Heritage Financial Group, Inc., the holding company for HeritageBank of the South, today announced unaudited financial results for the quarter ended June 30, 2014. Key aspects of the Company's results for the second quarter of 2014 include:

• Net income of $1.8 million or $0.23 per diluted share, up 32% from $1.3 million or $0.18 per diluted share for the linked quarter, but down 33% from $2.7 million or $0.36 per diluted share for the year-earlier quarter;

• Excluding special items for each quarter, net income of $2.4 million or $0.31 per diluted share, up 33% from $1.8 million or $0.24 per diluted share for the linked quarter, but down 17% from $2.9 million or $0.39 per diluted share for the year-earlier quarter (see non-GAAP reconciliation);

• Loan growth, excluding loans acquired through FDIC-assisted acquisitions, of $42.2 million or 6% on a linked-quarter basis and $106.7 million or 17% compared with the year-earlier quarter;

• A decline in nonperforming loans, excluding FDIC-acquired loans, of 24% on a linked-quarter basis and 43% compared with the year-earlier quarter;

• An increase in the provision for loan losses, excluding FDIC-acquired loans, to $510,000, up from $65,000 for the linked quarter and down 20% compared with $640,000 for the year-earlier quarter;

• Mortgage originations increased to $249.9 million for the quarter, up $114.4 million or 84% from the linked quarter and up $133.2 million or 114% from the year-earlier quarter; and

• FDIC-acquired portfolios experienced improvement in cash flows, which resulted in $12.7 million of non-accretable discount transferred to the accretable discount and also resulted in an increase in the FDIC clawback expenses to $882,000.

Commenting on the results, Leonard Dorminey, President and Chief Executive Officer, said, "We are pleased to report ongoing improvements in our operating results. Our core loan portfolio continued to grow in the second quarter, reflecting overall expansion along with continued organic growth, while at the same time credit quality metrics demonstrated further improvements in portfolio risks. Cash flows from our FDIC-acquired portfolios also have continued to improve, which have increased our interest income, but likewise resulted in a large increase in our clawback liability during the quarter. Additionally, our mortgage expansion efforts continue to cement as a solid platform for future growth, evidenced by a substantial increase in originations during the second quarter and a significantly larger pipeline of loans in process at quarter's end." Dorminey noted that HeritageBank Mortgage turned solidly profitable in the second quarter of 2014 as the Company begins to benefit from the investment it has made in these operations over the past two years.

Referring to the April 2014 announcement of the Company's pending acquisition of Alarion Bank, the banking subsidiary of Alarion Financial Services, Inc. ("Alarion"), Dorminey noted that the Company expects to complete the acquisition during the third quarter of 2014, assuming approval by regulatory authorities and Alarion's shareholders as well as the satisfaction of other customary closing conditions. Alarion has called a special meeting of its shareholders to be held on August 19, 2014, to consider and vote on the transaction, which is valued at approximately $22.3 million. Integration planning relating to the proposed transaction is continuing and, related to this, the Company has hired David C. Wilson to assist with preparation for the Company's entry into the Gainesville market. Wilson, with more than 30 years of lending experience, was most recently Gainesville City President for BBVA – Compass Bank.

Dorminey also 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 August 22, 2014, to stockholders of record as of August 8, 2014.

Second Quarter 2014 Results of Operations

The $429,000 increase in reported quarterly earnings for the second quarter of 2014 compared with the linked quarter resulted primarily from the following items:

• Increased interest income of $1.9 million, driven by growth in interest earning assets coupled with improved loan discount accretion from FDIC-acquired loans of $793,000;

• Solid growth in revenue from mortgage banking activities of $2.9 million; offset by

• Increased provision for loan losses expense of $445,000, driven by core loan growth;

• Accelerated negative accretion of the FDIC loss-share receivable of $1.3 million; and

• Increased salaries and employee benefits of $1.7 million, driven by mortgage banking expansion.

The $888,000 decrease in reported quarterly earnings for the second quarter of 2014 compared with the year-earlier quarter primarily resulted from the following items:

• Increased salaries and employee benefits of $2.1 million;

• Reduced interest income on loans of $972,000;

• Growth in FDIC loss-share clawback expenses of $758,000; offset by

• Increased revenue from mortgage banking activities of $1.6 million; and

• Improved interest income on loans held for sale of $1.2 million

Net interest income for the second quarter of 2014 increased 1% to $15.8 million from $15.6 million in the year-earlier quarter, primarily reflecting an increase in interest-earning assets related to acquisitions and organic growth. The Company's net interest margin was 4.92% for the second quarter of 2014, a decline of 48 basis points from 5.40% for the year-earlier period. The reduction in net interest margin for the second 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. Excluding FDIC-acquired loan discount adjustments from the net interest margin, the core net interest margin was 3.34% for the second quarter of 2014, an improvement of 27 basis points from 3.07% compared with the year-earlier quarter. The improvement in the core net interest margin was driven by an increase in the yield on core loans compared with the year-earlier quarter.

