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UNITED STATES SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-K
   
[X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
    For the fiscal year ended December 31, 2003
OR
[    ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15 (d) OF THE SECURITIES EXCHANGE ACT OF 1934 [NO FEE REQUIRED]
   
    For the transition period from ___________________________ to ___________________________
    Commission file number 0-22103




HEMLOCK FEDERAL FINANCIAL CORPORATION
(Exact name of small business issuer as specified in its charter)
   
Delaware
 36-4126192
(State or other jurisdiction of incorporation
or organization)		 (I.R.S. Employer Identification No.)
   
5700 West 159th Street, Oak Forest , Illinois
 60542
(Address of principal executive offices) (Zip Code)
   
Issuer's telephone number, including area code: (708) 687-9400



Securities Registered Pursuant to Section 12(b) of the Act:
None


Securities Registered Pursuant to Section 12(g) of the Act:
Common Stock, par value $.01 per share
(Title of class)

            Check whether the issuer (1) filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the past 12 months (or for such shorter period that the registrant was required to file such reports) and (2) has been subject to such requirements for the past 90 days. YES X NO ___

            Check if there is no disclosure of delinquent filers in response to Item 405 of Regulation S-K contained herein, and no disclosure will be contained, to the best of registrant's knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K. [ ]

            Indicate by check mark whether the registrant is an accelerated filer (s defined in Rule 12b-2f of the Act). YES       NO X

            The aggregate market value of the voting stock held by non-affiliates of the registrant, computed by reference to the price at which the common stock last sold on the Nasdaq SmallCap Market as of the last business day of the registrant's most recently completed second fiscal quarter was $15.9 million.

            As of March 3, 2004, there were issued and outstanding 974,168 shares of the Issuer's Common Stock.

            Transitional Small Business Disclosure Format (check one): Yes       No   X


DOCUMENTS INCORPORATED BY REFERENCE
Parts II and IV of Form 10-K - Annual Report to Stockholders for the fiscal year ended December 31, 2003.
Part III of Form 10-K - Proxy Statement for 2004 Annual Meeting of Stockholders.




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PART I

Item 1. Business

General

            Hemlock Federal Financial Corporation ("Hemlock" or the "Company") was formed in 1997 by Hemlock Federal Bank for Savings ("Hemlock Federal" or the "Bank") under the laws of Delaware for the purpose of becoming the savings and loan holding company of the Bank. The Company's business consists primarily of the business of Hemlock Federal.

            Hemlock Federal is a federally chartered stock savings bank headquartered in Oak Forest, Illinois. Hemlock Federal was originally chartered in 1904 as an Illinois-chartered savings bank. In 1959, Hemlock Federal converted to a federal mutual charter. In 1997 Hemlock Federal converted from a mutual to a federally chartered stock savings bank. Hemlock Federal currently serves the financial needs of communities in its market area through its main office located in Oak Forest, Illinois and its five branch offices located in Oak Lawn, Bolingbrook, Lemont, and Chicago. Its deposits are insured up to applicable limits by the Federal Deposit Insurance Corporation ("FDIC"). At December 31, 2003, Hemlock Federal had total assets of $318.8 million, deposits of $206.7 million and equity of $22.3 million (or 7.0% of total assets).

            Hemlock Federal has been, and intends to continue to be, an independent, community oriented, financial institution. Hemlock Federal's business involves attracting deposits from the general public and using such deposits, together with other funds, to originate primarily one- to four-family residential mortgages and, to a lesser extent, multi-family, consumer and other loans primarily in its market area. At December 31, 2003, $108.1 million, or 79.4%, of the Bank's total loan portfolio consisted of one- to four-family residential mortgage loans. The Bank also invests in mortgage-backed and other securities and other permissible investments.

            The executive offices of the Bank are located at 5700 West 159th Street, Oak Forest, Illinois 60452-3198 and its telephone number is (708) 687-9400. Unless the context otherwise requires, all references herein to the Bank or the Company include the Company and the Bank on a consolidated basis.

Forward-Looking Statements

            The Company has made, and may continue to make, various forward-looking statements with respect to earnings, credit quality and other financial and business matters for periods subsequent to December 31, 2003. The Company cautions that these forward-looking statements are subject to numerous assumptions, risks and uncertainties, and that statements for subsequent periods are subject to greater uncertainty because of the increased likelihood of changes in underlying factors and assumptions. Actual results could differ materially from forward-looking statements.

            In addition to those factors previously disclosed by the Company and those factors identified elsewhere herein, the following factors could cause actual results to differ materially from such forward-looking statements: pricing pressures on loan and deposit products; actions of competitors; changes in local and national economic conditions; customer deposit disintermediation; changes in

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customers' acceptance of the Company's products and services; the extent and timing of legislative and regulatory actions and reforms.

            The Company's forward-looking statements speak only as of the date on which such statements are made. By making any forward-looking statements, the Company assumes no duty to update them to reflect new, changing or unanticipated events or circumstances.

