Heritage Financial Group, Inc., the holding company for HeritageBank of the South, today announced unaudited financial results for the quarter and year ended December 31, 2013. Highlights of the Company's results for the year ended 2013 include:

“We continue to focus on improving our operating efficiency while expanding our mortgage and banking presence. While we have completed many efficiency initiatives, we anticipate building on the momentum gained in 2013 to further improve our operating efficiency in 2014.”

• Net income of $11.3 million or $1.50 per diluted share, up 67% from net income of $6.8 million or $0.85 per diluted share for the year ended 2012;
• Excluding special items for each year, net income of $10.6 million or $1.42 per diluted share, up 86% from $5.7 million or $0.71 per diluted share for the year ended 2012 (see reconciliation of non-GAAP items);
• Loan growth, excluding loans acquired through FDIC-assisted acquisitions, of $98.8 million or 17% from 2012;
• A decline in the provision for loan losses, excluding FDIC-acquired loans, to $1.7 million, down 34% from $2.5 million for 2012;

Commenting on the results, Leonard Dorminey, President and Chief Executive Officer, said, "We are pleased to announce solid financial results for the fourth quarter and for all of 2013. Our team has been focused on several strategic initiatives, and we are excited to report that those efforts came to fruition in our financial results this past quarter. Contributing to our results were organic loan growth from commercial banking, fee income and improved efficiency from our branch network, fee income and growth in assets under management from our brokerage division, continued growth in mortgage banking, and significant gains on resolutions from our FDIC-acquired special asset team. We enter 2014 well positioned on all strategic fronts."

Dorminey also noted that the Company's Board of Directors has declared a quarterly cash dividend of $0.07 per share, resuming regular payments after a special dividend was paid in December 2012 in lieu of dividends for 2013. The new dividend will be paid on February 28, 2014, to stockholders of record as of February 14, 2014.

Operating Efficiency Initiatives

During 2013, the Company closed its branch in Vincent, Alabama, and its Broadway Avenue branch in Sylacauga, Alabama, both of which were added with the FDIC-assisted acquisition of Frontier Bank in March 2013. Also, the Company completed staffing reductions related to the Frontier acquisition that will result in a decrease of approximately $1.6 million from Frontier's pre-acquisition level of personnel expenses. Separately, the Company reduced Bank staffing by nine full-time equivalent employees, resulting in a one-time charge of $67,000 for severance ($60,000 in the third quarter of 2013 and $7,000 in the fourth quarter), and anticipates expense savings of approximately $460,000 per year related to this staffing reduction.

Commenting on the operating efficiency initiatives, Heath Fountain, Executive Vice President and Chief Financial Officer, said, "We continue to focus on improving our operating efficiency while expanding our mortgage and banking presence. While we have completed many efficiency initiatives, we anticipate building on the momentum gained in 2013 to further improve our operating efficiency in 2014."

Fourth Quarter 2013 Results of Operations

Highlights of the Company's results for the fourth quarter of 2013 include:

• Net income of $3.4 million or $0.45 per diluted share, up 158% from $1.3 million or $0.18 per diluted share for the linked quarter and up 40% from $2.4 million or $0.31 per diluted share for the year-earlier quarter;
• Excluding special items for each quarter, net income of $4.0 million or $0.53 per diluted share, up 124% from $1.8 million or $0.24 per diluted share for the linked quarter and up 221% from $1.2 million or $0.16 per diluted share for the year-earlier quarter (see reconciliation of non-GAAP items);
• Loan growth, excluding loans acquired through FDIC-assisted acquisitions, of $19.0 million or 3% on a linked-quarter basis and $98.8 million or 17% compared with the year-earlier quarter;
• A decrease in FDIC-acquired loans of $9.3 million, or 8%, on a linked-quarter basis, but an increase of $29.9 million or 36% compared with the year-earlier quarter;
• A decrease in the provision for loan losses, excluding FDIC-acquired loans, to $220,000, down 37% from $350,000 for the linked quarter and down 63% compared with $600,000 for the year-earlier quarter;

The $2.1 million increase in reported quarterly earnings for the fourth quarter of 2013 compared with the linked quarter resulted primarily from the following items:

