Heritage Financial Group, Inc., the holding company for HeritageBank of the South, today announced unaudited financial results for the quarter ended June 30, 2013. Highlights of the Company's results for the second quarter of 2013 include:

-- Net income of $2.7 million or $0.36 per diluted share, up almost twofold from net income of $1.4 million or $0.17 per diluted share for the year-earlier quarter, but down 32% from $3.9 million or $0.52 per diluted share for the linked quarter, primarily due to the recording of a bargain purchase gain on an acquisition in the first quarter of 2013;

-- Excluding special items for each quarter, net income was $2.9 million or $0.39 per diluted share, up twofold from net income of $1.4 million or $0.17 per diluted share for the year-earlier quarter and up 43% from net income of $2.0 million or $0.27 per diluted share for the linked quarter (see reconciliation of non-GAAP items);

-- Loan growth, excluding loans acquired through FDIC-assisted acquisitions, of $34.4 million or 6% on a linked-quarter basis;

-- Loans held for sale increased $24.6 million or 130% on a linked-quarter basis;

-- A decrease in FDIC-acquired loans of $17.3 million or 12% on a linked-quarter basis;

-- A decrease in the provision for loan losses, excluding FDIC-acquired loans, to $640,000 compared with $750,000 for the year-earlier quarter, and an increase from $450,000 for the linked quarter; and

-- A decline in the provision for loan losses for FDIC-acquired loans, with approximately 80% of the losses reimbursable by the FDIC, to $28,000 compared with $341,000 for the year-earlier quarter and $35,000 for the linked quarter.

Commenting on the results, Leonard Dorminey, President and Chief Executive Officer, said, "We are pleased to report ongoing growth in our business and improving financial results. We continue to benefit from our efforts to increase revenue and manage our expenses. Additionally, our mortgage division has again achieved significant increases in volume and our commercial bank network continued to see solid loan growth.

"We remain on schedule with our conversion and integration plans for Frontier Bank," Dorminey continued. "We continue to make progress with integrating the new team into our system and filling key strategic roles to expand in the former Frontier Bank footprint. We are excited about the opportunities for loan growth in these new markets."

Expense Management Initiatives

In connection with the Frontier FDIC-assisted acquisition, the Company is on track to close its branch in Vincent, Alabama, and its Broadway Avenue branch in Sylacauga, Alabama, during the third quarter of 2013. The Company does not expect to experience a significant reduction in customer relationships and will serve these customers from other nearby locations. Separately, the Company is on track with the implementation of staffing reductions related to the Frontier acquisition that will be completed during the third quarter of 2013, resulting in a decrease of approximately $1.6 million from Frontier's pre-acquisition level of personnel expenses.

Commenting on the expense management initiatives in the Frontier acquisition, Heath Fountain, Executive Vice President and Chief Financial Officer, said, "While expenses increased related to the Frontier acquisition and our mortgage expansion, we continue to make progress in expense management initiatives within our branch network. We will convert the former Frontier branches to our core system in the third quarter, and we are well on schedule to achieve all of our previously identified cost-saving targets."

Capital Management Initiatives

During the second quarter of 2013, the Company repurchased approximately 77,000 shares of common stock at an average price of $14.26 under its stock repurchase program. Authorization to repurchase approximately 350,000 shares remains under the current program, which is set to expire in April 2014, unless extended or otherwise completed.

The Company's estimated total risk-based capital ratio at June 30, 2013, was 14.4%, 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 8.6% as of June 30, 2013.

Looking ahead, the Company intends to maintain its capital strength at the current level to support growth and its acquisition activities. Accordingly, future stock buybacks and future dividends will be premised largely on the Company's future earnings power rather than a return of capital to stockholders. As previously announced, it is not currently anticipated that any quarterly dividends will be paid in 2013, with the Company having accelerated 2013 dividends in December 2012, but the Company expects to resume regular quarterly dividends in 2014.

Second Quarter 2013 Results of Operations

The $1.3 million improvement in reported quarterly earnings for the second quarter of 2013 compared with the year-earlier quarter primarily resulted from the following items:

-- Improved net interest income of $6.1 million;

-- Decreased provision expense of $423,000; offset by

-- Reduced non-interest income of $1.1 million; and

-- Increased non-interest expense of $3.9 million.

Net interest income for the second quarter of 2013 increased 60% to $16.2 million from $10.2 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 liabilities. The Company's net interest margin was 5.61% for the second quarter of 2013, an increase of 10 basis points from 5.51% on a linked-quarter basis, and an increase of 86 basis points over 4.75% in the year-earlier period. The improvement in net interest margin for the second quarter of 2013 compared with the year-earlier quarter was driven by an increase in loan yields on the Company's FDIC-acquired loan portfolio coupled with reductions in the cost of interest-bearing liabilities as rates continue to reset to lower levels and the Company takes advantage of historically low interest rates on non-deposit funding, all of which were offset in part by declining yields on the investment portfolio. Excluding FDIC-acquired loan discount adjustments from the net interest margin, the core net interest margin was 3.27% for the second quarter of 2013, a decrease of nine basis points from 3.38% on a linked-quarter basis and six basis points from 3.33% for the year-earlier quarter.