Lending Activities

            General. The principal lending activity of the Bank is originating for its portfolio fixed and to a lesser extent, adjustable rate ("ARM") mortgage loans secured by one- to four-family residences located primarily in the Bank's market area. To a lesser extent, Hemlock Federal also originates multi-family real estate, consumer and other loans in its market area. At December 31, 2003, the Bank's net loans receivable, totaled $135.7 million.

            Under federal law, the aggregate amount of loans that the Bank is permitted to make to any one borrower is generally limited to 15% of unimpaired capital and surplus (25% if the security for such loan has a "readily ascertainable" value or 30% for certain residential development loans). At December 31, 2003, based on the above, the Bank's regulatory loans-to-one borrower limit was approximately $3.4 million. As of December 31, 2003, the largest dollar amount outstanding or committed to be lent to one borrower or group of related borrowers relates to one borrower totaling $1.8 million secured by four separate multi-family dwellings located in Tinley Park, Illinois, and two single family residences located in Orland Park, Illinois. The second largest amount outstanding or committed to be lent to one borrower or group of related borrowers as of December 31, 2003 related to one borrower totaling $1.3 million secured by three separate multi-family dwellings located in Oak Lawn and Chicago Ridge, Illinois, one three unit dwelling located in Chicago, Illinois, and one single family residence located in Oak Lawn, Illinois. The third largest amount outstanding or committed to be lent to one borrower or group of related borrowers related to one borrower totaling $894,331 secured by two separate multi-family dwellings located in Naperville, Illinois. At December 31, 2003, the Bank's largest multi-family loan outstanding to one borrower totaled $527,507 and was secured by a six-unit multi-family dwelling in Chicago Ridge, Illinois. At December 31, 2003, these loans were performing in accordance with their terms. As of December 31, 2003, there were no other loans with carrying values in excess of $500,000.

            All of the Bank's lending is subject to its written underwriting standards and to loan origination procedures. Decisions on loan applications are made on the basis of detailed applications and property valuations (consistent with the Bank's appraisal policy). The loan applications are designed primarily to determine the borrower's ability to repay and the more significant items on the application are verified through use of credit reports, financial statements, tax returns or confirmations. All loans originated by Hemlock Federal are approved by the loan committee currently comprised of Chairman Partynski, President Stevens, Director Bucz and Chief Lending Officer Neil Christensen and ratified by the full Board of Directors.

            The Bank requires title insurance or other evidence of title on its mortgage loans, as well as fire and extended coverage casualty insurance in amounts at least equal to the principal amount of the loan or the value of improvements on the property, depending on the type of loan. The Bank also

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requires flood insurance to protect the property securing its interest when the property is located in a flood plain.

























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            Loan Portfolio Composition. The following table sets forth the composition of the Bank's loan portfolio in dollar amounts and in percentages (before deductions (or additions) for loans in process, deferred fees (premiums) and discounts and allowances for losses) as of the dates indicated.

December 31,
2003
 2002
 2001
 2000
 1999
Amount
 Percent
 Amount
 Percent
 Amount
 Percent
 Amount
 Percent
 Amount
 Percent
                                                                        (Dollars in Thousands)
Real Estate Loans:
One- to four-family(1)             $108,091 79.42% $112,006 75.87% $122,608 78.30% $123,372 79.66% $ 91,505 78.03%
Multi-family             18,748 13.78 27,730 18.78 27,330 17.46    24,430 15.77    21,031 17.94   
Commercial                      151
       .11
          192
        .13
          379
       .24
   		          430
       .28
   		        181
     .15
   
        Total real estate loans             126,990 93.31 139,928 94.78 150,317 96.00    148,232 95.71    112,717 96.12   
Consumer loans:
Deposit account             103 .08 82 .06 78 .05    150 .10    114 .10   
Automobile             61 .04 136 .09 227 .15    358 .23    265 .23   
Home equity                   8,945
     6.57
       7,491
     5.07
       5,952
     3.80
   		       6,137
     3.96
   		     4,164
    3.55
   
        Total consumer loans                   9,109
     6.69
       7,709
        5.22
       6,257
     4.00
   		       6,645
     4.29
   		     4,543
    3.88
   
        Total loans             136,099 100.00% 147,637 100.00% 156,574 100.00% 154,877 100.00% 117,260 100.00%
Less:
Deferred costs             525 768 868 913 533
Allowance for losses                   (969)
       (969)
       (969)
       (969)
       (795)
        Total loans receivable, net             $135,655
 $147,436
 $156,473
 $154,821
 $116,998

(1)   Including loans held for sale.





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            The following table shows the composition of the Bank's loan portfolio by fixed- and adjustable-rate at the dates indicated.

