| HF FINANCIAL CORP Item 1A Risk Factors The following are certain material risks that our management believes are specific to us and our business |
| You should understand that it is not possible to predict or identify all such potential risks and, as such, this list of risk factors should not be viewed as all-inclusive or in any particular order |
| An investment in shares of our common stock involves various risks |
| Before deciding to make an investment decision regarding our common stock, you should carefully consider the risks described below in conjunction with the other information in this Form 10-K and information incorporated by reference into Form 10-K, including our consolidated financial statements and related notes which are set forth in Part II, Item 8 “Financial Statements and Supplementary Data” of this Form 10-K Our business, financial condition and results of operations could be harmed by any of the following risks or by other risks that have not been identified or that we may believe are immaterial or unlikely |
| The value or market price of our common stock could decline due to any of these risks, and you may lose all or part of your investment |
| The risks discussed below also include forward-looking statements and our actual results may differ substantially from those discussed in these forward-looking statements |
| Risks Related to Our Business We face strong competition for customers, which could prevent us from obtaining customers and may cause us to pay higher interest rates to attract deposits and charge lower rates to obtain the loan volume we need to grow, any of which may reduce our profitability |
| The banking business is highly competitive and we experience competition in each of our markets from many other financial institutions, many of which are larger and may have significantly greater financial and other resources than we have |
| Specifically, we compete with commercial banks, credit unions, savings and loan associations, mortgage banking firms, consumer finance companies, securities brokerage firms, insurance companies, money market funds and other mutual funds, as well as super-regional, national and international financial institutions, that operate offices in our primary market areas and elsewhere |
| Many of these competitors are also well-established financial institutions |
| Competitors that are not depository institutions are generally not subject to the extensive regulations that apply to us |
| We compete with these institutions both in attracting deposits and in making loans |
| In addition, we must attract our customer base from other existing financial institutions and from new residents |
| There is a risk that we will not be able to compete successfully with these other financial institutions in our markets, and that we may have to pay higher interest rates to attract deposits or charge lower interest rates to obtain loan volume, resulting in reduced profitability |
| In new markets that we may enter, we will also compete against well-established community banks that have developed relationships within the community |
| Changes in interest rates may reduce our profitability |
| Our profitability depends in large part on our net interest income, which is the difference between interest earned from interest-earning assets, such as loans and mortgage-backed securities, and interest paid on interest-bearing liabilities, such as deposits and borrowings |
| Our net interest income will be adversely affected if market interest rates change such that the interest we pay on deposits and borrowings increases faster than the interest we earn on loans and investments |
| Many factors cause changes in interest rates, including governmental monetary policies and domestic and international economic and political conditions |
| While we intend to manage the effects of changes in interest rates by adjusting the terms, maturities, and pricing of our assets and liabilities, our efforts may not be effective in a changing rate environment and our financial condition and results of operations may suffer |
| 31 ______________________________________________________________________ Interest rates were at historically low levels until June 2004 at which time the Federal Reserve began increasing short-term interest rates 17 times or 425 basis points |
| This flattening and slight inversion of the treasury yield curve caused by increasing short-term rates and lagging long-term rates has had, and continues to have, a negative impact on our net interest margin |
| If short-term interest rates continue to rise, and if rates on our deposits and borrowings continue to re-price upwards faster than the rates on our long-term loans and investments, we will experience further compression of our net interest margin, which will have a negative effect on our profitability |
| Our growth may require us to raise additional capital that may not be available when it is needed or may not be available on terms acceptable to us |
| We are required by regulatory authorities to maintain adequate levels of capital to support our operations |
| To support our future continued growth, we may need to raise additional capital |
| Our ability to raise additional capital, if needed, will depend in part on conditions in the capital markets at that time, which are outside our control |
| Accordingly, we cannot assure you of our ability to raise additional capital, if needed, on terms acceptable to us |
| If we cannot raise additional capital when needed, our ability to further expand our operations through internal growth could be materially impaired |
| In the event that we are able to raise capital through the issuance of additional shares of common stock or other securities, the ownership interests of current investors would be diluted and the per share book value of our common stock may be diluted |
| New investors may also have rights, preferences and privileges senior to the holders of our common stock, which may adversely affect the holders of our common stock |
| We may look to sell production assets, such as mortgage loans and auto loans, into the secondary market as a means to manage the size of the balance sheet and manage the use of capital |
| The demand for these products in the capital markets is not driven by us and may not benefit us at the time we look to sell the loans |
| We are subject to extensive regulations that may limit or restrict our activities and the cost of compliance is high |
| We operate in a highly regulated industry and are subject to examination, supervision and comprehensive regulation by various regulatory agencies |
| Banking regulations are primarily intended to protect the federal deposit insurance funds and depositors, not stockholders |
| Our compliance with these regulations is costly and restricts certain of our activities, including payment of dividends, mergers and acquisitions, investments, loans and interest rates charged, interest rates paid on deposits and locations of offices |
| We are also subject to regulatory capital requirements, which require us to maintain adequate capital to support our growth |
