Heritage Financial Group, Inc., the holding company for HeritageBank of the South, announced Thursday unaudited financial results for the quarter ended March 31, 2014. Key aspects of the Company's results for the first quarter of 2014 include:

• Net income of $1.3 million or $0.18 per diluted share, down 61% from $3.4 million or $0.45 per diluted share for the linked quarter and down 66% from $3.9 million or $0.52 per diluted share for the year-earlier quarter;

• Excluding special items for each quarter, net income of $1.8 million or $0.24 per diluted share, down 55% from $4.0 million or $0.53 per diluted share for the linked quarter and down 11% from $2.0 million or $0.27 per diluted share for the year-earlier quarter (see reconciliation of non-GAAP items);

• Loan growth, excluding loans acquired through FDIC-assisted acquisitions, of $18.0 million or 3% on a linked-quarter basis and $98.8 million or 16% compared with the year-earlier quarter;

• A decline in nonperforming loans, excluding FDIC-acquired loans, of 2% on a linked-quarter basis and 28% compared with the year-earlier quarter;

• A decrease in the provision for loan losses, excluding FDIC-acquired loans, to $65,000, down 70% from $220,000 for the linked quarter and down 86% compared with $450,000 for the year-earlier quarter; and

• An increase in the provision for FDIC-acquired loan losses to $105,000, up from $12,000 for the linked quarter (there was no provision for FDIC-acquired loan losses in the year-earlier quarter).

Commenting on the results, Leonard Dorminey, President and Chief Executive Officer, said, "While accretion from our FDIC-assisted acquisitions and mortgage banking add volatility to our earnings, we are pleased to note ongoing improvement in our core operations. Asset quality indicators in our core loan portfolio continue to improve and organic loan growth is on track for another year of double-digit growth. Our banking expansion efforts continue as we opened a loan production office in Birmingham during the quarter. Our mortgage expansion also continues as we were able to recruit a mortgage banking team in Colorado Springs, Colorado during the quarter. This team, which had previously worked with our mortgage executives, will add significantly to our mortgage expansion efforts."

Dorminey noted that the Company's Board of Directors has declared a regular quarterly cash dividend of $0.07 per share, which will be paid on May 23, 2014, to stockholders of record as of May 9, 2014. Dorminey also noted the Company’s Board of Directors also has extended the current stock repurchase plan for one year. The plan has approximately 340,000 shares authorized for repurchase and now expires in May 2015, unless otherwise completed or extended.

Acquisition News

Commenting on the Company's recently announced acquisition, Dorminey added, "We are excited and optimistic about our pending acquisition of Alarion Financial Services, Inc., which is expected to contribute significantly to our growth plans in Florida and for our mortgage division. This transaction is a significant event, not only for its implications for our franchise, but also because it demonstrates that our company is well positioned to be a consolidator in the post FDIC-assisted transaction merger and acquisition environment."

First Quarter 2014 Results of Operations

The $2.1 million decrease in reported quarterly earnings for the first quarter of 2014 compared with the linked quarter resulted primarily from the following items:

• Decreased loan discount accretion from FDIC-acquired loans of $2.4 million coupled with steady negative accretion of the FDIC loss-share receivable; and

• Decreased mortgage banking fees of $783,000.

The $2.6 million decrease in reported quarterly earnings for the first quarter of 2014 compared with the year-earlier quarter primarily resulted from the following items:

• Reduction in gain on acquisitions of $4.2 million;

• Increased salaries and employee benefits of $2.2 million; offset by

• Improved interest income on loans held for sale of $910,000; and

• Increased interest income on securities of $409,000.

Net interest income for the first quarter of 2014 increased 9% to $14.0 million from $12.9 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 4.66% for the first quarter of 2014, a decline of 69 basis points from 5.35% for the year-earlier period. The reduction in net interest margin for the first quarter of 2014 compared with the year-earlier quarter was driven by a decline in the yield on loans, offset in part by an increase in the yield on investment securities coupled with a reduction 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. Excluding FDIC-acquired loan discount adjustments from the net interest margin, the core net interest margin remained unchanged at 3.23% for the first quarter of 2014 compared to the year-earlier quarter.

In the first quarter of 2014, the Company continued to achieve loan growth, with its core loan portfolio increasing $18.0 million organically on a linked-quarter basis and advancing $98.8 million overall compared with the year-earlier quarter. For the first quarter of 2014, the Company's loan portfolio, including FDIC-acquired loans, totaled $800.9 million, increasing $11.1 million on a linked-quarter basis from $789.8 million and from $743.8 million compared with the year-earlier quarter. The organic loan growth for the linked quarter was primarily driven by growth in the Albany, Macon, South Atlanta, and Valdosta, Georgia markets, as well as in the Auburn and Birmingham, Alabama markets. Total deposits stood at $1.127 billion at the end of the first quarter of 2014, up 5% from $1.076 billion on a linked-quarter basis, and up 3% from $1.096 billion for the year-earlier quarter.

For the first quarter of 2014, the Company's loans held for sale totaled $126.4 million, increasing $15.8 million, or 14%, on a linked-quarter basis from $110.7 million, and increasing $107.5 million, or 569%, from $18.9 million compared with the year-earlier quarter. The increase in the loans held for sale for the current quarter was driven by an increase in production outpacing loan sales for the quarter. Loan sales to Fannie Mae for the first quarter totaled $88.3 million and, separately, the Company recorded a gain of $717,000 related to the mortgage servicing rights for those loans. During the quarter, the Company made the decision to slow loan sales to Fannie Mae in order to sell to Freddie Mac for better execution. The Company received approval to sell loans to Freddie Mac at the end of the first quarter of 2014, and expects to deliver loans during the second quarter of 2014. Total mortgage production for the first quarter was $135.5 million, up 13% on a linked-quarter basis from $120.4 million and up 146% from $55.0 million compared with the year-earlier quarter.