December 31,
2003
 2002
 2001
 2000
 1999
Amount
 Percent
 Amount
 Percent
 Amount
 Percent
 Amount
 Percent
 Amount
 Percent
                                                                                                                                    (Dollars in Thousands)
Fixed-Rate Loans:
Real estate:
One- to four-family (1)             $103,501 76.05% $105,556 71.50% $111,640 71.30% $107,612 69.48% $82,993 70.78%
Multi-family             18,748 13.78    27,730 18.78    27,330 17.46    24,430 15.77    21,031 17.94   
Commercial                      151
       .11
   		           192
       .13
   		          379
       .24
   		          430
       .28
   		          181
       .15
   
Total real estate loans             122,400 89.94    133,478 90.41    139,349 89.00    132,472 85.53    104,205 88.87   
Consumer                   9,109
     6.69
   		        7,709
     5.22
   		       6,257
     4.00
   		       6,645
     4.29
   		 4,543
     3.87
   
Total fixed-rate loans             131,509 96.63    141,187 95.63    145,606 93.00    139,117 89.82    108,748 92.74   
Adjustable-Rate Loans   
Real estate:
One-to four-family                   4,590
     3.37
   		        6,450
     4.37
   		     10,968
     7.00
   		     15,760
 10.18
   		     8,512
     7.26
   
Total adjustable rate loans                   4,590
     3.37
   		        6,450
     4.37
   		     10,968
     7.00
   		     15,760
 10.18
   		     8,512
     7.26
   
Total loans             136,099 100.00% 147,637 100.00% 156,574 100.00% 154,877 100.00% 117,260 100.00%
Less:
Deferred fees and discounts             525 768 868 913 533
Allowance for losses                   (969)
       (969)
       (969)
        (969)
        (795)
Total loans receivable, net             $135,655
 $147,436
 $156,473
 $154,821
 $116,998

(1)   Including loans held for sale.


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            The following schedule illustrates the contractual maturity of the Bank's loan portfolio at December 31, 2003. Mortgages which have adjustable or renegotiable interest rates are shown as maturing in the period during which the contract is due. The schedule does not reflect the effects of possible prepayments or enforcement of due-on-sale clauses.

Real Estate
One- to four-family(2)
 Multi-family and
Commercial Real
Estate
 Consumer
 Total
Amount
 Weighted
Average
Rate
 Amount
 Weighted
Average
Rate
 Amount
 Weighted
Average
Rate
 Amount
 Weighted
Average
Rate
(Dollars in Thousands)
Due During Year(s) Ended
December 31,
2004(1)             $    2,284 4.86% $    352 7.17% $6,875 4.00% $    9,511 4.32%
2005 and 2006             1,637 6.40    688 7.90    197 7.64    2,522 6.91   
2007 to 2011             20,182 5.86    5,829 6.48    910 6.85    26,921 6.02   
2012 to 2026             57,045 5.61    12,030 6.99    1,127 6.33    70,202 5.86   
2027 and following     26,943
 6.36    ---
 ---    ---
 ---    26,943
 6.36   
    Total             $108,091
 $18,899
 $9,109
 $136,099

_____________
(1) Included demand loans, loans having no stated maturity and overdraft loans.
(2) Includes loans held for sale.


            The total amount of loans due after December 31, 2004 which have predetermined interest rates is $124.1 million while the total amount of loans due after such dates which have floating or adjustable interest rates is $2.5 million.

            One- to Four-Family Residential Real Estate Lending. The cornerstone of the Bank's lending program is the origination of loans secured by mortgages on owner-occupied one- to four-family residences. Substantially all of the Bank's one- to four-family residential mortgage originations are secured by properties located in the Bank's market area.

            The Bank currently offers fixed-rate mortgage loans with maturities from 10 to 30 years. The Bank also offers a fixed rate seven year balloon product with a 30 year amortization schedule which is due in seven years but which, under certain circumstances, may be converted into a fully amortizing fixed rate loan for an additional term of up to 23 years. Interest rates and fees charged on these fixed-rate loans are established on a regular basis according to market conditions. As of December 31, 2003, the Bank had $16.6 million of fixed rate loans (most of which were seven year balloon loans) with contractual terms of less than 10 years, $57.8 million of fixed rate loans with contractual terms of 10-15 years and $29.0 million of fixed rate loans with contractual terms of more than 15 years.

            The Bank also offers ARMs which carry interest rates which adjust annually at a margin (generally 2.875%) over the yield on the One Year Average Monthly U.S. Treasury Constant Maturity Index ("one year CMT"). Such loans may carry terms to maturity of up to 30 years. The ARM loans currently offered by the Bank provide for up to 200 basis point annual interest rate change cap and a lifetime cap generally of up to 600 basis points over the initial rate. Initial

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interest rates offered on the Bank's ARMs may be approximately 100 basis points below the fully indexed rate, although borrowers are qualified at the fully indexed rate. As a result, the risk of default on these loans may increase as interest rates increase. The Bank also originates ARMs which carry interest rates which are fixed for an initial term of up to five years and subsequently adjust annually to a margin over the one-year CMT. The Bank's ARMs do not permit negative amortization of principal, do not contain prepayment penalties and may be convertible into fixed-rate loans. At December 31, 2003 one- to four-family ARMs totaled $4.6 million, or 3.4% of the Bank's total loan portfolio.

