Other			Total			Banking			Other			Total
Net interest income	$	23,920		$	(1,032	)	$	22,888		$	22,855		$	(1,237	)	$	21,618
(Provision) benefit for losses on loans and leases	(279		)	—			(279		)	172			—			172
Noninterest income	10,770			1,024			11,794			10,396			437			10,833
Intersegment noninterest income	216			(204		)	12			199			(189		)	10
Noninterest expense	(25,246		)	(1,778		)	(27,024		)	(24,358		)	(1,467		)	(25,825		)
Intersegment noninterest expense	—			(12		)	(12		)	—			(10		)	(10		)
Income (loss) before income taxes	$	9,381		$	(2,002	)	$	7,379		$	9,264		$	(2,466	)	$	6,798
Total assets at March 31⁽¹⁾⁽²⁾	$	1,255,298		$	2,946		$	1,258,244		$	1,192,492		$	4,680		$	1,197,172


⁽¹⁾	Included in total assets were goodwill and intangible assets, net totaling $4,366 and $491 for the banking segment and other segment, respectively, at March 31, 2014.

⁽²⁾ Included in total assets were goodwill and intangible assets, net totaling $4,366 for the banking segment at March 31, 2013.

HF FINANCIAL CORP.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)

(DOLLARS IN THOUSANDS, except share data)

(Unaudited)

NOTE 9—DEFINED BENEFIT PLAN

The Company has a noncontributory (cash balance) defined benefit pension plan covering all employees of the Company and its wholly-owned subsidiaries who have attained the age of 21 and have completed 1,000 hours in a plan year. The benefits are based on 6% of each eligible participant's annual compensation, plus income earned in the accounts at a rate determined annually based on 30-year Treasury note rates. The Company's funding policy is to make the minimum annual required contribution plus such amounts as the Company may determine to be appropriate from time to time. 100% vesting occurs after 3 years with a retirement age of the later of age 65 or 3 years of participation.

The information relative to the components of net periodic benefit cost for the Company’s defined benefit plan is presented below.



	Three Months Ended						Nine Months Ended
	March 31,						March 31,
	2014			2013			2014			2013
Net periodic benefit cost
Service cost	$	168		$	165		$	505		$	494
Interest cost	180			163			540			491
Expected return on plan assets	(153		)	(162		)	(437		)	(467		)
Amortization of prior losses	53			32			158			96
Total costs recognized in expense	$	248		$	198		$	766		$	614

The Company previously disclosed in its consolidated financial statements for fiscal 2013, which are included in Part II, Item 8 “Financial Statements and Supplementary Data” of the Company’s Annual Report on Form 10-K, that it contributed $400 in fiscal 2013 to fund its qualified pension plan. During the third quarter of fiscal 2014, the Company contributed $455 to fund its qualified pension plan. The Company does not anticipate to fund any additional contributions for fiscal 2014.

NOTE 10—SELF-INSURED HEALTHCARE PLAN

The Company has self-insured health and dental plans for its employees, subject to certain limits. The Bank is named the plan administrator for these plans and has retained the services of independent third party administrators to process claims and handle other duties for these plans. The third party administrators do not assume liability for benefits payable under these plans. To mitigate a portion of the risks involved with the self-insured health plan, the Company has a stop loss insurance policy through a commercial insurance carrier for coverage in excess of $75 per individual occurrence.

The Company assumes the responsibility for funding the plan benefits out of general assets; however, employees cover some of the costs of covered benefits through contributions, deductibles, co-pays and participation amounts. An employee is eligible for coverage upon completion of 30 calendar days of regular employment. The plans, which are on a calendar year basis, are intended to comply with, and be governed by, the Employee Retirement Income Security Act of 1974, as amended.

The accrual estimate for pending and incurred but not reported health claims is based upon a pending claims lag report provided by a third party provider. Although management believes that it uses the best information available to determine the accrual, unforeseen health claims could result in adjustments and net earnings being significantly affected if circumstances differ substantially from the assumptions used in estimating the accrual. Net healthcare costs are inclusive of health and dental claims expenses and administration fees offset by stop loss and employee reimbursement.

HF FINANCIAL CORP.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)

(DOLLARS IN THOUSANDS, except share data)

(Unaudited)

The following table is a summary of net healthcare costs by quarter:



	Fiscal Years Ended
	June 30,
	2014		2013
Quarter ended September 30	$	264	$	236
Quarter ended December 31	257		411
Quarter ended March 31	384		300
Quarter ended June 30	—		291
Net healthcare costs	$	905	$	1,238

NOTE 11—STOCK-BASED COMPENSATION PLANS

The fair value of each incentive stock option and each stock appreciation right grant is estimated at the grant date using the Black-Scholes option-pricing model. There were no stock options or stock appreciation rights (SARs) granted in the nine months ended March 31, 2014 and 2013.

Stock option activity for the nine months ended March 31, 2014, was as follows:



	Shares		Weighted Average Exercise Price		Weighted Average Remaining Contractual Term	Aggregate Intrinsic Value
Beginning Balance	35,772		$	15.16
Granted	—		—
Forfeited	(3,973	)	14.88
Expired	(7,267	)	14.75
Exercised	—		—
Ending Balance	24,532		$	15.32	0.6	$	—
Vested and exercisable at March 31	24,532		$	15.32	0.6	$	—

Stock appreciation rights activity for the nine months ended March 31, 2014, was as follows:



	SARs		Weighted Average Exercise Price		Weighted Average Remaining Contractual Term	Aggregate Intrinsic Value
Beginning Balance	101,709		$	13.56
Granted	—		—
Forfeited	(5,786	)	15.43
Exercised	(6,526	)	12.48
Ending Balance	89,397		$	13.52	4.9	$	50
Vested and exercisable at March 31	89,397		$	13.52	4.9	$	50

The total intrinsic value of options exercised during the nine months ended March 31, 2014 and 2013 was $6 and $22, respectively. Cash received from the exercise of options and SARs for the nine months ended March 31, 2014 and 2013, was $0 and $43, respectively. There were no cashless option exercises or related tax benefit realized for the nine months ended March 31, 2014 and 2013. There was no unrecognized compensation cost related to nonvested SARs awards at March 31, 2014.

HF FINANCIAL CORP.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)

(DOLLARS IN THOUSANDS, except share data)

(Unaudited)

Nonvested share activity for the nine months ended March 31, was as follows:



	2014				2013
	Shares		Weighted Average Grant Date Fair Value		Shares		Weighted Average Grant Date Fair Value
Nonvested Balance, beginning	30,019		$	12.15	62,281		$	11.76
Granted	—		—		9,000		12.75
Vested	(13,825	)	12.09		(35,354	)	11.54
Forfeited	—		—		(1,408	)	12.28
Nonvested Balance, ending	16,194		$	12.20	34,519		$	12.23

Pretax compensation expense recognized for nonvested shares for the nine months ended March 31, 2014 and 2013, was $85 and $151, respectively. The tax benefit for the nine months ended March 31, 2014 and 2013 was $32 and $51, respectively. As of March 31, 2014, there was $207 of total unrecognized compensation cost related to nonvested shares granted under the Plan. That cost is expected to be recognized over a weighted-average period of nine months. The total fair value of shares vested during the nine months ended March 31, 2014 and 2013 was $179 and $197, respectively.

In association with the 2002 Stock Option and Incentive Plan, awards of nonvested shares of the Company's common stock were made to outside directors of the Company. Each outside director was entitled to all voting, dividend and distribution rights during the vesting period. Pretax compensation expense recognized for nonvested shares for the nine months ended March 31, 2014 and 2013, was $0 and $131, respectively. The tax benefit for nine months ended March 31, 2014 and 2013 was $0 and $45, respectively. As of March 31, 2014, there was no unrecognized compensation cost related to nonvested shares. The total fair value of shares vested during the nine months ended March 31, 2014 and 2013 was $0 and $259, respectively.

The 2002 Option Plan expired effective September 20, 2012. No plan was in effect at March 31, 2014 for the purpose of issuing new shares. The Company's stock option and incentive plans are described more fully in Part II, Item 8 “Financial Statements and Supplementary Data” of the Company’s Annual Report on Form 10-K for the fiscal year ended June 30, 2013, under Note 17 of “Notes to Consolidated Financial Statements.”

NOTE 12—SUBORDINATED DEBENTURES PAYABLE TO TRUSTS

The Company has issued and outstanding 24,000 shares totaling $24,000 of Company Obligated Mandatorily Redeemable Preferred Securities. These four Trusts were established and exist for the sole purpose of issuing trust preferred securities and investing the proceeds in subordinated debentures of the Company. These subordinated debentures constitute the sole assets of the four Trusts. The securities provide for cumulative cash distributions calculated at a rate based on three-month LIBOR plus a range from 1.65% to 3.35% adjusted quarterly. The Company may, at one or more times, defer interest payments on the capital securities for up to 20 consecutive quarterly periods, but not beyond the respective maturity date. At the end of the deferral period, all accumulated and unpaid distributions must be paid. The capital securities have redemption dates ranging from January 7, 2033 to October 1, 2037; however, the Company has the option to shorten the respective maturity date for all four securities as the call option date has passed. Holders of the capital securities have no voting rights, are unsecured, and rank junior in priority of the payment to all of the Company's indebtedness and senior to the Company's capital stock.

NOTE 13—INTEREST RATE CONTRACTS

Interest rate swap contracts are entered into primarily as an asset/liability management strategy of the Company to modify interest rate risk. The primary risk associated with all swaps is the exposure to movements in interest rates and the ability of the counterparties to meet the terms of the contract. The Company is exposed to losses if the counterparty fails to make its payments under a contract in which the Company is in a receiving status. The Company minimizes its risk by monitoring the credit standing of the counterparties. The Company anticipates the counterparties will be able to fully satisfy their obligations under the remaining agreements. These contracts are typically designated as cash flow hedges.

The Company has outstanding interest rate swap agreements with notional amounts totaling $15,000 to convert two variable-rate trust preferred securities into fixed-rate instruments. The agreements have a weighted average maturity of 2.2

HF FINANCIAL CORP.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)

(DOLLARS IN THOUSANDS, except share data)

(Unaudited)

years and have fixed rates ranging from 5.68% to 6.58% with a weighted average rate of 5.98%. The fair value of the derivatives was an unrealized loss of $1,038 at March 31, 2014 and an unrealized loss of $1,544 at March 31, 2013. The Company pledged $1,354 in cash under collateral arrangements as of March 31, 2014, to satisfy collateral requirements associated with these interest rate swap contracts.

The Company has borrower interest rate swap agreements with notional amounts totaling $37,373 to facilitate customer transactions and meet the borrower's financing needs. These swaps qualify as derivatives, but consist of two different types of instruments. The back-to-back loan swaps are not designated as hedging instruments, while the one-way loan swaps are classified as fair value hedging instruments. The loan interest rate swap derivatives had no impact on the consolidated statements of income for the first nine months ended March 31, 2014 and 2013. Any amounts due to the Company are expected to be collected from the borrowers. Credit risk exists if the borrower's collateral or financial condition indicates that the underlying collateral or financial condition of the borrower makes it probable that amounts due will be uncollectible. Management monitors this credit exposure on a quarterly basis.

During the first quarter of fiscal 2013, the Company terminated its five interest rate swap agreements with notional amounts totaling $35,000 which converted the variable-rate attributes of a pool of deposits into fixed-rate instruments. The Company recognized a charge of $1,456, which is included in other noninterest income in the financial statements for the quarter ending September 30, 2012.

No deferred net losses on interest rate swaps in other comprehensive loss as of March 31, 2014, are expected to be reclassified into net income during the current fiscal year. See Note 14 "Accumulated Other Comprehensive Loss" for amounts reported as other comprehensive loss.

The following table summarizes the derivative financial instruments utilized as of March 31, 2014:



				Estimated Fair Value
	Balance Sheet Location	Notional Amount		Gain		Loss
Non-designated derivatives	Other assets	$	7,911	$	722	$	(3	)
Fair value hedge	Loans and leases receivable	21,551		249		(107		)
Cash flow hedge	Accrued expenses and other liabilities	15,000		—		(1,038		)
Non-designated derivatives	Accrued expenses and other liabilities	7,911		3		(722		)
		$	52,373	$	974	$	(1,870	)

The following table summarizes the derivative financial instruments utilized as of June 30, 2013:



				Estimated Fair Value
	Balance Sheet Location	Notional Amount		Gain		Loss
Non-designated derivatives	Other assets	$	8,437	$	861	$	—
Fair value hedge	Loans and leases receivable	15,147		380		—
Cash flow hedge	Accrued expenses and other liabilities	22,000		—		(1,446		)
Non-designated derivatives	Accrued expenses and other liabilities	8,437		—		(861		)
		$	54,021	$	1,241	$	(2,307	)

The following table details the derivative financial instruments, the average remaining maturities and the weighted-average interest rates being paid and received as of March 31, 2014:



	Notional Value		Average Maturity (years)	Fair Value Gain (Loss)			Receive		Pay
Liability conversion swaps	$	15,000	2.2	$	(1,038	)	2.57	%	5.98	%
Loan interest rate swaps	37,373		8.1	142			2.11		4.46
	$	52,373		$	(896	)

HF FINANCIAL CORP.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)

(DOLLARS IN THOUSANDS, except share data)

(Unaudited)

The following table summarizes the amount of gains (losses) included in the income statement for the periods indicated:



		Three Months Ended				Nine Months Ended
		March 31,				March 31,
	Income Statement Location	2014		2013		2014		2013
Cash flow hedge	Other noninterest income	$	—	$	—	$	—	$	(1,456	)

NOTE 14—ACCUMULATED OTHER COMPREHENSIVE LOSS

The components of other comprehensive loss balances as of the respective dates were:



	March 31,			June 30,
	2014			2013
Unrealized (loss) on securities available for sale net of related tax effect of $1,374 and $849	$	(2,243	)	$	(1,385	)
Unrealized (loss) on defined benefit plan net of related tax effect of $1,193 and $1,193	(1,946		)	(1,946		)
Unrealized (loss) on cash flow hedging activities net of related tax effect of $353 and $492	(685		)	(954		)
	$	(4,874	)	$	(4,285	)

The following tables summarize the components of other comprehensive income (loss) balances at March 31, 2014 and 2013, changes and reclassifications out of accumulated other comprehensive income (loss) during the three months ended March 31, 2014 and 2013. The amounts reclassified from accumulated other comprehensive income for the investment securities available for sale are included in net gain on sale of investment securities on the consolidated statements of income, while the amounts reclassified from cash flow hedging activities are a component of other noninterest income on the consolidated statements of income.



	Investment Securities Available for Sale			Defined Benefit Plan			Cash Flow Hedging Activities			Accumulated Other Comprehensive Loss
Balance January 1, 2014	$	(2,726	)	$	(1,946	)	$	(788	)	$	(5,460	)
Other comprehensive income before reclassifications	1,013			—			156			1,169
Amounts reclassified from accumulated other comprehensive (loss)	(233		)	—			—			(233		)
Income tax (expense)	(297		)	—			(53		)	(350		)
Balance March 31, 2014	$	(2,243	)	$	(1,946	)	$	(685	)	$	(4,874	)



	Investment Securities Available for Sale			Defined Benefit Plan			Cash Flow Hedging Activities			Accumulated Other Comprehensive Loss
Balance January 1, 2013	$	1,987		$	(1,351	)	$	(1,834	)	$	(1,198	)
Other comprehensive income (loss) before reclassifications	(593		)	—			223			(370		)
Amounts reclassified from accumulated other comprehensive income (loss)	(146		)	—			—			(146		)
Income tax (expense) benefit	281			—			(76		)	205
Balance March 31, 2013	$	1,529		$	(1,351	)	$	(1,687	)	$	(1,509	)

HF FINANCIAL CORP.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)

(DOLLARS IN THOUSANDS, except share data)

(Unaudited)

The following tables summarize the components of other comprehensive income (loss) balances at March 31, 2014 and 2013, changes and reclassifications out of accumulated other comprehensive income (loss) during the nine months ended March 31, 2014 and 2013. The amounts reclassified from accumulated other comprehensive income for the investment securities available for sale are included in net gain on sale of investment securities on the consolidated statements of income, while the amounts reclassified from cash flow hedging activities are a component of other noninterest income on the consolidated statements of income.



	Investment Securities Available for Sale			Defined Benefit Plan			Cash Flow Hedging Activities			Accumulated Other Comprehensive Loss
Balance July 1, 2013	$	(1,385	)	$	(1,946	)	$	(954	)	$	(4,285	)
Other comprehensive income (loss) before reclassifications	(792		)	—			408			(384		)
Amounts reclassified from accumulated other comprehensive (loss)	(591		)	—			—			(591		)
Income tax (expense) benefit	525			—			(139		)	386
Balance March 31, 2014	$	(2,243	)	$	(1,946	)	$	(685	)	$	(4,874	)



	Investment Securities Available for Sale			Defined Benefit Plan			Cash Flow Hedging Activities			Accumulated Other Comprehensive Loss
Balance July 1, 2012	$	2,659		$	(1,351	)	$	(2,930	)	$	(1,622	)
Other comprehensive income before reclassifications	145			—			521			666
Amounts reclassified from accumulated other comprehensive income (loss)	(1,968		)	—			1,456			(512		)
Income tax (expense) benefit	693			—			(734		)	(41		)
Balance March 31, 2013	$	1,529		$	(1,351	)	$	(1,687	)	$	(1,509	)

NOTE 15—FINANCIAL INSTRUMENTS

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, standby letters of credit and financial guarantees. Those instruments involve, to varying degrees, elements of credit and interest-rate risk in excess of amounts recognized in the consolidated statements of financial condition. The contract or notional amounts of those instruments reflect the extent of the Company's involvement in particular classes of financial instruments.