In the second quarter of 2013, the Company continued to achieve loan growth, with its core loan portfolio increasing $34.4 million organically on a linked-quarter basis and advancing $135.7 million overall compared with the year-earlier quarter. For the second quarter of 2013, the Company's loan portfolio, including FDIC-acquired loans, totaled $769.9 million, increasing $17.1 million on a linked-quarter basis from $752.9 million and from $605.0 million compared with the year-earlier quarter. The organic loan growth for the linked quarter was driven by all the Company's markets with the exception of the Ocala, Florida market, which recorded a slight reduction. For the second quarter of 2013, the Company's loans held for sale totaled $43.5 million, increasing $24.6 million on a linked-quarter basis from $18.9 million and from $6.0 million compared with the year-earlier quarter. Total deposits stood at $1.066 billion at the end of the second quarter of 2013, up 24% from $860.3 million at June 30, 2012, but down 3% or $30.0 million from $1.096 billion on a linked-quarter basis. The linked quarter decrease in deposits was primarily driven by planned run-off of non-relationship customers from the Frontier acquisition, which accounted for $22.0 million of the decrease.

Non-interest income for the second quarter of 2013 decreased 30% to $2.6 million from $3.7 million in the year-earlier quarter, primarily because of an increase in negative accretion for the FDIC loss-share receivable of $3.2 million partially offset by an increase in mortgage banking fees of $1.9 million. Non-interest expense for the second quarter of 2013 increased 36% to $14.6 million from $10.7 million in the year-earlier quarter, primarily driven by increased salaries and employee benefits of $2.7 million associated with the hiring of employees from the Frontier acquisition and for the mortgage division. The increased equipment and occupancy expense of $443,000 related to the Company's continued efforts to expand the mortgage division and the Frontier acquisition.

Accounting for FDIC-Assisted Acquisitions

The Company performs ongoing assessments of the estimated cash flows of its FDIC-acquired loan portfolios. The fair value of the FDIC-acquired loan portfolios consisted of $57.2 million in covered and $74.6 million in non-covered loans at the end of the second quarter of 2013 compared with $65.8 million in covered and $83.3 million in non-covered loans for the linked quarter. The outstanding principal balance of the FDIC-acquired loan portfolios totaled $210.0 million at the end of the second quarter of 2013 compared with $234.8 million for the linked quarter. The details of the accounting for the FDIC-acquired loan portfolios for the second quarter of 2013 are as follows:

-- Covered FDIC-acquired loans decreased $8.6 million to $57.2 million;

-- Non-covered FDIC-acquired loans decreased $8.7 million to $74.6 million;

-- The FDIC loss-share receivable associated with covered assets acquired in FDIC-assisted acquisitions decreased $3.9 million to $48.1 million;

-- The negative accretion for the FDIC loss-share receivable was $3.4 million and the FDIC loss-share clawback accrual was increased to $1.4 million;

-- Provision expense for individually assessed FDIC-acquired loans was $28,000;

-- The non-accretable discount decreased $4.4 million to $55.2 million; and

-- The accretable discount decreased $3.1 million to $23.0 million.

For the second quarter of 2013, provision expense of $28,000 was recorded for loan charge-offs on individually assessed FDIC-acquired loans not provided for by the discount, with approximately 80% of the charge-offs reimbursable by 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-acquired assets decreased $3.9 million from $52.0 million for the prior quarter to $48.1 million, primarily driven by negative accretion of $3.4 million affecting the loss-share receivable asset associated with the improvement in expected cash flows of the covered FDIC-acquired performing loan portfolios. An increase to the FDIC clawback liability accrual was recorded as an expense for the current quarter of $124,000, which increased the total accrual to $1.4 million. This clawback was caused by an improvement in estimates of expected cash flows for both FDIC-assisted acquisitions covered under loss-sharing agreements.

The covered FDIC-acquired loan discounts affecting the loss-share receivable was $56.8 million, or 94.5% of the loss-share receivable, for the second quarter 2013 compared with $63.6 million, or 97.8% of the loss-share receivable, for the linked quarter. The gross balance of covered FDIC-acquired assets decreased to $125.6 million for the second quarter of 2013 compared with $142.9 million for the linked quarter. The FDIC loss-share receivable as a percent of the covered FDIC-acquired assets increased to 38.3% compared with 36.4% for the linked quarter.

Asset Quality

Total non-performing assets, excluding FDIC-acquired assets, decreased to $15.3 million, or 1.14% of total assets, compared with $15.8 million, or 1.15% of total assets, for the linked quarter, but it increased from $11.5 million, or 1.08% of total assets, from the year-earlier quarter. Annualized net charge-offs to average outstanding loans, excluding FDIC-acquired loans, were 0.45% for the second quarter of 2013 compared with 0.27% for the linked quarter and 0.23% for the year-earlier quarter. Non-performing loans totaled $12.2 million, down from $12.7 million for the linked quarter, but up from $10.0 million for the year-earlier quarter. Other real estate owned and repossessed assets, excluding FDIC-acquired assets, totaled $3.0 million for the second quarter of 2013, in line with the $3.0 million for the linked quarter and up from the $1.5 million for the year-earlier quarter.

The provision for loan losses on non-FDIC-acquired loans decreased to $640,000 for the second quarter of 2013 from $750,000 for the year-earlier quarter, primarily driven by improving trends in total criticized and classified assets. For the second quarter in 2013, the allowance for loan losses represented 1.42% of total loans outstanding, excluding FDIC-acquired loans, versus 1.51% for the linked quarter and 1.61% for the year-earlier quarter. The improving loan loss allowance is primarily the result of declining criticized and classified assets as a percentage of total loans.