            Hemlock Federal will generally lend up to 95% of the lesser of the sales price or appraised value of the security property on owner occupied one- to four-family loans. The loan-to-value ratio on non-owner occupied, one- to four-family loans is generally 80% of the lesser of the sales price or appraised value of the security property. Non-owner occupied one- to four-family loans may pose a greater risk of default to the Bank than traditional owner occupied one- to four-family loans. In underwriting one- to four-family residential real estate loans, the Bank currently evaluates both the borrower's ability to make principal, interest and escrow payments, the value of the property that will secure the loan and debt to income ratios.

            Residential loans do not currently include prepayment penalties, are non-assumable and do not produce negative amortization. Although the Bank originates mortgage loans primarily for its portfolio, the Bank's loans are generally underwritten to permit their sale in the secondary market.

            While the Bank seeks to originate most of its one- to four-family residential loans in amounts which are less than or equal to the applicable Federal Home Loan Mortgage Corporation maximum (currently $333,700), the Bank does, on an exceptional basis, make one- to four-family residential loans in amounts in excess of such maximum. The Bank's delinquency experience on such loans has been similar to its experience on its other residential loans.

            The Bank's residential mortgage loans customarily include due-on-sale clauses giving the Bank the right to declare the loan immediately due and payable in the event that, among other things, the borrower sells or otherwise disposes of the property subject to the mortgage and the loan is not repaid.

            Multi-family and Commercial Real Estate Lending.   In order to increase the yield of its loan portfolio and to complement residential lending opportunities, the Bank originates permanent multi-family real estate loans secured by properties in its primary market area. At December 31, 2003, the Bank had multi-family loans totaling $18.7 million, or 13.8% of the Bank's total loan portfolio, and $151,000 in commercial real estate loans, representing 0.1% of the total loan portfolio.

            The Bank's permanent multi-family real estate loans generally carry a maximum term of 15 years and have fixed rates. These loans are generally made in amounts of up to 80% of the lesser of the appraised value or the purchase price of the property. Appraisals on properties securing multi-family and commercial real estate loans are performed by an independent appraiser designated by the Bank at the time the loan is made. All appraisals on multi-family real

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estate loans are reviewed by the Bank's loan committee. In addition, the Bank's underwriting procedures require verification of the borrower's credit history, income and financial statements, banking relationships, references and income projections for the property. The Bank obtains personal guarantees on these loans.

            At December 31, 2003, the Bank's largest multi-family loan outstanding totaled $527,507 secured by a six-unit multi-family dwelling located in Chicago Ridge, Illinois. At such date, this loan was performing in accordance with its terms.

            Multi-family and commercial real estate loans may present a higher level of risk than loans secured by one- to four-family residences. This greater risk is due to several factors, including the concentration of principal in a limited number of loans and borrowers, the effects of general economic conditions on income producing properties and the increased difficulty of evaluating and monitoring these types of loans. While the Bank has experienced losses on several multi-family and commercial real estate loans in the past, as of December 31, 2003, there were no multi-family loans or commercial real estate loans delinquent 90 days or more.

            Consumer Lending. Management believes that offering consumer loan products helps to expand the Bank's customer base and to create stronger ties to its existing customer base. In addition, because consumer loans generally have shorter terms to maturity and carry higher rates of interest than do residential mortgage loans, they can be valuable asset/liability management tools. The Bank originates a variety of different types of consumer loans, including home equity loans, automobile and deposit account loans for household and personal purposes. Due to the tax advantages to the borrower of home equity loans and the low interest rate environment, the Bank has focused its recent consumer lending activities on home equity lending. At December 31, 2003 consumer loans totaled $9.1 million or 6.7% of total loans outstanding.

            Consumer loan terms vary according to the type and value of collateral, length of contract and creditworthiness of the borrower. The Bank's consumer loans are made at both fixed and adjustable interest rates, with terms of up to 10 years.

            The Bank's home equity loans are written so that the total commitment amount, when combined with the balance of the first mortgage lien, may not exceed 90% of the appraised value of the property or $100,000. These loans are written with fixed terms of up to 10 years and carry fixed interest rates. At December 31, 2003, the Bank's home equity loans totaled $8.9 million, or 6.6% of the Bank's total loan portfolio. In 1998 the Bank also began offering home equity lines of credit to qualifying borrowers. These loans, when combined with the balance of a first mortgage lien, may not exceed 90% if the first mortgage lien is held by the Bank, or 80% if the first mortgage lien is held elsewhere, or in either case $100,000. At December 31, 2003, the Bank's home equity lines of credit totaled $6.7 million outstanding, or 4.9% of the Bank's total loan portfolio.

            The underwriting standards employed by the Bank for consumer loans include a determination of the applicant's payment history on other debts and ability to meet existing obligations and payments on the proposed loan. Although creditworthiness of the applicant is of primary consideration, the underwriting process also includes a comparison of the value of the

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security, if any, in relation to the proposed loan amount. Consumer loans may entail greater credit risk than do residential mortgage loans, particularly in the case of consumer loans which are unsecured or are secured by rapidly depreciable assets, such as automobiles. In such cases, any repossessed collateral for a defaulted consumer loan may not provide an adequate source of repayment of the outstanding loan balance as a result of the greater likelihood of damage, loss or depreciation. In addition, consumer loan collections are dependent on the borrower's continuing financial stability, and thus are more likely to be affected by adverse personal circumstances. Furthermore, the application of various federal and state laws, including bankruptcy and insolvency laws, may limit the amount which can be recovered on such loans.