| If we fail to meet these capital and other regulatory requirements, our ability to grow, our cost of funds and FDIC insurance, our ability to pay dividends on common stock, and our ability to make acquisitions could be materially and adversely affected |
| Congress and federal agencies continually review laws, regulations and policies applicable to the banking industry for possible changes, and we cannot predict the effects of these changes on our business and profitability |
| Because, like all banks and bank holding companies, government regulation greatly affects our business and financial results, our cost of compliance could adversely affect our ability to operate profitably |
| See “Regulation” under Part I, Item 1 “Business” of this Form 10-K for a detailed discussion of regulation requirements |
| Changes in accounting standards may materially impact our financial statements |
| Accounting principles generally accepted in the United States of America and accompany accounting pronouncements, implementation guidelines, interpretations and practices for many aspects of our business are complex and involve subjective judgments, such as accounting for the allowance for loan and lease losses and pending and incurred but not reported health claims |
| Changes in these estimates or changes in other accounting rules and principles, or their interpretation, could significantly change our reported earnings and operating results, and could add significant volatility to those measures, without a comparable underlying change in cash flow from operations |
| 32 ______________________________________________________________________ Our success is influenced by growth in South Dakota and lack of growth or changes in national and South Dakota economic and political conditions could adversely affect our earnings, as our borrowers’ ability to repay loans and the value of the collateral securing our loans decline and as loans and deposits decline |
| Our success and growth is significantly influenced by the growth in population and income levels and deposits in our primary market areas which are mainly in South Dakota |
| If the communities in which we operate do not grow or if prevailing economic conditions locally or nationally are unfavorable, our business may be negatively affected |
| Additionally, there are inherent risks associated with our lending activities, including credit risk, which is the risk that borrowers may not repay outstanding loans or the value of the collateral securing loans will decrease |
| Conditions such as inflation, recessions, unemployment, changes in interest rates and money supply and other factors beyond our control may adversely affect the ability of our borrowers to repay their loans and the value of collateral securing the loans, which could adversely affect our earnings |
| Because our business operations and activities are concentrated in the State of South Dakota and most of our credit exposure is in that state, we are specifically at risk from adverse economic, political and business conditions that affect South Dakota |
| Our allowance for loan losses may prove to be insufficient to absorb losses in our loan portfolios, which could adversely affect our operating results |
| Like all financial institutions, we maintain an allowance for loan losses to provide for loans in our portfolio that may not be repaid in their entirety |
| Although we believe that our allowance for loan losses is maintained at a level adequate to absorb probable losses inherent in our loan portfolio as of the corresponding balance sheet date, the determination of the appropriate level of the allowance for loan losses inherently involves a high degree of subjectivity and requires us to make significant estimates of current credit risks and future trends, all of which may undergo material changes |
| Accordingly, our allowance for loan losses may not be sufficient to cover actual loan losses, and future provisions for loan losses could materially adversely affect our operating results by decreasing our net income |
| In evaluating the adequacy of our allowance for loan losses, we consider numerous quantitative factors, including our historical charge-off experience, growth of our loan portfolio, changes in the composition of our loan portfolio and the volume of delinquent and criticized loans |
| In addition, we use information about specific borrower situations, including their financial position and estimated collateral values, to estimate the risk and amount of loss for those borrowers |
| Finally, we also consider many qualitative factors, including general and economic business conditions, duration of the current business cycle, current general market collateral valuations, trends apparent in any of the factors we take into account and other matters, which are by nature more subjective and fluid |
| Our estimates of the risk of loss and amount of loss on any loan are complicated by the significant uncertainties surrounding our borrowers’ abilities to successfully execute their business models through changing economic environments, competitive challenges and other factors |
| In considering information about specific borrower situations our analysis is subject to the risk that we are provided inaccurate or incomplete information |
| Because of the degree of uncertainty and susceptibility of these factors to change, our actual losses may vary from our current estimates |
| Additionally, bank regulators periodically review our allowance for loan losses and may require an increase in the provision for loan losses or recognize loan charge-offs based upon their judgments, which may be different from ours |
| Any increase in our allowance for loan losses or loan charge-offs required by these regulatory authorities may adversely affect our operating results |
| Our ability to retain and attract qualified employees is critical to the success of our business and the failure to do so may materially adversely affect our performance |
| Our people are our most important resource and competition for qualified employees is intense |
| In order to retain and attract qualified employees, we must compensate such employees at market levels |
| Typically, those levels have caused employee compensation to be our greatest noninterest expense |
| In addition, because certain information concerning our employee compensation is included in our filings with the SEC and is, therefore, available to our competitors, we believe that our employees may be more highly recruited by our competitors |
| If we are unable to continue to retain and attract qualified employees, or if compensation costs required to retain and attract qualified employees becomes more expensive, our performance, including our competitive position, could be affected |
| Our ability to maintain our reputation is critical to the success of our business and the failure to do so may materially adversely affect our performance |
| Our reputation is one of the most valuable components of our business |
