Heritage Financial 10-Q 2011 Q2 Quarterly report

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

______________________________________________________________

FORM 10-Q

QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE

SECURITIES EXCHANGE ACT OF 1934

For the quarterly period ended June 30, 2011

Commission File Number 000-51305

______________________________________________________________

HERITAGE FINANCIAL GROUP, INC.

(A Maryland Corporation)

IRS Employer Identification Number 38-3814230

721 N. Westover Blvd., Albany, GA 31707

229-420-0000

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 and 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.  Yes x   No o

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).   Yes o  No o

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer or a smaller reporting company.  See the definitions of “large accelerated filer”, “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act.  Large accelerated filer o Accelerated filer  o Non-accelerated filer  x  Smaller reporting company  o

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the exchange Act).  Yes o  No x

Indicate the number of shares outstanding of each issuer’s classes of common equity, as of the latest practicable date:  At August 15, 2011, there were 8,830,280 shares of issuer’s common stock outstanding.

HERITAGE FINANCIAL GROUP, INC.

INDEX

			Page
			Number
PART I – FINANCIAL INFORMATION
	ITEM 1.	FINANCIAL STATEMENTS
		CONSOLIDATED BALANCE SHEETS AS OF JUNE 30, 2011 AND DECEMBER 31, 2010	3
		CONSOLIDATED STATEMENTS OF OPERATIONS FOR THE THREE AND SIX MONTHS ENDED JUNE 30, 2011 AND 2010	4
		CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME FOR THE THREE AND SIX MONTHS ENDED JUNE 30, 2011 AND 2010	5
		CONSOLIDATED STATEMENTS OF STOCKHOLDERS’ EQUITY FOR THE SIX MONTHS ENDED JUNE 30, 2011 AND THE YEAR ENDED DECEMBER 31, 2010	6
		CONSOLIDATED STATEMENTS OF CASH FLOWS FOR THE SIX MONTHS ENDED JUNE 30, 2011 AND 2010	8
		CONDENSED NOTES TO CONSOLIDATED FINANCIAL STATEMENTS	10
	ITEM 2.	MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS	36
	ITEM 3.	QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK	56
	ITEM 4.	CONTROLS AND PROCEDURES	59
PART II – OTHER INFORMATION
	ITEM 1	LEGAL PROCEEDINGS	61
	ITEM 1A	RISK FACTORS	61
	ITEM 2	UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS	61
	ITEM 3	DEFAULTS UPON SENIOR SECURITIES	61
	ITEM 4	(REMOVED AND RESERVED)	61
	ITEM 5	OTHER INFORMATION	61
	ITEM 6	EXHIBITS	62

HERITAGE FINANCIAL GROUP, INC. AND SUBSIDIARY

CONSOLIDATED BALANCE SHEETS

(Dollars in Thousands)

	Unaudited June 30, 2011			Audited December 31, 2010
Assets
Cash and due from banks	$	15,225		$	28,803
Interest-bearing deposits in banks		100,309			10,911
Federal funds sold		26,619			2,700
Securities available for sale, at fair value		186,867			238,377
Federal Home Loan Bank Stock, at cost		4,286			3,703
Other equity securities, at cost		1,010			1,010
Loans held for sale		5,579			225
Loans		440,298			418,997
Covered loans		60,427			-
Less allowance for loan losses		6,585			8,101
Loans, net		494,140			410,896
Other real estate owned		2,725			3,689
Covered other real estate owned		6,968			-
Total other real estate owned		9,693			3,689
FDIC loss-share receivable		58,152			-
Premises and equipment, net		27,576			21,412
Premises held for sale		1,080			1,080
Accrued interest receivable		3,467			2,907
Goodwill and intangible assets		4,388			2,912
Cash surrender value of bank owned life insurance		15,316			15,024
Other assets		9,865			11,787
	$	963,572		$	755,436
Liabilities and Stockholders' Equity
Deposits
Noninterest-bearing	$	73,382		$	44,769
Interest-bearing		690,291			489,474
Total deposits		763,673			534,243
Federal funds purchased and securities sold under repurchase agreements		31,989			32,421
Other borrowings		35,000			62,500
Accrued interest payable		1,066			702
Other liabilities		9,806			6,230
Total liabilities		841,534			636,096
Stockholders' equity
Preferred stock, par value; $0.01; 5,000,000 and 1,000,000 shares authorized; none issued, respectively		-			-
Common stock, par value $0.01; 45,000,000 and 25,000,000 shares authorized; 8,712,750  and 8,710,511 shares issued, respectively		87			87
Capital surplus		89,288			88,876
Retained earnings		39,747			39,536
Accumulated other comprehensive loss, net of tax of $2,149 and $2,609		(2,141	)		(3,914	)
Unearned employee stock ownership plan (ESOP) shares, 465,672 and 492,320 shares		(4,943	)		(5,245	)
Total stockholders' equity		122,038			119,340
	$	963,572		$	755,436

See Notes to Consolidated Financial Statements.

3

HERITAGE FINANCIAL GROUP, INC AND SUBSIDIARY

Consolidated Statements of Operations (Unaudited)

For the Three and Six Months Ended June 30, 2011 and 2010

(Dollars in Thousands)

	For the Three Months Ended June 30,						For the Six Months Ended June 30,
	2011			2010			2011		2010
Interest income
Interest and fees on loans	$	7,564		$	5,763		$	14,709	$	11,083
Interest on loans held for sale		46			-			54		-
Interest on taxable securities		1,221			790			2,428		1,566
Interest on nontaxable securities		211			239			422		537
Interest on federal funds sold		16			18			29		27
Interest on deposits in other banks		51			45			91		90
		9,109			6,855			17,733		13,303
Interest expense
Interest on deposits		1,983			1,512			3,831		3,036
Interest on other borrowings		684			647			1,427		1,161
		2,667			2,159			5,258		4,197
Net interest income		6,442			4,696			12,475		9,106
Provision for loan losses		700			650			1,300		1,150
Net interest income after provision for loan losses		5,742			4,046			11,175		7,956
Noninterest income
Service charges on deposit accounts		1,222			982			2,273		1,806
Other service charges, commissions and fees		749			466			1,409		868
Brokerage fees		406			257			760		479
Mortgage origination fees		624			71			892		110
Bank owned life insurance		149			154			294		306
Gain on sales of securities		453			8			453		160
Bargain purchase gain (loss)		(117	)		-			2,217		-
Other		74			17			103		38
		3,560			1,955			8,401		3,767
Noninterest expense
Salaries and employee benefits		4,923			2,974			9,251		5,539
Equipment		428			252			779		507
Occupancy		536			329			981		636
Advertising and marketing		220			124			384		244
Legal and accounting		167			179			377		328
Consulting & other professional fees		198			66			377		137
Directors fees and retirement		161			139			388		277
Telecommunications		204			103			349		173
Supplies		145			96			240		153
Data processing fees		615			511			1,133		991
(Gain) loss on sales and write-downs of other real estate owned		535			(112	)		937		(344	)
Foreclosed asset expenses		245			427			415		598
FDIC insurance and other regulatory fees		354			228			647		399
Acquisition related expenses		474			267			757		267
Other operating		835			443			1,423		825
		10,040			6,026			18,438		10,730
Income (loss) before income taxes		(738	)		(25	)		1,138		993
Applicable income tax (benefits)		(257	)		(153	)		404		66
Net income (loss)	$	(481	)	$	128		$	734	$	927
Basic earnings (loss) per share	$	(0.06	)	$	0.02		$	0.09	$	0.11
Diluted earnings (loss) per share	$	(0.06	)	$	0.02		$	0.09	$	0.11

See Notes to Consolidated Financial Statements.

4

HERITAGE FINANCIAL GROUP, INC AND SUBSIDIARY

Consolidated Statements of Comprehensive Income (Unaudited)

For the Three and Six Months Ended June 30, 2011 and 2010

(Dollars in Thousands)

	For the Three Months Ended June 30,						For the Six Months Ended June 30,
	2011			2010			2011			2010
Net income (loss)	$	(481	)	$	128		$	734		$	927
Other comprehensive income:
Accretion of realized gain on terminated cash flow hedge, net of tax of $25 and $35 for the quarter and $60 and $70 for the year to date		(37	)		(53	)		(90	)		(106	)
Unrealized holding gains on investments arising during the period, net of tax of $927 and $412 for the quarter and $1,423 and  $450 for the year to date		1,391			618			2,135			675
Reclassification adjustment for investment gains included in net income, net of tax of  $181 and  $3 for the quarter and $181 and $64 for the year to date		(272	)		(5	)		(272	)		(96	)
Total other comprehensive income		1,083			560			1,773			473
Comprehensive income	$	602		$	688		$	2,507		$	1,400

See Notes to Consolidated Financial Statements.

5

HERITAGE FINANCIAL GROUP, INC. AND SUBSIDIARY

CONSOLIDATED STATEMENTS OF STOCKHOLDER’S EQUITY

For the Six Months Ended June 30, 2011(Unaudited)

 And The Year Ended December 31, 2010

(Dollars in thousands, except per share data)

																			Accumulated
													Unearned						Other
	Common Stock						Capital			Retained			ESOP			Treasury			Comprehensive
	Shares			Par Value			Surplus			Earnings			Shares			Stock			loss			Total
Balance, December 31, 2009		11,454,344		$	115		$	40,610		$	38,984		$	(2,424	)	$	(14,080	)	$	(2,387	)	$	60,818
Net income		-			-			-			1,406			-			-			-			1,406
Cash dividend declared, $0.36 per share		-			-			-			(854	)		-			-			-			(854	)
Stock-based compensation expense		-			-			810			-			-			-			-			810
Repurchase of 1,578 shares of stock for the treasury		-			-			-			-			-			(19	)		-			(19	)
Issuance of 1,075 shares of common stock from the treasury		-			-			(4	)		-			-			14			-			10
Items relating to conversion and stock offering:
Merger of Heritage MHC		(7,868,875	)		(79	)		102			-			-			-			-			23
Treasury stock retired		(1,055,587	)		(11	)		(14,074	)		-			-			14,085			-			-
Common stock exchanged for cash in lieu of issuing fractional shares		(411,127	)		(4	)		4			-			-			-			-			-
Proceeds from stock offering, net offering expenses ($4,459)		6,591,756			66			61,393			-			-			-			-			61,459
Purchase of ESOP shares (327,677)		-			-			-			-			(3,277	)		-			-			(3,277	)
Other comprehensive loss		-			-			-			-			-			-			(1,527	)		(1,527	)
Tax benefit from stock-based compensation plans		-			-			(14	)		-			-			-			-			(14	)
ESOP shares earned, 38,403 shares		-			-			3			-			456			-			-			459
Tax benefit on ESOP expense		-			-			46			-			-			-			-			46
Balance, December 31, 2010		8,710,511		$	87		$	88,876		$	39,536		$	(5,245	)	$	-		$	(3,914	)	$	119,340

(Continued)

6

HERITAGE FINANCIAL GROUP, INC. AND SUBSIDIARY

CONSOLIDATED STATEMENTS OF STOCKHOLDER’S EQUITY

For the Six Months Ended June 30, 2011(Unaudited)

 And The Year Ended December 31, 2010

(Dollars in thousands, except per share data)

																	Accumulated
												Unearned					Other
	Common Stock					Capital			Retained			ESOP			Treasury		Comprehensive
	Shares			Par Value		Surplus			Earnings			Shares			Stock		loss			Total
Balance, December 31, 2010		8,710,511		$	87	$	88,876		$	39,536		$	(5,245	)	$	-	$	(3,914	)	$	119,340
Net income							-			734			-			-					734
Cash dividend declared, $0.03 per share		-			-		-			(523	)		-			-					(523	)
Issuance of  4,000 shares of restricted common stock		4000			-		-			-			-			-					-
Forfeiture of 1,761 of							-			-			-			-					-
restricted common stock		(1,761	)		-		-			-			-			-					-
Stock-based compensation expense		-			-		412			-			-			-					412
Other comprehensive income		-			-		-			-			-			-		1,773			1,773
Tax benefit from stock- based compensation plans		-			-		(8	)		-			-			-					(8	)
ESOP shares earned, 26,648 shares		-			-		23			-			302			-					325
Tax benefit on ESOP expense		-			-		(15	)		-			-			-					(15	)
Balance, June 30, 2011		8,712,750			87		89,288			39,747			(4,943	)		-		(2,141	)		122,038

See Notes to Consolidated Financial Statements.