Originations of Loans

            Real estate loans are originated by Hemlock Federal's staff, including commissioned loan officers, through referrals from existing customers or real estate agents. The Bank's ability to originate loans is dependent upon customer demand for loans in its market and to a limited extent, various marketing efforts and the Bank's ability to hire commissioned loan officers. Demand is affected by both the local economy and the interest rate environment. See "- Market Area." Under current policy, all fixed rate loans are evaluated for sale on a quarter-by-quarter basis. See "Management's Discussion and Analysis of Financial Condition and Results of Operations - Quantitative and Qualitative Disclosures About Market Risk" in the Annual Report attached hereto as Exhibit 13.

            In order to supplement loan originations, the Bank has acquired mortgage-backed and other securities which are held, depending on the investment intent, in the "held-to-maturity" or "available-for-sale" portfolios. See "Investment Activities - Mortgage-Backed and Related Securities." In addition, depending on market conditions, the Bank may also consider the purchase of residential loans from other lenders.













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            The following table shows the loan origination and repayment activities of the Bank for the periods indicated.

Year Ended
December 31,
2003
 2002
 2001
(In Thousands)
Originations by type:
Adjustable rate:
Real estate - one- to four-family 644 758 $ 1,259
                     - multi-family                       ---
        ---
          ---
       Total adjustable-rate             644 758 1,259
Fixed rate:
Real estate - one- to four-family             47,463 38,479 41,234
                     - multi-family             7,966 6,003 6,987
Non-real estate - consumer                 6,983
     6,533
     5,363
       Total fixed-rate                62,412
 51,015
 53,584
          Total loans originated             63,056 51,773 54,843
Loans acquired             --- --- ---
Sales:
Real estate - one- to four-family             (1,515) (3,372) (14,900)
Principal repayments             (73,079)
 (57,338)
 (38,249)
       Total reductions             (74,594) (60,710) (53,149)
Increase (decrease) in other items, net                    (243)
       (100)
        (42)
       Net increase (decrease)             $(11,781)
 $ (9,037)
 $ 1,652


Delinquencies and Non-Performing Assets

            Delinquency Procedures. When a borrower fails to make a required payment on a loan, the Bank attempts to cure the delinquency by contacting the borrower. Generally, Bank personnel work with the delinquent borrower on a case by case basis to solve the delinquency. Generally, a late notice is sent on all delinquent loans followed by a phone call after the thirtieth day of delinquency. Additional written and verbal contacts may be made with the borrower between 30 and 60 days after the due date. If the loan is contractually delinquent for 90 days, the Bank may institute appropriate action to foreclose on the property. After 120 days, foreclosure procedures are initiated. If foreclosed, the property is sold at public sale and may be purchased by the Bank.

            Real estate acquired by Hemlock Federal as a result of foreclosure or by deed in lieu of foreclosure is classified as real estate owned until it is sold. When property is acquired by foreclosure or deed in lieu of foreclosure, it is recorded at the lower of cost or fair value less estimated selling costs. After acquisition, all costs incurred in maintaining the property are expensed. Costs relating to the development and improvement of the property, however, are capitalized.


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            Delinquent Loans. The following table sets forth information concerning delinquent mortgage and other loans at December 31, 2003. The amounts presented represent the total remaining principal balances of the related loans, rather than the actual payment amounts which are overdue.


Real Estate
One- to four-family(1)
 Commercial/Multi-Family
 Consumer and Other
 Total
Number
 Amount
 Percent
 Number
 Amount
 Percent
 Number
 Amount
 Percent
 Number
 Amount
 Percent
(Dollars in Thousands)
Loans delinquent for:
December 31, 2003:
30-59 days             19 $1,461 83.39% --- $    --- ---% 11 $359 100.00% 30 $1,820 86.22%
60-89 days             --- --- ---    --- --- ---    --- --- ---    --- --- ---   
90 days and over                 2
     291
 16.61   
    ---
       ---
     ---   
    ---
     ---
        ---   
     2
     291
 13.78   
    Total             21
 $1,752
 100.00%
    ---
 $    ---
     ---%
    11
 $359
 100.00%
 32
 $2,111
 100.00%

(1) Includes loans held for sale.









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            Classification of Assets. Federal regulations require that each savings institution classify its own assets on a regular basis. In addition, in connection with the examinations of savings institutions, OTS and FDIC examiners have authority to identify problem assets and, if appropriate, require them to be classified. There are three classifications for problem assets: Substandard, Doubtful and Loss. Substandard assets have one or more defined weaknesses and are characterized by the distinct possibility that the Bank will sustain some loss if the deficiencies are not corrected. Assets classified as Doubtful have the weaknesses of Substandard assets, with the additional characteristics that the weaknesses make collection or liquidation in full on the basis of currently existing facts, conditions and values questionable, and there is a high possibility of loss. An asset classified Loss is considered uncollectible and of such little value that continuance as an asset on the balance sheet of the institution is not warranted. Assets classified as Substandard or Doubtful require the institution to establish prudent general allowances for loan losses. If an asset or portion thereof is classified as a loss, the institution charges off such amount against the loan loss allowance. If an institution does not agree with an examiner's classification of an asset, it may appeal this determination to the District Director of the OTS.