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, standby letters of credit, and financial guarantees written is represented by the contractual notional amount of those instruments. The Company uses the same credit policies in making commitments and conditional obligations as it does for on-balance-sheet instruments.

Unless noted otherwise, the Company does not require collateral or other security to support financial instruments with credit risk.

HF FINANCIAL CORP.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)

(DOLLARS IN THOUSANDS, except share data)

(Unaudited)

The following methods and assumptions were used by the Company in estimating the fair value of its financial instruments:

Cash and cash equivalents—The carrying amounts reported in the statements of financial condition for cash and cash equivalents approximate their fair values.

Securities—Fair values for investment securities are based on quoted market prices or whose value is determined using discounted cash flow methodologies, except for correspondent bank stock for which fair value is assumed to equal cost.

Loans and leases, net—The fair values for loans are estimated using discounted cash flow analyses, using interest rates currently being offered for loans with similar terms and credit quality. Leases are stated at cost which equals fair value.

Accrued interest receivable—The carrying value of accrued interest receivable approximates its fair value.

Servicing rights—Fair values are estimated using discounted cash flows based on current market rates of interest.

Interest rate swap contracts—Valuations of interest rate swap contracts are based on inputs observed in active markets for similar instruments. Typical inputs include the LIBOR curve, option volatility and option skew.

Off-statement-of-financial-condition instruments—Fair values for the Company's off-statement-of-financial-condition instruments (unused lines of credit and letters of credit), which are based upon fees currently charged to enter into similar agreements taking into account the remaining terms of the agreements and counterparties' credit standing, are not significant. Many of the Company's off-statement-of-financial-condition instruments, primarily loan commitments and standby letters of credit, are expected to expire without being drawn upon; therefore, the commitment amounts do not necessarily represent future cash requirements.

Deposits—The fair values for deposits with no defined maturities equal their carrying amounts, which represent the amount payable on demand. Fair values for fixed-rate certificates of deposit are estimated using a discounted cash flow calculation that applies interest rates currently being offered on a comparably termed wholesale funding alternative (i.e., FHLB borrowings).

Borrowed funds—The carrying amounts reported for variable rate advances approximate their fair values. Fair values for fixed-rate advances and other borrowings are estimated using a discounted cash flow calculation that applies interest rates currently being offered on advances and borrowings with corresponding maturity dates.

Subordinated debentures payable to trusts—Fair values for subordinated debentures are estimated using a discounted cash flow calculation that applies interest rates on comparable borrowing instruments with corresponding maturity dates.

Accrued interest payable and advances by borrowers for taxes and insurance—The carrying values of accrued interest payable and advances by borrowers for taxes and insurance approximate their fair values.

HF FINANCIAL CORP.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)

(DOLLARS IN THOUSANDS, except share data)

(Unaudited)

Estimated fair values of the Company's financial instruments are as follows:



March 31, 2014			Fair Value Measurements
	Carrying Amount		Fair Value		Level 1		Level 2		Level 3
Financial assets
Cash and cash equivalents	$	26,548	$	26,548	$	26,548	$	—	$	—
Investment securities	407,965		408,052		14		408,038		—
Correspondent bank stock	7,439		7,439		—		7,439		—
Loans held for sale	3,204		3,204		—		3,204		—
Net loans and leases receivable	744,473		745,924		—		16,525		729,399
Accrued interest receivable	5,050		5,050		—		5,050		—
Servicing rights, net	11,458		11,865		—		—		11,865
Interest rate swap contracts	719		719		—		719		—
Financial liabilities
Deposits	952,363		952,495		—		—		952,495
Interest rate swap contracts	1,757		1,757		—		1,757		—
Borrowed funds	147,436		153,847		—		153,847		—
Subordinated debentures payable to trusts	24,837		26,801		—		—		26,801
Accrued interest payable and advances by borrowers for taxes and insurance	20,195		20,195		—		20,195		—



June 30, 2013			Fair Value Measurements
	Carrying Amount		Fair Value		Level 1		Level 2		Level 3
Financial assets
Cash and cash equivalents	$	21,352	$	21,352	$	21,352	$	—	$	—
Investment securities	424,481		424,481		12		424,469		—
Correspondent bank stock	8,936		8,936		—		8,936		—
Loans held for sale	9,169		9,169		—		9,169		—
Net loans and leases receivable	685,028		686,883		—		16,165		670,718
Accrued interest receivable	5,301		5,301		—		5,301		—
Servicing rights, net	10,987		10,987		—		—		10,987
Interest rate swap contracts	861		861		—		861		—
Financial liabilities
Deposits	898,761		899,523		—		—		899,523
Interest rate swap contracts	2,307		2,307		—		2,307		—
Borrowed funds	167,163		172,893		—		172,893		—
Subordinated debentures payable to trusts	24,837		26,830		—		—		26,830
Accrued interest payable and advances by borrowers for taxes and insurance	14,178		14,178		—		14,178		—

HF FINANCIAL CORP.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)

(DOLLARS IN THOUSANDS, except share data)

(Unaudited)

Fair Value Measurement

The Company uses fair value measurements to record fair value adjustments to certain assets and liabilities and to determine fair value disclosures. The fair value of a financial instrument is the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date. Fair value is best determined based upon quoted market prices. However, in many instances, there are no quoted market prices for the Company's various financial instruments. In cases where quoted market prices are not available, fair values are based on estimates using present value or other valuation techniques. Those techniques are significantly affected by the assumptions used, including the discount rate and estimates of future cash flows. Accordingly, the fair value estimates may not be realized in an immediate settlement of the instrument.

Fair value accounting guidance provides a consistent definition of fair value, which focuses on exit price in an orderly transaction (that is, not a forced liquidation or distressed sale) between market participants at the measurement date under current market conditions. If there has been a significant decrease in the volume and level of activity for the asset or liability, a change in valuation technique or the use of multiple valuation techniques may be appropriate. In such instances, determining the price at which willing market participants would transact at the measurement date under current market conditions depends on the facts and circumstances and requires the use of significant judgment. The fair value is a reasonable point within the range that is most representative of fair value under current market conditions.

The Company groups its financial assets and financial liabilities generally measured at fair value in 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.

Level 1: Quoted prices (unadjusted) for identical assets or liabilities in active markets that the entity has the ability to access as of the measurement date.

Level 2: Significant other observable inputs other than Level 1 prices such as quoted prices for similar assets or liabilities; quoted prices in markets that are not active; or other inputs that are observable or can be corroborated by observable market data.

Level 3: Significant unobservable inputs that reflect a company's own assumptions about the assumptions that market participants would use in pricing an asset or liability. Level 3 assets and liabilities include financial instruments whose value is determined using pricing models, discounted cash flow methodologies, or similar techniques, as well as instruments for which the determination of fair value requires significant management judgment or estimation.

HF FINANCIAL CORP.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)

(DOLLARS IN THOUSANDS, except share data)

(Unaudited)

The table below presents the Company's balances of financial instruments measured at fair value on a recurring basis by level within the hierarchy at March 31, 2014:



	Quoted Prices In Active Markets (Level 1)		Significant Other Observable Inputs (Level 2)		Significant Unobservable Inputs (Level 3)		Total at Fair Value
Securities available for sale
Debt securities:
U.S. government agencies	$	—	$	15,690	$	—	$	15,690
Municipal bonds	—		10,782		—		10,782
Equity securities:
Federal Ag Mortgage	14		—		—		14
Other investments	—		253		—		253
Agency residential mortgage-backed securities	—		362,076		—		362,076
Securities available for sale	14		388,801		—		388,815
Interest rate swap contracts	—		974		—		974
Total assets	14		389,775		—		389,789
Interest rate swaps contracts	—		1,870		—		1,870
Total liabilities	$	—	$	1,870	$	—	$	1,870

The Company used the following methods and significant assumptions to estimate the fair value of items:

Securities available for sale: The fair values of securities available for sale are determined by obtaining quoted prices on nationally recognized securities exchanges (Level 1 inputs), or matrix pricing, which is a mathematical technique widely used in the industry to value debt securities without relying exclusively on quoted prices for the specific securities, but rather by relying on the securities' relationship to other benchmark quoted securities (Level 2 inputs). The Company outsources this valuation primarily to a third party provider which utilizes several sources for valuing fixed-income securities. Sources utilized by the third party provider include pricing models that vary based by asset class and include available trade, bid, and other market information. This methodology includes broker quotes, proprietary models, descriptive terms and conditions databases, as well as extensive quality control programs. As further valuation sources, the third party provider uses a proprietary valuation model and capital markets trading staff. This proprietary valuation model is used for valuing municipal securities. This model includes a separate yield curve structure for Bank-Qualified municipal securities. The grouping of municipal securities is further broken down according to insurer, credit support, state of issuance, and rating to incorporate additional spreads and municipal curves. Management reviews this third party analysis and has approved the values estimated for the fair values.

Interest rate swap contracts: The fair values of interest rate swap contracts relate to cash flow hedges of trust preferred debt securities issued by the Company and for specific borrower interest rate swap contracts classified as fair value hedges and non-designated derivatives. The fair value is estimated by a third party using inputs that are observable or that can be corroborated by observable market data and, therefore, are classified within Level 2 of the valuation hierarchy. These fair value estimations include primarily market observable inputs, such as yield curves, and include the value associated with counterparty credit risk. Management reviews this third party analysis and has approved the values estimated for the fair values.

The Company had no assets or liabilities that are measured at fair value on a recurring basis using significant unobservable inputs (Level 3) during fiscal years 2014 and 2013 and thus, no reconciliation is presented.

HF FINANCIAL CORP.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)

(DOLLARS IN THOUSANDS, except share data)

(Unaudited)

The table below presents the Company's balances of financial instruments measured at fair value on a nonrecurring basis by level within the hierarchy at March 31, 2014:



	Quoted Prices In Active Markets (Level 1)		Significant Other Observable Inputs (Level 2)		Significant Unobservable Inputs (Level 3)		Fiscal 2014 Incurred Losses (Gains)
Impaired loans	$	—	$	16,525	$	5,710	$	(513	)
Mortgage servicing rights	—		—		11,865		(1,249		)
Foreclosed real estate and other properties	—		—		45		11

The table below presents the Company's balances of financial instruments measured at fair value on a nonrecurring basis by level within the hierarchy at June 30, 2013:



	Quoted Prices In Active Markets (Level 1)		Significant Other Observable Inputs (Level 2)		Significant Unobservable Inputs (Level 3)		Fiscal 2013 Incurred Losses (Gains)
Impaired loans	$	—	$	15,785	$	6,133	$	(159	)
Mortgage servicing rights	—		—		10,987		361

The significant unobservable inputs used in the fair value measurement of impaired loans not dependent on collateral primarily relate to present value of cash flows. Cash flows are derived from scenarios which estimate the probability of default and factor in the amount of estimated principal loss. The resulting fair value is then compared to the carrying value of each credit and a specific valuation allowance is recorded when the carrying value exceeds the fair value.

The significant unobservable inputs used in the fair value measurement of collateral for collateral-dependent impaired loans primarily relate to customized discounting criteria applied to the customer's reported amount of collateral. The amount of the collateral discount depends upon the marketability of the underlying collateral. The Company's primary objective in the event of default would be to monetize the collateral to settle the outstanding balance of the loan, in which collateral with lesser marketability characteristics would receive a larger discount.

The Credit Administration department evaluates the valuations on impaired loans and other real estate owned monthly. The results of these valuations are reviewed at least quarterly by the internal Asset Classification Committee and are considered in the overall calculation of the allowance for loan and lease losses. Unobservable inputs are monitored and adjusted if market conditions change.

Servicing rights, net do not trade in an active, open market with readily observable prices. While sales of mortgage servicing rights do occur, the precise terms and conditions typically are not readily available to allow for a “quoted price for similar assets” comparison. Accordingly, the Company relies on an internal discounted cash flow model to estimate the fair value of its mortgage servicing rights. The Company uses a valuation model to project mortgage servicing rights cash flows based on the current interest rate scenario, which is then discounted to estimate an expected fair value of the mortgage servicing rights. The valuation model considers portfolio characteristics of the underlying mortgages, contractually specified servicing fees, prepayment assumptions, discount rate assumptions, other ancillary revenue, costs to service, and other economic factors. Certain tranches of the portfolio may exhibit distinct liquidity traits compared to other tranches. The Company reassesses and periodically adjusts the underlying inputs and assumptions used in the model to reflect market conditions, and assumptions that a market participant would consider in valuing the mortgage servicing rights asset. In addition, the Company compares its fair value estimates and assumptions to observable market data for mortgage servicing rights, where available, and to recent market activity and actual portfolio experience. Due to the nature of the valuation inputs, mortgage servicing rights are classified within Level 3 of the fair value hierarchy. The Company uses the amortization method (i.e., lower of amortized cost or estimated fair value), not fair value measurement accounting, for its servicing rights assets. During the year, the estimated fair

HF FINANCIAL CORP.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)

(DOLLARS IN THOUSANDS, except share data)

(Unaudited)

value was less than the amortized cost and a valuation allowance was recorded, which classifies servicing rights, net as a nonrecurring valuation.

Foreclosed real estate and other properties include those assets which have subsequent market adjustments after the original possession as a foreclosed asset. The estimated fair value is based on what the local markets are currently offering for assets with similar characteristics, less costs to sell, which the Company classifies as a Level 3 fair value measurement. Foreclosed assets which have market adjustments due to the modifications in values that are not reflected in the most recent appraisal or valuation, or have updated appraisals with valuation changes since its inclusion as a foreclosed asset are included as a nonrecurring valuation.

For Level 3 assets and liabilities measured at fair value on a recurring or nonrecurring basis as of March 31, 2014, the significant unobservable inputs used in the fair value measurements were as follows:



	Fair Value		Valuation Technique	Unobservable Input	Range (Weighted Averages)
Impaired loans	$	5,710	Discounted cash flow	Discount rate	3.3% - 10.0% (4.9%)
				Principal loss probability	0.0% - 50.2% (6.0%)

			Collateral valuation	Discount from appraised value	0.0% - 62.1% (19.5%)
				Costs to sell	2.9% - 15.9% (8.7%)

Servicing rights, net	11,865		Discounted cash flow	Constant prepayment rate	8.6%
				Discount rate	10.0%

Foreclosed real estate and other properties	45		Collateral valuation	Costs to sell	9.0%

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

Forward-Looking Statements

This Quarterly Report on Form 10-Q ("Form 10-Q"), as well as other reports issued by HF Financial Corp. (the "Company") include "forward-looking statements" within the meaning of Section 27A of the Securities Act of 1933, as amended, and Section 21E of the Securities Exchange Act of 1934, as amended. In addition, the Company's management may make forward-looking statements orally to the media, securities analysts, investors and others from time to time. Forward-looking statements can be identified by the fact that they do not relate strictly to historical or current facts. Words such as "optimism," "look-forward," "bright," "believe," "expect," "anticipate," "intend," "hope," "plan," "estimate" or words of similar meaning, or future or conditional verbs such as "will," "would," "should," "could" or "may," are intended to identify these forward-looking statements.

These forward-looking statements might include one or more of the following:


•	projections of income, loss, revenues, earnings or losses per share, dividends, capital expenditures, capital structure, tax benefit or other financial items.


•	descriptions of plans or objectives of management for future operations, products or services, transactions, investments and use of subordinated debentures payable to trusts.


•	forecasts of future economic performance.


•	use and descriptions of assumptions and estimates underlying or relating to such matters.

Forward-looking statements are subject to certain risks and uncertainties that could cause actual results to differ materially from our historical experience and our present expectations or projections. Factors that could cause actual results to differ from those discussed in the forward-looking statements include, but are not limited to:


•	adverse economic and market conditions of the financial services industry in general, including, without limitation, the credit markets;


•	the effect of recent legislation to help stabilize the financial markets;


•	increase of non-performing loans and additional provisions for loan losses;


•	the failure of assumptions underlying the establishment of reserves for loan losses and other estimates;


•	the failure to maintain our reputation in our market area;


•	prevailing economic, political and business conditions in South Dakota and Minnesota;


•	the effects of competition from a wide variety of local, regional, national and other providers of financial services;


•	compliance with existing and future banking laws and regulations, including, without limitation, regulatory capital requirements and FDIC insurance coverages and costs;


•	changes in the availability and cost of credit and capital in the financial markets;


•	the effects of FDIC deposit insurance premiums and assessments;


•	the risks of changes in market interest rates on the composition and costs of deposits, loan demand, net interest income, and the values and liquidity of loan collateral, and our ability or inability to manage interest rate and other risks;


•	changes in the prices, values and sales volumes of residential and commercial real estate;


•	an extended period of low commodity prices, significantly reduced yields on crops, reduced levels of governmental assistance to the agricultural industry, and reduced farmland values;


•	soundness of other financial institutions;


•	the risks of future acquisitions and other expansion opportunities, including, without limitation, the related time and costs of implementing such transactions, integrating operations as part of these transactions and possible failures to achieve expected gains, revenue growth and expense savings from such transactions;


•	security and operations risks associated with the use of technology;


•	the loss of one or more of our key personnel, or the failure to attract, assimilate and retain other highly qualified personnel in the future;


•	changes in or interpretations of accounting standards, rules or principles; and


•	other factors and risks described under the caption "Risk Factors" in our most recent Annual Report on Form 10-K and subsequently filed quarterly reports on Form 10-Q.