7

HERITAGE FINANCIAL GROUP, INC. AND SUBSIDIARY

CONSOLIDATED STATEMENTS OF CASH FLOWS

 (Dollars in thousands)

	Six Months Ended June 30,
	2011			2010
OPERATING ACTIVITIES	$	734		$	926
Net income
Adjustments to reconcile net income to net cash provided by operating activities:
Depreciation and amortization		609			431
Deposit premium amortization		302			106
Provision for loan losses		1,300			1,150
ESOP compensation expense		325			235
Stock-based compensation expense		412			404
Accretion of gain on termination of cash flow hedge		(150	)		(176	)
Gain on sales of securities available for sale		(453	)		(160	)
(Gain) loss on sales and write-downs of other real estate owned		892			(344	)
Increase in bank owned life insurance		(293	)		(306	)
Excess tax benefit related to stock-based compensation plans		8			11
Excess tax expense related to ESOP		15			(17	)
(Increase) decrease in interest receivable		(559	)		305
Increase (decrease) in interest payable		363			(63	)
(Increase) decrease in taxes receivable		(10	)		479
Decrease in prepaid FDIC assessment		581			367
Bargain purchase gain (loss)		(2,217	)		-
Net other operating activities		(37	)		809
Total adjustments		1,088			3,231
Net cash provided by operating activities		1,822			4,157
INVESTING ACTIVITIES
(Increase) decrease in interest-bearing deposits in banks		(89,398	)		22,228
Purchases of securities available for sale		(30,216	)		(76,131	)
Proceeds from maturities of securities available for sale		61,691			24,784
Proceeds from sales of securities available for sale		36,967			16,641
Increase in Federal Home Loan Bank stock		78			-
Increase  in federal funds sold		(23,919	)		(2,690	)
Increase in loans, net		(12,890	)		(9,393	)
Purchases of premises and equipment		(6,742	)		(1,754	)
Net cash received from acquisition activity		57,900			40,531
Proceeds from sales of premises and equipment		12			-
Proceeds from sales of other real estate owned		1,686			1,983
Net cash provided by (used in) investing activities	$	(4,831	)	$	16,197

(Continued)

8

HERITAGE FINANCIAL GROUP, INC. AND SUBSIDIARY

CONSOLIDATED STATEMENTS OF CASH FLOWS

 (Dollars in thousands)

	Six Months Ended June 30,
	2011			2010
FINANCING ACTIVITIES
Increase (decrease) in deposits	$	23,153		$	(7,749	)
Increase (decrease) in federal funds purchasedand securities sold under repurchase agreements		(432	)		1,111
Repayment of other borrowings		(32,744	)		-
Excess tax benefit related to stock-based compensation plans		(8	)		(11	)
Excess tax (benefit) related to ESOP		(15	)		17
Dividends paid to stockholders		(523	)		(486	)
Net cash used in financing activities		(10,569	)		(7,134	)
Net increase (decrease) in cash and due from banks		(13,578	)		13,220
Cash and due from banks at beginning of year		28,803			14,922
Cash and due from banks at end of year	$	15,225		$	28,142
SUPPLEMENTAL DISCLOSURES OF CASH FLOW INFORMATION
Cash paid during the year for:
Interest	$	4,894		$	4,221
Income taxes paid	$	-		$	9
NONCASH TRANSACTIONS
Decrease in unrealized losses on securities available for sale	$	3,093		$	965
Principal balances of loans transferred to other real estate owned	$	843		$	2,910

See Notes to Consolidated Financial Statements.

9

HERITAGE FINANCIAL GROUP, INC. AND SUBSIDIARY

CONDENSED NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

NOTE 1. BASIS OF PRESENTATIONAND ACCOUNTING ESTIMATES

Heritage Financial Group, Inc.  (the “Company”), a Maryland corporation, was incorporated in May 2010 and organized by Heritage MHC (the “MHC”), Heritage Financial Group and HeritageBank of the South ( the “Bank”) to facilitate the second-step conversion  from the mutual holding company structure to the stock holding company structure (the “Conversion”).  Upon consummation of the Conversion, which occurred on November 30, 2010, the Company became the holding company for the Bank and a 100% publicly owned stock holding company.  As a result of the Conversion, each share of Heritage Financial Group’s common stock owned by public shareholders was exchanged for 0.8377 shares of the Company’s common stock, with cash being paid in lieu of issuing fractional shares.  All shares and per share information for periods prior to the Conversion have been adjusted to reflect the 0.8377:1 exchange ratio on publicly traded shares.  All references to the Company refer to Heritage Financial Group for periods prior to the completion of the Conversion.

The accompanying consolidated financial information of the Company is unaudited; however, such information reflects all adjustments (consisting of normal recurring adjustments) which are, in the opinion of management, necessary for a fair presentation of the financial position and results of operations. The results of operations for the three and six months ended June 30, 2011, are not necessarily indicative of the results that may be expected for the full year. These statements should be read in conjunction with the consolidated financial statements and related notes included in the Company’s Annual Report on Form 10-K for the year ended December 31, 2010.

The consolidated financial statements include the accounts of the Company and its subsidiary.  Significant intercompany transactions and balances have been eliminated in consolidation.

In preparing the consolidated financial statements in conformity with accounting principles generally accepted in the United States of America, management is required to make estimates and assumptions that affect the reported amounts of assets and liabilities as of the date of the balance sheet and the reported amounts of revenues and expenses during the reporting period.  Actual results could differ from those estimates.

Material estimates that are particularly susceptible to significant change in the near-term relate to the determination of the allowance for loan losses, the valuation of foreclosed real estate, deferred tax assets, other-than-temporary impairments of securities and the fair value of financial instruments.

The accompanying consolidated financial information of the Company as of June 30, 2011 and for the three and six months ended June 30, 2011 and 2010, is unaudited; however, such information reflects all adjustments (consisting of normal recurring adjustments) which are, in the opinion of management, necessary for a fair presentation of the financial position and results of operations.

10

HERITAGE FINANCIAL GROUP, INC. AND SUBSIDIARY

CONDENSED NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

NOTE 2. EARNINGS (LOSS) PER SHARE

Basic earnings (loss) per share represent income available attributable to common shareholders divided by the weighted-average number of common shares outstanding during the period, excluding unallocated shares of the Employee Stock Ownership Plan.  The table below sets forth our earnings (loss) per share for the three and six months ended June 30, 2011 and 2010:

	Three Months Ended June 30,					Six Months Ended June 30,
	2011			2010		2011		2010
	(dollars in thousands, except per share amounts)
Basic earnings (loss) per share:
Net income (loss)	$	(481	)	$	128	$	734	$	927
Weighted average common shares outstanding		8,214			8,469		8,200		8,457
Basic earnings (loss) per common share	$	(0.06	)	$	0.02	$	0.09	$	0.11
Diluted earnings (loss) per share:
Net income (loss)	$	(481	)	$	128	$	734	$	927
Weighted average common shares outstanding		8,214			8,469		8,200		8,457
Effect of dilutive stock options and restricted stock		1			2		2		1
Weighted average dilutive common shares outstanding		8,215			8,471		8,202		8,458
Diluted earnings (loss) per common share	$	(0.06	)	$	0.02	$	0.09	$	0.11

For the three months ended June 30, 2011, potential common shares of 568,495 were not included in the calculation of diluted earnings per share because the assumed exercise of such shares would be anti-dilutive.

11

HERITAGE FINANCIAL GROUP, INC. AND SUBSIDIARY

CONDENSED NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

NOTE 3. SHARE BASED COMPENSATION

On May 17, 2006, the Company’s stockholders approved the 2006 Equity Incentive Plan (the “Plan”).  The purpose of the Plan is to promote the long-term growth and profitability of Heritage Financial Group, Inc, to provide directors, advisory directors, officers and employees of Heritage Financial Group, Inc. and its affiliates with an incentive to achieve corporate objectives, to attract and retain individuals of outstanding competence, and to provide such individuals with an equity interest in Heritage Financial Group, Inc.  Under the Plan, the Compensation Committee of the Board of Directors has discretion to award up to 645,990 shares, of which 461,422 were available as stock options or stock appreciation rights and 184,568 shares were available as restricted stock awards.

On June 22, 2011, the Company’s stockholders approved the 2011 Equity Incentive Plan (the “2011 Plan”).  Under the 2011 Plan, the Compensation Committee has the discretion to award up to 573,481 shares, of which 409,429 were available as stock options or stock appreciation rights and163,852 were available as restricted stock awards.  As of June 30, 2011, no awards had been granted under the 2011 Plan.

The Company granted restricted awards that may not be sold or otherwise transferred until certain restrictions have lapsed.  The unearned compensation related to these awards is being amortized to compensation expense over the period the restrictions lapse (generally one to five years).  The share-based expense for these awards was determined based on the market price of the Company's stock at the date of grant applied to the total number of shares that were anticipated to fully vest, amortized over the vesting period.   As of June 30, 2011, there was approximately $75,000 of unrecognized compensation associated with these awards.  For each of the three months ended June 30, 2011 and 2010, we recognized compensation expense associated with these awards of approximately $124,000. For each of the six months ended June 30, 2011 and 2010, we recognized compensation expense associated with these awards of approximately $248,000.

The Company recognized compensation expense related to stock options of approximately $101,000 and $78,000 for each of the three months ended June 30, 2011, and 2010, respectively.  For the six months ended June 30, 2011 and 2010, the Company recognized compensation expense related to these options of $164,000 and $156,000, respectively.  At June 30, 2011, there was approximately $63,000 of unrecognized compensation related to stock options.

12

HERITAGE FINANCIAL GROUP, INC. AND SUBSIDIARY

CONDENSED NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

NOTE 4. SECURITIES

The amortized cost and fair value of securities available for sale with gross unrealized gains and losses are summarized as follows:

			Gross		Gross
	Amortized		Unrealized		Unrealized			Fair
	Cost		Gains		Losses			Value
June 30, 2011 (unaudited):	(dollars in thousands)
U. S. Government sponsored agencies (GSEs) and U. S. Treasury securities	$	46,774	$	258	$	(559	)	$	46,473
State and municipal securities		20,940		243		(694	)		20,489
Corporate debt securities		2,165		-		(121	)		2,044
GSE residential mortgage-backed securities		116,561		1,087		(270	)		117,378
Total debt securities		186,440		1,588		(1,644	)		186,384
Equity securities		435		150		(102	)		483
Total securities	$	186,875	$	1,738	$	(1,746	)	$	186,867

December 31, 2010:
U. S. Government sponsored agencies (GSEs) and U. S. Treasury securities	$	89,680	$	246	$	(894	)	$	89,032
State and municipal securities		20,642		65		(1,547	)		19,160
Corporate debt securities		2,170		-		(470	)		1,700
GSE residential mortgage-backed securities		125,749		724		(1,137	)		125,336
Private label residential mortgage-backed securities		2,800		7		-			2,807
Total debt securities		241,041		1,042		(4,048	)		238,035
Equity securities		435		31		(124	)		342
Total securities	$	241,476	$	1,073	$	(4,172	)	$	238,377

* At June 30, 2011 and December 31, 2010, the Company held no securities of any single issuer (excluding the U.S. Government and federal agencies) with a book value that exceeded 10% of stockholders’ equity.

13

HERITAGE FINANCIAL GROUP, INC. AND SUBSIDIARY

CONDENSED NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

NOTE 4. SECURITIES (Continued)

The amortized cost and fair value of debt securities available for sale as of June 30, 2011 by contractual maturity are shown below.  Actual maturities may differ from contractual maturities in mortgage-backed securities because the mortgages underlying the securities may be called or repaid without penalty.  Therefore, these securities are not included in the maturity categories in the following maturity summary.

	Amortized Cost		Fair Value
	(dollars in thousands)
Due from one to five years	$	14,733	$	14,740
Due from five to ten years		10,110		9,924
Due after ten years		45,471		44,825
Mortgage-backed securities		116,561		117,378
	$	186,875	$	186,867

Securities with a carrying value of $74,552 and $68,809 at June 30, 2011 and December 31, 2010, respectively, were pledged to secure public deposits, repurchase agreements and for other purposes required or permitted by law.