            On the basis of management's review of its assets, at December 31, 2003, the Bank had classified a total of $291,000 of its loans and other assets as follows:

December 31,
2003
(In Thousands)
Special Mention $291
Substandard     ---
Doubtful     ---
Loss     ---
    Total $291
General loss allowance $969
Specific loss allowance     ---
Charge-offs     ---









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            Non-Performing Assets. The table below sets forth the amounts and categories of non-performing assets in the Bank's loan portfolio. Foreclosed assets include assets acquired in settlement of loans.

December 31,
2003
 2002
 2001
(Dollars in Thousands)
Non-accruing loans:
    One- to four-family 291 415 $588
    Multi-family --- --- ---
    Commercial real estate --- --- ---
    Construction or development --- --- ---
   Consumer     ---
     ---
     ---
       Total 291 415 588
Accruing loans delinquent more than 90 days:
   One- to four-family --- --- ---
    Multi-family --- --- ---
    Commercial real estate --- --- ---
    Construction or development --- --- ---
    Consumer     ---
     ---
     ---
       Total --- ---    ---
Foreclosed assets:
    One- to four-family --- --- ---
    Multi-family --- --- ---
    Commercial real estate --- --- ---
   Construction or development --- --- ---
    Consumer     ---
     ---
     ---
       Total --- ---    ---
Renegotiated loans     ---
     ---
     ---
Total non-performing assets $ 291
 $ 415
 $ 588
Total as a percentage of total assets;    .09%
    .13%
    .20%


            For the years ended December 31, 2003 and 2002, gross interest income which would have been recorded had the non-accruing loans been current in accordance with their original terms amounted to $20,887 and $28,736, respectively. The amounts that were included in interest income on such loans were $14,769 and $19,965 for the years ended December 31, 2003 and 2002, respectively.

            Management considers the Bank's non-performing and "of concern" assets in establishing its allowance for loan losses.






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            The following table sets forth an analysis of the Bank's allowance for loan losses.

Year Ended December 31,
2003
 2002
 2001
(Dollars in Thousands)
Balance at beginning of period $969    $969    $969   
Charge-offs:
    One- to four-family ---    ---    ---   
    Multi-family ---    ---    ---   
   Commercial real estate ---    ---    ---   
    Consumer    ---
   		    ---
   		    ---
   
   ---
   		    ---
   		    ---
   
Recoveries:
    One- to four-family ---    ---    ---   
    Multi-family ---    ---    ---   
    Commercial real estate ---    ---    ---   
    Consumer    ---
   		    ---
   		 ---
   
   ---
   		    ---
   		 ---
   
Net charge-offs ---    ---    ---   
Additions charged to operations    ---
    		   ---
    		    ---
   
Balance at end of period $969   
 $969   
 $969   
Ratio of net charge-offs (recoveries) during
   the period to average loans outstanding
   during the period            

   ---%

   ---%

   ---%
Ratio of net charge-offs (recoveries) during
   the period to average non-performing assets
   ---%
   ---%
   ---%






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            The distribution of the Bank's allowance for losses on loans at the dates indicated is summarized as follows:

December 31,
2003
 2002
 2001
Amount
of loan
loss
Allowance
 Loan
Amounts
by
Category
 Percent
of loans
in Each
Category
of Total
Loans
 Amount
of loan
loss
Allowance
 Loan
Amounts
by
Category
 Percent
of loans
in Each
Category
of Total
Loans
 Amount
of loan
loss
Allowance
 Loan
Amounts
by
Category
 Percent
of loans
in Each
Category
of Total
Loans
(In Thousands)
One- to four-family(1) $323 $108,091 79.42% $225 $112,006 75.87% $245 $122,608 78.30%
107 18,748 13.78    277 27,730 18.78    273 27,330 17.46   
Commercial real estate 1 151 .11    6 192 .13    12 379 .24   
Consumer             113 9,109 6.69    23 7,709 5.22    19 6,257 4.00   
Unallocated 425
           ---
        ---   
 438
           ---
        ---   
 420
           ---
        ---   
    Total $969
 $136,099
 100.00%
 $969
 $147,637
 100.00%
 $969
 $156,574
 100.00%

(1) Includes loans held for sale.


            The Bank recognizes that credit losses will be experienced and the risk of loss will vary with, among other things, general economic conditions; the type of loan being made; the creditworthiness of the borrower over the terms of the loan; and in the case of a collateralized loan, the quality of the collateral for such loan. The allowance for losses represents the Bank's estimate of the allowance necessary to provide for probable incurred losses in the portfolio. In making this determination, the Bank analyzes the ultimate collectibility of the loans in its portfolio, incorporating feedback provided by internal loan staff and information provided by examinations performed by regulatory agencies. The Bank makes an ongoing evaluation as to the adequacy of the allowance for loan losses.