Forward-looking statements speak only as of the date they are made. Forward-looking statements are based upon management's then-current beliefs and assumptions, but management does not give any assurance that such beliefs and assumptions will prove to be correct. We undertake no obligation to publicly update or revise any forward-looking statements included or incorporated by reference in this Form 10-Q or to update the reasons why actual results could differ from those contained in such statements, whether as a result of new information, future events or otherwise, except to the extent required by federal securities laws. Based upon changing conditions, should any one or more of the above risks or uncertainties materialize, or should any of our underlying beliefs or assumptions prove incorrect, actual results may vary materially from those described in any forward-looking statement.

References in this Form 10-Q to "we," "our," "us" and other similar references are to the Company, unless otherwise expressly stated or the context requires otherwise.

Executive Summary

The Company's net income for the first nine months of fiscal 2014 was $5.1 million, or $0.73 in basic and diluted earnings per common share, compared to $4.5 million, or $0.64 in basic and diluted earnings per common share, for the first nine months of fiscal 2013. This resulted in a return on average equity (i.e., net income divided by average equity) of 7.02% and 6.11%, respectively, in the year-over-year comparison, while the return on average assets (i.e., net income divided by average assets) was 0.55% and 0.51%, respectively.

Net interest income for the first nine months of fiscal 2014 was $22.9 million, an increase of $1.3 million, or 5.9%, compared to the same period a year ago. For the comparative time-frames, average interest-earning assets and average interest-bearing liabilities increased 7.2% and 4.7%, respectively. The average yield on interest-earning assets decreased to 3.40% for the first nine months of fiscal 2014, compared to 3.63% a year ago, a decrease of 23 basis points, due primarily to the repricing of adjustable rate loans and competitive pricing pressures in a low interest rate environment. In addition, this economic environment impacts the yields on investment securities and other short-term investments and prepayment speeds of mortgage-backed securities purchased at a premium. For the nine months ended March 31, 2014, cost of deposits, which include all interest-bearing and noninterest-bearing deposits, decreased by 13 basis points to 0.43%, compared to 0.56% for the same period of the prior fiscal year.

The net interest margin expressed on a fully taxable equivalent basis (“Net Interest Margin, TE”) for the nine months ended March 31, 2014 was 2.66%, which is a decrease of 2 basis points from the same period of the prior fiscal year. Net interest income attributable to the increases in average balances of interest-earning assets and interest-bearing liabilities amounted to an increase of $1.7 million for the nine month period. Interest-earning asset average balance increases contributed to an increase of $2.0 million in interest revenue, primarily driven from the increase in average loan and lease receivable balances of 6.6%, when compared to the same period of the prior fiscal year. Conversely, the average balances of FHLB advances increased by14.6%, which contributed to an increase in interest expense of $460,000. Net interest income attributable to changes in rates amounted to a net decrease of $414,000 for the nine month period. The yield on interest-earning assets decreased by 23 basis points and resulted in a decrease of interest income of $1.9 million, while the rate paid on interest-bearing liabilities decreased 22 basis points and resulted in a decrease in interest expense of $1.5 million. The combined effects of volume and rate changes resulted in an overall net interest income increase of $1.3 million for the nine months ended March 31, 2014 when compared to the same period of the prior year.

Average FHLB advance balances increased to fund the increased interest-earning assets, but generated lower interest expense due to the reduction in rates paid and maturities of higher cost advances during the current nine month period. Subordinated debentures payable to trusts contributed to the reduced interest expense in the current fiscal year due primarily to the extinguishment of $3.0 million of debt during the fourth quarter of fiscal 2013. A sustained overall decline in the interest rate yield curve has affected both the yield for the interest-earning assets and the cost of interest-bearing liabilities. Net Interest Margin, TE is a non-GAAP financial measure. See “Analysis of Net Interest Income” for a calculation of this non-GAAP financial measure and for further discussion as to the reasons we believe this non-GAAP financial measure is useful.

Total loans increased by $59.0 million during the current fiscal year to $754.8 million at March 31, 2014, compared to $695.8 million at June 30, 2013 and $682.6 million at March 31, 2013. Commercial real estate and agricultural lending portfolios increased by $72.2 million and $6.8 million, respectively, since the prior fiscal year end, while strong underwriting standards remain in place. Residential mortgage loan originations were tempered by the recent rise in long term interest rates which reduced refinancing activity and impacted the home equity portfolio. We believe the overall increase in average loan balances was attributable to a gradual improvement in general economic conditions, resulting in the willingness of borrowers to consider incurring more debt to support growth in their businesses, while also acknowledging that we continue to operate in uncertain national economic and fiscal conditions. We believe that the operating environment has resulted in increased competition among financial institutions for loan demand from credit-worthy borrowers.

The allowance for loan and lease losses decreased by $397,000 to $10.3 million at March 31, 2014, compared to June 30, 2013. The ratio of allowance for loan and lease losses to total loans and leases was 1.37% compared to 1.54% at June 30, 2013. The overall loan balances increased by $59.0 million during the first nine months of fiscal 2014, while the amount of classified assets decreased by $8.0 million to $32.1 million and nonperforming loans decreased by $4.1 million to $18.6 million at March 31, 2014. The Company continues to pro-actively manage its problem assets which have been enhanced by improving conditions in the regional commercial and agricultural markets. The provision for loan and lease losses, which results from adjusting the allowance for loan and lease losses to the estimated amount needed to reserve for the loan and lease portfolio, was $279,000 for the first nine months of fiscal 2014. Total nonperforming assets at March 31, 2014 were $18.8 million as

compared to $23.2 million at June 30, 2013. The ratio of nonperforming assets to total assets decreased to 1.50% at March 31, 2014, compared to 1.90% at June 30, 2013. Net charge-offs for the nine month period ended March 31, 2014 were $676,000 and represent 0.12% of gross loans and leases. The valuation allowance recorded in accordance with ASC 310 on identified impaired loans decreased to $718,000 at March 31, 2014, compared to $2.5 million at June 30, 2013, due primarily to payments received on nonaccruing impaired loans, which reduced the principal balance and the amount of valuation allowance for those credits. The valuation allowance recorded in accordance with ASC 450 increased by $1.3 million due to the effects of the increase in applicable loan balances since the prior fiscal year end and management's assessment of the allowance using historical charge-off activity and environmental factor information. Approximately 35% of the valuation allowance on impaired loans relates to agricultural loans and, more specifically, 29% are within the dairy sector. All identified impaired loans are reviewed to assess the borrower's ability to make payments under the terms of the loan and/or a shortfall in collateral value that would result in charging off the loan or the portion of the loan that was impaired.

Foreclosed real estate and other properties totaled $266,000 at March 31, 2014, compared to $564,000 at June 30, 2013, or a decrease of $298,000. The balance at March 31, 2014 consists primarily of residential loans that were foreclosed and remained unsold at quarter end.

The allowance for loan and lease losses is calculated based on loan and lease levels, loan and lease loss history over 12, 36, and 60 month time periods, credit quality of the loan and lease portfolio, and environmental factors such as economic health of the region and management experience. This risk rating analysis is designed to give the Company a consistent and systematic methodology to determine proper levels for the allowance at a given time. Management intends to continue its disciplined credit administration and loan underwriting processes and to remain focused on the creditworthiness of new loan originations. Management believes that it has identified the most significant nonperforming assets in the loan portfolio and is working to clarify and resolve the credit, credit administration, and environmental factor issues related to these assets to obtain the most favorable outcome for the Company.

Total deposits at March 31, 2014, were $952.4 million, an increase of $53.6 million from June 30, 2013. This increase was primarily due to increases of $11.7 million from in-market, non-public fund customer deposits, $46.5 million from public fund deposits and partially offset by a decrease of $4.7 million from out-of-market certificates of deposit. Public funds have seasonal fluctuations due to semiannual tax collection and subsequent disbursement to entities. Interest rates on deposits decreased to the average rate paid of 0.52% on interest-bearing deposits for the nine month period ended March 31, 2014, compared to 0.66% for the same period of the prior year.

On April 28, 2014, the Company announced it will pay a quarterly cash dividend of 11.25 cents per common share for the third quarter of fiscal 2014. The dividend will be paid on May 16, 2014, to stockholders of record on May 9, 2014.

The total risk-based capital ratio of 15.27% at March 31, 2014, decreased by 56 basis points from 15.83% at June 30, 2013. Tier I capital decreased 5 basis points to 9.51% at March 31, 2014 when compared to 9.56% at June 30, 2013. These decreases stem from management's successful efforts to generate loan growth, which require a higher risk-weighting than do investment securities or cash. These ratios continue to place the Company in the “well-capitalized” category within financial institution regulations at March 31, 2014 and are consistent with the “well-capitalized” regulatory category in which the Company plans to operate. The Company historically has been able to manage the size of its assets through secondary market loan sales of single-family mortgages.

Noninterest income was $11.8 million for the nine months ended March 31, 2014, compared to $10.8 million for the same period in the prior fiscal year, an increase of $961,000. This increase was due to net loan servicing income and commission and insurance income increases of $2.2 million and $539,000, respectively, and partially offset by decreases in the net gain on sale of loans and fees on deposits of $1.8 million and $194,000, respectively. Loan servicing income increased primarily from the recapture of previously expensed valuation allowances on the mortgage servicing rights portfolio, and reduced amortization expenses which were affected by reduced prepayment speeds in the current fiscal year. Commission and insurance income increased due primarily to an increased book of business within the investment services line of business, which was acquired in the fourth quarter of fiscal 2013 and has since expanded. The decrease in net gain on the sale of loans reflects reduced refinancing activities on residential lending in the current fiscal year due to rising rates since the prior fiscal year. We expect that maintaining this level of fee income will be more dependent on customer purchase activity for new loan originations and less dependent on refinance transactions, as many borrowers have already taken advantage of historically low market interest rates. Fees on deposits decreased for the first nine months of fiscal 2014 when compared to the same period of the prior year due to reduced vendor incentive fees and partially offset by an increase in point-of-sale interchange fees from

increased volume of activity. In addition, net service charge fees increased by $92,000, while NSF/overdraft fees decreased by $69,000 when comparing the nine months ended March 31, 2014 to the same period of the prior fiscal year.

Noninterest expense was $27.0 million for the nine months ended March 31, 2014, as compared to $25.8 million for the same period of the prior fiscal year, an increase of $1.2 million, or 4.6%. The increase was attributed primarily to an increase in compensation and employee benefits of $1.1 million. Compensation costs increased primarily due to variable and incentive pay increases of $245,000 and decreased compensation deferrals related to loan costs under ASC 310-20 of $541,000, which increases net expense. Base compensation increased by approximately $176,000 related to staffing additions directed toward revenue-based functions and costs incurred for severance pay of executive and closed branch staff. Pension plan expenses, which are determined annually based upon actuarial analysis, increased by $152,000 for the nine month period ended March 31, 2014, as compared to the same period of the prior year. Partially offsetting compensation expense increases were the reduced health claims costs of $42,000 in the year-over-year comparison. Marketing and community investments increased by $157,000 for the nine month period ended March 31, 2014 as compared to the prior fiscal year, due to an increase in expenses related to customer rewards in the current fiscal year compared to reward expirations and expense adjustments due to program modifications in the prior fiscal year.

General

The Company is a financial services provider and, as such, has inherent risks that must be managed in order to achieve net income. Primary risks that affect net income include credit risk, liquidity risk, operational risk, regulatory compliance risk and reputation risk. The Company's net income is derived by management of the net interest margin, the ability to collect fees from services provided, by controlling the costs of delivering services and the management of loan and lease losses. The primary source of revenues is the net interest margin, which represents the difference between income on interest-earning assets (i.e. loans and investment securities) and expense on interest-bearing liabilities (i.e. deposits and borrowed funding). The net interest margin is affected by regulatory, economic and competitive factors that influence interest rates, loan demand and deposit flows. Fees earned include charges for deposit and debit card services, trust services and loan services. Personnel costs are the primary expenses required to deliver the services to customers. Other costs include occupancy and equipment and general and administrative expenses.

Financial Condition Data

At March 31, 2014, the Company had total assets of $1.26 billion, an increase of $40.7 million from the amount at June 30, 2013. Total loans and leases receivable increased $59.0 million, while total investment securities decreased $16.5 million. Total liabilities increased $38.5 million primarily due to an increase in deposits of $53.6 million and partially offset by a decrease in advances from FHLB and other borrowings of $19.7 million. Stockholders' equity increased $2.2 million since June 30, 2013, primarily due to an increase in retained earnings of $2.7 million.

The increase in loans and leases receivable, net, which excludes loans in process and deferred fees, was $59.4 million due to the increase in loan balances. Commercial real estate and agricultural loans increased $72.2 million and $6.8 million, respectively. The investment securities available for sale decreased $35.7 million primarily due to the sale of securities and principal cash flow during the first nine months of fiscal 2014. Total proceeds on the sale of securities available for sale during the current fiscal year were $61.7 million for a net gain on sale of $591,000. During the first nine months of fiscal 2014, the Company purchased investment securities classified as held to maturity and carried an amortized cost of $19.2 million at March 31, 2014, compared to no securities classified as held to maturity at June 30, 2013.

Loans held for sale decreased $6.0 million, to $3.2 million at March 31, 2014, primarily due to residential mortgage loan originations being tempered by the recent rise in long term interest rates which has begun to slow refinancing activity. The timing of mortgage financing activity sold to secondary market investors also impacts the remaining amount of loans held for sale which are recorded at the balance sheet date.

See the Consolidated Statement of Cash Flows for a detailed analysis of the change in cash and cash equivalents.

Deposits increased $53.6 million, to $952.4 million at March 31, 2014, due to an $11.7 million increase from in-market, non-public fund customer deposits, $46.5 million increase in public fund deposits and partially offset by a decrease of $4.7 million in out-of-market certificates of deposit. Advances from the FHLB and other borrowings decreased $19.7 million, to $147.4 million at March 31, 2014 as compared to June 30, 2013, due to reduced funding needs.

Stockholders' equity increased $2.2 million at March 31, 2014 when compared to June 30, 2013. Retained earnings increased by $2.7 million due to net income of $5.1 million and offset by the payment of cash dividends of $2.4 million. Stockholders' equity was also reduced by the net increase of $589,000 in accumulated other comprehensive loss, net of related deferred tax effect, which totaled $4.9 million at March 31, 2014.

Analysis of Net Interest Income

Net interest income represents the difference between income on interest-earning assets and expense on interest-bearing liabilities. Net interest income depends upon the volume of interest-earning assets and interest-bearing liabilities and the interest rates earned or paid on them.

Average Balances, Interest Rates and Yields. The following tables present for the periods indicated, the total dollar amount of interest income from average interest-earning assets and the resulting yields, as well as the interest expense on average interest-bearing liabilities, expressed both in dollars and rates, and the net interest margin. The tables do not reflect any effect of income taxes. Average balances consist of daily average balances for the Bank with simple average balances for all other subsidiaries of the Company. The average balances include nonaccruing loans and leases. The yields on loans and leases include origination fees, net of costs, which are considered adjustments to yield.



	Three Months Ended March 31,
	2014						2013
	Average Outstanding Balance		Interest Earned/ Paid		Yield/ Rate		Average Outstanding Balance		Interest Earned/ Paid		Yield/ Rate
	(Dollars in Thousands)
Interest-earning assets:
Loans and leases receivable⁽¹⁾⁽³⁾	$	739,044	$	8,781	4.82	%	$	687,223	$	8,082	4.77	%
Investment securities⁽²⁾⁽³⁾	421,329		1,670		1.61		415,936		1,508		1.47
Correspondent bank stock	6,644		46		2.81		7,417		53		2.90
Total interest-earning assets	1,167,017		$	10,497	3.65	%	1,110,576		$	9,643	3.52	%
Noninterest-earning assets	74,254						79,912
Total assets	$	1,241,271					$	1,190,488
Interest-bearing liabilities:
Deposits:
Checking and money market	$	378,006	$	234	0.25	%	$	380,004	$	241	0.26	%
Savings	166,425		103		0.25		118,408		70		0.24
Certificates of deposit	251,795		623		1.00		268,814		800		1.21
Total interest-bearing deposits	796,226		960		0.49		767,226		1,111		0.59
FHLB advances and other borrowings	128,575		907		2.86		132,781		1,029		3.14
Subordinated debentures payable to trusts	24,837		305		4.98		27,837		403		5.87
Total interest-bearing liabilities	$	949,638	$	2,172	0.93	%	$	927,844	$	2,543	1.11	%
Noninterest-bearing deposits	158,368						130,687
Other liabilities	34,549						32,987
Total liabilities	1,142,555						1,091,518
Equity	98,716						98,970
Total liabilities and equity	$	1,241,271					$	1,190,488
Net interest income; interest rate spread⁽⁴⁾			$	8,325	2.72	%			$	7,100	2.41	%
Net interest margin⁽⁴⁾⁽⁵⁾					2.89	%					2.59	%
Net interest margin, TE⁽⁶⁾					2.95	%					2.64	%

_____________________________________


⁽¹⁾	Includes loan fees and interest on accruing loans and leases past due 90 days or more.