Gains and losses on sales of securities available for sale consist of the following:

	June 30,
	2011		2010
	(dollars in thousands)
Gross gains on sales of securities	$	453	$	170
Gross losses on sales of securities		-		(10	)
Net realized gains on sales of securities available for sale	$	453	$	160

14

HERITAGE FINANCIAL GROUP, INC. AND SUBSIDIARY

CONDENSED NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

NOTE 4. SECURITIES (Continued)

The following table shows the gross unrealized losses and fair value of securities aggregated by category and length of time that securities have been in a continuous unrealized loss position at June 30, 2011 and December 31, 2010.

	Less Than 12 Months					12 Months or More					Total
Description of Securities	Fair Value		Unrealized Losses			Fair Value		Unrealized Losses			Fair Value		Unrealized Losses
	(dollars in thousands)
June 30, 2011 (unaudited):
U.S. Government sponsored agency securities (GSEs) and U. S. Treasury securities		24,744	$	(559	)	$	-	$	-		$	24,744	$	(559	)
State and municipal securities		6,679		(143	)		3,700		(551	)		10,379		(694	)
Corporate debt securities		-		-			1,043		(121	)		1,043		(121	)
GSE residential mortgage-backed Securities		31,370		(270	)		-		-			31,370		(270	)
Subtotal, debt securities		62,793		(972	)		4,743		(672	)		67,536		(1,644	)
Equity securities		-		-			147		(102	)		147		(102	)
Total temporarily impaired securities	$	62,793	$	(972	)	$	4,890	$	(774	)	$	67,683	$	(1,746	)

December 31, 2010 :
U.S. Government sponsored agencies (GSEs) and U.S. Treasury securities	$	68,948	$	(894	)	$	-	$	-		$	68,948	$	(894	)
State and municipal securities		13,815		(639	)		3,541		(908	)		17,356		(1,547	)
Corporate debt securities		934		(79	)		766		(391	)		1,700		(470	)
GSE residential mortgage-backed Securities		72,748		(1,137	)		-		-			72,748		(1,137	)
Subtotal, debt securities		156,445		(2,749	)		4,307		(1,299	)		160,752		(4,048	)
Equity securities		-		-			310		(124	)		310		(124	)
Total temporarily impaired securities	$	156,445	$	(2,749	)	$	4,617	$	(1,423	)	$	161,062	$	(4,172	)

Management evaluates securities for other-than-temporary impairment at least on a quarterly basis, and more frequently when economic or market concerns warrant such evaluation.

In analyzing an issuer’s financial condition, management considers whether the securities are issued by the federal government or its agencies, whether downgrades by bond rating agencies have occurred and industry analysts’ reports.  As management has the intent and ability to hold the securities until maturity, or for the foreseeable future and due to the fact that the unrealized losses relate primarily to changes in interest rates and do not affect the expected cash flows of the underlying collateral or issuer, no declines are deemed to be other than temporary.

15

HERITAGE FINANCIAL GROUP, INC. AND SUBSIDIARY

CONDENSED NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

NOTE 4. SECURITIES (Continued)

The investment in the common stock of the Federal Home Loan Bank of Atlanta is accounted for by the cost method, which also represents par value, and is made for long-term business affiliation reasons.  In addition, this investment is subject to restrictions relating to sale, transfer or other disposition.  Dividends are recognized in income when declared.  The carrying value of this investment at June 30, 2011 is approximately $4.3 million.  The estimated fair value of this investment is approximately $4.3 million as of June 30, 2011, and therefore is not considered impaired.

Other equity securities represent an investment in the common stock of the Chattahoochee Bank of Georgia (“Chattahoochee”), a de novo bank in Gainesville, Georgia.  The Company accounts for this investment by the cost method.  This investment represents approximately 4.9% of the outstanding shares of Chattahoochee.  Since its initial capital raise, Chattahoochee has not had any stock transactions, and therefore, no fair market value is readily available.  The carrying value of this investment at June 30, 2011 is approximately $1.0 million. The Company plans to hold this investment for the foreseeable future, and does not consider it impaired as of June 30, 2011.

NOTE 5. LOANS AND ALLOWANCE FOR LOAN LOSSES

The composition of loans is summarized as follows:

	June 30,		December 31,
	2011		2010
	(dollars in thousands)
Commercial real estate	$	157,058	$	136,016
Consumer real estate		157,736		157,384
Construction and land		26,688		24,522
Commercial and industrial loans		50,997		52,589
Consumer and other		23,592		27,115
		416,071		397,626
Loans acquired through FDIC-assisted acquisitions
Non Covered		24,227		21,371
Covered		60,427		-
Total loans		500,725		418,997
Total allowance for loan losses		6,585		8,101
Loans, net	$	494,140	$	410,896

16

HERITAGE FINANCIAL GROUP, INC. AND SUBSIDIARY

CONDENSED NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

NOTE 5. LOANS AND ALLOWANCE FOR LOAN LOSSES (Continued)

Loans acquired through FDIC-assisted acquisitions including the acquisition of The Tattnall Bank in December 2009 and the acquisition of Citizens Bank of Effingham in February 2011 are accounted for under ASC 310-30 Loans and Debt Securities Acquired with Deteriorated Credit Quality, and have been excluded from the tables below.

Changes in the allowance for loan losses are as follows:

		For the three months ended June 30			For the six months ended June 30,			For the twelve months ended December 31,
		2011			2011			2010
		(dollars in thousands)
Balance, beginning of period	$	6,138		$	8,101		$	6,060
Provision for loan losses		700			1,300			5,500
Loans charged off		(298	)		(2,930	)		(3,686	)
Recoveries of loans previously charged off		45			114			227
Balance, end of period	$	6,585		$	6,585		$	8,101

The following table details activity in the allowance for loan losses by portfolio segment for the three months ended June 30, 2011.  Allocation of a portion of the allowance to one category of loans does not preclude its availability to absorb losses in other categories.

	Commercial Real Estate			Consumer Real Estate			Construction and Land			Commercial and Industrial Loans			Consumer			Total
	(dollars in thousands)
Balance, March 31, 2011	$	1,760		$	1,845		$	1,132		$	1,078		$	323		$	6,138
Add (deduct):
Charge-offs		(65	)		(181	)		(10	)		(18	)		(24	)		(298	)
Recoveries		10			6			-			-			29			45
Provision		881			(15	)		(299	)		242			(109	)		700
Balance, June 30, 2011	$	2,586		$	1,655		$	823		$	1,302		$	219		$	6,585

17

HERITAGE FINANCIAL GROUP, INC. AND SUBSIDIARY

CONDENSED NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

The following tables detail activity in the allowance for loan losses by portfolio segment for the six months ended June 30, 2011 and the year ended December 31, 2010.  Allocation of a portion of the allowance to one category of loans does not preclude its availability to absorb losses in other categories.

	Commercial Real Estate			Consumer Real Estate			Construction and Land			Commercial and Industrial Loans			Consumer			Total
	(dollars in thousands)
Balance, January 1, 2011	$	1,721		$	2,197		$	1,977		$	1,601		$	605		$	8,101
Add (deduct):
Charge-offs		(401	)		(2,319	)		(18	)		(77	)		(115	)		(2,930	)
Recoveries		10			9			1			-			94			114
Provision		1,256			1,768			(1,137	)		(222	)		(365	)		1,300
Balance, June 30, 2011	$	2,586		$	1,655		$	823		$	1,302		$	219		$	6,585
Allowance:
Ending balance: specific	$	-		$	-		$	-		$	-		$	-		$	-
Ending balance: collective	$	2,586		$	1,655		$	823		$	1,302		$	219		$	6,585
Loans:
Ending balance: individually evaluated for impairment	$	874		$	5,202		$	4,669		$	848		$	-		$	11,593
Ending balance: collectively evaluated for impairment	$	156,184		$	152,534		$	22,019		$	50,149		$	23,592		$	404,478

	Commercial Real Estate			Consumer Real Estate			Construction and Land			Commercial and Industrial Loans			Consumer			Total
	(dollars in thousands)
Balance, January 1, 2010	$	1,176		$	1,422		$	1,419		$	1,193		$	850		$	6,060
Add (deduct):
Charge-offs		(412	)		(1,278	)		(704	)		(804	)		(488	)		(3,686	)
Recoveries		-			10			-			-			217			227
Provision		957			2,043			1,262			1,212			26			5,500
Balance, December 31, 2010	$	1,721		$	2,197		$	1,977		$	1,601		$	605		$	8,101
Loans:
Ending balance: individually evaluated for impairment	$	3,322		$	6,757		$	4,909		$	932		$	-		$	15,920
Ending balance: collectively evaluated for impairment	$	132,694		$	150,627		$	19,613		$	51,657		$	27,115		$	381,706

18

HERITAGE FINANCIAL GROUP, INC. AND SUBSIDIARY

CONDENSED NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

NOTE 5. LOANS AND ALLOWANCE FOR LOAN LOSSES (Continued)

The following is a summary of information pertaining to impaired loans:

	June 30,		December 31,
	2011		2010
	(dollars in thousands)
Impaired loans without a valuation allowance	$	-	$	-
Impaired loans with a valuation allowance		14,815		16,441
Total impaired loans	$	14,815	$	16,441
Valuation allowance related to impaired loans	$	330	$	2,803
Year to date average investment in impaired loans	$	15,714	$	16,441
Foregone interest income on impaired loans	$	181	$	538

A loan is considered impaired, in accordance with the impairment accounting guidance (ASC 310-10-35-16), when based on current information and events, it is probable that the Company will be unable to collect all amounts due from the borrower in accordance with the contractual term of the loan.  Impaired loans include loans modified in troubled debt restructuring where concessions have been granted to borrowers experiencing financial difficulties.  These concessions could include a reduction in the interest rate on the loan, payment extensions, forgiveness of principal, forbearance or other actions intended to maximize collection.

Included in certain loan categories are troubled debt restructurings that were classified as impaired.  At June 30, 2011, the Company had troubled debt restructurings totaling $11.6 million, which involve forgiving a portion of interest or principal on any loans or making loans at a rate materially less than that of market rates.  Included in nonaccruing loans at June 30, 2011, are troubled debt restructurings of $5.4 million.  In addition, at that date the Company had troubled debt restructurings totaling $6.2 million that were performing in accordance with their modified terms and are not included in nonaccruing loans.

Impaired loans by class are presented below as of and for the six months ending June 30, 2011:

									Interest
			Unpaid				Average		Income
	Recorded		Principal		Related		Recorded		Recognized
	Investment		Balance		Allowance		Investment		YTD 2011
	(dollars in thousands)
Commercial real estate	$	2,422	$	2,848	$	169	$	2,549	$	3
Consumer real estate		5,996		8,160		82		6,712		32
Construction and land		5,153		5,724		24		5,174		4
Commercial and industrial loans		1,095		1,113		39		1,118		14
Consumer		149		174		16		161		3
Total	$	14,815	$	18,019	$	330	$	15,714	$	56

19

HERITAGE FINANCIAL GROUP, INC. AND SUBSIDIARY

CONDENSED NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

NOTE 5. LOANS AND ALLOWANCE FOR LOAN LOSSES (Continued)

At December 31, 2010, the Company had troubled debt restructurings totaling $7.7 million, which involve forgiving a portion of interest or principal on any loans or making loans at a rate materially less than that of market rates.  Included in nonaccruing loans at December 31, 2010, are troubled debt restructurings of $1.1 million.  In addition, at that date the Company had troubled debt restructurings totaling $6.6 million that were performing in accordance with their modified terms and are not included in nonaccruing loans.

Impaired loans by class are presented below as of and for the year ended December 31, 2010:

									Interest
			Unpaid				Average		Income
	Recorded		Principal		Related		Recorded		Recognized
	Investment		Balance		Allowance		Investment		YTD 2010
	(dollars in thousands)
Commercial real estate	$	3,356	$	3,356	$	455	$	3,356	$	77
Consumer real estate		6,918		6,918		898		6,918		251
Construction and land		4,997		4,997		1,114		4,997		198
Commercial and industrial loans		1,005		1,005		266		1,005		62
Consumer		165		165		70		165		8
Total	$	16,441	$	16,441	$	2,803	$	16,441	$	596

Below is an analysis of the age of recorded investment in loans that are past due as of June 30, 2011.

