Heritage Financial Group, Inc., the holding company for HeritageBank of the South, today announced unaudited financial results for the quarter ended June 30, 2012. Highlights of the Company's results for the second quarter 2012 include:

• Net income of $1.4 million or $0.17 per diluted share compared with a net loss of $481,000 or $0.06 per diluted share for the second quarter of 2011;
• Excluding special items for each quarter, net income was $1.4 million or $0.17 per diluted share for 2012 versus a net loss of $96,000 or $0.01 per diluted share for 2011 (see reconciliation of non-GAAP items);
• The successful completion of a previously announced branch acquisition in Auburn, Alabama, adding $12.2 million in loans and $18.7 million in deposits;
• Loan growth for the quarter, excluding loans acquired through FDIC-assisted acquisitions, of $51.7 million or 11%;
• A decrease in loans acquired through FDIC-assisted acquisitions of $10.3 million or 9% for the quarter;
• An increase in provision for non-FDIC acquired loan losses of $50,000 to $750,000 for the second quarter of 2012 compared with the same quarter for 2011;
• Provision expense of $341,000 for FDIC-acquired loan losses;
• A decrease in net charge-offs to 0.23% for the second quarter of 2012 compared with 0.26% for the second quarter of 2011 and 0.24% for the first quarter of 2012; and
• A decline in nonperforming assets (NPAs) to total assets, excluding assets acquired in FDIC-assisted acquisitions, to 1.08% at the end of the second quarter of 2012 from 1.17% at the end of the second quarter of 2011 and 1.27% at the end of the first quarter of 2012.

Commenting on the results, Leonard Dorminey, President and Chief Executive Officer, said, "We are pleased to report continued improvement in our operating results, which reflect the impact of significant organic loan growth, successful expense management efforts, and ongoing acquisition and expansion activities. Noninterest expense declined on a linked-quarter basis and has remained essentially level for three consecutive quarters, illustrating our commitment to expense management. Regarding acquisitions, we were pleased to complete our previously announced acquisition during the quarter of a branch in Auburn, Alabama, marking our entry into another growth market to further expand our franchise."

In closing, Dorminey added, "Over the past few years, our company has experienced significant growth and has invested heavily in our infrastructure to support expansion and capitalize on emerging opportunities across our market footprint. At this point, with a strong leadership team in place to pursue these dual objectives, we continue to increase our focus on creating efficiencies in our operations and managing our expenses in light of our customers' needs and prevailing business conditions. Accordingly, we are pleased to see that noninterest expense has stabilized, and we remain committed in our efforts to further reduce these expenses across the Company in coming quarters to enhance the Company's performance and build stockholder value, without compromising our commitment to maintaining what we believe is the best customer service in our markets."

Expense Management Initiatives

In the second half of 2012, the Company will pursue several expense management initiatives. Among these, the Company has offered an early retirement program to certain employees. It is expected that the one-time pre-tax cost of this early retirement program will be between $500,000 and $800,000 in the third quarter; however, the Company expects to realize annual savings of approximately $500,000 to $800,000 per year as a result. The Company also is terminating its Director’s and Supplemental Executive Retirement Plans. Under these plans, the current participants are fully vested in their benefits.

Additionally, the Company plans to close two branches that it acquired in FDIC-assisted acquisitions. The Company intends to close its branch in Collins, Georgia, which was acquired as part of the acquisition of The Tattnall Bank in 2009, and its branch in Guyton, Georgia, which was acquired as part of the acquisition of the Citizens Bank of Effingham in 2011. Combined, these branches have loans of approximately $5 million and deposits of $13 million. The Company expects that it will not experience a material reduction in customer relationships in these areas and will seek to service these customers from nearby branches. The Company expects these branches to close in the fourth quarter of 2012, subject to customary regulatory conditions, and anticipates expense savings of approximately $500,000 per year related to these closures.

Capital Initiatives

The Company's estimated total risk-based capital ratio at June 30, 2012, was 19.6%, significantly exceeding the required minimum of 10% to be considered a well-capitalized institution. The ratio of tangible common equity to total tangible assets was 11.2% as of June 30, 2012.

Looking ahead, the Company intends to maintain its capital strength at the current level to support growth and its acquisition activities. Accordingly, stock buybacks and dividend growth in the future will reflect largely the Company's future earnings power, rather than a return of capital to stockholders.

During the second quarter of 2012, the Company repurchased approximately 179,000 shares under its stock repurchase programs. The program expiring in July 2012 has been completed, and the program, expiring in December 2012 unless extended or otherwise completed, has a remaining authorization to repurchase approximately 260,000 shares.

Second Quarter 2012 Results of Operations

The Company reported net income of $1.4 million or $0.17 per diluted share for the second quarter in 2012 compared with a net loss of $481,000 or $0.06 per diluted share for the second quarter in 2011. However, the Company's results for the second quarters of 2012 and 2011 included special items that affect comparability. Results for the second quarter of 2012 included net non-recurring expenses of $23,000, net of tax, while the results of the year-earlier quarter included net non-recurring expenses of $385,000, net of tax. Excluding these special items, the Company's adjusted net income for the second quarter of 2012 was $1.4 million or $0.17 per diluted share compared with a net loss of $96,000 or $0.01 per diluted share for the second quarter of 2011 (see reconciliation of non-GAAP items).