⁽²⁾	Includes federal funds sold and interest earning reserve balances at the Federal Reserve Bank.


⁽³⁾	Yields do not reflect the tax-exempt nature of loans, equipment leases and municipal securities.


⁽⁴⁾	Percentages for the three months ended March 31, 2014 and 2013 have been annualized.


⁽⁵⁾	Net interest income divided by average interest-earning assets.

⁽⁶⁾

Net interest margin expressed on a fully taxable equivalent basis ("Net Interest Margin, TE") is a non-GAAP financial measure. See the following Non-GAAP Disclosure Reconciliation of Net Interest Income (GAAP) to Net Interest Margin, TE (Non-GAAP). The tax-equivalent adjustment to net interest income recognizes the income tax savings when comparing taxable and tax-exempt assets and adjusting for federal and state exemption of interest income and certain other permanent income tax differences. We believe that it is a standard practice in the banking industry to present net interest margin expressed on a fully taxable equivalent basis, and accordingly believe the presentation of this non-GAAP financial measure may be useful for peer comparison purposes. As a non-GAAP financial measure, Net Interest Margin, TE should be considered supplemental to and not a substitute for or superior to, financial measures calculated in accordance with GAAP. As other companies may use different calculations for Net Interest Margin, TE, this presentation may not be comparable to similarly titled measures reported by other companies.



	Nine Months Ended March 31,
	2014						2013
	Average Outstanding Balance		Interest Earned/ Paid		Yield/ Rate		Average Outstanding Balance		Interest Earned/ Paid		Yield/ Rate
	(Dollars in Thousands)
Interest-earning assets:
Loans and leases receivable(1)(3)	$	742,320	$	25,740	4.62	%	$	696,667	$	25,892	4.95	%
Investment securities(2)(3)	419,338		3,925		1.25		386,484		3,668		1.26
Correspondent bank stock	7,882		174		2.94		7,627		158		2.76
Total interest-earning assets	1,169,540		$	29,839	3.40	%	1,090,778		$	29,718	3.63	%
Noninterest-earning assets	73,184						81,219
Total assets	$	1,242,724					$	1,171,997
Interest-bearing liabilities:
Deposits:
Checking and money market	$	362,809	$	708	0.26	%	$	357,910	$	889	0.33	%
Savings	143,448		255		0.24		113,678		215		0.25
Certificates of deposit	264,470		2,033		1.02		273,610		2,612		1.27
Total interest-bearing deposits	770,727		2,996		0.52		745,198		3,716		0.66
FHLB advances and other borrowings	157,187		2,944		2.49		137,177		3,128		3.04
Subordinated debentures payable to trusts	24,837		1,011		5.42		27,837		1,256		6.01
Total interest-bearing liabilities	$	952,751	$	6,951	0.97	%	$	910,212	$	8,100	1.19	%
Noninterest-bearing deposits	162,141						131,603
Other liabilities	30,642						31,677
Total liabilities	1,145,534						1,073,492
Equity	97,190						98,505
Total liabilities and equity	$	1,242,724					$	1,171,997
Net interest income; interest rate spread(4)			$	22,888	2.43	%			$	21,618	2.44	%
Net interest margin(4)(5)					2.61	%					2.64	%
Net interest margin, TE(6)					2.66	%					2.68	%

_____________________________________


⁽¹⁾	Includes loan fees and interest on accruing loans and leases past due 90 days or more.


⁽²⁾	Includes federal funds sold and interest earning reserve balances at the Federal Reserve Bank.


⁽³⁾	Yields do not reflect the tax-exempt nature of loans, equipment leases and municipal securities.


⁽⁴⁾	Percentages for the nine months ended March 31, 2014 and 2013 have been annualized.


⁽⁵⁾	Net interest income divided by average interest-earning assets.

⁽⁶⁾

The reconciliation of the Net Interest Income (GAAP) to Net Interest Margin, TE (non-GAAP) is as follows:



	Three Months Ended March 31,						Nine Months Ended March 31,
	2014			2013			2014			2013
	(Dollars in Thousands)
Net interest income	$	8,325		$	7,100		$	22,888		$	21,618
Taxable equivalent adjustment	176			118			486			312
Adjusted net interest income	8,501			7,218			23,374			21,930
Average interest-earning assets	1,167,017			1,110,576			1,169,540			1,090,778
Net interest margin, TE	2.95		%	2.64		%	2.66		%	2.68		%

Rate/Volume Analysis of Net Interest Income

The following schedule presents the dollar amount of changes in interest income and interest expense for major components of interest-earning assets and interest-bearing liabilities. It distinguishes between increases and decreases resulting from fluctuating outstanding balances that are due to the levels and volatility of 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 previous rate) and (ii) changes in rate (i.e., changes in rate multiplied by previous volume). 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.



	Three Months Ended March 31,									Nine Months Ended March 31,
	2014 vs 2013									2014 vs 2013
	Increase (Decrease) Due to Volume			Increase (Decrease) Due to Rate			Total Increase (Decrease)			Increase (Decrease) Due to Volume			Increase (Decrease) Due to Rate			Total Increase (Decrease)
	(Dollars in Thousands)
Interest-earning assets:
Loans and leases receivable⁽¹⁾	$	608		$	91		$	699		$	1,692		$	(1,844	)	$	(152	)
Investment securities⁽²⁾	20			142			162			290			(33		)	257
Correspondent bank stock	(6		)	(1		)	(7		)	5			11			16
Total interest-earning assets	$	622		$	232		$	854		$	1,987		$	(1,866	)	$	121
Interest-bearing liabilities:
Deposits:
Checking and money market	$	(1	)	$	(6	)	$	(7	)	$	12		$	(193	)	$	(181	)
Savings	29			4			33			52			(12		)	40
Certificates of deposit	(50		)	(127		)	(177		)	(86		)	(493		)	(579		)
Total interest-bearing deposits	(22		)	(129		)	(151		)	(22		)	(698		)	(720		)
FHLB advances and other borrowings	(33		)	(89		)	(122		)	460			(644		)	(184		)
Subordinated debentures payable to trusts	(43		)	(55		)	(98		)	(135		)	(110		)	(245		)
Total interest-bearing liabilities	$	(98	)	$	(273	)	$	(371	)	$	303		$	(1,452	)	$	(1,149	)

Net interest income decrease	$	720		$	505		$	1,225		$	1,684		$	(414	)	$	1,270

_____________________________________


⁽¹⁾	Includes loan fees and interest on accruing loans and leases past due 90 days or more.


⁽²⁾	Includes federal funds sold and interest earning reserve balances at the Federal Reserve Bank.

Application of Critical Accounting Policies

GAAP requires management to utilize estimates when reporting financial results. The Company has identified the policies discussed below as Critical Accounting Policies because the accounting estimates require management to make certain assumptions about matters that may be uncertain at the time the estimate was made and a different method of estimating could have been reasonably made that could have a material impact on the presentation of the Company's financial condition, changes in financial condition or results of operations.

Investment Securities. Management determines the appropriate classification of securities at the date individual securities are acquired and evaluates the appropriateness of such classifications at each statement of financial condition date.

Investment securities classified as held to maturity are those debt securities that management has the positive intent and ability to hold to maturity, and are reported at amortized cost, adjusted for amortization of premiums and accretion of discounts, using a method that approximates level yield. Investment securities classified as available for sale are those debt securities that the Company intends to hold for an indefinite period of time, but may not hold necessarily to maturity, and all equity securities. Any decision to sell a security classified as available for sale would be based on various factors, including significant movements in interest rates, changes in the maturity mix of the Company's assets and liabilities, liquidity needs, regulatory capital considerations, and other similar factors. Investment securities available for sale are carried at fair value and unrealized gains or losses are reported as increases or decreases in other comprehensive income net of the related deferred tax effect. Sales of securities available for sale are recorded on a trade date basis.

Premiums and discounts on securities are amortized over the contractual lives of those securities, except for agency residential mortgage-backed securities, for which prepayments are probable and predictable, which are amortized over the estimated expected repayment terms of the underlying mortgages. The method of amortization results in a constant effective yield on those securities (the interest method). Interest on debt securities is recognized in income as accrued. Realized gains and losses on the sale of securities are determined using the specific identification method.

Loans and Leases Receivable. Loans receivable are stated at unpaid principal balances and net of deferred loan origination fees, costs and discounts.

The Company's leases receivable are classified as direct finance leases. Under the direct financing method of accounting for leases, the total net payments receivable under the lease contracts and the residual value of the leased equipment, net of unearned income, are recorded as a net investment in direct financing leases and the unearned income is recognized each month on a basis which approximates the interest method.

In accordance with ASC 310, the loan portfolio was disaggregated into segments and then further disaggregated into classes for certain disclosures. A portfolio segment is defined as the level at which an entity develops and documents a systematic method for determining its allowance for credit losses. A class is generally determined based on the initial measurement attribute, risk characteristics of the loan, and an entity's method for monitoring and assessing credit risk. Residential and Consumer loan portfolio segments include classes of one-to four-family, construction, consumer direct, consumer home equity, consumer overdraft and reserves, and consumer indirect. Commercial, Commercial Real Estate and Agriculture loan portfolio segments include the classes of commercial business, equipment finance leases, commercial real estate, multi-family real estate, construction, agricultural business, and agricultural real estate.

Interest on loans is recognized on an accrual basis at the applicable interest rate on the principal amount outstanding. Loan origination fees and direct costs as well as premiums and discounts are amortized as level yield adjustments over the respective loan terms. Unamortized net fees or costs are recognized upon early repayment of the loans. Loan commitment fees are generally deferred and amortized on a straight-line basis over the commitment period.

Impaired loans are generally carried on a nonaccrual status when there are reasonable doubts as to the collectability of principal and/or interest and/or when payment becomes 90 days past due, except loans which are well secured and in the process of collection. For all portfolio segments and classes accrued but uncollected, interest is reversed and charged against interest income when the loan is placed on nonaccrual status. Management may elect to continue the accrual of interest when the estimated net realizable value of collateral is sufficient to recover the principal balance and accrued interest. Interest payments received on nonaccrual and impaired loans are normally applied to principal. Once all principal has been received, additional interest payments are recognized on a cash basis as interest income.

A loan is considered impaired when, based on current information and events, it is probable that the Company will be unable to collect the scheduled payments of principal or interest when due according to the contractual terms of the loan agreement. Factors considered by management in determining impairment include payment status, collateral value, and the probability of collecting scheduled principal and interest payments when due. Loans that experience insignificant payment delays and insignificant payment shortfalls generally are not classified as impaired. Management determines the significance of payment delays and payment shortfalls on a case-by-case basis, taking into consideration all of the circumstances surrounding the loan and the borrower, including the length of the delay, the reasons for the delay, the borrower's prior payment record, and the amount of the shortfall in relation to the principal and interest owed. Impairment is measured on a loan by loan basis for commercial, commercial real estate and agricultural loans by either the present value of expected future cash flows discounted at the loan's effective interest rate or the fair value of the collateral if the loan is collateral dependent.

As part of the Company's ongoing risk management practices, management attempts to work with borrowers when necessary to extend or modify loan terms to better align with their current ability to repay. Extensions and modifications to

loans are made in accordance with internal policies and guidelines which conform to regulatory guidance. Each occurrence is unique to the borrower and is evaluated separately. In a situation where an economic concession has been granted to a borrower that is experiencing financial difficulty, the Company identifies and reports that loan as a troubled debt restructuring ("TDR"). Management considers regulatory guidelines when restructuring loans to ensure that prudent lending practices are followed. As such, qualification criteria and payment terms consider the borrower's current and prospective ability to comply with the modified terms of the loan. Additionally, the Company structures loan modifications with the intent of strengthening repayment prospects.

The Company considers whether a borrower is experiencing financial difficulties, as well as whether a concession has been granted to a borrower determined to be troubled, when determining whether a modification meets the criteria of being a TDR under ASC 310-40. For such purposes, evidence which may indicate that a borrower is troubled includes, among other factors, the borrower's default on debt, the borrower's declaration of bankruptcy or preparation for the declaration of bankruptcy, the borrower's forecast that entity-specific cash flows will be insufficient to service the related debt, or the borrower's inability to obtain funds from sources other than existing creditors at an effective interest rate equal to the current market interest rate for similar debt for a non-troubled debtor. If a borrower is determined to be troubled based on such factors or similar evidence, a concession will be deemed to have been granted if a modification of the terms of the debt occurred that management would not otherwise consider. Such concessions may include, among other modifications, a reduction of the stated interest for the remaining original life of the debt, an extension of the maturity date at a stated interest rate lower than the current market rate for new debt with similar risk, a reduction of accrued interest, or a reduction of the face amount or maturity amount of the debt.

A modification of loan terms that management would generally not consider to be a TDR could be a temporary extension of maturity to allow a borrower to complete an asset sale whereby the proceeds of such transaction are to be paid to satisfy the outstanding debt. Additionally, a modification that extends the term of a loan, but does not involve reduction of principal or accrued interest, in which the interest rate is adjusted to reflect current market rates for similarly situated borrowers is not considered a TDR. Nevertheless, each assessment will take into account any modified terms and will be comprehensive to ensure appropriate impairment assessment.

Loans that are reported as TDRs apply the identical criteria in the determination of whether the loan should be accruing or nonaccruing. Typically, the event of classifying the loan as a TDR due to a modification of terms is independent from the determination of accruing interest on a loan in accordance with accounting standards.

For all non-homogeneous loans (including TDRs) that have been placed on nonaccrual status, the Company's policy for returning nonaccruing loans to accrual status requires the following criteria: six months of continued performance, timely payments, positive cash flow and an acceptable loan to value ratio. For homogeneous loans (including TDRs), typical in the residential and consumer portfolio, the policy requires six months of consecutive timely loan payments for returning nonaccrual loans to accruing status.

Allowance for Loan and Lease Losses. GAAP requires the Company to maintain an allowance for probable loan and lease losses in the loan and lease portfolio. Management must develop a consistent and systematic approach to estimate the appropriate balances that will cover the probable losses.

The allowance for loan and lease losses is maintained at a level that management determines is sufficient to absorb estimated probable incurred losses in the loan portfolio through a provision for loan losses charged to net income. Loan losses are charged against the allowance when management believes the uncollectibility of a loan balance is confirmed. Management charges off loans, or portions of loans, in the period that such loans, or portions thereof, are deemed uncollectible. The collectability of individual impaired loans is determined through an estimate of the fair value of the underlying collateral and/or an assessment of the financial condition and repayment capacity of the borrower. The allowances for loan and lease losses are comprised of both specific valuation allowances and general valuation allowances that are determined in accordance with authoritative accounting guidance. Additions are made to the allowance through periodic provisions charged to current operations and recovery of principal on loans previously charged off.

The allowance for loan and lease losses is evaluated on a regular basis by management and is based upon management's periodic review of the collectability of the loans in light of historical experience, the nature and volume of the loan portfolio, adverse situations that may affect the borrower's ability to repay, estimated value of any underlying collateral and prevailing economic conditions. This evaluation is inherently subjective as it requires estimates that are susceptible to significant revision as more information becomes available.

Specific valuation allowances are established based on the Company's analyses of individual loans that are considered impaired. If a loan is deemed to be impaired, management measures the extent of the impairment and establishes a specific valuation allowance for that amount. The Company applies this classification to loans individually evaluated for impairment in

the loan portfolio segments of commercial, commercial real estate and agricultural loans. Smaller balance homogeneous loans are evaluated for impairment on a collective rather than an individual basis. The Company measures impairment on an individual loan and the extent to which a specific valuation allowance is necessary by comparing the loan's outstanding balance to the fair value of the collateral, less the estimated cost to sell, if the loan is collateral dependent, or to the present value of expected cash flows, discounted at the loan's effective interest rate. A specific valuation allowance is established when the fair value of the collateral, net of estimated costs, or the present value of the expected cash flows is less than the recorded investment in the loan.

The Company also follows a process to assign general valuation allowances to loan portfolio segment categories. General valuation allowances are established by applying the Company's loan loss provisioning methodology, and reflect the estimated probable incurred losses in loans outstanding. The loan loss provisioning methodology considers various factors in determining the appropriate quantified risk factors to use in order to determine the general valuation allowances. The factors assessed begin with the historical loan loss experience for each of the loan portfolio segments. The Company's historical loan loss experience is then adjusted by considering qualitative or environmental factors that are likely to cause estimated credit losses associated with the existing portfolio to differ from historical loss experience, including, but not limited to, the following:


•	Changes in lending policies and procedures, including changes in underwriting standards and collection, charge-off, and recovery practices;


•	Changes in international, national, regional, and local economic and business conditions and developments that affect the collectability of the portfolio, including the condition of various market segments;


•	Changes in the nature and volume of the portfolio and in the terms of loans;


•	Changes in the volume and severity of past due loans, the volume of nonaccrual loans, and the volume and severity of adversely classified or graded loans;


•	Changes in the quality of the Company's loan review system;


•	Changes in the value of the underlying collateral for collateral-dependent loans;


•	The existence and effect of any concentrations of credit, and changes in the level of such concentrations;


•	Changes in the experience, ability, and depth of lending management and other relevant staff; and


•	The effect of other external factors, such as competition and legal and regulatory requirements, on the level of estimated credit losses in the existing portfolio.