	30-59		60-89		Greater		Total
	Days		Days		Than		Past				Total
	Past Due		Past Due		90 Days		Due		Current		Loans
	(dollars in thousands)
Commercial real estate	$	-	$	-	$	1,798	$	1,798	$	155,260	$	157,058
Consumer real estate		259		195		3,932		4,386		153,350		157,736
Construction and land		-		-		1,615		1,615		25,073		26,688
Commercial and industrial loans		144		4		1,095		1,243		49,754		50,997
Consumer		108		17		149		274		23,318		23,592
Total	$	511	$	216	$	8,589	$	9,316	$	406,755	$	416,071

There were no accruing loans that were greater than 90 days past due at June 30, 2011.

20

HERITAGE FINANCIAL GROUP, INC. AND SUBSIDIARY

CONDENSED NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

NOTE 5. LOANS AND ALLOWANCE FOR LOAN LOSSES (Continued)

Below is an analysis of the age of recorded investment in loans that are past due as of the year ended December 31, 2010.

	30-59		60-89		Greater		Total
	Days		Days		Than		Past				Total
	Past Due		Past Due		90 Days		Due		Current		Loans
	(dollars in thousands)
Commercial real estate	$	-	$	-	$	3,356	$	3,356	$	132,660	$	136,016
Consumer real estate		1,167		38		4,873		6,040		151,344		157,384
Construction and land		295		-		1,423		1,718		22,804		24,522
Commercial and industrial loans		40		89		88		217		52,372		52,589
Consumer		235		15		165		415		26,700		27,115
Total	$	1,737	$	142	$	9,905	$	11,746	$	385,880	$	397,626

There were no accruing loans that were greater than 90 days past due at December 31, 2010.

The Bank manages the loan portfolio by assigning one of eight credit risk ratings based on an internal assessment of credit risk.  The credit risk categories are Pass 1 Highest Quality, Pass 2 Highest Quality to Satisfactory, Pass 3 Satisfactory, Pass 4 Minimum Acceptable Credit, OAEM Special Mention 5, Substandard 6 Excessive Credit Risk, Doubtful 7, and Loss 8.

Pass-1-Highest Quality- Assets of this grade are the highest quality credits of the Bank. They exceed substantially all the Bank's underwriting criteria, and provide superior protection for the Bank through the paying capacity of the borrower and value of the collateral. The Bank's credit risk is considered to be negligible.

Pass-2-Highest Quality to Satisfactory - Loans that are fully secured by tangible collateral and the borrowers have demonstrated or documented exceptional credit history, net worth or some other measure of repayment ability.

Pass-3-Satisfactory - Loans that are of satisfactory credit quality, are properly structured and documented, and require only normal supervision.  Financial data is current and adequate income, profits, cash flow and satisfactory credit history and leverage position of borrower, make financial condition satisfactory.  Loan is in proportion to worth.  Unsecured loans are normally for specific purposes and short term.  Secured loans have good collateral margin.  Repayment terms are realistic, clearly defined and based upon the primary source of repayment and all such loans meet banks lending criteria.  Seasonal loans, such as crop production or working capital, are seasonally rested.  Real estate loans are within proper loan to value ratios and have adequate debt service coverage.

21

HERITAGE FINANCIAL GROUP, INC. AND SUBSIDIARY

CONDENSED NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

NOTE 5. LOANS AND ALLOWANCE FOR LOAN LOSSES (Continued)

Pass-4-Minimum Acceptable Credit - Loans which exhibit all the characteristics of a Satisfactory Credit but warrant more than the normal level of Loan Officer supervision, due to: Circumstances which elevate the risks of performance prospects (i.e., start-up operations, untested management, heavy leverage, interim losses); Adverse, extraordinary, events that have affected, or could affect, the borrower’s cash flow, financial condition, ability to continue operating profitability, or refinancing (i.e., death of principal, fire, divorce).

OAEM-5-Special Mention - Loans With Greater Than Normal Credit Risk - (Other Assets Especially Mentioned)- Credits in this category include loans on which payment is probable, but timeliness of payment is not certain.  Assets in this category have potential weaknesses, which, if not corrected, will leave the bank inadequately protected.  Such weaknesses threaten the integrity of the asset or will leave the bank’s position vulnerable.  Potential weakness may be evidenced by inadequate financial information, deteriorating capacity to service term debt, inability to meet reduction or payout requirements for interim or short term financing, unfavorable industry or company trends and companies with weak or deteriorating management.  Individuals with excessive leverage, or with financial information which omits or ignores cash flow or debt service, should also be classified OAEM.  Also includes, companies and individuals whose financial information is out of date.  Game plans must be developed on all OAEM assets and time frames established to cure the weaknesses in the credit or move the relationship out of the bank.

Substandard-6-Excessive Credit Risk- Loans rated #6 are substandard assets and are classified loans.  These loans represent an excessive credit risk for the bank and must be monitored closely for adherence to game plans. Substandard assets are inadequately protected by the tangible net worth and repayment capacity of the borrower.  The collateral pledged may be insufficient to cover the bank’s exposure.  There are well-defined weaknesses which jeopardize the repayment of the loan on reasonable terms and the borrower may not be able to keep up the interest payments.  Adverse trends may result in payment over an excessive period of time and there may be the possibility of loss.  Substandard loans may or may not be placed on non-accrual, the unsecured portion of some loans may be written down.

Doubtful-7 - Loans that have all of the weaknesses inherent in those classified as Substandard, with the additional characteristic that the weaknesses make collection or liquidation in full highly questionable and improbable.  This assessment should be made on current facts, conditions and values.  The probability of some loss is extremely high, but because of certain important and reasonably specific pending factors (i.e., merger/liquidation, capital injection, refinancing plans, and perfection of liens), the amount of loss cannot yet be determined.  Determination of the pending factors should generally be resolved within six months and the asset partially, or fully, charged-off or moved to substandard.  All doubtful assets must be placed on non-accrual.  A reserve allocation of at least 50% is normally recommended for such loans.

22

HERITAGE FINANCIAL GROUP, INC. AND SUBSIDIARY

CONDENSED NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

NOTE 5. LOANS AND ALLOWANCE FOR LOAN LOSSES (Continued)

Loss-8 - Loans in the loss category are those, which are deemed uncollectible, and as such, are charged to the Loan Loss Reserve.  Loans may be charged off, either in whole or in part.  Loans, which carry a #8 rating, are no longer considered assets of the bank.  The 8-risk rating may be used to designate the remaining portion of a relationship still on the Bank’s books after the exposure has been charged off.

Credit quality indicators by class are presented below for June 30, 2011:

					Construction
	Commercial		Consumer		and
	Real Estate		Real Estate		Land		Commercial
	(dollars in thousands)
Real Estate and Commercial Credit Exposure
Pass 1	$	1,824	$	1,490	$	-	$	1,290
Pass 2		-		64		2,613		279
Pass 3		76,478		113,776		7,630		25,906
Pass 4		70,309		31,946		10,128		21,036
Special Mention 5		4,050		470		691		592
Substandard 6		4,397		9,990		5,626		1,894
Doubtful 7		-		-		-		-
Loss 8		-		-		-		-
Total	$	157,058	$	157,736	$	26,688	$	50,997

	Consumer Other
	(dollars in thousands)
Consumer Other Credit Exposure
Pass 1-4	$	23,284
Special Mention 5		39
Substandard 6		269
Doubtful 7		-
Loss 8		-
Total	$	23,592

23

HERITAGE FINANCIAL GROUP, INC. AND SUBSIDIARY

CONDENSED NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

NOTE 5. LOANS AND ALLOWANCE FOR LOAN LOSSES (Continued)

Credit quality indicators by class are presented below for December 31, 2010:

					Construction
	Commercial		Consumer		and
	Real Estate		Real Estate		Land		Commercial
	(dollars in thousands)
Real Estate and Commercial Credit Exposure
Pass 1	$	-	$	-	$	75	$	1,008
Pass 2		-		49		-		281
Pass 3		63,380		116,329		8,497		29,683
Pass 4		64,718		29,504		9,723		19,015
Special Mention 5		2,832		2,896		530		667
Substandard 6		5,086		8,606		5,697		1,935
Doubtful 7		-		-		-		-
Loss 8		-		-		-		-
Total	$	136,016	$	157,384	$	24,522	$	52,589

	Consumer Other
	(dollars in thousands)
Consumer Other Credit Exposure
Pass 1-4	$	26,773
Special Mention 5		29
Substandard 6		313
Doubtful 7		-
Loss 8		-
Total	$	27,115

24

HERITAGE FINANCIAL GROUP, INC. AND SUBSIDIARY

CONDENSED NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

NOTE 5. LOANS AND ALLOWANCE FOR LOAN LOSSES (Continued)

FDIC-Assisted Transactions

On December 4, 2009, the Company elected to account for loans acquired in The Tattnall Bank acquisition under ASC 310 – 30.  Under ASC 310-30 Loans and Debt Securities Acquired with Deteriorated Credit Quality, applies to a loan with evidence of deterioration of credit quality since origination, acquired by completion of a transfer for which it is probable, at acquisition, that the investor will be unable to collect all contractually required payments receivable. FASB ASC 310 prohibits carrying over or creating an allowance for loan losses upon initial recognition for loans which fall under the scope of this statement. Loans with specific evidence of deterioration in credit quality were accounted for under FASB ASC 310.  In addition, the Company determined it would not be able to collect all the contractually required principal and interest payments on other loans in the portfolio which did not have specific evidence of credit quality due to multiple factors, including the deterioration of the economy since origination of these loans, the decline in real estate values in the market areas of the loans, and the poor underwriting standards under which these loans were originated.   These loans are accounted for by analogy to FASB ASC 310.

The following table represents the loans receivable as of June 30, 2011 and reflects reclassifications from the balances reported at December 31, 2010:

	Acquired Loans Without Specific Evidence of Deterioration in Credit Quality			Acquired Loans With Specific Evidence of Deterioration in Credit Quality			Total Loans Acquired
	(dollars in thousands)
Contractually required principal and interest	$	22,122		$	6,435		$	28,547
Non-accretable difference		(971	)		(5,775	)		(6,746	)
Cash flows expected to be collected		21,141			660			21,801
Accretable yield		(4,329	)		(1	)		(4,330	)
Basis in acquired loans	$	16,812		$	659		$	17,471

25

HERITAGE FINANCIAL GROUP, INC. AND SUBSIDIARY

CONDENSED NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

NOTE 5. LOANS AND ALLOWANCE FOR LOAN LOSSES (Continued)

FDIC-Assisted Transactions (Continued)

The following table is a summary of changes in the accretable yields of acquired loans since the acquisition date and reflect refinements to the Company's initial estimate:

	Acquired Loans Without Specific Evidence of Deterioration in Credit Quality			Acquired Loans With Specific Evidence of Deterioration in Credit Quality			Total Loans Acquired
	(dollars in thousands)
Balance at acquisition, December 4, 2009	$	1,090		$	2,480		$	3,570
Accretion		(65	)		(128	)		(193	)
Balance, December 31, 2009	$	1,025		$	2,352		$	3,377
Transfers from non-accretable difference to accretable yield		3,823			(485	)		3,338
Accretion		(1,549	)		(568	)		(2,117	)
Balance, December 31, 2010	$	3,299		$	1,299		$	4,598
Transfers from non-accretable difference to accretable yield		1,573			(1,299	)		274
Accretion		(543	)		1			(542	)
Balance, June 30, 2010	$	4,329		$	1		$	4,330

26

HERITAGE FINANCIAL GROUP, INC. AND SUBSIDIARY

CONDENSED NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

NOTE 5. LOANS AND ALLOWANCE FOR LOAN LOSSES (Continued)

FDIC-Assisted Transactions (Continued)

On February 18, 2011, the Company elected to account for loans acquired in The Citizens Bank of Effingham acquisition under ASC 310 – 30.  Under ASC 310-30 Loans and Debt Securities Acquired with Deteriorated Credit Quality, applies to a loan with evidence of deterioration of credit quality since origination, acquired by completion of a transfer for which it is probable, at acquisition, that the investor will be unable to collect all contractually required payments receivable. FASB ASC 310 prohibits carrying over or creating an allowance for loan losses upon initial recognition for loans which fall under the scope of this statement. Loans with specific evidence of deterioration in credit quality were accounted for under FASB ASC 310.  In addition, the Company determined it would not be able to collect all the contractually required principal and interest payments on other loans in the portfolio which did not have specific evidence of credit quality due to multiple factors, including the deterioration of the economy since origination of these loans, the decline in real estate values in the market areas of the loans, and the poor underwriting standards under which these loans were originated.   These loans are accounted for by analogy to FASB ASC 310.