| As such, we strive to conduct our business in a manner than enhances our reputation |
| This is done, in part, by recruiting, hiring and retaining employees who share our core values of being an integral part of the communities we serve, delivering superior service to our customers and caring about our customers and associates |
| If our reputation is negatively affected, by the actions of our employees or otherwise, our business and, therefore, our operating results may be materially adversely affected |
| 33 ______________________________________________________________________ Risks Related to Our Common Shares The trading volume in our common stock has been low, and the sale of a substantial number of shares of our common stock in the public market could depress the price of our common stock and make it difficult for you to sell your shares |
| Our common stock is listed to trade on the NASDAQ National Market, but is thinly traded |
| Additionally, thinly traded stock can be more volatile than stock trading in an active public market |
| The sale of a substantial number of shares of our common stock at one time could temporarily depress the market price of our common stock, making it difficult for you to sell your shares and impairing our ability to raise capital |
| Our ability to pay dividends depends primarily on dividends from our banking subsidiary, Home Federal Bank, which is subject to regulatory limits |
| We are a unitary thrift holding company and our operations are conducted primarily by our banking subsidiary, Home Federal Bank |
| Since we receive substantially all of our revenue from dividends from Home Federal Bank, our ability to pay dividends on our commons stock depends on our receipt of dividends from Home Federal Bank |
| Dividend payments from Home Federal Bank are subject to legal and regulatory limitations, generally based on net income and retained earnings |
| The ability of Home Federal Bank to pay dividends to us is also subject to its profitability, financial condition, capital expenditures and other cash flow requirements |
| There is no assurance that Home Federal Bank will be able to pay dividends to us in the future or that we will generate adequate cash flow to pay dividends in the future |
| The inability to receive dividends from Home Federal Bank could have an adverse affect on our business and financial conditions |
| Similarly, our failure to pay dividends on our common stock could have a material adverse effect on the market price of our common stock |
| We are subject to security and operational risks relating to our use of technology that could damage our reputation and our business |
| Security breaches in our internet banking activities or other communication and information systems could damage our reputation, result in a loss of customer business, subject us to additional regulatory scrutiny, or expose us to civil litigation and possible financial liability, any of which could have a material adverse effect on our financial condition and results of operations |
| We rely on standard internet and other security systems to provide the security and authentication necessary to effect secure transmission of data |
| These precautions may not protect our systems from compromises or breaches of our security measures |
| Certain provisions of our certificate of incorporation and bylaws and our stockholder rights plan, as well as federal law, may discourage, delay or prevent an acquisition of control of us |
| Certain provisions included in our certificate of incorporation and bylaws and our stockholder rights plan, as well as certain provisions of federal law, may discourage, delay or prevent potential acquisitions of control of us, particularly when attempted in a transaction that is not negotiated directly with, and approved by, our Board of Directors, despite possible benefits to our stockholders |
| Specifically, our certificate of incorporation and bylaws include certain provisions that: • limit the voting power of shares held by a stockholder beneficially owning in excess of 10prca of the then-outstanding shares of our common stock; • require that certain business combinations between us and a stockholder beneficially owning in excess of 10prca of the then-outstanding shares of our common stock (i) be approved by at least 66 2/3prca of the total number of our outstanding voting shares, voting as a single class, (ii) be approved by a majority of the Board of Directors serving prior to the 10prca stockholder becoming such, or (iii) involve consideration per share generally equal to that paid by such 10prca stockholder when such stockholder acquired his, her or its stock; • divide our Board of Directors into three classes serving staggered three-year terms and provide that a director may only be removed prior to the expiration of a term for cause by the affirmative vote of the holders of at least 80prca of the voting power of all of the then-outstanding shares of capital stock entitled to vote in an election of directors; • require that a special meeting of stockholders be called pursuant to a resolution adopted by a majority of our Board of Directors; • authorize the issuance of preferred stock with such designations, rights and preferences as may be determined from time to time by our Board of Directors; and • require that amendments to (i) our certificate of incorporation be approved by a two-thirds vote of our Board of Directors and by a majority of the outstanding shares of our voting stock or, with respect to the amendment of certain provisions (regarding, among other things, provisions relating to number, classification, election and removal of directors, amendment of the bylaws, call of special stockholder meetings, acquisitions of control, director liability, and certain business combinations), by 80prca of the outstanding shares of our voting stock, and (ii) our bylaws be approved by a majority vote of our Board of Directors or the affirmative vote of at least 80prca of the total votes eligible to be voted at a duly constituted meeting of stockholders |
| 34 ______________________________________________________________________ In addition, we have adopted a stockholder rights plan designed to protect our stockholders against transactions that our Board of Directors believes are unfair or otherwise not in our best interests or the best interests of our stockholders |
| Under the rights plan, each holder of record of our common stock, subject to the limits of the rights plan, has received, or will receive, one preferred share purchase right for each common share |
| The rights generally become exercisable if an acquiring party accumulates, or announces an offer to acquire, 20prca or more of our voting stock |
| Each right entitles the holder (other than the acquiring party) to purchase, under specified circumstances, one one-hundredth of a share of our Series A Junior Participating Preferred Stock |
| Furthermore, federal law requires OTS approval prior to any direct or indirect acquisition of “control” (as defined in OTS regulations) of the Bank, including any acquisition of control of us |