By considering the factors discussed above, the Company determines quantified risk factors that are applied to each non-impaired loan or loan type in the loan portfolio to determine the general valuation allowances.

The time periods considered for historical loss experience are the last five years, the last three years and the last 12 months. The Company also evaluates the sufficiency of the overall allocations used for the loan loss allowances by considering the loss experience in the most recent 12 month period.

The process of establishing the loan and lease loss allowances may also involve:


•	Periodic inspections of the loan collateral;


•	Regular meetings of executive management with the pertinent Board committee, during which observable trends in the local economy, commodity prices and/or the real estate market are discussed; and


•	Analysis of the portfolio in the aggregate, as well as on an individual loan basis, taking into consideration payment history, underwriting analyses, and internal risk ratings.

In order to determine the overall adequacy, each loan portfolio segment's respective loan loss allowance is reviewed quarterly by management and by the Audit Committee of the Company's Board of Directors, as applicable.

Future adjustments to the allowance for loan and lease losses and methodology may be necessary if economic or other conditions differ substantially from the assumptions used in making the estimates or, if required by regulators, based upon information at the time of their examinations. Such adjustments to estimates are made in the period in which these factors and other relevant considerations indicate that loss levels vary from previous estimates.

Although management believes that it uses the best information available to determine the allowance, unforeseen market or borrower conditions could result in adjustments and net income being significantly affected if circumstances differ substantially from the assumptions used in making the final determinations.

Mortgage Servicing Rights ("MSR"). The Company records a servicing asset for contractually separated servicing from the underlying mortgage loans. The asset is initially recorded at fair value and represents an intangible asset backed by an income stream from the serviced assets. The asset is amortized in proportion to and over the period of estimated net servicing income.

At each balance sheet date, the MSRs are analyzed for impairment, which occurs when the fair value of the MSRs is lower than the amortized book value. The majority of the Company's MSRs in the portfolio were acquired from the South Dakota Housing Development Authority's first-time homebuyer's program. Due to the lack of quoted markets for the Company's servicing portfolio, the Company estimates the fair value of the MSRs using a present value of future cash flow analysis. If the fair value is greater than or equal to the amortized book value of the MSRs, no impairment is recognized. If the fair value is less than the book value, an adjustment is made to a MSR valuation allowance to record the estimated impairment. If the Company determines this impairment is temporary, any future changes in impairment are recorded as a change in net income and the valuation account. If the Company determines the impairment to be permanent, the valuation is written off against the MSRs, which results in a new amortized balance.

The Company has included MSRs as a critical accounting policy because the use of estimates for determining fair value using present value concepts may produce results which may significantly differ from other fair value analysis, perhaps even to the point of recording impairment. The risk to net income is when the underlying mortgages are paid off significantly faster than the assumptions used in the previously recorded amortization. Estimating future cash flows on the underlying mortgages is a difficult analysis and requires judgment based on the best information available. The Company looks at alternative assumptions and projections when preparing a reasonable and supportable analysis.

Security Impairment. Management has a process in place to identify securities that could potentially have a credit impairment that is other-than-temporary. This process involves the length of time and extent to which the fair value has been less than the amortized cost basis, review of available information regarding the financial position of the issuer, monitoring the rating of the security, cash flow projections, and the Company's intent to sell a security or whether it is more likely than not the Company will be required to sell the security before the recovery of its amortized cost which, in some cases, may extend to maturity. To the extent we determine that a security is deemed to be other-than-temporarily impaired, an impairment loss is recognized. If the Company intends to sell a security or it is more likely than not that the Company would be required to sell a security before the recovery of its amortized cost, less any current period credit loss, the Company recognizes an other-than-temporary impairment in net income for the difference between amortized cost and fair value. If we do not expect to recover the amortized cost basis, we do not plan to sell the security and if it is not more likely than not that the Company would be required to sell a security before the recovery of its amortized cost, less any current period credit loss, the recognition of the other-than-temporary impairment is bifurcated. For those securities, the Company separates the total impairment into a credit loss component recognized in net income, and the amount of the loss related to other factors is recognized in other comprehensive income net of taxes.

The amount of the credit loss component of a debt security impairment is estimated as the difference between amortized cost and the present value of the expected cash flows of the security. The present value is determined using the best estimate cash flows discounted at the effective interest rate implicit to the security at the date of purchase or the current yield to accrete an asset-backed or floating rate security. At March 31, 2014, the Company does not have other-than-temporarily impaired debt securities for which credit losses exist.

Level 3 Fair Value Measurement. GAAP requires the Company to measure the fair value of financial instruments under a standard which describes three levels of inputs that may be used to measure fair value. Level 3 measurement includes significant unobservable inputs that reflect the Company's own assumptions about the assumptions that market participants would use in pricing an asset or liability. Level 3 assets and liabilities include financial instruments whose value is determined using pricing models, discounted cash flow methodologies, or similar techniques, as well as instruments for which the determination of fair value requires significant management judgment or estimation. This valuation process may take into consideration factors such as market liquidity. Imprecision in estimating these factors can impact the amount recorded on the balance sheet for a particular asset or liability with related impacts to earnings or other comprehensive income (loss).

Although management believes that it uses a best estimate of information available to determine fair value, due to the uncertainty of future events, the approach includes a process that may differ significantly from other methodologies and still produce an estimate that is in accordance with GAAP.

Self-Insurance. The Company has a self-insured healthcare plan and a self-insured dental plan for its employees up to certain limits. To mitigate a portion of the risks involved with a self-insurance health plan, the Company has a stop-loss insurance policy through a commercial insurance carrier for coverage in excess of $75,000 per individual occurrence. The estimate of self-insurance liability for each plan is based upon known claims and an estimate of incurred, but not reported ("IBNR") claims. IBNR claims are estimated using historical claims lag information received by a third party claims administrator. Due to the uncertainty of claims, the approach includes a process that may differ significantly from other methodologies and still produce an estimate that is in accordance with GAAP. Although management believes that it uses the best information available to determine the accrual, unforeseen claims could result in adjustments to the accrual. These adjustments could significantly affect net income if circumstances differ substantially from the assumptions used in estimating the accrual.

Asset Quality

When a borrower fails to make a required payment on a loan within 10 to 15 days after the payment is due, the Bank generally institutes collection procedures by issuing a late notice. The customer is contacted again when the payment is between 17 and 40 days past due. In most cases, delinquencies are cured promptly; however, if a loan has been delinquent for more than 40 days, the Bank attempts additional written as well as verbal contacts and, if necessary, personal contact with the borrower in order to determine the reason for the delinquency and to affect a cure. Where appropriate, Bank personnel review the condition of the property and the financial circumstances of the borrower. Based upon the results of any such investigation, the Bank may: (i) accept a repayment program which under appropriate circumstances could involve an extension in the case of consumer loans for the arrearage from the borrower, (ii) seek evidence, in the form of a listing contract, of efforts by the borrower to sell the property if the borrower has stated that he is attempting to sell, or (iii) initiate foreclosure proceedings. When a loan payment is delinquent for 90 days, the Bank generally will initiate foreclosure proceedings unless management is satisfied the credit problem is correctable.

Loans are generally classified as nonaccrual when there are reasonable doubts as to the collectability of principal and/or interest and/or when payment becomes 90 days past due, except loans which are well secured and in the process of collection. Interest collections on nonaccrual loans, for which the ultimate collectability of principal is uncertain, are applied as principal reductions.

Leases are generally classified as nonaccrual when there are reasonable doubts as to the collectability of principal and/or interest. Leases may be placed on nonaccrual when the lease has experienced either four consecutive months with no payments or once the account is five months in arrears. Interest collections on nonaccrual leases, for which the ultimate collectability of principal is uncertain, are applied as principal reductions.

When a lessee fails to make a required lease payment within 10 days after the payment is due, Mid America Capital generally institutes collection procedures. The lessee may be contacted by telephone on the 10th, but no later than the 30th day of delinquency. A late notice is automatically issued by the system on the 11th day of delinquency and is sent to the lessee. The lease may be referred to legal counsel when the lease is past due beyond four payments and no positive response has been received or when other considerations are present.

Nonperforming assets (i.e., nonaccrual loans and leases, accruing loans and leases delinquent more than 90 days and foreclosed assets) decreased $4.4 million during the fiscal year to $18.8 million at March 31, 2014. The ratio of nonperforming assets to total assets, which is one indicator of credit risk exposure, decreased to 1.50% at March 31, 2014, from 1.90% at June 30, 2013.

Nonaccruing loans and leases decreased to $18.6 million at March 31, 2014 compared to $22.6 million at June 30, 2013. Included in nonaccruing loans and leases at March 31, 2014 were one consumer residential relationships totaling $125,000, eight commercial business relationships totaling $3.9 million, seven commercial real estate relationships totaling $1.2 million, eight agricultural real estate relationships totaling $8.2 million, three agricultural business relationships totaling $4.1 million, and 17 consumer relationships totaling $1.0 million.

There were no accruing loans and leases delinquent more than 90 days at March 31, 2014 and at June 30, 2013.

The Company's nonperforming loans and leases, which represent nonaccrual loans and leases plus those past due over 90 days and still accruing were $18.6 million, a decrease of $4.1 million from the levels at June 30, 2013. Slightly less than two-thirds of the nonperforming loans at March 31, 2014 were comprised of dairy operations, which is similar to the percentage at June 30, 2013. The risk rating system in place is designed to identify and manage the nonperforming loans and leases. Commercial and agricultural loans and equipment finance leases will have specific reserve allocations based on collateral values or based on the present value of expected cash flows if the loans or leases are deemed impaired. Loans and leases that are not performing do not necessarily result in a loss.

As of March 31, 2014, the Company had $266,000 of foreclosed assets. The balance of foreclosed assets consisted of $217,000 in single-family residences, $46,000 in consumer home equity collateral, and $3,000 in consumer vehicle collateral.

At March 31, 2014, the Company had designated $32.1 million of its assets as classified, which management has determined need to be closely monitored because of possible credit problems of the borrowers or the cash flows of the secured properties. This amount includes $203,000 of unused lines of credit for those borrowers that have classified assets. At March 31, 2014, the Company had $3.4 million in commercial real estate and commercial business loans purchased, of which none of the amounts were currently classified. These loans and leases were considered in determining the adequacy of the allowance for loan and lease losses. The allowance for loan and lease losses is established based on management's evaluation of the risks probable in the loan and lease portfolio and changes in the nature and volume of loan and lease activity. Such evaluation, which includes a review of all loans and leases for which full collectability may not be reasonably assured, considers the estimated fair market value of the underlying collateral, present value of expected principal and interest payments, economic conditions, historical loss experience and other factors that warrant recognition in providing for an adequate loan and lease loss allowance.

Although the Company's management believes that the March 31, 2014, recorded allowance for loan and lease losses was adequate to provide for probable losses on the related loans and leases, there can be no assurance that the allowance existing at March 31, 2014 will be adequate in the future.

In accordance with the Company's internal classification of assets policy, management evaluates the loan and lease portfolio on a monthly basis to identify loss potential and determines the adequacy of the allowance for loan and lease losses quarterly. Loans are placed on nonaccrual status when the collection of principal and/or interest becomes doubtful. Foreclosed assets include assets acquired in settlement of loans.

The following table sets forth the amounts and categories of the Company's nonperforming assets from continuing operations for the periods indicated.



	March 31, 2014			June 30, 2013
	(Dollars in Thousands)
Nonaccruing loans and leases:
One- to four-family	$	125		$	236
Commercial business	3,932			4,365
Equipment finance leases	—			35
Commercial real estate	1,214			1,180
Multi-family real estate	27			27
Agricultural real estate	8,172			11,634
Agricultural business	4,063			4,113
Consumer direct	21			15
Consumer home equity	999			1,018
Total nonaccruing loans and leases	18,553			22,623
Accruing loans and leases delinquent more than 90 days:
Total accruing loans and leases delinquent more than 90 days	—			—
Foreclosed assets:
One- to four-family	217			557
Consumer direct	3			7
Consumer home equity	46			—
Total foreclosed assets⁽¹⁾	266			564
Total nonperforming assets⁽²⁾	$	18,819		$	23,187
Ratio of nonperforming assets to total assets⁽³⁾	1.50		%	1.90		%
Ratio of nonperforming loans and leases to total loans and leases⁽⁴⁾	2.46		%	3.25		%
Accruing troubled debt restructures	$	1,384		$	1,792

_____________________________________


⁽¹⁾	Total foreclosed assets do not include land or other real estate owned held for sale.


⁽²⁾	Nonperforming assets include nonaccruing loans and leases, accruing loans and leases delinquent more than 90 days and foreclosed assets.


⁽³⁾	Percentage is calculated based upon total consolidated assets of the Company.


⁽⁴⁾	Nonperforming loans and leases include nonaccruing loans and leases and accruing loans and leases delinquent more than 90 days.

The following table sets forth information with respect to activity in the Company's allowance for loan and lease losses from continuing operations during the periods indicated.



	Nine Months Ended March 31,
	2014			2013
	(Dollars in Thousands)
Balance at beginning of period	$	10,743		$	10,566
Charge-offs:
One- to four-family	(7		)	(1		)
Commercial business	(103		)	(14		)
Equipment finance leases	(22		)	(20		)
Commercial real estate	(41		)	—
Construction	—			(7		)
Agricultural real estate	—			(21		)
Agricultural business	(491		)	(374		)
Consumer direct	(16		)	(64		)
Consumer home equity	(263		)	(521		)
Consumer OD & reserve	(151		)	(172		)
Consumer indirect	—			(25		)
Total charge-offs	(1,094		)	(1,219		)
Recoveries:
One- to four-family	1			20
Commercial business	284			282
Equipment finance leases	29			7
Agricultural real estate	5			232
Agricultural business	8			744
Consumer direct	10			15
Consumer home equity	7			58
Consumer OD & reserve	67			79
Consumer indirect	7			52
Total recoveries	418			1,489
Net recoveries (charge-offs)	(676		)	270
Additions charged to operations	279			(172		)
Allowance related to assets acquired (sold), net	—			—
Balance at end of period	$	10,346		$	10,664
Ratio of net (recoveries) charge-offs during the period to average loans and leases outstanding during the period ⁽²⁾	0.12		%	(0.05		)%
Ratio of allowance for loan and lease losses to total loans and leases at end of period	1.37		%	1.56		%
Ratio of allowance for loan and lease losses to nonperforming loans and leases at end of period⁽¹⁾	55.76		%	46.96		%

_____________________________________


⁽¹⁾	Nonperforming loans and leases include nonaccruing loans and leases and accruing loans and leases delinquent more than 90 days.


⁽²⁾	Percentages for the nine months ended March 31, 2014 and 2013 have been annualized.

The distribution of the Company’s allowance for loan and lease losses and impaired loss summary as required by ASC Topic 310, “Accounting by Creditors for Impairment of a Loan” are summarized in the following tables. The combination of ASC Topic 450, “Accounting for Contingencies” and ASC Topic 310 calculations comprise the Company’s allowance for loan and lease losses.



	General Allowance for Loan and Lease Losses		Specific Impaired Loan Valuation Allowance		General Allowance for Loan and Lease Losses		Specific Impaired Loan Valuation Allowance
Loan Type	March 31, 2014				June 30, 2013
	(Dollars in Thousands)
Residential	$	221	$	17	$	195	$	8
Commercial business	866		168		893		665
Commercial real estate	3,536		28		2,225		148
Agricultural	3,749		250		3,156		1,481
Consumer	1,256		255		1,811		161
Total	$	9,628	$	718	$	8,280	$	2,463



	Number of Loan Customers	Loan Balance		Impaired Loan Valuation Allowance		Number of Loan Customers	Loan Balance		Impaired Loan Valuation Allowance
Loan Type	March 31, 2014					June 30, 2013
	(Dollars in Thousands)
Residential	2	$	165	$	17	3	$	277	$	8
Commercial business	9	4,435		168		7	5,129		665
Commercial real estate	8	1,277		28		9	1,360		148
Agricultural	14	15,332		250		16	16,295		1,481
Consumer	34	1,744		255		30	1,320		161
Total	67	$	22,953	$	718	65	$	24,381	$	2,463

The allowance for loan and lease losses was $10.3 million at March 31, 2014, as compared to $10.7 million at June 30, 2013. The general valuation allowance increased by $1.3 million due to increased loan volumes and adjusted for fluctuations in historical losses and environmental factors. The specific valuation allowance decreased by $1.7 million to $718,000, due primarily to payments received on nonaccruing impaired loans in the current fiscal year, which reduced the principal balance and the amount of valuation allowance for those credits. The specific valuation allowance decreased significantly from the prior fiscal year end due to the reduction of specific allowances on impaired loans within the agricultural segment. The agricultural segment represented 34.8% of the specific reserve in the portfolio, while the consumer segment represented 35.5% of the total. The ratio of the allowance for loan and lease losses to total loans and leases was 1.37% at March 31, 2014, compared to 1.54% at June 30, 2013. The Company's management has considered nonperforming assets and other assets of concern in establishing the allowance for loan and lease losses. The Company continues to monitor its allowance for possible loan and lease losses and make future additions or reductions in light of the level of loans and leases in its portfolio and as economic conditions dictate. The current level of the allowance for loan and lease losses is a result of management's assessment of the risks within the portfolio based on the information revealed in credit reporting processes. The Company utilizes a risk-rating system on commercial business, agricultural, construction, multi-family and commercial real estate loans, including purchased loans. The Company periodically utilizes an external loan review to assist in the assessment of the appropriateness of risk ratings and of risks within the portfolio. A periodic credit review is performed on all types of loans and leases to establish the necessary reserve based on the estimated risk within the portfolio. This assessment of risk takes into account the composition of the loan and lease portfolio, historical loss experience for each loan and lease category, previous loan and lease experience, concentrations of credit, current economic conditions and other factors that in management's judgment deserve recognition.