The following table represents the loans receivable as of June 30, 2011:

	Acquired Loans Without Specific Evidence of Deterioration in Credit Quality			Acquired Loans With Specific Evidence of Deterioration in Credit Quality			Total Loans Acquired
	(dollars in thousands)
Contractually required principal and interest	$	123,349		$	38,160		$	161,509
Non-accretable difference		(37,552	)		(22,988	)		(60,540	)
Cash flows expected to be collected		85,797			15,172			100,969
Accretable yield		(33,900	)		(365	)		(34,265	)
Basis in acquired loans	$	51,897		$	14,807		$	66,704

The following table is a summary of changes in the accretable yields of acquired loans since the acquisition date and reflect refinements to the Company's initial estimate:

	Acquired Loans Without Specific Evidence of Deterioration in Credit Quality			Acquired Loans With Specific Evidence of Deterioration in Credit Quality			Total Loans Acquired
	(dollars in thousands)
Balance at acquisition, February 18, 2011	$	35,731		$	423		$	36,154
Accretion		(1,831	)		(58	)		(1,889	)
Balance, June 30, 2011	$	33,900		$	365		$	34,265

27

HERITAGE FINANCIAL GROUP, INC. AND SUBSIDIARY

CONDENSED NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

NOTE 6.  FAIR VALUE MEASUREMENTS

On January 1, 2008, the Company adopted Fair Value Measurements and Disclosures (FASB ASC 820), Fair Value Measurements.  Fair Value Measurements and Disclosures defines fair value, establishes a framework for measuring fair value, and expands disclosures about fair value measurements.  Fair Value Measurements and Disclosures applies to reported balances that are required or permitted to be measured at fair value under existing accounting pronouncements; accordingly, the standard does not require any new fair value measurements of reported balances.

Fair Value Measurements and Disclosures emphasizes that fair value is a market-based measurement, not an entity-specific measurement.  Therefore, a fair value measurement should be determined based on the assumptions that market participants would use in pricing the asset or liability.  As a basis for considering market participant assumptions in fair value measurements, Fair Value Measurements and Disclosures establishes a fair value hierarchy that distinguishes between market participant assumptions based on market data obtained from sources independent of the reporting entity (observable inputs that are classified within Level 1 and 2 of the hierarchy) and the reporting entity’s own assumptions about market participant assumptions (unobservable inputs classified within Level 3 of the hierarchy).

Level 1 inputs utilize quoted prices (unadjusted) in active markets for identical assets or liabilities that the Company has the ability to access.  Level 2 inputs are inputs other than quoted prices included in Level 1 that are observable for the asset or liability, either directly or indirectly.  Level 2 inputs may include quoted prices for similar assets and liabilities in active markets, as well as inputs that are observable for the asset or liability (other than quoted prices), such as interest rates, foreign exchange rates and yield curves that are observable at commonly quoted intervals.  Level 3 inputs are unobservable inputs for the assets or liabilities, which are typically based on an entity’s own assumptions, as there is little, if any, related market activity.  In instances where the determination of the fair value hierarchy within which the entire fair value measurement falls is based on the lowest level input that is significant to the fair value measurement in its entirety.  The Company’s assessment of the significance of a particular input to the fair value measurement in its entirety requires judgment, and considers factors specific to the asset or liability.

28

HERITAGE FINANCIAL GROUP, INC. AND SUBSIDIARY

CONDENSED NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

NOTE 6.  FAIR VALUE MEASUREMENTS (continued)

The table below presents the Company’s assets and liabilities measured at fair value on a recurring basis as of June 30, 2011, aggregated by the level in the fair value hierarchy within which those measurements fall.

	Quoted Prices		Significant
	in Active		Other		Significant
	Markets for		Observable		Unobservable
	Identical Assets		Inputs		Inputs
	(Level 1)		(Level 2)		(Level 3)		Total
Assets
Available for sale investment securities	$	150	$	186,717	$	-	$	186,867
Total assets at fair value	$	150	$	186,717	$	-	$	186,867

Assets Measured at Fair Value on a Nonrecurring Basis

The following is a description of the valuation methodologies used for instruments measured at fair value on a non-recurring basis and recognized in the accompanying balance sheet, as well as the general classification of such instruments pursuant to the valuation hierarchy.

Loan impairment is reported when full payment under the loan terms is not expected.  In accordance with the provisions of the loan impairment guidance (FASB ASC 310-10-35), individual loans were written down to their fair value. Loans applicable to write downs of impaired loans are estimated using the present value of expected cash flows or the appraised value of the underlying collateral discounted as necessary due to management’s estimates of changes in economic conditions.  A portion of the allowance for loan losses is allocated to impaired loans if the value of such loans is deemed to be less than the unpaid balance. If these allocations cause the allowance for loan losses to require an increase, such increase is reported as a component of the provision for loan losses. Loan losses are charged against the allowance when management believes the uncollectibility of a loan is confirmed.  When the fair value of the collateral is based on an observable market price or a current appraised value, the Company records the loan impairment as non-recurring Level 2. When an appraised value is not available or management determines the fair value of the collateral is further impaired below the appraised value and there is no observable market price, the Company records the loan impairment as non-recurring Level 3.

29

HERITAGE FINANCIAL GROUP, INC. AND SUBSIDIARY

CONDENSED NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

NOTE 6.  FAIR VALUE MEASUREMENTS (continued)

Assets Measured at Fair Value on a Nonrecurring Basis (Continued)

Foreclosed assets are adjusted to fair value upon transfer of the loans to foreclosed assets. Subsequently, foreclosed assets are carried at the lower of carrying value or fair value. Fair value is based upon independent market prices, appraised values of the collateral or management’s estimation of the value of the collateral. When the fair value of the collateral is based on an observable market price or a current appraised value, the Company records the foreclosed assets as nonrecurring Level 2. When an appraised value is not available or management determines the fair value of the collateral is further impaired below the appraised value and there is no observable market price, the Company records the foreclosed asset as nonrecurring Level 3.

At June 30, 2011, there were no impaired loans reported at fair value utilizing Level 2 valuation inputs.  Impaired loans with a carrying value of $14.8  million were reduced by specific valuation allowance allocations totaling $302,000 for a total reported fair value of $14.5 million on collateral valuations utilizing Level 3 valuation inputs at June 30, 2011.

Fair Value Option

Fair Value Measurements and Disclosures (FASB ASC 820) allows companies to report selected financial assets and liabilities at fair value. The changes in fair value are recognized in earnings and the assets and liabilities measured under this methodology are required to be displayed separately on the balance sheet. While this became effective for the Company beginning January 1, 2008, the Company has not elected the fair value option that is offered.

30

HERITAGE FINANCIAL GROUP, INC. AND SUBSIDIARY

CONDENSED NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

NOTE 6.  FAIR VALUE MEASUREMENTS (continued)

Disclosures about Fair Value of Financial Instruments

The fair value of a financial instrument is the current amount that would be exchanged between willing parties, other than in a forced liquidation.  Fair value is best determined based upon quoted market prices.  However, in many instances, there are no quoted market prices for the Company’s various financial instruments.  In cases where quoted market prices are not available, fair value is based on discounted cash flows or other valuation techniques.  These techniques are significantly affected by the assumptions used, including the discount rate and estimates of future cash flows.  Accordingly, the fair value estimates may not be realized in an immediate settlement of the instrument.  In accordance with the Fair Value Measurement and Disclosures Topic of the FASB Accounting Standards Codification, the Company excludes certain financial instruments and all nonfinancial instruments from its disclosure requirements.  Accordingly, the aggregate fair value amounts presented may not necessarily represent the underlying fair value of the Company.

The following methods and assumptions were used by the Company in estimating the fair value of its financial instruments:

Cash, Due From Banks, Interest-Bearing Deposits in Banks and Federal Funds Sold:  The carrying amount of cash, due from banks, interest-bearing deposits at other financial institutions and federal funds sold approximates fair value.

Securities:  Fair value of securities is based on available quoted market prices.  The carrying amount of equity securities with no readily determinable fair value approximates fair value.

Loans held for sale:  The carrying amount of loans held for sale approximates fair value.

Loans:  The carrying amount of variable-rate loans that reprice frequently and have no significant change in credit risk approximates fair value.  The fair value of fixed-rate loans is estimated based on discounted contractual cash flows, using interest rates currently being offered for loans with similar terms to borrowers with similar credit quality.  The fair value of impaired loans is estimated based on discounted contractual cash flows or underlying collateral values, where applicable.

Covered Loans:  Covered loans include loans on which the majority of losses would be covered by loss-sharing agreements with the FDIC.  Management initially valued these assets at fair value using mostly unobservable inputs and, as such, has classified these assets as Level 3.

FDIC Loss-Share Receivable:  Because the FDIC will reimburse the Company for certain acquired loans, should the Company experience a loss, an indemnification asset is recorded at fair value at the acquisition date.  The indemnification asset is recognized at the same time as the indemnified loans and measured on the same basis, subject to collectability or contractual limitations. The shared loss agreements on the acquisition date reflect the reimbursements expected to be received from the FDIC, using an appropriate discount rate, which reflects counterparty credit risk and other uncertainties.  The shared loss agreements continue to be measured on the same basis as the related indemnified loans, and the loss share receivable is impacted b changes in estimated cash flows associated with these loans.

31

HERITAGE FINANCIAL GROUP, INC. AND SUBSIDIARY

CONDENSED NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

NOTE 6.  FAIR VALUE MEASUREMENTS (continued)

Deposits:  The carrying amount of demand deposits, savings deposits and variable-rate certificates of deposit approximates fair value.  The fair value of fixed-rate certificates of deposit is estimated based on discounted contractual cash flows using interest rates currently being offered for certificates of similar maturities.

Federal Funds Purchased and Securities Sold Under Repurchase Agreements:  The fair value of fixed rate federal funds purchased and securities sold under repurchase agreements is estimated based on discounted contractual cash flows using the current incremental borrowing rates for similar type borrowing arrangements.

Other Borrowings:  The carrying amount of variable rate advances approximates fair value.The fair value of fixed rate advances is estimated based on discounted contractual cash flows using the current incremental borrowing rates for similar type borrowing arrangements.  Accrued Interest:  The carrying amount of accrued interest approximates fair value.

Off-Balance-Sheet Instruments:  The carrying amount of commitments to extend credit and standby letters of credit approximates fair value.

The carrying amount and estimated fair value of the Company's financial instruments were as follows:

	June 30, 2011				December 31, 2010
	Carrying Amount		Fair Value		Carrying Amount		Fair Value
Financial assets:
Cash, due from banks and interest-bearing deposits in banks	$	115,534	$	115,534	$	39,714	$	39,714
Federal funds sold	$	26,619	$	26,619	$	2,700	$	2,700
Securities available for sale	$	186,867	$	186,867	$	238,377	$	238,377
Federal Home Loan Bank stock	$	4,286	$	4,286	$	3,703	$	3,703
Other equity securities	$	1,010	$	1,010	$	1,010	$	1,010
Loans held for sale	$	5,579	$	5,579	$	225	$	225
Non covered loans	$	440,298	$	428,681	$	418,997	$	419,835
Allowance for loan losses		6,585		-		8,101		-
Non covered loans, net		433,713	$	428,681	$	410,896	$	419,835
Covered loans	$	60,427		60,427	$	-	$	-
Accrued interest receivable	$	3,467	$	3,467	$	2,907	$	2,907
FDIC loss-share receivable	$	58,152	$	58,152	$	-	$	-
Financial liabilities:
Deposits	$	763,673	$	759,170	$	534,242	$	532,050
Federal funds purchased and securities sold under repurchase agreements	$	31,989	$	31,989	$	34,421	$	32,425
Other borrowings	$	35,000	$	38,161	$	62,500	$	65,592
Accrued interest payable	$	1,066	$	1,066	$	702	$	702

32

HERITAGE FINANCIAL GROUP, INC. AND SUBSIDIARY

CONDENSED NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

NOTE 7.  ACQUISITION ACTIVITY

Citizens Bank of Effingham

On February 18, 2011 (the “Closing Date”), HeritageBank of the South, a wholly-owned subsidiary of Heritage Financial Group, Inc. entered into a Purchase and Assumption Agreement by and among the Federal Deposit Insurance Corporation as receiver of Citizens Bank of Effingham, Springfield, Georgia, the Bank and the FDIC acting in its corporate capacity, pursuant to which the Bank acquired a majority of all assets and assumed substantially all of the liabilities of Citizens (the “Acquisition”). In connection with the Acquisition, the Bank also acquired other real estate owned (“OREO”) as of the Closing Date.