• Increased loan discount accretion from FDIC-acquired loans of $2.3 million, partially offset by increased negative accretion of the FDIC loss-share receivable of $522,000;
• Increased mortgage banking fees of $1.0 million;
• Decreased FDIC-acquired other real estate owned write-downs and foreclosed asset expenses of $410,000;
• Decreased legacy other real estate owned write-downs and foreclosed asset expenses of $394,000;
• Increased interest income on core loans and loans held for sale of $385,000;
• Decreased acquisition-related expenses of $178,000; offset by
• Increased salaries and employee benefits of $614,000; and
• Increased impairment loss on assets held for sale of $328,000.

Commenting on the fourth quarter results, Fountain added, "During the fourth quarter, we were able to resolve several FDIC-acquired non-covered loans that significantly improved our loan discount accretion income. Loan discount accretion income can vary significantly based on the timing of asset resolutions and will continue to cause volatility in earnings. We also posted a significant increase in our mortgage banking fees, building on the momentum that our mortgage division developed in the previous quarter."

The $977,000 increase in reported quarterly earnings for the fourth quarter of 2013 compared with the year-earlier quarter primarily resulted from the following items:

• Improved net interest income of $1.7 million;
• Decreased provision expense of $2.3 million;
• Increased non-interest income of $1.4 million; offset by
• Increased non-interest expense of $3.4 million.

Net interest income for the fourth quarter of 2013 increased 12% to $16.3 million from $14.5 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 5.50% for the fourth quarter of 2013, a decline of 87 basis points from 6.37% for the year-earlier period. The reduction in net interest margin for the fourth quarter of 2013 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 was 3.20% for the fourth quarter of 2013, a decrease of two basis points from 3.22% for the year-earlier quarter.

In the fourth quarter of 2013, the Company continued to achieve loan growth, with its core loan portfolio increasing $19.0 million organically on a linked-quarter basis and advancing $98.8 million overall compared with the year-earlier quarter. For the fourth quarter of 2013, the Company's loan portfolio, including FDIC-acquired loans, totaled $798.8 million, increasing $9.7 million on a linked-quarter basis from $789.1 million and from $670.0 million compared with the year-earlier quarter. The organic loan growth for the linked quarter was primarily driven by growth in Albany, Macon, and South Atlanta, Georgia markets, Auburn and Birmingham, Alabama markets, and the Ocala, Florida market. Total deposits stood at $1.076 billion at the end of the fourth quarter of 2013, up 2% from $1.052 billion on a linked-quarter basis, and up 24% from $869.6 million for the year-earlier quarter.

For the fourth quarter of 2013, the Company's loans held for sale totaled $110.7 million, increasing significantly by $72.6 million, or 191%, on a linked-quarter basis from $38.0 million, and increasing $95.1 million, or 609%, from $15.6 million compared with the year-earlier quarter. The significant increase in the loans held for sale for the current quarter was driven by a slowing in loan sales as the Company prepared to deliver directly to Fannie Mae. Loan sales to Fannie Mae for the fourth quarter totaled $20.8 million and, separately, the Company recorded a gain of $202,000 related to the mortgage servicing rights for those loans. Total mortgage production for the fourth quarter was $120.4 million, up 4% on a linked-quarter basis from $115.3 million and up 116% from $55.8 million compared with the year-earlier quarter.

Non-interest income for the fourth quarter of 2013 increased 47% to $4.5 million from $3.1 million in the year-earlier quarter, primarily driven by increases in mortgage banking fees of $1.5 million and service charges on deposit accounts of $335,000 and a decline in negative accretion for the FDIC loss-share receivable of $552,000, together which were partially offset by a decline in the gain on sales of securities of $1.2 million. Non-interest expense for the fourth quarter of 2013 increased 28% to $15.7 million from $12.3 million in the year-earlier quarter, primarily driven by increases in salaries and employee benefits of $2.6 million, impairment loss on assets held for sale of $328,000 and realized loss on assets held for sale of $228,000. The increase in salaries and employee benefits was associated with the hiring of employees from the Frontier acquisition and for the mortgage division expansion, while the impairment loss on assets held for sale was driven by two former branch buildings and a corporate facility the Company holds, and the realized loss on assets held for sale was the result of the Company selling its former corporate headquarters building in Albany, Georgia.