Real estate properties acquired through foreclosure are initially recorded at fair value (less a deduction for disposition costs). Valuations are periodically updated by management and a specific provision for losses on such properties is established by a charge to operations if the carrying values of the properties exceed their estimated net realizable values.

At March 31, 2014, the Company also had an allowance for credit losses on off-balance sheet credit exposures of $105,000. This amount is maintained as a separate liability account to cover estimated potential credit losses associated with off-balance sheet credit instruments such as off-balance sheet loan commitments, standby letters of credit, and guarantees and is recorded in other liabilities in the Consolidated Statements of Financial Condition. Although management believes that it uses the best information available to determine the allowances, unforeseen market conditions could result in adjustments and net income being significantly affected if circumstances differ substantially from the assumptions used in making the final determinations. Future additions to the Company's allowances may result from periodic loan, property and collateral reviews and thus cannot be predicted in advance. See Note 1 of "Notes to Consolidated Financial Statements," which is included in Part II, Item 8 "Financial Statements and Supplementary Data" of the Company's Form 10-K for the year ended June 30, 2013, for a description of the Company's policy regarding the provision for losses on loans and leases.

Comparison of the Three Months Ended March 31, 2014 and March 31, 2013

General. The Company's net income was $2.0 million or $0.28 for basic and diluted earnings per common share for the quarter ended March 31, 2014, a $568,000 increase in net income compared to $1.4 million or $0.20 for basic and diluted earnings per common share for the quarter ended March 31, 2013. The third quarter of fiscal 2014 resulted in a return on average equity (i.e., net income divided by average equity) of 8.11%, compared to 5.76% for the same quarter of the prior year, while the return on average assets (i.e., net income divided by average assets) was 0.64% compared to 0.48%, respectively. As discussed in more detail below, the increases were due to a variety of key factors, including an increase in net interest income of $1.2 million and partially offset by an increase in the provision for losses on loans and leases of $260,000 and an increase in noninterest expense of $370,000.

Interest, Dividend and Loan Fee Income. Interest, dividend and loan fee income was $10.5 million for the quarter ended March 31, 2014, as compared to $9.6 million for the same quarter of the prior year, an increase of $854,000 or 8.9%. Interest earned on loans and leases receivable totaled $8.8 million for the quarter which is an increase of $699,000 when compared to the same quarter of the prior fiscal year. The average balance of loans and leases receivable was $739.0 million for the quarter ended March 31, 2014, or increase of 7.5%, while the average yield increased by 5 basis points to 4.82% in the quarter-over-quarter comparison. Interest earned on investment securities and interest-earning deposits increased by $155,000, to $1.7 million for the current quarter compared to $1.6 million for quarter ended March 31, 2013. The average yield on investment securities and interest-earning deposits increased by 13 basis points to 1.63%, while the average balance increased by $4.6 million to $428.0 million for the quarter ended March 31, 2014. Overall, the average balance of total interest-earning assets increased by 5.1% and resulted in an increase in interest and dividend revenue of $622,000, while the average yield on interest-earning assets increased by 13 basis points and resulted in an increase to interest and dividend revenue of $232,000.

The average yield on interest-earning assets increased, from the quarter a year earlier, primarily due to the recovery of approximately $490,000 of interest income from an agricultural borrower relationship, which complied with modified loan terms and qualified for accrual status. Previously, the payments received for this borrower were all applied to principal since the loans were in nonaccrual status. Upon placing the borrower back on accrual status in the fiscal third quarter of 2014, all of the interest previously collected and applied to principal were treated as interest revenue and the principal was reclassified to the proper amounts under the accrual method. The effect on the yield on loans and leases receivable was an increase of 27 basis points for the quarter. When excluding the recovery of interest income from this borrower for the third fiscal quarter of 2014, the average yield on interest-earning assets decreased primarily due to the repricing of adjustable rate loans, refinancing activity and competitive pricing pressures in a low interest rate environment when compared to the same quarter of the prior fiscal year.

Interest Expense. Interest expense was $2.2 million for the quarter ended March 31, 2014, as compared to $2.5 million for the same quarter of the prior year, a decrease of $371,000 or 14.6%. Interest expense related to interest-bearing deposits decreased by $151,000, of which $129,000 decrease was the result of declining rates and $22,000 decrease was due to average balance changes. The $129,000 decrease in deposit interest expense was the result of average deposit rate decreases of 10 basis points. The average rate on interest-bearing deposits was 0.49% for the quarter ended March 31, 2014, as compared to 0.59% for the prior year's third quarter. In addition, a $22,000 decrease in interest expense was the result of the redistribution of deposits from the term deposits to the non-term deposits which generated interest savings, even though total deposits had a 3.8% increase in the average balance. Interest expense related to the FHLB advances and other borrowings decreased by $122,000 due to decreased average rates and balances. The average rate decrease of 28 basis points resulted in interest savings of $89,000, while the average balance decrease resulted in interest savings of $33,000. Interest expense on subordinated debentures decreased by $98,000 for the three months ended March 31, 2014, when compared to the prior fiscal year, due to the extinguishment of $3.0 million in debt in the fourth quarter of fiscal 2013 and reduced rates on the effective swap contracts on existing outstanding debentures.

Net Interest Income. Net interest income for the third quarter of fiscal 2014 was $8.3 million, an increase of $1.2 million, or 17.3%, compared to fiscal 2013, due to an increase in interest income of $854,000 or 8.9% and a decrease in interest

expense of $371,000 or 14.6%. The net interest margin was 2.89%, compared to 2.59% for the same quarter of the prior fiscal year, an increase of 30 basis points. The Company's net interest margin on a fully taxable equivalent basis was 2.95% for the quarter ended March 31, 2014, as compared to 2.64% for the same quarter a year ago. The yield on interest-earning assets increased 13 basis points to 3.65% for the third quarter of fiscal 2014, while the average rate paid on interest-bearing liabilities decreased 18 basis points to 0.93% during the quarter. Meanwhile, average balances increased when compared to the same quarter from the prior fiscal year for interest-earning assets and interest-bearing liabilities by 5.1% and 2.3%, respectively. The Company continues to have a diversified loan portfolio comprised of a mix of consumer and business type lending. This mix helps the Company manage the net interest margin and interest rate risk by retaining loan and lease production on the balance sheet or by looking at alternatives through secondary markets.

Provision for Losses on Loans and Leases. The allowance for loan and lease losses is maintained at a level which is believed by management to be adequate to absorb probable losses on existing loans and leases that may become uncollectible, based on an evaluation of the collectability of the loans and leases and prior loan and lease loss experience. The evaluation takes into consideration such factors as changes in the nature and balances of the loan and lease portfolio, overall portfolio quality, review of specific problem loans and leases, and current economic conditions that may affect the borrower's ability to pay. The allowance for loan and lease losses is established through a provision for losses on loans and leases charged to expense. See "Asset Quality" above for further discussion.

Provision for losses on loans and leases increased to a provision of $260,000 for the quarter ended March 31, 2014, as compared to no provision in the prior year's quarter. During the third quarter, net charge-offs were $519,000, while loans and leases increased by $9.0 million and the valuation allowance on impaired loans decreased by $775,000. These factors, among others, contributed to the estimation of the allowance for loan and lease losses and the provision for loan and lease losses for the quarter. In addition, nonperforming assets decreased by $2.6 million, while classified assets increased by $4.7 million during the quarter. In comparing the third quarter of fiscal 2014 to fiscal 2013, net charge-offs increased to $519,000 from $116,000; while loan and lease balances at March 31, 2014 were $754.8 million, or an increase of 10.6% when compared to balances at March 31, 2013. The valuation allowance on impaired loans was $718,000 at March 31, 2014, compared to $2.7 million a year ago. Classified assets decreased by $7.6 million to $32.1 million at March 31, 2014, when compared to March 31, 2013. In addition, nonperforming assets decreased by $4.8 million to $18.8 million at March 31, 2014, when compared to March 31, 2013. Dairy-related credits within the agricultural sector remain the largest segment within nonperforming assets at March 31, 2014.

The allowance for losses on loans and leases at March 31, 2014, was $10.3 million. The allowance decreased from the March 31, 2013, balance of $10.7 million due to a decrease in the specific valuation allowance recorded on impaired loans and partially offset by an increase in the general allowance due to an increase in overall loans and adjusted for changes in environmental factors and loan loss history. The ratio of allowance for loan and lease losses to nonperforming loans and leases at March 31, 2014, was 55.76% compared to 46.96% at March 31, 2013. The allowance for loan and lease losses to total loans and leases ratio at March 31, 2014, was 1.37% compared to 1.56% at March 31, 2013. The Bank's management believes that the March 31, 2014, recorded allowance for loan and lease losses is adequate to provide for probable losses on the related loans and leases, based on its evaluation of the collectability of loans and leases and prior loss experience.

Noninterest Income. Noninterest income was $3.7 million for the quarter ended March 31, 2014, an increase of $29,000 or 0.8% as compared to the quarter ended March 31, 2013. For the third quarter of fiscal 2014, increases over the prior fiscal year's third quarter included loan servicing income, commission and insurance income and fees on deposits of $297,000, $227,000, and $111,000, respectively. In addition, gain on sale of securities and other income increased by $87,000 and $93,000, respectively. Overall, these increases were offset by a decrease in gain on sale of loans of $807,000, when comparing the third quarter of fiscal 2014 to the same quarter of fiscal 2013.

Loan servicing income increased by $297,000 to $703,000 for the third quarter of fiscal 2014 partially due to a valuation allowance benefit recaptured for the quarter ended March 31, 2014, of $374,000 compared to a benefit recaptured of $220,000 in the prior year's quarter. Amortization expense, which is a component of net loan servicing income, was $416,000 for the third quarter of fiscal 2014 and represented a decrease in expense of $211,000 when compared to the third quarter of fiscal 2013. The valuation allowance reversal increased the carrying value of the capitalized portfolio asset to the current book value. An assessment of prepayment speeds within the portfolio contributed to the valuation allowance adjustment, and also decreased the amount of amortization expense as compared to the same period of the prior year. In the quarter-over-quarter comparison, servicing income decreased by $68,000 due to a decreasing asset base and an overall lesser net servicing fee percentage which is based on investor mix and modified for delinquencies.

Commission and insurance income was $404,000 for the quarter ended March 31, 2014, an increase of $227,000 when compared to the third quarter of fiscal 2013. This increase is due primarily to an increased book of business within the investment services line of business and from an increased asset base from which commissions are earned, which expanded primarily through a book of business purchase in the fourth quarter of fiscal 2013. In conjunction with the increased revenue, variable pay for the current quarter, which is included in compensation expense, increased by $123,000 when compared to the same quarter of the prior year.

Fees on deposits increased by $111,000 to $1.5 million for the quarter ended March 31, 2014, as compared to the same quarter of the prior fiscal year, primarily due to point-of-sale revenue increases. Point-of-sale interchange fees, which include vendor incentive fees, increased by $100,000 to $693,000 for the quarter ended March 31, 2014, due primarily to vendor incentives earned of $85,000 as compared to no incentive fees earned in the same quarter of the prior year. Point-of-sale interchange income increased due to increased volumes and resulted in an increase of $15,000, in the quarter-over-quarter analysis. In addition, net service charge income increased by $38,000 to $185,000 for the quarter ended March 31, 2014, and was offset by an NSF/overdraft fees decrease of $50,000, to $453,000 for the current quarter, when compared to the same quarter of the prior fiscal year.

Net gain on the sale of loans totaled $344,000, a decrease of $807,000 for the three months ended March 31, 2014, as compared to the prior fiscal year's quarter. This decrease was due to reduced refinancing activity with the general rise in mortgage interest rates. Origination activity for residential lending continues to remain sound due to the local economic climate and favorable interest rates relative to historical levels.

Noninterest Expense. Noninterest expense was $8.9 million for the quarter ended March 31, 2014, as compared to $8.5 million for the quarter ended March 31, 2013, an increase of $370,000, or 4.3%. An increase in marketing and community investment of $209,000 was primarily responsible for the increase, while increases in check and data processing and compensation and employee benefits of $107,000 and $40,000, respectively, also contributed to the overall expense increase.

Marketing and community investment increased $209,000 to $315,000 for the quarter ended March 31, 2014, due to a net increase in expense related to a customer reward program for debit card usage. In the third quarter of the prior fiscal year, the program had matured and modification of the program led to expiration for a significant amount of outstanding points and an expense accrual adjustment was recorded. Thereafter, the program was modified to utilize different guidelines in accruing and awarding points, which resulted in the expense reported for the current quarter. The prior year's quarter expense for the rewards cards was minimal due to the reversal of outstanding points from which the accrual was estimated.

Check and data processing expense was $784,000 for the third quarter of fiscal 2014, which is an increase of $107,000, or 15.8%, from the third quarter of fiscal 2013. This increase was due primarily to a debit card processing expense increase of $63,000 and computer services expense increase of $24,000. Card and related program expenses increased as a result of additional maintenance contract costs, increased costs due to debit card activity volume, and additional costs related to reimbursement of customer ATM foreign fees. Computer services increased due to expanded services related to a mortgage platform enhancement.

Compensation and employee benefits were $5.3 million for the three months ended March 31, 2014, an increase of $40,000, or 0.8% when compared to the quarter ended March 31, 2013. Increased variable pay related to commission and insurance expense of $123,000, reduced deferred loan costs of $128,000, and increased employee benefits from the pension and health insurance benefit increases of $134,000, were the primary segments which increased compensation expense when compared to the same quarter of the prior fiscal year. Offsetting these increases were a reduction in mortgage commissions and incentive pay of $129,000 and $160,000 in the quarter-over-quarter comparison. Increased expense for variable pay related to commission and insurance income occurred as a result of increased revenue from the investment subsidiary's commission revenue. Compensation expense for deferred loan costs under ASC 310-20 declined when compared to the prior year due to fewer loan originations from residential refinancing activities. Pension expense and health insurance expense increased by $50,000 and $84,000, respectively, in the quarter-over-quarter comparisons due to computed net periodic pension cost increases and healthcare utilization increases when compared to the same quarter of the prior year. Mortgage commissions decreased due to the reduced amount of mortgages closed, which are primarily related to lessened refinancing activity due to rising interest rates. Incentive pay accruals decreased due to the amount of incentives accrued in the third quarter of fiscal 2013 as compared to the lesser accruals recorded in the third quarter of fiscal 2014. Overall, the payables related to incentive pay at March 31, 2014, are higher than the payable one year earlier, but more was accrued in the previous quarters of the current fiscal year due to projected outcomes during those quarters when compared to the prior fiscal year.

Income tax expense. The Company's income tax expense for the quarter ended March 31, 2014, increased to $858,000 compared to $802,000 for the same period of the prior fiscal year. The effective tax rates were 30.3% and 36.3% for the quarter ended March 31, 2014 and 2013, respectively. The current quarter's tax rate is lower than anticipated due to an increase in permanent tax items which reduce the effective tax rate, while the prior year's rate is higher than anticipated due to tax adjustments related to nonrecurring income items.

Comparison of the Nine Months Ended March 31, 2014 and March 31, 2013

General. The Company's net income was $5.1 million or $0.73 for basic and diluted earnings per common share for the nine months ended March 31, 2014, a $607,000 increase in net income compared to $4.5 million or $0.64 for basic and diluted earnings per common share for the same period of the prior year. For the first nine months of fiscal 2014, the return on average equity (i.e., net income divided by average equity) was 7.02%, compared to 6.11% in the same period of the prior year, while the return on average assets (i.e., net income divided by average assets) was 0.55% and 0.51%, respectively. As discussed in more detail below, the income statement changes were due to a variety of key factors. Total revenue increased by $2.2 million due to an increase in net interest income of $1.3 million and an increase in noninterest income of $961,000. The provision for losses on loans and leases increased by $451,000, noninterest expense increased by $1.2 million and income taxes decreased by $26,000, which resulted in an increase to net income of $607,000 for the nine months ended March 31, 2014 as compared to the same period of the prior year.