Pursuant to the Agreement, the Bank agreed to pay a premium on deposits totaling $1.4 million and to acquire the specified assets, net of liabilities, at a discount to book value of $25.1 million. The Bank also received a cash payment from the FDIC in the amount of $24 million.

The Bank and the FDIC also have entered into loss-sharing agreements that provide the Bank with significant protection against credit losses on Citizens’ loans and related assets acquired in the Acquisition. Under these agreements, discussed in more detail below, the FDIC will, for a specified number of years, reimburse the Bank for 80% of all losses and related expenses on covered assets, primarily acquired loans and OREO.

The fair values of the assets acquired and liabilities assumed in conjunction with the Acquisition as of the Closing Date are detailed in the following table (dollars in thousands):

	February 18, 2011		Average maturity (years)		Effective Yield / Cost
Assets Acquired:
Cash and due from banks	$	33,900
Securities available for sale		13,386		4.20		1.49	%
Loans		72,720		1.34		4.53	%
Other real estate owned		7,540
Estimated reimbursement from the FDIC		58,164
Core deposit intangible		1,895
Other assets		2,245
Total assets acquired		189,850
Cash paid to settle the acquisition		24,000
Fair value of assets acquired		213,850
Liabilities assumed:
Deposits		206,276		1.26		1.58	%
Other liabilities		6,174
Fair value of liabilities assumed		212,450
Net Assets Acquired / Gained from Acquisition	$	1,400

33

HERITAGE FINANCIAL GROUP, INC. AND SUBSIDIARY

CONDENSED NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

NOTE 7.  ACQUISITION ACTIVITY (Continued)

The following table summarizes the assets covered by the loss-sharing agreements, the amount covered by the FDIC and the estimated fair values (dollars in thousands):

	Amounts Covered		Fair Value		SF Certificate (10 Years for Losses)		Non-SF Certificate (5 Years for Losses)
Loans	$	131,256	$	66,671	$	22,744	$	108,512
OREO		21,663		7,540		-		21,663
Total	$	152,919	$	74,211	$	22,744	$	130,175

The Company elected to account for loans acquired in the Citizens Bank acquisition under ASC 310-30, Loans and Debt Securities Acquired with Deteriorated Credit Quality. Topic 310-30 applies to a loan with evidence of deterioration of credit quality since origination, acquired by completion of a transfer for which it is probable, at acquisition, that the investor will be unable to collect all contractually required payments receivable. Topic 310-30 prohibits carrying over or creating an allowance for loan losses upon initial recognition for loans that fall under its scope

The following table presents information regarding the loan portfolio acquired on February 18, 2011 at fair value (dollars in thousands):

	Loans With Deterioration of Credit Quality		Loans Without A Deterioration of Credit Quality		Total Loans, at Fair Value
Construction and Land	$	5,641	$	7,454	$	13,095
Farmland		1,272		2,362		3,634
Residential (1 to 4 family)		3,804		14,936		18,740
Commercial Real Estate		4,635		15,551		20,186
Commercial		1,787		11,643		13,430
Consumer		31		3,604		3,635
	$	17,170	$	55,550	$	72,720

The following table presents purchased loans accounted for under ASC Topic 310-30 as of the Closing Date:

February 18, 2011

(dollars in thousands)

Contractually-required principal and interest	$	172,568
Non-accretable difference		(63,694	)
Cash flows expected to be collected		108,874
Accretable yield		(36,154	)
Fair value of loans accounted for under ASC 310-30	$	72,720

34

HERITAGE FINANCIAL GROUP, INC. AND SUBSIDIARY

CONDENSED NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

NOTE 7.  ACQUISITION ACTIVITY (Continued)

The Company recognizes that the determination of the initial fair value of loans at the acquisition date involves a high degree of judgment and complexity.  The carrying value of the acquired loans reflect management’s best estimate of the fair value of these assets as of the acquisition date.  However, the amount the Company ultimately recognizes on these assets could differ materially from the value reflected in these financial statements, based upon the timing and amount of collections on the acquired loans in future periods.  To the extent the actual values recognized for the acquired loans are less than the Company’s estimate, additional losses will be incurred.  These fair value estimates are considered preliminary, and are subject to change for up to one year after the closing date of the acquisition as additional information relative to the closing date fair values becomes available.

The Company did not immediately acquire the real estate, banking facilities, furniture or equipment of Citizens as part of the purchase and assumption agreement.  However, the Company subsequently purchased the real estate, banking facilities, furniture or equipment of Citizens from the FDCIC at fair value in the amount of $3.2 million during the second quarter of 2011.

NOTE 8. SUBSEQUENT EVENTS

Subsequent events and transactions that occurred after June 30, 2011 but prior to August 15, 2011, the date these financial statements were available to be issued, have been evaluated for potential recognition or disclosure in these financial statements.

The Company announced on July 25, 2011 in connection with the Plan that a new stock repurchase program was authorized where the Company may repurchase during the coming year up to 163,852 shares, or 2% of its currently outstanding publicly held shares of common stock.

35

ITEM 2.   MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

Forward-Looking Statements.

When used in this Quarterly Report on Form 10-Q and in other filings by the Company with the Securities and Exchange Commission (the "SEC"), in the Company's press releases or other public or shareholder communications, and in oral statements made with the approval of an authorized executive officer, the words or phrases "will likely result," "are expected to," "will continue," "is anticipated," "estimate," "project," "intends" or similar expressions are intended to identify "forward-looking statements" within the meaning of the Private Securities Litigation Reform Act of 1995.  Such statements are subject to certain risks and uncertainties, including, among other things, (i) expected cost savings, synergies and other benefits from the Company’s merger and acquisition activities might not be realized within the anticipated time frames or at all, and costs or difficulties relating to integration matters, including but not limited to customer and employee retention, might be greater than expected; (ii) changes in economic conditions, either nationally or in the Company’s market areas; (iii) fluctuations in interest rates; (iv) the risks of lending and investing activities, including changes in the level and direction of loan delinquencies and write-offs and changes in estimates of the adequacy of the allowance for loan losses; (v) the possibility of other-than-temporary impairments of securities held in the Company’s securities portfolio; (vi) the Company’s ability to access cost-effective funding; (vii) fluctuations in real estate values and both residential and commercial real estate market conditions; (viii) demand for loans and deposits in the Company’s market areas; (ix) legislative or regulatory changes that adversely affect the Company’s business, including, without limitation, the Dodd-Frank Wall Street Reform and Consumer Protection Act and its implementing regulations, and the new overdraft protection regulations and customers’ responses thereto; (x) monetary and fiscal policies of the Federal Reserve Board and the U.S. Government and other governmental initiatives affecting the financial services industry; (xi) results of examinations of the Company and the Bank by their regulators, including the possibility that the regulators may, among other things, require the Company to increase its allowance for loan losses or to write-down assets; (xiv) costs and effects of litigation, including settlements and judgments; and (xiv) competition.  The Company wishes to advise readers that the factors listed above could affect the Company's financial performance and could cause the Company's actual results for future periods to differ materially from any opinions or statements expressed with respect to future periods in any current statements.

The Company does not undertake, and specifically declines, any obligation-to publicly release the result of any revisions which may be made to any forward-looking statements to reflect events or circumstances after the date of such statements or to reflect the occurrence of anticipated or unanticipated events.

General

Heritage Financial Group, Inc. (“Heritage” or the “Company”) is a Maryland corporation that was organized in 2010 to become the holding company of HeritageBank of the South (“HeritageBank” or the “Bank”) after the completion of the second-step conversion and related public offering.  In that conversion, Heritage succeeded to all of the business and operations of Heritage Financial Group and Heritage MHC, which merged into the Company.  The Company completed the public offering on November 30, 2010.  It sold 6,591,756 shares of common stock for $10.00 per share, and its employee stock ownership plan purchased 327,677 of those shares with the proceeds of a loan from the Company.  The Company also issued 2,188,884 shares in a stock exchange based on an 0.8377 exchange ratio for each outstanding share of Heritage Financial Group.  The Company received net proceeds of $61.4 million in the public offering, 50% of which was contributed to HeritageBank and $3.3 million of which was lent to the ESOP for its purchase of shares in the offering.  At June 30, 2011, the Company had 8,712,750outstanding shares.  Its stock trades on the Nasdaq Global Market under the symbol “HBOS.”

The principal business of Heritage is operating its wholly owned subsidiary, HeritageBank.  On an unconsolidated basis, Heritage has no significant assets, other than 100% of the outstanding common stock of HeritageBank, the liquid assets it acquired with the net proceeds it retained from the offering and the loan to the employee stock ownership plan and certain liquid assets, and it has no significant liabilities.  Heritage uses staff and offices of HeritageBank and pays HeritageBank for these services.  If Heritage expands or changes its business in the future, it may hire its own employees.  In the future, we may pursue other business activities, including mergers and acquisitions, investment alternatives and diversification of operations.  There are, however, no current understandings or agreements for these activities.

36

ITEM 2.   MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

HeritageBank was originally chartered in 1955 as a federal credit union, serving the Marine Corps Logistic Base in Albany, Georgia.  Over the years, it evolved into a full-service, multi-branch community credit union in Dougherty, Lee, Mitchell and Worth counties in Georgia.  It was converted from a federal credit union charter to a federal mutual savings bank in July 2001.  The objective of that charter conversion was to better serve customers and the local community though the broader lending ability of a savings bank and to expand our customer base beyond the limited field of membership permitted for credit unions.  In February 2002, HeritageBank converted to stock form in a reorganization into a two-tier mutual holding company structure, which was eliminated in the second-step conversion.  On January 1, 2005, HeritageBank converted to a Georgia-chartered stock savings bank, because that charter best suited our continued efforts to grow and expand our commercial business.  HeritageBank now operates from 21 full service branch locations, 10 mortgage loan production offices and 2 investment offices throughout Georgia and north-central Florida.

Heritage was historically examined by the Office of Thrift Supervision; however, effective July 21, 2011 that regulatory oversight was transferred to the Board of Governors of the Federal Reserve system and the Federal Reserve Bank of Atlanta.  HeritageBank continues to be regulated by the Department of Banking and Finance and the FDIC.

37

ITEM 2.   MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

Evolution of Business Strategy

Our current business strategy is to operate a well-capitalized and profitable commercial and retail financial institution dedicated to serving the needs of our customers.  We strive to be the primary financial institution in the market areas we serve.  We offer a broad range of products and services while stressing personalized and efficient customer service and convenient access to these products and services.  We intend to continue to operate as a commercial and consumer lender.  We have structured operations around a branch system that is staffed with knowledgeable and well-trained employees.  Subject to capital requirements and our ability to grow in a reasonable and prudent manner, we may open or acquire additional branches as opportunities arise.  In addition to our branch system, we continue to expand electronic services for our customers.  We attempt to differentiate ourselves from our competitors by providing a higher level of customer service.

Expansion Efforts.  A key element of our business strategy is increasing our presence and growing the “Heritage” brand in the markets we currently serve and expanding our operations beyond our original southwest Georgia market by entering new markets in other parts of southern Georgia, north central Florida and other adjacent communities that present attractive opportunities for expansion consistent with our capital availability.  This expansion of our market beyond southwest Georgia began in 2006, when we commenced operating a branch in Ocala, Florida.

We have pursued this expansion program through both prudent, disciplined internal growth and strategic acquisitions.  Because many of the financial institutions in our market areas are experiencing financial difficulties, these opportunities have increased in recent months.  As those troubled financial institutions have closed or curtailed their lending activities, decreased their assets or sold branches to improve their capital levels, we have experienced increased loan demand and branch acquisition opportunities.  We have also hired highly regarded and experienced lending officers and commercial bankers and expanded into new market areas that are contiguous to our existing market areas. These recent activities reflect our ability to take advantage of these expansion opportunities.