            On a quarterly basis, management of the Bank meet to review the adequacy of the allowance for loan losses. Individual credits are graded. The grading system is in compliance with the regulatory classifications and the allowance is allocated to the loans based on the regulatory grading, except in instances where there are known differences (i.e., collateral value is nominal, etc.).

            The analysis of the allowance for loan losses is comprised of three components: specific credit allocation, general portfolio allocation, and subjective determined allocation. The specific credit allocation includes a detailed review of the credit in accordance with SFAS 114 and 118 and an allocation is made based on this analysis. The general portfolio allocation consists of an assigned reserve percentage based on the credit rating of the loan. The subjective portion of the allowance is influenced by current economic conditions and trends in the portfolio including delinquencies and impairments, as well as changes in the composition of the portfolio.

            The allowance for loan losses is based on estimates, and ultimate losses will vary from current estimates. These estimates are reviewed monthly, and as adjustments, either positive or negative, become necessary, a corresponding increase or decrease is made in the provision for loan losses. The methodology used to determine the amount of the allowance for loan losses is consistent with prior years.


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Investment Activities

            General. Hemlock Federal must maintain minimum levels of investments and other assets that qualify as liquid assets under OTS regulations to ensure Hemlock Federal's safe and sound operation. Liquidity may increase or decrease depending upon the availability of funds and comparative yields on investments in relation to the return on loans. Historically, Hemlock Federal has maintained liquid assets at levels believed adequate to meet the requirements of normal operations, including potential deposit outflows. At December 31, 2003, Hemlock Federal's liquidity ratio was 17.4%.

            Generally, the investment policy of Hemlock Federal is to invest funds among categories of investments and maturities based upon the Bank's asset/liability management policies, investment quality, loan and deposit volume, liquidity needs and performance objectives. As required by Statement of Financial Accounting Standard No. 115, securities are classified into three categories: trading, held-to-maturity and available-for-sale. Securities that are bought and held principally for the purpose of selling them in the near term are classified as trading securities and are reported at fair value with unrealized gains and losses included in trading account activities in the statement of operations. Securities that Hemlock Federal has the positive intent and ability to hold to maturity are classified as held-to-maturity and reported at amortized cost. All other securities not classified as trading or held-to-maturity are classified as available-for-sale. At December 31, 2003, Hemlock Federal had no securities that were classified as trading, and had $61.5 million of mortgage-backed and related securities and $18.5 million of other securities classified as held-to-maturity. Available- for-sale securities are reported at fair value with unrealized gains and losses included, on an after-tax basis, in a separate component of retained earnings. At December 31, 2003, $29.2 million of mortgage-backed and related securities and $36.2 million of other securities were classified as available-for-sale.

            Mortgage-Backed and Related Securities. In order to supplement its lending activities and achieve its asset liability management goals, the Bank invests in mortgage-backed and related securities. As of December 31, 2003, all of the mortgage-backed and related securities owned by the Bank are issued, insured or guaranteed either directly or indirectly by a federal agency or are rated "AAA" by a nationally recognized credit rating agency. However, it should be noted that, while a (direct or indirect) federal guarantee or a high credit rating may indicate a high degree of protection against default, they do not indicate that the securities will be protected from declines in value based on changes in interest rates or prepayment speeds.

            Consistent with its asset/liability management strategy, at December 31, 2003, $37.1 million, or 40.9% of Hemlock Federal's mortgage-backed and related securities had adjustable or floating interest rates. In addition, as discussed below, as of the same date, the Bank had $7.4 million of fixed rate collateralized mortgage obligations ("CMOs") with anticipated average lives of five years or less.

            The Bank's CMOs are securities derived by reallocating the cash flows from mortgage-backed securities or pools of mortgage loans in order to create multiple classes, or tranches, of securities with coupon rates and average lives that differ from the underlying collateral as a

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whole. The terms to maturity of any particular tranche is dependent upon the prepayment speed of the underlying collateral as well as the structure of the particular CMO. Although a significant proportion of the Bank's CMOs are interests in tranches which have been structured (through the use of cash flow priority and "support" tranches) to give somewhat more predictable cash flows, the cash flow and hence the value of CMOs is subject to change.

            The Bank invests in CMOs as an alternative to mortgage loans and conventional mortgage-backed securities as part of its asset/liability management strategy. Management believes that CMOs represent attractive investment alternatives relative to other investments due to the wide variety of maturity and repayment options available through such investments. In particular, the Bank has from time to time concluded that short and intermediate duration CMOs (five years or less average life) often represent a better combination of rate and duration than adjustable rate mortgage-backed securities.

            The following table sets forth the composition of the Bank's mortgage-backed securities at the dates indicated.