Interest, Dividend and Loan Fee Income. Interest, dividend and loan fee income was $29.8 million for the nine months ended March 31, 2014, as compared to $29.7 million for the same period of the prior year, an increase of $121,000 or 0.4%, due primarily to increased average balances in excess of decreasing overall yields on interest-earning assets. Interest earned on loans and leases receivable totaled $25.7 million for the first nine months of fiscal 2014 which is a decrease of $152,000, when compared to the same period of the prior fiscal year and due primarily to a decrease in the average yields earned. The average yield on interest earned from loans and leases receivable decreased by 33 basis points to 4.62% in the year-over-year comparison. This was partially offset by an increase in the average balance of loans and leases receivable of $45.7 million, or 6.6% for the first nine months of fiscal 2014 as compared to the same period in fiscal 2013. Interest earned on investment securities and interest-earning deposits increased by $273,000 in the year-over-year comparison to $4.1 million for the nine month period ended March 31, 2014, primarily due to an increase in average balances. The average balance of investment securities and interest-earning deposits increased by $33.1 million, or 8.4%, to $427.2 million for the nine month period ended March 31, 2014, while the average yield decreased by 1 basis point to 1.28%. Overall, the average balance of total interest-earning assets, which include loans and leases receivable and investment securities and interest-earning deposits, increased by 7.2%, resulting in an increase to revenue of $2.0 million in the comparison to the same nine month period of the prior year, while the average yield on interest-earning assets, decreased by 23 basis points and resulted in a decrease of $1.9 million in revenue. The resulting net increase to interest, dividend and loan fee income was $121,000 or 0.4%,

Interest Expense. Interest expense was $7.0 million for the nine months ended March 31, 2014, as compared to $8.1 million for the same period of the prior year, a decrease of $1.1 million or 14.2%. Interest expense related to interest-bearing deposits decreased by $720,000, of which a $698,000 decrease was the result of declining rates and a $22,000 decrease was due to average balance changes. A $698,000 decrease in interest expense was the result of a 14 basis point decrease in average rates paid on interest-bearing deposits. The average balance of interest-bearing deposits increased by 3.4%, but a change in the mix of average balances from higher rate paying certificates to the lower paying checking and money market accounts contributed to a reduction in interest expense of $22,000. The average rate on interest-bearing deposits was 0.52% for the nine months ended March 31, 2014, as compared to 0.66% for the same period of the prior year. Noninterest-bearing deposits increased by $30.5 million to an average balance of $162.1 million for the nine months ended March 31, 2014, as compared to the prior year. Interest expense related to FHLB advances and other borrowings decreased by $184,000 due to declining rates in excess of increased average balances. The average rate decrease of 55 basis points resulted in interest savings of $644,000, while the average balance increase resulted in additional interest expense of $460,000. Interest expense on subordinated debentures decreased by $245,000 for the nine months ended March 31, 2014, when compared to the prior fiscal year, due primarily to the extinguishment of $3.0 million in debt in the fourth quarter of fiscal 2013 and reduced rates on the effective swap contracts on existing outstanding debentures.

Net Interest Income. Net interest income for fiscal 2014 was $22.9 million, an increase of $1.3 million, or 5.9%, compared to fiscal 2013, due to a decrease in interest expense of $1.1 million or 14.2% and an increase in interest income of $121,000 or 0.4%. The net interest margin for the the nine months of fiscal 2014 was 2.61% as compared to 2.64% for the

prior fiscal year, a decrease of 3 basis points. The Company's net interest margin on a fully taxable equivalent basis was 2.66% for the fiscal year ended March 31, 2014, as compared to 2.68% for the prior fiscal year. The yield on interest-earning assets decreased 23 basis points to 3.40% for fiscal 2014, while the average rate paid on interest-bearing liabilities decreased 22 basis points to 0.97% in fiscal 2014. In fiscal 2014, the average balances increased from a year ago for interest-earning assets and interest-bearing liabilities by 7.2% and 4.7%, respectively. The average yield on interest-earning assets was impacted due to the recovery of approximately $490,000 in the third fiscal quarter of interest income from an agricultural borrower relationship, which complied with modified loan terms and qualified for accrual status. Previously, the payments received for this borrower were all applied to principal since the loans were in nonaccrual status. Upon placing the borrower back on accrual status in the fiscal third quarter of 2014, all of the interest previously collected and applied to principal were now treated as interest revenue and the principal was reclassified to the proper amounts under the accrual method. The effect on the yield on loans and leases receivable was an increase of 9 basis points for the nine months ended March 31, 2014. When excluding the recovery of interest income from this borrower for the year-to-date period, the average yield on interest-earning assets decreased primarily due to the repricing of adjustable rate loans, refinancing activity and competitive pricing pressures in a low interest rate environment. In addition, this economic environment impacts the yields on investment securities and other short-term investments and prepayment speeds of mortgage-backed securities purchased at a premium. The Company continues to have a diversified loan portfolio comprised of a mix of consumer and business type lending. This mix helps the Company manage the net interest margin and interest rate risk by retaining loan and lease production on the balance sheet or by looking at alternatives through secondary markets.

Provision for Losses on Loans and Leases. The allowance for loan and lease losses is maintained at a level which is believed by management to be adequate to absorb probable losses on existing loans and leases that may become uncollectible, based on an evaluation of the collectability of the loans and leases and prior loan and lease loss experience. The evaluation takes into consideration such factors as changes in the nature and balance of the loan and lease portfolio, overall portfolio quality, review of specific problem loans and leases, and current economic conditions that may affect the borrower's ability to pay. The allowance for loan and lease losses is established through a provision for losses on loans and leases charged to expense. See "Asset Quality" above for further discussion.

Provision for losses on loans and leases increased $451,000, to $279,000 for the nine months ended March 31, 2014, as compared to a net benefit of $172,000 for the same period in the prior year. The increase in the provision is due to increasing loan balances and an increase in net charge-offs for the comparable periods. Total loans and lease receivables increased by $72.2 million, or 10.6% when comparing the balances at March 31, 2014 and March 31, 2013, while net charge-offs for the current year-to-date period totaled $676,000, an increase of $946,000 when compared to the $270,000 of net recoveries from the prior year's results. Factors which helped minimize the amount of provision were the decrease in specific valuation allowance on impaired loans in accordance with ASC 310 of $2.0 million and reduced classified assets of $7.6 million when comparing the balances at March 31, 2014 and March 31, 2013. In addition, nonperforming assets decreased by $4.8 million to $18.8 million at March 31, 2014, when compared to March 31, 2013. Dairy-related credits within the agricultural sector remained the largest segment within the nonperforming assets for March 31, 2014.

The allowance for losses on loans and leases at March 31, 2014 was $10.3 million, which is slightly less than the amount reported at March 31, 2013 of $10.7 million. The ratio of allowance for loan and lease losses to total loans and leases was 1.37% at March 31, 2014, compared to 1.56% at March 31, 2013. The specific valuation allowance of $718,000, which is a decrease of $2.0 million from March 31, 2013, is comprised of $250,000 allowance attributed to impaired agricultural loans and $168,000 allowance attributed to impaired commercial business loans. In addition, the valuation for residential and consumer loans totaled $272,000. At March 31, 2014 the general valuation allowance of $9.6 million is an increase of $1.7 million since March 31, 2013, and is evaluated based primarily upon a review of historical loss and environmental factors and applied to loan and lease balances outstanding according to risk rating classifications. The ratio of allowance for loan and lease losses to nonperforming loans and leases at March 31, 2014, was 55.76% compared to 46.96% at March 31, 2013. The Bank's management believes that the March 31, 2014, recorded allowance for loan and lease losses is adequate to provide for probable losses on the related loans and leases, based on its evaluation of the collectability of loans and leases and prior loss experience.

Noninterest Income. Noninterest income was $11.8 million for the nine months ended March 31, 2014, as compared to $10.8 million for the same period of the prior fiscal year, which represents an increase of $961,000 or 8.9%. This increase was due to an increase in net loan servicing income and commission and insurance income of $2.2 million and $539,000, respectively, and offset by a decrease in the net gain on sale of loans and fees on deposits of $1.8 million and $194,000, respectively. In September 2012, interest rate swap contracts on deposits were terminated which resulted in a one-time charge of $1.5 million and was reported as a reduction to other noninterest income. Investment securities with unrealized gains were

sold to offset the effect of the contract termination losses. For fiscal 2014, the decrease in net gains on securities of $1.4 million and the increase in other noninterest income of $1.6 million reflect the effect of these prior year transactions.

Loan servicing income increased by $2.2 million to $2.1 million for the first nine months of fiscal 2014 primarily due to the net decrease of the valuation allowance provision of $2.0 million. For the nine month period ended March 31, 2014, the valuation allowance provision was a net benefit of $1.2 million compared to a net provision expense for the same period of the prior year of $750,000. In addition, amortization expense decreased by $453,000, but was partially offset by a decrease in servicing income of $236,000 when compared to the same period of the prior year. The valuation allowance reversal increased the carrying value of the capitalized portfolio asset to the current book value. An assessment of prepayment speeds within the portfolio contributed to the valuation allowance decrease, and also decreased the amount of amortization expense as compared to the same period of the prior year. Servicing income decreased due to a decreasing asset base and an overall lesser net servicing fee percentage which is based on investor mix and modified for delinquencies.

Commission and insurance income totaled $1.0 million for the first nine months of fiscal 2014, which is an increase of $539,000, when compared to the same period of the prior fiscal year. This increase is due primarily to an increased book of business within the investment services line of business and increased the asset base from which commissions are earned, which expanded primarily through a book of business purchase in the fourth quarter of fiscal 2013. In conjunction with the increased revenue, variable pay for the current quarter, which is included in compensation expense, increased by $302,000 when compared to the same nine months of the prior fiscal year.

Net gain on the sale of loans totaled $1.8 million, a decrease of $1.8 million for the nine months ended March 31, 2014, as compared to the same period of the prior fiscal year. The decrease reflects reduced customer refinancing volume on residential lending in the current fiscal year, due to recent increases to interest rates. Origination activity for residential lending continues to remain sound due to the local economic climate and favorable interest rates relative to historical levels.

Net gain on the sale of securities totaled $591,000, a decrease of $1.4 million for the nine months ended March 31, 2014, as compared to the same period of the prior fiscal year. As mentioned above, in September 2012, securities with unrealized gains were sold to offset the effect of the termination losses associated with the termination of interest rate swap contracts reported in other income. The Company received proceeds of $61.7 million for net gains of $591,000 for the first nine months of fiscal 2014 as compared to proceeds received of $91.4 million for net gains of $2.0 million for the first nine months of fiscal 2013.

Fees on deposits decreased $194,000, or 3.9% to $4.7 million for the nine months ended March 31, 2014, as compared to the same period of the prior year. Point-of-sale interchange fees, which include vendor incentive fees, decreased by $237,000 due primarily to the amount of debit card vendor incentive fees received. In the first quarter of the prior fiscal year, a nonrecurring vendor incentive fee was received totaling $600,000 compared to $223,000 of recurring vendor incentive fees earned during the first nine months of fiscal 2014. Point-of-sale interchange fees increased by $140,000 for the first nine months of fiscal 2014 as compared to the same period of the prior fiscal year due to increased volume of transactions in the year-over-year comparison. In addition, net service charges increased by $92,000, or 16.7% and overdraft fees decreased by $69,000, or 4.3% when compared to the same nine month period of the prior fiscal year.

Noninterest Expense. Noninterest expense was $27.0 million for the nine months ended March 31, 2014, compared to $25.8 million for the nine months ended March 31, 2013, an increase of $1.2 million, or 4.6%. Increases in compensation and employee benefits of $1.1 million due primarily to a decline in deferred loan costs under ASC 310-20 was the primary factor for the increase in noninterest expense. In addition, marketing and community investment increased by $157,000 for the nine month period ended March 31, 2014 as compared to the prior fiscal year due to an increase in debit card reward accruals.

Compensation and employee benefits were $16.0 million for the nine months ended March 31, 2014, an increase of $1.1 million, or 7.0% when compared to the same period ended March 31, 2013. Reduced deferred loan costs and increased variable pay increases were the primary components of the increase when comparing the first nine months of fiscal 2014 to the same period of fiscal 2013. Compensation expense for deferred loan costs under ASC 310-20 declined when compared to the prior year due to fewer loan originations from residential refinancing activities. The increase in expense related to the reduced deferrals was $541,000 for the nine months ended March 31, 2014 as compared to the same period of the prior year. Variable and incentive pay increased by $245,000 to $1.6 million for the first nine months of fiscal 2014 due to variable pay increases related to commissions and insurance income of $302,000 and employee incentive pay increases of $85,000 related to performance standard accruals. These increases to variable and incentive pay were partially offset by decreases in stock-based compensation amortization expense of $102,000 as a result of fewer unvested shares to amortize when compared to the same

period of the prior year. Base salaries and wages increased by $176,000 or 1.6% for the first nine months of fiscal 2014, when compared to the same period of fiscal 2013. The factors impacting this increase were annual salary increases since the quarter ended one year ago and the hiring of revenue-producing mortgage, agricultural and business banking staff to produce additional revenues. Overall FTEs slightly decreased through the Company's continued efforts in improving efficiencies with the Bank. Included in compensation expense were an increase in pension plan expense of $153,000 and a decrease in healthcare costs of $42,000 in the year-over-year comparisons. Pension plan expenses increased due to the annual actuarial valuation and computed net periodic pension cost increases, while healthcare costs decreased due to utilization and reimbursement factors within the self-insured plan.

Marketing and community investment increased $157,000 to $935,000 for the nine months ended March 31, 2014, due to an increase in expenses related to a customer reward program for debit card usage. In the third quarter of the prior fiscal year, the program had matured and modification of the program led to expiration for a significant amount of outstanding points and an expense accrual adjustment was recorded. Thereafter, the program was modified to utilize different guidelines in accruing and awarding points, which resulted in the expense reported for the current fiscal year. The prior year's expense for the rewards program was minimal due to the reversal of outstanding points from which the accrual was estimated.

Income tax expense. The Company's income tax expense for the nine months ended March 31, 2014 decreased by $26,000 to $2.3 million when compared to the same period of the prior fiscal year. The effective tax rates were 30.6% and 33.6% for the nine months ended March 31, 2014 and 2013, respectively. The current year's tax rate is lower than anticipated due to an increase in permanent tax items which reduce the effective tax rate

Liquidity and Capital Resources

The Company's liquidity is comprised of three primary classifications: cash flows from operating activities, cash flows from investing activities, and cash flows from financing activities. Net cash provided by operating activities and financing activities for the nine months ended March 31, 2014 was $14.3 million and $38.1 million, respectively, which was partially offset by net cash used in investing activities of $47.2 million. For the same period ended March 31, 2013, net cash provided by operating activities was $21.3 million, which were offset by cash used in investing and financing activities of $48.0 million and $691,000, respectively. The results were an increase in cash and cash equivalents of $5.2 million for the nine months ended March 31, 2014 compared to a decrease in cash and cash equivalents of $27.4 million for the same period of the prior fiscal year.

The Company's primary sources of funds are net interest income, in-market deposits, FHLB advances and other borrowings, repayments of loan principal, agency residential mortgage-backed securities and callable agency securities and, to a lesser extent, sales of mortgage loans, sales and maturities of investment securities, out-of-market deposits, and short-term investments. While scheduled loan payments and maturing securities are relatively predictable, deposit flows and loan and security prepayments are more influenced by interest rates, general economic conditions and competition. The Bank attempts to price its deposits to meet its asset/liability objectives consistent with local market conditions. Excess balances are invested in overnight funds.

Liquidity management is both a daily and long-term responsibility of management. The Bank adjusts its investments in liquid assets based upon management's assessment of (i) expected loan demand, (ii) projected loan sales, (iii) expected deposit flows, (iv) yields available on interest-bearing deposits, and (v) the objectives of its asset/liability management program. Excess liquidity is invested generally in interest-bearing overnight deposits and other short-term government and agency obligations. During the nine months ended March 31, 2014, the Bank decreased its borrowings with the FHLB and other borrowings by $19.7 million.

Although in-market deposits is one of the Bank's primary source of funds, the Bank's policy has been to utilize borrowings where the funds can be invested in either loans or securities at a positive rate of return or to use the funds for short-term liquidity purposes. At March 31, 2014, the Bank had the following sources of additional borrowings:


•	$15.0 million in an uncommitted, unsecured line of federal funds with First Tennessee Bank, NA;


•	$20.0 million in an uncommitted, unsecured line of federal funds with Zions Bank;


•	$65.5 million of available credit from the Federal Reserve Bank; and


•	$289.9 million of available credit from FHLB of Des Moines (after deducting outstanding borrowings with FHLB of Des Moines).

The Bank may also seek other sources of contingent liquidity including additional federal funds purchased lines with correspondent banks and lines of credit with the Federal Reserve Bank. There were no funds drawn on the uncommitted, unsecured line of federal funds with First Tennessee Bank, NA, Zions Bank and the Federal Reserve Bank at March 31, 2014. The Bank, as a member of the FHLB of Des Moines, is required to acquire and hold shares of capital stock in the FHLB of Des Moines equal to 0.12% of the total assets of the Bank at December 31 annually. The Bank is also required to own activity-based stock, which is based on 4.00% of the Bank's outstanding advances. These percentages are subject to change at the discretion of the FHLB Board of Directors.

In addition to the above sources of additional borrowings, the Bank has implemented arrangements to acquire out-of-market certificates of deposit as an additional source of funding. As of March 31, 2014, the Bank had $17.9 million in out-of-market certificates of deposit.

The Bank anticipates that it will have sufficient funds available to meet current loan commitments. At March 31, 2014, the Bank had outstanding commitments to originate and purchase mortgage and commercial loans of $15.3 million and to sell mortgage loans of $3.2 million. Commitments by the Bank to originate loans are not necessarily executed by the customer. The Bank monitors the ratio of commitments to funding for use in liquidity management. At March 31, 2014, the Bank had no outstanding commitments to purchase investment securities and no commitments to sell investment securities available for sale.

The Company has an available line of credit with United Bankers' Bank for liquidity needs of $4.0 million with no funds advanced at March 31, 2014. The line of credit was renewed on October 1, 2013 and is available through October 1, 2014. The Company has pledged 100% of Bank stock as collateral for this line of credit.