In February 2011, we acquired the Citizens Bank of Effingham (“Citizens”), with four branch offices east of Savannah, in Springfield, Guyton, Rincon and Port Wentworth, Georgia, through an FDIC-assisted transaction.  In that acquisition, we acquired substantially all of the assets (approximately $214.0 million, including $145.0 million in loans) and assumed substantially all of the liabilities (approximately $211.0 million, including $206.0 million in deposits) of Citizens.  We entered into a loss-share agreement with the FDIC that provides HeritageBank with significant protection for certain acquired assets.  Under the agreement, the FDIC will provide reimbursement for 80% of the losses on approximately $152.9 million of covered loans and other real estate owned acquired in the acquisition.  In order to maintain this loss-share protection, we must comply with specific servicing and reporting procedures in the agreement.  The approximately $214.0 million of acquired assets were purchased at a $25.1 million discount, which was approximately 11.7% of assets acquired and a 16.4% discount to covered assets.  This acquisition expanded our footprint into the Savannah, Georgia market.  Many of the loans acquired were nonperforming and had poor documentation of the borrowers’ capacity to service the debt and the underlying value of collateral securing the loans.

Operating branches outside of the Southwest Georgia market subjects us to additional risk factors. These risk factors include, but are not limited to the following: management of employees from a distance, lack of knowledge of the local market, additional credit risks, logistical operational issues, and time constraints of management. These risk factors, as well as others we have not identified, may affect our ability to successfully operate outside of our current market area.

There have been no material changes to the Company’s core business strategies as disclosed in Item 7. in our Annual Report on Form 10-K for the year ended December 31, 2010.

38

ITEM 2.   MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

Critical Accounting Policies

We have not changed any of our critical accounting policies since those disclosed in our Form 10-K, which was filed with the Securities and Exchange Commission on March 31, 2011. Those accounting policies relate to the judgments and estimates used in the preparation of our financial statements in the calculation of the allowance for loan losses, estimates of fair value, the accounting for impaired loans and the provision for income taxes.

Off Balance Sheet Liabilities

The Company is a party to financial instruments with off-balance-sheet risk in the normal course of business to meet the financing needs of our customers.  These financial instruments include commitments to extend credit and standby letters of credit.  We use the same credit policies in making these commitments as we do for on-balance sheet instruments.  A summary of the Company's commitments as of June 30, 2011, is as follows:

	(In Thousands)
Commitments to extend credit	$	64,465
Financial stand-by letters of credit		80
	$	64,545

Comparison of Financial Condition at June 30, 2011 and December 31, 2010

General.  Total assets increased by $208.2 million or 27.6% to $963.6 million at June 30, 2011, from $755.4 million at December 31, 2010.  Cash and due from banks decreased $13.6 million or 47.2% to $15.2 million at June 30, 2011 from $28.8 million at December 31, 2010.  Total interest-earning assets increased $148.9 million or 22.2% to $820.1 million at June 30, 2011, from $671.2 million at December 31, 2010.  Loans, including loans held for sale, increased $87.1 million and interest-bearing deposits in banks increased $89.4 million while securities available for sale decreased $51.5 million.

Cash and Securities.The Company increased our liquidity position significantly in the second quarter of 2011, primarily as a result of our acquisition of Citizens.  Cash and securities (including bank deposits and federal funds sold) increased in the aggregate $48.2 million or 17.2% to $329.0 million at June 30, 2011, from $280.8 million at December 31, 2010.

The increase in cash and due from banks was primarily a result of the correspondent cash balances added and the additional branch cash from our acquisition activity.    The increase in interest-bearing deposits in banks and federal funds sold was due to the excess liquidity from acquisition activity, as well as the maturity of securities available for sale.  The decrease in securities available for sale was due to the maturity and sales of securities available for sale that were not reinvested during the quarter.

We expect to maintain higher than historical balances in cash, funds due from banks, federal funds sold and securities in 2011.  We continue to maintain excess liquidity for three purposes.  First, we believe it is prudent to maintain higher liquidity during uncertain economic times.  Second, we believe this excess liquidity gives us additional flexibility in our expansion strategy.  Third, we believe this excess liquidity will provide us flexibility for funding loans or other investments if we see a dramatic rise in interest rates.  Maintaining excess liquidity does impact the net interest margin in a negative way in the short-term; however, we feel the benefits of maintaining excess liquidity outweigh the cost to net interest margin.

39

ITEM 2.   MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

Loans. Our net loan portfolio increased $83.2 million, or 20.3%, to $494.1 million at June 30, 2011, from $410.9 million at December 31, 2010.  Our non-covered loan portfolio increased $21.3 million, or 5.1%, due to organic loan growth in our  Valdosta and Statesboro markets.  Our covered loan portfolio decreased to $60.4 million at June 30, 2011 from prior quarter’s $62.3 million.

Delinquencies and Non-performing Assets.As of June 30, 2011, our total loans delinquent for 30 to 89 days, excluding loans acquired in FDIC-assisted transactions, was $ 727,000 or 0.15% compared to $1.7 million 0.44% at December 31, 2010.

The table below sets forth the amounts and categories of non-performing assets, excluding loans and OREO acquired in FDIC-assisted transactions at the dates indicated:

	June 30, 2011		December 31, 2010		Amount Change			Percent Change
	(Dollars in thousands)
Non-accruing loans	$	8,589	$	9,905	$	(1,316	)		(13.2	)   %
Foreclosed assets		2,725		3,689		(964	)		(26.1	)
Total	$	11,314	$	13,594	$	(2,280	)		(16.7	)   %

At June 30, 2011, our largest non-performing loan was $1.9 million secured by various residential and commercial properties in South Georgia. This loan amount decreased from the balance of $3.9 million at December 31, 2010 due to a $2.0 million charge off during the first quarter of 2011.  Our next largest non performing loan was $1.1 million secured by 20.1 acres of land in Ocala, Florida.  The remainder of our non-performing loans consists of various consumer and commercial loans, none exceeding $1.0 million.  Current appraisals on real estate loans, expected cost of foreclosure or other disposition, and other probable losses on these loans are considered in our analysis of the allowance for loan losses.

Foreclosed assets decreased from $3.7 million at December 31, 2010, to $2.7 million at June 30, 2011. The Company continues to aggressively confront credit quality issues in its loan portfolio.  At June 30, 2011 and December 31, 2010, our largest foreclosed asset was $1.2 million on undeveloped property in the Atlanta metropolitan market.  The original loan balance on this property was $5.0 million and the current value represents our estimated disposition value based on current appraisals and market data.  The remainder of our foreclosed assets consists of various properties, primarily located in southwest Georgia, with no single property having a book value over $1.0 million.  All of these properties are being marketed actively for disposition.

40

ITEM 2.   MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

Our internally criticized (watch list) and classified assets, excluding FDIC assisted transactions, totaled $30.0 million at June 30, 2011, compared to $32.1 million at December 31, 2010.  This includes loans with respect to which known information about the possible credit problems of the borrowers have caused management to have doubts as to the ability of the borrowers to comply with present loan repayment terms and which may result in the future inclusion of such items in the non-performing asset categories.  These balances include the aforementioned nonperforming loans, other real estate, and repossessed assets.  These loans have been considered in management's determination of the adequacy of our allowance for loan losses.  Our internal loan review processes strive to identify weaknesses in loans prior to performance issues.  However, our processes do not always provide sufficient time to work out plans with borrowers that would avoid foreclosure and/or losses.

Although improvement was recognized in our non-performing assets for the current quarter, we expect nonperforming assets to remain at elevated levels, at least in the near term, as a result of the continued weakness in the economy.  We have taken actions to prevent losses in our current portfolio, including the development of a special assets committee and a weekly meeting of members of management and lenders to discuss the status and action plan on each problem loan.  We have also taken steps to better evaluate the capital and liquidity positions of our commercial loan guarantors, particularly those involved in commercial real estate construction and development.

Allowance for Loan Losses.  The following tables present information related to loan type and asset quality as of the periods indicated.

	Loans by Type as of
	6/30/11		12/31/10		6/30/10
Construction and land loans	$	26,688	$	24,522	$	23,637
Farmland loans		13,276		12,339		14,702
Permanent 1 – 4		131,596		131,293		110,325
Permanent 1 - 4 - junior liens and revolving		26,140		26,091		27,178
Multifamily		12,755		13,598		12,601
Nonresidential		131,027		110,079		98,353
Commercial business loans		50,997		52,589		46,603
Consumer and other loans		23,592		27,115		32,684
	$	416,071	$	397,626	$	366,083
Loans acquired through FDIC- assisted acquisitions:
Non covered loans	$	24,227	$	21,371	$	22,654
Covered loans		60,427		-		-
	$	500,725	$	418,997	$	388,737

41

ITEM 2.   MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

	Asset Quality Data (excluding loans acquired through FDIC-assisted acquisitions) as of
	6/30/11			12/31/10			6/30/10
Allowance for loan losses to total loans		1.58	%		2.04	%		1.65	%
Allowance for loan losses to average loans		1.48	%		2.03	%		1.77	%
Allowance for loan losses to non-performing loans		76.67	%		81.79	%		80.21	%
Accruing loans past due 30-89 days	$	727		$	1,737		$	2,498
Nonaccrual loans		8,589			9,905			7,514
Loans - 90 days past due & still accruing		-			-			-
Total non-performing loans		8,589			9,905			7,514
OREO and repossessed assets		2,725			3,689			3,019
Total non-performing assets		11,314			13,594			10,533
Non-performing loans to total loans		2.06	%		2.50	%		2.05	%
Non-performing assets to total assets		1.17	%		1.85	%		1.59	%
Net charge-offs to average loans (annualized)		0.26	%		1.84	%		0.51	%
Net charge-offs	$	253		$	1,833		$	439

For further information on the loan portfolio and allowance for loan losses, see Note 5 of the Condensed Notes to Consolidated Financial Statements contained in this 10-Q.

Premises and Equipment. Premises and equipment increased approximately $6.2 million or 28.8% at June 30, 2011, primarily due to the purchase of the real estate, banking facilities, furniture or equipment of Citizens from the FDIC at fair value in the amount of $3.2 million during the second quarter of 2011.  The remaining increase was related to the construction in progress for our new branch in Lee County, Georgia, scheduled to open in 2011, at an approximate cost of $2.5 million.

Intangible, Goodwill and Other Assets.   Intangible assets and goodwill increased $1.5 million or 50.7% to $4.4 million, as a result of our acquisition of Citizens in the first quarter of 2011

Deposits.  Total deposits increased $229.4 million or 42.9% to $763.7 million at June 30, 2011 compared with $534.3 million at December 31, 2010, primarily as a result of the Citizens acquisition.

Federal Home Loan Bank Advances, Other Borrowings and Other Liabilities.  The total amount of Federal Home Loan Bank advances decreased by $27.5 million or 44.0% from $62.5 million at December 31, 2010 to $35.0 million at June 30, 2011 due to the use of excess liquidity to pay down advances early with no prepayment penalty or as they matured.  Federal funds purchased and securities sold under agreements to repurchase decreased slightly to $32.0 million at June 30, 2011 compared with $32.4 million at December 31, 2010.

Equity.  Total equity increased $2.7 million or 2.3% to $122.0 million at June 30, 2011, compared with $119.3 million at December 31, 2010, primarily as a result of net income of $734,000 for the six months ended June 30, 2011, stock-based compensation of $412,000, other comprehensive income of $1.8 million and the allocation of $302,000 in ESOP shares which increased equity.   Partially offset by year-to-date dividends of $523,000 paid as of June 30, 2011.

42

ITEM 2.   MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

Average Balances, Net Interest Income, Yields Earned and Rates Paid

The following table presents for the periods indicated the total dollar amount of interest income from average interest-earning assets and the resultant yields, as well as the interest expense on average interest-bearing liabilities, expressed both in dollars and rates.  Yields on tax-exempt obligations have been computed on a tax equivalent basis using an assumed tax rate of 34%.  Nonaccruing loans have been included in the table as loans carrying a zero yield.