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 $50.9 million in covered and $63.3 million in non-covered loans at the end of the fourth quarter of 2013 compared with $72.4 million in covered and $11.9 million in non-covered loans for the year-earlier quarter. The outstanding principal balance of the FDIC-acquired loan portfolios totaled $177.8 million at the end of the fourth quarter of 2013 compared with $152.1 million for the year-earlier quarter. The details of the accounting for the FDIC-acquired loan portfolios for the fourth quarter of 2013 are as follows:

• Covered FDIC-acquired loans decreased $3.0 million from the linked quarter to $50.9 million;
• Non-covered FDIC-acquired loans decreased $6.3 million to $63.3 million;
• The FDIC loss-share receivable associated with covered assets acquired in FDIC-assisted acquisitions decreased $3.2 million to $41.3 million;
• The negative accretion for the FDIC loss-share receivable was $2.0 million and the FDIC loss-share clawback accrual increased to $1.9 million;
• Increase in provision expense for FDIC-acquired non-covered loans to $12,000;
• Loan discount accretion recognized in interest income improved $2.6 million;
• The non-accretable discount decreased $11.8 million to $36.7 million; and
• The accretable discount increased $3.4 million to $26.9 million.

For the fourth quarter of 2013, loan discount accretion recognized in interest income improved 69% to $6.3 million from $3.7 million for the linked quarter, but declined 6% from $6.6 million for the year-earlier quarter. The FDIC loss-share receivable associated with covered FDIC-acquired assets decreased 7% to $41.3 million from $44.5 million for the linked quarter and declined 32% from $60.7 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 $1.2 million. An increase to the FDIC clawback liability accrual was recorded as an expense for the current quarter of $261,000, which increased the total accrual to $1.9 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 $39.1 million, or 94.6% of the loss-share receivable, for the fourth quarter 2013 compared with $55.2 million, or 90.9% of the loss-share receivable, for the year-earlier quarter. The gross balance of covered FDIC-acquired assets decreased to $109.2 million for the fourth quarter of 2013 compared with $156.0 million for the year-earlier quarter. The FDIC loss-share receivable as a percent of the covered FDIC-acquired assets decreased to 37.8% compared with 38.9% for the year-earlier quarter.

Asset Quality

Total non-performing assets, excluding FDIC-acquired assets, decreased to $11.2 million, or 0.81% of total assets, compared with $13.6 million, or 1.03% of total assets, for the linked quarter and declined from $17.3 million, or 1.58% of total assets, for the year-earlier quarter. Annualized net charge-offs to average outstanding loans, excluding FDIC-acquired loans, were 0.10% for the fourth quarter of 2013 compared with 0.31% for the linked quarter and 0.05% for the year-earlier quarter. Non-performing loans, excluding FDIC-acquired loans, totaled $9.4 million, down from $11.0 million for the linked quarter and from $14.7 million for the year-earlier quarter. Other real estate owned and repossessed assets, excluding FDIC-acquired assets, totaled $1.8 million for the fourth quarter of 2013, down from $2.7 million for the linked quarter and from $2.6 million for the year-earlier quarter.

The provision for loan losses on non-FDIC-acquired loans decreased to $220,000 for the fourth quarter of 2013 from $350,000 for the linked quarter and from $600,000 for the year-earlier quarter, primarily driven by improving trends in total criticized and classified loans. For the fourth quarter in 2013, the allowance for loan losses represented 1.31% of total loans outstanding, excluding FDIC-acquired loans, versus 1.34% for the linked quarter and 1.55% 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 reinstated its regular quarterly dividend during January 2014 at $0.07 per share. Looking ahead, the Company intends to maintain its capital strength at the current level to support growth and its acquisition activities. The Company currently has authorization to purchase approximately 344,000 shares under the current repurchase program, which is set to expire in April 2014, unless extended or otherwise completed. 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 December 31, 2013, was 14.5%, 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 8.8% as of December 31, 2013.