In the second quarter of 2014, the Company continued to achieve loan growth, with its core loan portfolio increasing $42.2 million organically on a linked-quarter basis and advancing $106.7 million overall compared with the year-earlier quarter. For the second quarter of 2014, the Company's loan portfolio, including FDIC-acquired loans, totaled $845.1 million, increasing $35.1 million on a linked-quarter basis from $810.0 million and from $769.9 million compared with the year-earlier quarter. The organic loan growth from the linked quarter was primarily driven by growth in the Albany, South Atlanta, and Macon, Georgia markets, as well as in the Birmingham, Alabama market. Total deposits stood at $1.209 billion at the end of the second quarter of 2014, up 7% from $1.127 billion on a linked-quarter basis, and up 13% from $1.066 billion for the year-earlier quarter.

For the second quarter of 2014, the Company's loans held for sale totaled $127.2 million, increasing $750,000 or 1% on a linked-quarter basis from $126.4 million, and increasing $83.6 million or 192% from $43.5 million compared with the year-earlier quarter. The slight increase in the loans held for sale for the current quarter occurred as loan sales paced current production for the quarter. Loan sales to the agencies for the second quarter totaled $158.0 million and, separately, the Company recorded a gain of $1.3 million related to the mortgage servicing rights for those loans. Total mortgage production for the second quarter was $249.9 million, up 84% on a linked-quarter basis from $135.5 million and up 114% from $116.7 million compared with the year-earlier quarter.

Noninterest income for the second quarter of 2014 improved 65% to $5.3 million from $3.2 million in the year-earlier quarter, primarily driven by increases in revenue from mortgage banking activities of $1.6 million, service charges on deposit accounts of $206,000, gain on sales of securities of $138,000 and bankcard services income of $110,000. Noninterest expense for the second quarter of 2014 increased 24% to $18.1 million from $14.6 million in the year-earlier quarter, primarily driven by increases in salaries and employee benefits of $2.1 million related to the expansion of the mortgage division and an increase in FDIC loss-share clawback expenses of $758,000 related to the improvement in cash flows experienced on covered loss-share loan portfolios.

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 $43.4 million in covered and $56.9 million in non-covered loans at the end of the second quarter of 2014 compared with $57.2 million in covered and $74.6 million in non-covered loans for the year-earlier quarter. The outstanding principal balance of the FDIC-acquired loan portfolios totaled $153.0 million at the end of the second quarter of 2014 compared with $210.0 million for the year-earlier quarter. The details of the accounting for the FDIC-acquired loan portfolios for the second quarter of 2014 are as follows:

• Covered FDIC-acquired loans decreased $4.2 million and non-covered FDIC-acquired loans decreased $2.9 million from the linked quarter;

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

• Provision expense for FDIC-acquired covered loans increased to $25,000 while non-covered loans decreased to negative $61,000; and

• Loan discount accretion recognized in interest income increased to $4.6 million.

For the second quarter of 2014, loan discount accretion recognized in interest income improved 21% to $4.6 million from $3.9 million for the linked quarter, but declined 24% from $6.1 million for the year-earlier quarter. Provision expense of $25,000 was recorded for loan charge-offs on covered 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 covered loans did not affect the Company's loan loss reserve. Negative provision expense of $61,000 was recorded for non-covered FDIC-acquired loans, driven by the reversal of the $105,000 valuation allowance recorded during the first quarter of 2014, offset in part by $44,000 in loan charge-offs on non-covered individually assessed loans not provided by the discount. The FDIC loss-share receivable associated with covered FDIC-acquired assets decreased 12% to $33.2 million from $37.6 million for the linked quarter and declined 31% from $48.1 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 $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 and FDIC reimbursements received of $896,000. An increase to the FDIC clawback liability accrual was recorded as an expense for the current quarter of $882,000, which increased the total accrual to $3.4 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 discount affecting the loss-share receivable was $29.9 million, or 89.8% of the loss-share receivable, for the second quarter of 2014 compared with $45.4 million, or 94.5% of the loss-share receivable, for the year-earlier quarter. The gross balance of covered FDIC-acquired assets decreased to $89.5 million for the second quarter of 2014 compared with $125.6 million for the year-earlier quarter. The FDIC loss-share receivable as a percent of the covered FDIC-acquired assets decreased to 37.1% compared with 38.3% for the year-earlier quarter.

Asset Quality

Total nonperforming assets, excluding FDIC-acquired assets, decreased to $7.5 million, or 0.50% of total assets, compared with $10.3 million, or 0.73% of total assets, for the linked quarter and declined from $15.3 million, or 1.14% of total assets, for the year-earlier quarter. Annualized net charge-offs to average outstanding loans, excluding FDIC-acquired loans, were 0.05% for the second quarter of 2014 compared with annualized net recoveries of 0.01% for the linked quarter and annualized net charge-offs of 0.45% for the year-earlier quarter. Nonperforming loans, excluding FDIC-acquired loans, totaled $7.0 million for the second quarter of 2014, down from $9.2 million for the linked quarter and from $12.2 million for the year-earlier quarter. Other real estate owned and repossessed assets, excluding FDIC-acquired assets, totaled $507,000 for the second quarter of 2014, down from $1.1 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 increased to $510,000 for the second quarter of 2014 from $65,000 for the linked quarter, but decreased from $640,000 for the year-earlier quarter, primarily driven by improving trends in total criticized and classified loans offset in part by core loan growth. For the second quarter in 2014, the allowance for loan losses represented 1.27% of total loans outstanding, excluding FDIC-acquired loans, versus 1.30% for the linked quarter and 1.42% for the year-earlier quarter.

Capital Management Initiatives

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 June 30, 2014, was 14.0%, 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 8.5% as of June 30, 2014.