The Company uses its capital resources to pay dividends to its stockholders, to support organic growth, to make acquisitions, to service its debt obligations and to provide funding for investment into the Bank as Tier 1 (core) capital.

Savings institutions insured by the FDIC are required to meet three regulatory capital requirements. If a requirement is not met, regulatory authorities may take legal or administrative actions, including restrictions on growth or operations or, in extreme cases, seizure. Institutions not in compliance may apply for an exemption from the requirements and submit a recapitalization plan. At March 31, 2014, the Bank met all current capital requirements.

The OCC has adopted capital requirements for savings institutions comparable to the requirement for national banks. The minimum OCC core capital requirement for well-capitalized institutions is 5.00% of total adjusted assets. The Bank had Tier 1 (core) capital of 9.51% at March 31, 2014. The minimum OCC total risk-based capital requirement for well-capitalized institutions is 10.00% of risk-weighted assets. The Bank had total risk-based capital of 15.27% at March 31, 2014.

The Company has entered into interest rate swap contracts which are classified as cash flow hedge contracts, fair value hedge contracts, or non-designated derivative contracts. At March 31, 2014, the total notional amount of interest rate swap contracts was $52.4 million with a fair value net loss of $896,000. The Company is exposed to losses if the counterparties fail to make their payments under the contract in which the Company is in a receiving status. The Company minimizes its risk by monitoring the credit standing of the counterparties. The Company anticipates the counterparties will be able to fully satisfy their obligations under the remaining agreements. See Note 13 of "Notes to Consolidated Financial Statements" of this Form 10-Q for additional information.

Impact of Inflation and Changing Prices

The unaudited Consolidated Financial Statements and Notes thereto presented in this Quarterly Report on Form 10-Q have been prepared in accordance with GAAP, which require the measurement of financial position and operating results in terms of historical dollars without considering the change in the relative purchasing power of money over time due to inflation. The impact of inflation is reflected in the increased cost of the Bank's operations. Unlike most industrial companies, nearly all the assets and liabilities of the Bank are monetary in nature. As a result, interest rates have a greater impact on the Bank'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.

Off-Balance Sheet Arrangements

In the normal course of business, the Company makes use of a number of different financial instruments to help meet the financial needs of its customers. In accordance with GAAP, the full notional amounts of these transactions are not recorded in the accompanying consolidated financial statements and are referred to as off-balance sheet instruments. These transactions and activities include commitments to extend lines of credit and standby letters of credit and are discussed further in Part II, Item 8 “Financial Statements and Supplementary Data” of the Company's Annual Report on Form 10-K for fiscal 2013, under Note 20 in the “Notes to Consolidated Financial Statements.”

Off-balance sheet arrangements also include trust preferred securities, which have been de-consolidated in this report. Further information regarding trust preferred securities can be found in Note 12 in the "Notes to Consolidated Financial Statements" of this Form 10-Q.

Recent Accounting Pronouncements

In February 2013, FASB issued ASU 2013-04 “Liabilities” (ASC Topic 405), obligations resulting from joint and several liability arrangements for which the total amount of the obligation is fixed at the reporting date. This update requires measuring the obligation resulting from joint and several liability arrangements to include (1) the amount the reporting entity agreed to pay on the basis of its arrangement amount of its co-obligors and, (2) any additional amount the reporting entity expects to pay on behalf of its co-obligors. The guidance is effective for fiscal years beginning after December 15, 2013, and the interim periods within those fiscal years. The amendments in this update should be applied retrospectively to all prior periods presented for those obligations resulting from joint and several liability arrangements within the update's scope that exist at the beginning of an entity's fiscal year of adoption. Early adoption is permitted. The Company anticipates to adopt this update in the first quarter of fiscal 2015 and does not expect the adoption to have a material effect on the Company's consolidated financial condition, results of operations or cash flows.

In April 2013, FASB issued ASU 2013-07 “Presentation of Financial Statements” (ASC Topic 205), liquidation basis of accounting. The amendments require an entity to prepare its financial statements using the liquidation basis of accounting when liquidation is imminent. Liquidation is imminent when the likelihood is remote that the entity will return from liquidation and either (a) a plan for liquidation is approved by the person or persons with the authority to make such a plan effective and the likelihood is remote that the execution of the plan will be blocked by other parties or (b) a plan for liquidation is being imposed by other forces (for example, involuntary bankruptcy). The guidance is effective for entities that determine liquidation is imminent for fiscal years beginning after December 15, 2013, and the interim periods within those fiscal years. The Company anticipates to adopt this update in the first quarter of fiscal 2015 and does not expect the adoption to have a material effect on the Company's consolidated financial condition, results of operations or cash flows.

In July 2013, FASB issued ASU 2013-10 “Derivatives and Hedging” (ASC Topic 815), inclusion of the Fed Funds effective swap rate (or overnight index swap rate) as a benchmark interest rate for hedge accounting purposes. The amendments permit the Fed Funds Effective Swap Rate (OIS) to be used as a U.S. benchmark interest rate for hedge accounting purposes, in addition to the US Treasury Rate and London Interbank Offered Rate ("LIBOR"). The amendments also remove the restriction on using different benchmark rates for similar hedges. The guidance is effective for fiscal years beginning after December 15, 2013, and the interim periods within those fiscal years. Early adoption is permitted. The Company anticipates to adopt this update in the first quarter of fiscal 2015 and does not expect the adoption to have a material effect on the Company's consolidated financial condition, results of operations or cash flows.

In July 2013, FASB issued ASU 2013-11 “Income Taxes” (ASC Topic 740), regarding presentation of an unrecognized tax benefit when a net operating loss carryforward, a similar tax loss, or a tax credit carryforward exists. To the extent a net operating loss carryforward, a similar tax loss, or a tax credit carryforward is not available at the reporting date under the tax law to settle any additional income taxes that would result from the disallowance of a tax position, or the entity is not planning on using any deferred tax for such purpose, the unrecognized tax benefit should be presented in the financial statements as a liability and should not be combined with deferred tax assets. The guidance is effective for fiscal years beginning after December 15, 2013, and the interim periods within those fiscal years. Early adoption is permitted. The Company anticipates to adopt this update in the first quarter of fiscal 2015 and does not expect the adoption to have a material effect on the Company's consolidated financial condition, results of operations or cash flows.

In January 2014, FASB issued ASU 2014-04 “Receivables-Troubled Debt Restructurings by Creditors” (ASC Topic 310-40), regarding guidance to reduce inconsistencies when derecognizing loan receivables and recording real estate

recognized. A creditor is considered to have received physical possession of residential real estate property collateralizing a consumer mortgage loan, upon either (1) the creditor obtaining legal title to the residential real estate property upon completion of a foreclosure or (2) the borrower conveying all interest in the residential real estate property to the creditor to satisfy that loan through completion of a deed in lieu of foreclosure or through a similar legal agreement. Additionally, the amendments require interim and annual disclosure of both (1) the amount of foreclosed residential real estate property held by the creditor and (2) the recorded investment in consumer mortgage loans collateralized by residential real estate property that are in the process of foreclosure according to local requirements of the applicable jurisdiction. The guidance is effective for fiscal years beginning after December 15, 2014, and the interim periods within those fiscal years. An entity can elect to adopt the amendments using either a modified retrospective transition method or a prospective transition method. Early adoption is permitted. The Company anticipates to adopt this update in the first quarter of fiscal 2016 and does not expect the adoption to have a material effect on the Company's consolidated financial condition, results of operations or cash flows.

In April 2014, FASB issued ASU 2014-08 “Presentation of Financial Statement (ASC Topic 205) and Property, Plant, and Equipment" (ASC Topic 360), regarding guidance to report discontinued operations and disclosures of disposals of components of an entity. This update addresses the issue that currently, many disposals of small groups of assets, that are recurring in nature, qualify for discontinued operations. This update changes the criteria for reporting discontinued operations and also enhances convergence of the FASB’s and the International Accounting Standard Board’s (IASB) reporting requirements for discontinued operations.The guidance is effective for fiscal years beginning after December 15, 2014, and the interim periods within those fiscal years. Early adoption is permitted, but only for disposals that have not been reported in the financial statements previously issued or available for issuance. The Company anticipates to adopt this update in the first quarter of fiscal 2016 and does not expect the adoption to have a material effect on the Company's consolidated financial condition, results of operations or cash flows.

Since January 1, 2014, the FASB issued ASU No. 2014-05 through 2014-08. Other than ASU 2014-08 mentioned above, no other updates are applicable to the consolidated financial statements of the Company.

Subsequent Event

Item 3. Quantitative and Qualitative Disclosures About Market Risk

Interest Rate Risk Management

The Company's net income is largely dependent on its net interest income. Net interest income is susceptible to interest rate risk to the degree that interest-bearing liabilities with short- and medium-term maturities mature or reprice more rapidly than its interest-earning assets. When interest-bearing liabilities mature or reprice more quickly than interest-earning assets in a given period, a significant increase in market rates of interest could adversely affect net interest income. Similarly, when interest-earning assets mature or reprice more quickly than interest-bearing liabilities, falling interest rates could result in a decrease in net income.

In an attempt to manage its exposure to change in interest rates, management monitors the Company's interest rate risk. The Company's Asset/Liability Committee meets periodically to review the Company's interest rate risk position and profitability, and to recommend adjustments for consideration by executive management. Management also reviews the Bank's securities portfolio, formulates investment strategies, and oversees the timing and implementation of transactions to assure attainment of the Board's objectives in the most effective manner. In managing market risk and the asset/liability mix, the Bank has placed its emphasis on developing a portfolio in which, to the extent practicable, assets and liabilities reprice within similar periods. Notwithstanding the Company's interest rate risk management activities, the potential for changing interest rates is an uncertainty which may have an adverse effect on net income.

The Company adjusts its asset/liability position to mitigate the Company's interest rate risk. At times, depending on the level of general interest rates, the relationship between long- and short-term interest rates, market conditions and competitive factors, management may increase the Company's interest rate risk position in order to increase its net interest margin. The Company's results of operations and net portfolio values remain vulnerable to increases in interest rates and to fluctuations in the difference between long- and short-term interest rates.

As set forth below, the volatility of a rate change, the change in asset or liability mix of the Company or other factors may produce a decrease in net interest margin in an upward moving rate environment even as the net portfolio value (“NPV”) estimate indicates an increase in net value. The inverse situation may also occur. One approach used by the Company to quantify interest rate risk is an NPV analysis. This analysis calculates the difference between the present value of the liabilities and the present value of expected cash flows from assets and off-balance sheet contracts. The following tables set forth, at March 31, 2014 and June 30, 2013, an analysis of the Company's interest rate risk as measured by the estimated changes in NPV resulting from instantaneous and sustained parallel shifts in the yield curve. Management does not believe that the Company has experienced any material changes in its market risk position from that disclosed in the Company's Annual Report on Form 10-K for fiscal 2013 or that the Company's primary market risk exposures and how those exposures were managed during the nine months ended March 31, 2014 changed significantly when compared to June 30, 2013.

Even if interest rates change in the designated amounts, there can be no assurance that the Company's assets and liabilities would perform as set forth below. In addition, a change in U.S. Treasury rates in the designated amounts accompanied by a change in the shape of the Treasury yield curve would cause significantly different changes to the NPV than indicated below.



March 31, 2014
			Estimated Increase (Decrease) in NPV
Change in Interest Rates	Estimated NPV Amount		Estimated Increase (Decrease) in NPV
Change in Interest Rates	Estimated NPV Amount		Amount			Percent
	(Dollars in Thousands)
Basis Points
+300	$	253,432	$	21,069		9	%
+200	249,672		17,309			7
+100	242,519		10,156			4
—	232,363		—			—
-100	179,710		(52,653		)	(23	)



June 30, 2013
			Estimated Increase (Decrease) in NPV
Change in Interest Rates	Estimated NPV Amount		Estimated Increase (Decrease) in NPV
Change in Interest Rates	Estimated NPV Amount		Amount			Percent
	(Dollars in Thousands)
Basis Points
+300	$	249,104	$	27,463		12	%
+200	243,835		22,194			10
+100	234,513		12,872			6
—	221,641		—			—
-100	184,269		(37,372		)	(17	)

In managing market risk and the asset/liability mix, the Bank has placed an emphasis on developing a portfolio in which, to the extent practicable, assets and liabilities reprice within similar periods. The goal of this policy is to provide a relatively consistent level of net interest income in varying interest rate cycles and to minimize the potential for significant fluctuations from period to period.

Item 4. Controls and Procedures

Evaluation of Disclosure Controls and Procedures

As of March 31, 2014, an evaluation was performed by the Company's management, including the Company's President and Chief Executive Officer and the Company's Senior Vice President, Chief Financial Officer and Treasurer, of the effectiveness of the design and operation of the Company's disclosure controls and procedures (as defined in Rules 13a-15(e) and 15d-15(e) under the Securities Exchange Act of 1934, as amended) to provide reasonable assurance that information required to be disclosed in the reports the Company files and submits under the Securities Exchange Act of 1934, as amended, is recorded, processed, summarized and reported within the time periods specified in the Securities and Exchange Commission's rules and forms. Based upon that evaluation, the Company's President and Chief Executive Officer and the Company's Senior Vice President, Chief Financial Officer and Treasurer concluded that the Company's disclosure controls and procedures were effective as of March 31, 2014.

There were no changes in the Company's internal control over financial reporting that occurred during the quarter ended March 31, 2014, that have materially affected, or are reasonably likely to materially affect, the Company's internal control over financial reporting.

PART II - OTHER INFORMATION

Item 1. Legal Proceedings

The Company, the Bank and each of their subsidiaries are, from time to time, involved as plaintiff or defendant in various legal actions arising in the normal course of their businesses. While the ultimate outcome of any such proceedings cannot be predicted with certainty, it is generally the opinion of management, after consultation with counsel representing the Bank and the Company in any such proceedings, that the resolution of any such proceedings should not have a material effect on the Company's consolidated financial position or results of operations. The Company, the Bank and each of their subsidiaries are not aware of any material legal actions or other proceedings contemplated by governmental authorities outside of the normal course of business.

Item 1A. Risk Factors

The discussion of our business and operations should be read together with the risk factors contained in Part I, Item 1A of our Annual Report on Form 10-K for the fiscal year ended June 30, 2013, which describe various risks and uncertainties to which we are or may become subject. These risks and uncertainties have the potential to affect our business, financial condition, results of operations, cash flows, strategies or prospects in a material and adverse manner. There have been no material changes to the risk factors set forth in the above-referenced filing as of March 31, 2014.

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

None.

Item 3. Defaults upon Senior Securities

None.

Item 4. Mine Safety Disclosures

Not applicable.

Item 5. Other Information

None.

Item 6. Exhibits

See "Exhibit Index."

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.



		HF FINANCIAL CORP.
Date:	May 9, 2014	By:	/s/ STEPHEN M. BIANCHI
			Stephen M. Bianchi, President and Chief Executive Officer (Principal Executive Officer)


Date:	May 9, 2014	By:	/s/ BRENT R. OLTHOFF
			Brent R. Olthoff, Senior Vice President, Chief Financial Officer (Principal Financial and Accounting Officer)

Exhibit Index



Exhibit Number		Description
10.1		Second Amended and Restated Employment Agreement between Stephen M. Bianchi and Home Federal Bank, dated March 13, 2014 (incorporated by reference to Exhibit 10.1 from the Company's Current Report on Form 8-K dated March 13, 2014, and filed with the SEC on March 17, 2014, file no. 033-44383).
10.2		Renewal Addendum No. 1 to Employment Agreement between Brent R. Olthoff and Home Federal Bank, dated March 27, 2013 (incorporated by reference to Exhibit 10.2 from the Company's Current Report on Form 8-K dated March 13, 2014, and filed with the SEC on March 17, 2014, file no. 033-44383).
10.3		Renewal Addendum No. 1 to Employment Agreement between Michael Westberg and Home Federal Bank, dated March 27, 2013 (incorporated by reference to Exhibit 10.3 from the Company's Current Report on Form 8-K dated March 13, 2014, and filed with the SEC on March 17, 2014, file no. 033-44383).
10.4		Renewal Addendum No. 1 to Employment Agreement between Jon M. Gadberry and Home Federal Bank, dated March 27, 2013 (incorporated by reference to Exhibit 10.4 from the Company's Current Report on Form 8-K dated March 13, 2014, and filed with the SEC on March 17, 2014, file no. 033-44383).
31.1		Certification of President and Chief Executive Officer Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.
31.2		Certification of Senior Vice President, Chief Financial Officer and Treasurer Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.
32.1		Certification of President and Chief Executive Officer Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.
32.2		Certification of Senior Vice President, Chief Financial Officer and Treasurer Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.
101.INS*		XBRL Instance Document
101.SCH*		XBRL Taxonomy Extension Schema
101.CAL*		XBRL Taxonomy Extension Calculation Linkbase
101.DEF*		XBRL Taxonomy Extension Definition Linkbase
101.LAB*		XBRL Taxonomy Extension Label Linkbase
101.PRE*		XBRL Taxonomy Extension Presentation Linkbase

^{___________________________________________________}

*Pursuant to Rule 406T of Regulation S-T, these interactive data files are deemed not filed or part of a registration statement or prospectus for purposes of Sections 11 or 12 of the Securities Act of 1933 or Section 18 of the Securities Exchange Act of 1934 and otherwise are not subject to liability.