The $1.8 million improvement in reported earnings was primarily the result of the following items:

• Improved net interest income of $3.7 million due to growth in interest-earning assets and a reduction in the cost of interest-bearing deposits;
• Increased noninterest income of $119,000, driven by improvements in mortgage banking fees of $314,000, bankcard services income of $157,000 and bargain purchase gains of $151,000, partially offset by reductions in the gain on sale of securities of $426,000 and in the accretion for the FDIC loss-share receivable of $138,000; offset by
• Increased noninterest expense of $634,000, primarily due to higher salaries and employment benefits of $537,000 and increased equipment and occupancy expense of $279,000 and $152,000, respectively, driven by the acquisition-related hiring of an additional 24 full-time equivalent employees, as well as growth in most other noninterest expense categories, and offset in part by reduced acquisition-related expenses of $405,000;
• Increased provision expense for non-FDIC-acquired loan losses of $50,000, driven by organic loan growth;
• Increased provision expense for FDIC-acquired loan losses of $341,000, driven by the resolution of those assets, which did not increase the allowance for loan losses.

Net interest income for the second quarter of 2012 increased 58% to $10.1 million from $6.4 million in the year-earlier quarter, primarily reflecting an increase in interest-earning assets related to both acquisitions and organic growth and a reduction in the cost of interest-bearing deposits. The Company's net interest margin was 4.75% for the second quarter of 2012, an increase of 26 basis points over 4.49% on a linked-quarter basis and 139 basis points over 3.36% in the year-earlier period. The improvement in the second quarter of 2012 net interest margin on a linked-quarter basis was driven by an increase in loan yields on the Company's FDIC-assisted loan portfolios, coupled with a decline in the cost of interest-bearing deposits as rates continue to reset to lower levels.

In the second quarter of 2012, the Company continued to achieve loan growth, with its loan portfolio increasing $40.7 million organically on a linked-quarter basis and advancing $74.3 million overall compared with the year-earlier quarter. For the second quarter of 2012, the Company's loan portfolio, including loans acquired through FDIC-assisted acquisitions, totaled $605.0 million, which increased $42.4 million on a linked-quarter basis. Total deposits stood at $860.3 million at the end of the second quarter of 2012, down 1% or $8.4 million on a linked-quarter basis from $868.7 million, primarily reflecting a planned runoff of time deposits.

Accounting for FDIC-Assisted Loans

The Company performs ongoing assessments of the estimated cash flows of its acquired FDIC-assisted loan portfolios. The fair value of the FDIC-assisted loan portfolios consisted of $87.4 million in covered and $15.2 million in non-covered loans at the end of the second quarter of 2012 compared with $95.5 million in covered and $17.4 million in non-covered loans at the end of the first quarter of 2012. The principal balance of the FDIC-assisted loan portfolios totaled $188.0 million at the end of the second quarter of 2012 compared with $209.8 million as of the end of the first quarter of 2012. The details of the accounting for the FDIC-assisted loan portfolios for the second quarter of 2012 are as follows:

• Covered loans acquired in FDIC-assisted acquisitions decreased $8.1 million to $87.4 million;
• Non-covered loans acquired in FDIC-assisted acquisitions decreased $2.2 million to $15.2 million;
• The FDIC loss-share receivable associated with covered loans acquired in FDIC-assisted acquisitions decreased $6.6 million to $76.3 million;
• The negative accretion for the FDIC loss-share receivable was $133,000;
• Provision expense for loans acquired in FDIC-assisted acquisitions was $341,000;
• The non-accretable discount decreased $17.6 million to $66.5 million; and
• The accretable discount increased $6.1 million to $18.8 million.

For the second quarter of 2012, provision expense of $341,000 was recorded for loan charge-offs on loans acquired in FDIC-assisted acquisitions not provided for by the discount or reimbursement from the FDIC. The provision expense for these loans did not affect the Company's loan loss reserve. The FDIC loss-share receivable associated with covered FDIC-assisted loans decreased $6.6 million from $82.9 million for the prior quarter to $76.3 million, primarily driven by reimbursements received from the FDIC of $5.1 million and negative accretion of $858,000 affecting the loss-share receivable asset that was associated with the improvement in expected cash flows of the loss-share performing portfolios.

The non-accretable discount decreased to $66.5 million at the end of the second quarter of 2012 from $84.1 million on a linked-quarter basis, primarily driven by the clearing of $9.4 million of discount in conjunction with the resolution of FDIC-assisted loans and transfers to accretable discount of $8.2 million. The accretable discount increased to $18.8 million for the second quarter of 2012 from $12.7 million on a linked-quarter basis, primarily due to the transfer from the non-accretable discount as a result of the improvement in cash flows, partially offset by loan discount accretion of $2.1 million.

Asset Quality

Net charge-offs to average outstanding loans on an annualized basis, excluding loans acquired in FDIC-assisted acquisitions, were down to 0.23% for the second quarter of 2012 versus 0.26% for the second quarter of 2011. Total nonperforming assets, excluding assets acquired in FDIC-assisted acquisitions, have significantly improved as a percentage of assets compared with the prior year and were $11.5 million or 1.08% of total assets for the second quarter of 2012 compared with $11.3 million or 1.17% of total assets for the same quarter in 2011. Other real estate owned and repossessed assets, excluding assets acquired in FDIC-assisted acquisitions, totaled $1.5 million for the second quarter of 2012, down from $2.7 million for the same quarter in 2011.

The provision for loan losses on non-FDIC-acquired loans increased to $750,000 for the second quarter of 2012 from $700,000 for the same quarter in 2011, primarily driven by organic loan growth. For the second quarter in 2012, the allowance for loan losses represented 1.61% of total loans outstanding, excluding loans acquired in FDIC-assisted acquisitions, versus 1.58% for the same quarter in 2011.