December 31,
2003
 2002
 2001
Carrying
Value
 % of
Total
 Carrying
Value
 % of
Total
 Carrying
Value
 % of
Total
(Dollars in Thousands)
Mortgage-backed securities
   held-to- maturity:
    GNMA $16,658 18.37% $22,454 23.37% $19,419 26.88%
   FNMA 31,788 35.06 22,647 23.57 17,054 23.61
    FHLMC 7,766 8.56 6,942 7.22 4,874 6.75
    CMOs     5,302
     5.85
 20,254
 21.08
 10,518
 14.56
61,514 67.84 72,297 75.24 51,865 71.80
Mortgage-backed securities
    available-for- sale:
    FNMA 13,260 14.62 14,107 14.68 3,759 5.20
    FHLMC 4,208 4.64 1,056 1.10 1,383 1.92
    CMOs 4,965 5.48 8,625 8.98 15,229 21.08
    GNMA     6,732
     7.42
          ---
          ---
          ---
          ---
29,165
 32.16
 23,788
 24.76
 20,371
 28.20
Total mortgage-backed
   securities		 $90,679
 100.00%
 $96,085
 100.00%
 $72,236
 100.00%






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            The following table sets forth the contractual maturities of the Bank's mortgage-backed securities at December 31, 2003.

Due in
 December 31,
2003
6 Months
or Less
6 Months
to 1 Year
 1 to
3 Years
3 to 5
Years
5 to 10
Years
10 to 20
Years
 Over 20
Years
 Amortized
Cost
Carrying
Value
(In Thousands)
Federal Home Loan Mortgage Corporation $ --- $ --- $ 98 $ 204 $    97 $10,217 $ 1,276 $11,892 $11,974
Federal National Mortgage Association --- --- --- 21 2,304 16,591 25,891 44,807 45,048
Government National Mortgage Association 3 --- --- --- 51 5,024 18,439 23,517 23,390
CMOs     ---
     ---
     ---
 1,779
        ---
     1,013
     7,408
 10,200
 10,267
    Total $    3
 $ ---
 $ 98
 $2,004
 $2,452
 $32,845
 $53,014
 $90,416
 $90,679
Weighted average yield 10.00% ---% 8.57% 2.85% 6.92% 5.70% 5.11% 5.33% 5.33%










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            As of December 31, 2003, the Bank did not have any mortgage-backed securities in excess of 10% of retained earnings except for FNMA, FHLMC and GNMA issues, amounting to $45.0 million, $12.0 million and $23.4 million, respectively.

            The market values of a portion of the Bank's mortgage-backed securities held-to-maturity have been from time to time lower than their carrying values. However, for financial reporting purposes, such declines in value are considered to be temporary in nature since they have been due to changes in interest rates rather than credit concerns.

            The following table shows mortgage-backed securities purchase, sale and repayment activities of the Bank for the periods indicated.

Year Ended
December 31,
2003
 2002
 2001
(In Thousands)
Purchases:
    Adjustable-rate $12,995 $23,761 $13,045
    Fixed-rate 39,237 16,682 5,268
    CMOs 22,188
 14,152
 16,732
         Total purchases 74,420 54,595 35,045
Sales:
   Adjustable-rate --- --- ---
    Fixed-rate --- --- ---
    CMOs          ---
          ---
    2,347
          Total sales --- --- 2,347
    Principal repayments (80,057) (31,144) (28,103)
    Discount/premium net change 545 311 701
   Fair value net change       (314)
          87
       487
         Net increase (decrease) $ (5,406)
 $23,849
$ 5,783



            The Bank continues to maintain a moderate portion of its assets in mortgage-backed securities, although in recent years the percentage of such securities to total assets has decreased. Since pass-through mortgage-backed securities generally carry a yield approximately 50 to 100 basis points below that of the corresponding type of residential loan (due to the implied federal agency guarantee fee and the retention of a servicing spread by the loan servicer), and the Bank's CMOs and REMICs also carry lower yields (due to the implied federal agency guarantee and because such securities tend to have shorter actual durations than 30 year loans), in the event that the proportion of the Bank's assets consisting of mortgage-backed and related securities increases, the Bank's asset yields could be somewhat adversely affected. The Bank will evaluate mortgage-backed and related securities purchases in the future based on its asset/liability objectives, market conditions and alternative investment opportunities.


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

            In order to complement its lending and mortgage-backed securities investment activities and to increase its holding of short and medium term assets, the Bank invests in liquid investments and in high-quality investments, such as U.S. Treasury and agency obligations. At December 31, 2001, the Bank's securities portfolio totaled $5.2 million. Equity securities at December 31, 2003 includes approximately $18.2 million in mutual funds invested primarily in short-term government obligations and pools of adjusted rate mortgage loans.

            The following table sets forth the composition of the Bank's securities and other earning assets at the dates indicated.

December 31,
2003
 2002
 2001
Carrying
Value
 % of
Total
 Carrying
Value
 % of
Total
 Carrying
Value
 % of
Total
(Dollars in Thousands)
Securities held-to-maturity:
    Federal agency obligations $18,472 100.00% $ 5,147 100.00% $ 4,402 100.00%
Securities available-for sale:
    Federal agency obligations        ---
        ---
        ---
           ---
        ---
        ---
   
       Total securities $18,472
 100.00%
 $5,147
 100.00%
 $4,402
 100.00%
Average remaining life of securities: 7 years 6 years 7 years