Noninterest income for the first quarter of 2014 declined 48% to $3.5 million from $6.8 million in the year-earlier quarter, primarily driven by a decrease in gain on acquisitions of $4.2 million offset in part by a decline in negative accretion for the FDIC loss-share receivable of $366,000 and increases in service charges on deposit accounts of $289,000 and bankcard services income of $127,000. Noninterest expense for the first quarter of 2014 increased 16% to $15.5 million from $13.4 million in the year-earlier quarter, primarily driven by increases in salaries and employee benefits of $2.2 million related to the expansion of the mortgage division.

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 $47.7 million in covered and $59.8 million in non-covered loans at the end of the first quarter of 2014 compared with $65.8 million in covered and $83.3 million in non-covered loans for the year-earlier quarter. The outstanding principal balance of the FDIC-acquired loan portfolios totaled $165.8 million at the end of the first quarter of 2014 compared with $234.8 million for the year-earlier quarter. The details of the accounting for the FDIC-acquired loan portfolios for the first quarter of 2014 are as follows:

• Covered FDIC-acquired loans decreased $3.2 million and non-covered FDIC-acquired loans decreased $3.5 million from the linked quarter;

• The negative accretion for the FDIC loss-share receivable was $2.0 million and the FDIC loss-share clawback accrual increased to $2.5 million;

• Provision expense for FDIC-acquired non-covered loans increased to $93,000; and

• Loan discount accretion recognized in interest income declined $2.4 million.

For the first quarter of 2014, loan discount accretion recognized in interest income declined 39% to $3.9 million from $6.3 million for the linked quarter, and declined 16% from $4.6 million for the year-earlier quarter. Provision expense for non-covered loans of $105,000 was recorded for a valuation adjustment needed for the Frontier portfolio to adjust the yield for the current quarter compared with $12,000 for the linked quarter and no provision expense for the year-earlier quarter. The FDIC loss-share receivable associated with covered FDIC-acquired assets decreased 9% to $37.6 million from $41.3 million for the linked quarter and declined 28% from $52.0 million for the year-earlier quarter. The reduction in the FDIC loss-share receivable for the linked quarter was primarily driven by negative accretion of $2.0 million affecting the loss-share receivable asset associated with the improvement in expected cash flows of the covered FDIC-acquired performing loan portfolios and FDIC reimbursements received of $1.5 million. An increase to the FDIC clawback liability accrual was recorded as an expense for the current quarter of $543,000, which increased the total accrual to $2.5 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 discount affecting the loss-share receivable was $35.9 million, or 95.4% of the loss-share receivable, for the first quarter of 2014 compared with $50.9 million, or 97.8% of the loss-share receivable, for the year-earlier quarter. The gross balance of covered FDIC-acquired assets decreased to $100.5 million for the first quarter of 2014 compared with $142.9 million for the year-earlier quarter. The FDIC loss-share receivable as a percent of the covered FDIC-acquired assets decreased to 37.5% compared with 36.4% for the year-earlier quarter.

Asset Quality

Total nonperforming assets, excluding FDIC-acquired assets, decreased to $10.3 million, or 0.73% of total assets, compared with $11.2 million, or 0.81% of total assets, for the linked quarter and declined from $15.8 million, or 1.15% of total assets, for the year-earlier quarter. Annualized net recoveries to average outstanding loans, excluding FDIC-acquired loans, were 0.01% for the first quarter of 2014 compared with annualized net charge-offs of 0.10% for the linked quarter and annualized net-charge-offs of 0.27% for the year-earlier quarter. Nonperforming loans, excluding FDIC-acquired loans, totaled $9.2 million for the first quarter of 2014, down from $9.4 million for the linked quarter and from $12.7 million for the year-earlier quarter. Other real estate owned and repossessed assets, excluding FDIC-acquired assets, totaled $1.1 million for the first quarter of 2014, down from $1.8 million for the linked quarter and from $3.0 million for the year-earlier quarter.

The provision for loan losses on non-FDIC-acquired loans decreased to $65,000 for the first quarter of 2014 from $220,000 for the linked quarter and from $450,000 for the year-earlier quarter, primarily driven by improving trends in total criticized and classified loans. For the first quarter in 2014, the allowance for loan losses represented 1.30% of total loans outstanding, excluding FDIC-acquired loans, versus 1.31% for the linked quarter and 1.51% for the year-earlier quarter. The improving loan loss allowance was primarily the result of declining criticized and classified loans as a percentage of total loans.

Capital Management Initiatives

The Company's Board of Directors has declared a regular quarterly cash dividend of $0.07 per share, payable on May 23, 2014, to stockholders of record as of May 9, 2014. The Board of Directors also has extended the Company's current stock repurchase program for an additional year until April 2015, unless extended or otherwise completed earlier, and has total authorization under the program to purchase 340,000 shares, or 4% of the Company's currently outstanding common stock.

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.

The Company's estimated total risk-based capital ratio at March 31, 2014, was 13.8%, 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 8.7% as of March 31, 2014.