	Three Months Ended June 30,
	2011							2010
	(Dollars in Thousands)
	Average Outstanding Balance		Interest Earned/ Paid		Yield/ Rate			Average Outstanding Balance		Interest Earned/ Paid		Yield/ Rate
Interest-Earning Assets:
Loans	$	501,929	$	7,564		6.05	%	$	364,075	$	5,763		6.36	%
Loans held for sale		3,878		46		4.70			30		-		5.07
Taxable investment securities		189,602		1,221		2.58			88,276		790		3.58
Tax-exempt investment securities		20,659		211		6.18			24,170		239		5.99
Federal funds sold		20,447		16		0.32			27,384		18		0.26
Interest bearing deposits  with banks		44,525		51		0.46			40,968		45		0.45
Total interest-earning Assets		781,040		9,109		4.73			544,903		6,855		5.14
Interest-Bearing Liabilities:
Interest-bearing demand		132,434		209		0.63			87,087		222		1.02	%
Savings and money market		270,796		652		0.97			179,263		506		0.68
Retail time deposits		267,100		1,073		1.61			153,317		717		2.41
Wholesale time deposits		10,094		49		1.96			11,316		67		2.37
Borrowings		85,807		684		4.06			75,998		647		3.42
Total interest-bearing liabilities		766,231		2,667		1.40			506,981		2,159		1.71
Net interest income			$	6,442						$	4,696
Net interest rate spread						3.33	%						3.43	%
Net earning assets	$	14,809						$	37,922
Net interest margin						3.36	%						3.55	%
Average interest-earning assets to average interest-bearing liabilities		1.02							1.07

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ITEM 2.   MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

	Six Months Ended June 30,
	2011							2010
	(Dollars in Thousands)
	Average Outstanding Balance		Interest Earned/ Paid		Yield/ Rate			Average Outstanding Balance		Interest Earned/ Paid		Yield/ Rate
Interest-Earning Assets:
Loans	$	479,390	$	14,709		6.19	%	$	350,438	$	11,083		6.39	%
Loans held for sale		2,307		54		4.61			15		-		5.07
Taxable investment securities		198,743		2,428		2.44			88,221		1,566		3.55
Tax-exempt investment securities		20,653		422		6.19			27,149		537		5.99
Federal funds sold		22,279		29		0.27			20,693		27		0.26
Interest bearing deposits  with banks		30,338		91		0.60			37,193		90		0.49
Total interest-earning Assets		753,710		17,733		4.80			523,709		13,303		5.23
Interest-Bearing Liabilities:
Interest-bearing demand		127,860		449		0.71			77,400		405		1.06	%
Savings and money market		251,583		1,225		0.98			168,276		967		0.72
Retail time deposits		242,698		2,059		1.71			154,883		1,518		2.45
Wholesale time deposits		11,136		98		1.77			12,449		146		2.37
Borrowings		89,562		1,427		4.04			75,773		1,161		3.09
Total interest-bearing liabilities		722,839		5,258		1.47			488,781		4,197
Net interest income			$	12,475						$	9,106
Net interest rate spread						3.33	%						3.50	%
Net earning assets	$	30,871						$	34,928
Net interest margin						3.39	%						3.61	%
Average interest-earning assets to average interest-bearing liabilities		1.04							1.07

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ITEM 2.   MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

Rate/Volume Analysis

The following schedule presents the dollar amount of changes in interest income and interest expense for major components of interest-earning assets and interest-bearing liabilities.  It distinguishes between the changes related to outstanding balances and that due to the changes in interest rates.  The change in interest attributable to rate has been determined by applying the change in rate between years to average balances outstanding in the later year.  The change in interest due to volume has been determined by applying the rate from the earlier year to the change in average balances outstanding between years.  Changes that are not solely due to volume have been consistently attributed to rate.

	Three Months Ended June 30,
	2011 vs. 2010
	Increase (Decrease)						Total
	Due to						Increase
	Volume			Rate			(Decrease)
	(Dollars in Thousands)
Interest-earning assets:
Loans	$	1,545		$	256		$	1,801
Loans held for sale		46			-			46
Taxable investment securities		675			(244	)		431
Tax-exempt investment securities		(42	)		14			(28	)
Federal funds sold		(5	)		3			(2	)
Interest bearing deposits with banks		4			2			6
Total interest-earning assets	$	2,223		$	31			2,254
Interest-bearing liabilities:
Interest-bearing demand	$	90		$	(103	)		(13	)
Savings and money market		256			(110	)		146
Retail time deposits		557			(201	)		356
Wholesale time deposits		(8	)		(10	)		(18	)
Borrowings		97			(60	)		37
Total interest-bearing liabilities	$	992		$	(484	)		508
Net interest income							$	1,746

45

ITEM 2.   MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

	Six Months Ended June 30,
	2011 vs. 2010
	Increase (Decrease)					Total
	Due to					Increase
	Volume			Rate		(Decrease)
	(Dollars in Thousands)
Interest-earning assets:
Loans	$	3,449		$	177	$	3,626
Loans held for sale		54			-		54
Taxable investment securities		1,416			(554		862
Tax-exempt investment securities		(149	)		34		(115
Federal funds sold		1			1		2
Interest-bearing deposits with banks		(18	)		19		1
Total interest-earning assets	$	4,753		$	(323		4,430
Interest-bearing liabilities:
Interest-bearing demand	$	208		$	(164		44
Savings and money market		479			(221		258
Retail time deposits		1,000			(459		541
Wholesale time deposits		(28	)		(20		(48
Borrowings		251			15		266
Total interest-bearing liabilities	$	1,910		$	(849		1,061
Net interest income						$	3,369

Comparison of Operating Results for the Three and Six Month Periods Ended June 30, 2011 and 2010

General.  During the three months June 30, 2011, we recorded net loss of $481,000 or $0.06 basic and diluted loss per share compared to a net income of $128,000 or $0.02 basic and diluted earnings per share for the three months ending June 30, 2010.

During the six months June 30, 2011, the Company recorded net income of $734,000 or $0.09 basic and diluted earnings per share compared to a net income of $927,000 or $0.11 basic and diluted earnings per share for the six months ending June 30, 2010.  The reduction in operating results was primarily driven by increased loss on sales and write-downs of OREO, net of tax, of $1.2 million coupled with increased acquisition expenses related to the Citizens acquisition, net of tax, of $456,000 partially offset by a bargain purchase gain, net of tax, of $1.2 million on the Citizens acquisition.

46

ITEM 2.   MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

Interest Income.  Total interest income for the three months ended June 30, 2011, increased $2.3 million or 32.9% to $9.1 million, compared to $6.9 million for this same period in 2010.  The increase was due to a $236.1 million, or 43.3%, increase in average interest-earning assets to $781.0 million at the end of the second quarter of 2011, compared to $544.9 million at the end of the second quarter of 2010.  This increase in the average balance of earning assets was partially offset by a 41 basis point decline in the yield on average-earning assets to 4.73% for the second quarter of 2011 as compared to 5.14% for this same period in 2010, as a result of the low interest rate environment where maturing loans are being replaced with much lower yielding assets.

Total interest income for the six months ended June 30, 2011, increased $4.4 million or 33.3% to $17.7 million, compared to $13.3 million for this same period in 2010.  The increase was due to a $230.0 million, or 43.9%, increase in average interest-earning assets to $753.7 million for the six months ended June 30, 2011, compared to $523.7 million for the six months ended June 30, 2010.  This increase in the average balance of earning assets was partially offset by a 43 basis point decline in yield on average-earning assets to 4.80% for the six months ended June 30, 2011 as compared to 5.23% for this same period in 2010.

This increase in average interest-earning assets was due primarily to the branch acquisition activity in 2010 and the Citizens acquisition in February 2011. Our overall yield on average interest-earning assets decreased in 2011, because we carried excess liquidity on our balance sheet, primarily from our branch and FDIC-assisted acquisitions and the net proceeds of the conversion stock offering, which have not yet been fully deployed.The primary purpose of maintaining excess liquidity is to support our acquisition growth strategy.

Interest income on loans for the three months ended June 30, 2011 was $7.6 million compared to $5.8 million for the second quarter of 2010 and $14.7 million for the six months ended June 30, 2011 compared to $11.1 million for the same period of 2011.  The increase in interest income on loans was primarily a result of the loans acquired in our branch and FDIC-assisted transactions and our expansion into the Valdosta and Statesboro markets, which was reflected in the $128.9 million increase in the average loan portfolio balance offset by a 20 basis point decline in the weighted average yield on loans to 6.19% for the six months ended June 30, 2011 compared to 6.39% for the same period in 2010.

Interest income on investment securities for the second quarter of 2011 was $1.4 million compared to $1.0 million in the second quarter of 2010 and was $2.9 million for the six months ended June 30, 2011 compared to $2.1 million for the same period in 2010. Our average taxable investment securities increased by $110.5 million to $198.7 million offset by a decrease in tax exempt securities portfolio of $6.5 million for the six months ended June 30, 2011 compared to the same period of 2010 as excess liquidity from acquisition activity and the stock offering were invested.  Tax-exempt securities average yield increased by 20 basis points from the six months ended June 20, 2011 2010 to second quarter of 2011; however, the average yield on taxable investment securities decreased by 111 basis points to 2.44 % for this same period.  We expect to see the yield on our taxable investment portfolio continue to decline during this low interest rate environment as maturing investments are replaced with lower yielding investments.

Interest Expense.  Total interest expense increased $508,000 or 23.5% to $2.7 million for the three months ended June 30, 2011, compared to $2.2 million during the same period in 2010 and increased $1.1 million or 25.3% to $5.3 million for the six months ended June 30, 2011 compared to $4.2 million the same period in 2010.  The cost of interest-bearing liabilities decreased 26 basis points to 1.47% during first six months of 2011 compared with 1.73% during the first six months 2010, as a result of the continued downward trends in the rate cycle.  This decrease in costs was offset by an increase in the average balance of interest-bearing liabilities during the first six months of 2011 to $722.8 million, an increase of $234.0 million compared to $488.8 million during the first six months of 2010, which reflects increases in deposits from our acquisitions and market expansion.    We expect the decline in the cost of interest-bearing liabilities to slow during 2011 as changes in Federal law which authorized interest to be payable on business accounts in July 2011.

47

ITEM 2.   MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

Interest expense on deposits for the second quarter of 2011 was $2.0 million compared to $1.5 million for the second quarter of 2010.  The $500,000 increase in interest expense on deposits was due to an increase in the average balance of interest-bearing deposits portfolio of $249.4 million from the second quarter of 2010 to the second quarter of 2011, primarily as a result of our acquisitions and market expansion.  This increase in average balance was partially offset by a decrease of 24 basis points in the average rate paid on the deposit portfolio from 1.41% for second quarter of 2010 to 1.17% for the second quarter of 2011, due to a decrease in market rates of interest.

Interest expense on deposits for the first six months of 2011 was $3.8 million compared to $3.0 million for the first six months of 2010.  The $800,000 increase in interest expense on deposits was due to an increase in the average balance of interest-bearing deposits portfolio of $220.3 million from the first six months of 2010 to the first six months of 2011, primarily as a result of our acquisitions and market expansion.  This increase in average balance was partially offset by a decrease of 26 basis points in the average rate paid on the deposit portfolio from 1.73% for first six months of 2010 to 1.47% for the first six months of 2011, due to a decrease in market rates of interest.

Interest expense on other borrowings, consisting of Federal Home Loan Bank advances, federal funds purchased and securities sold under agreement to repurchase, for the second quarter of 2011 was $684,000 compared to $647,000 for the second quarter of 2010 and was $1.4 million for the first six months of 2011 compared to $1.2 million for the first six months of 2010.  This reflects a $9.8 million increase  in average other borrowings to $85.8 million from the second  quarter of 2010 to the second quarter of 2011 and a declining rate paid on these borrowings, from an average rate paid of 3.42% for second quarter of 2010 compared to 3.19% for the second quarter of 2011.  For the six months ended June 30, 2011, there was a $13.8 million increase in average other borrowings to $89.6 million compared to $75.8 million for the same period in 2010 and an increased rate paid on these borrowings, from an average rate paid of 3.09% for first six months of 2010 compared to 3.21% for the same period in 2011.

Net Interest Income.  Net interest income for the three months ended June 30, 2011 increased $1.7 million or 37.2% to $6.4 million compared to $4.7 million for the three months ended June 30,2010.  For the six months ended June 30, 2011, net interest income increased $3.4 million or 37.0% to $12.5 million compared to $9.1 million for the six months ended June 30, 2011.  The overall increase in both periods is primarily due to an increase in interest-bearing assets relatively equal to the increase in interest-bearing liabilities.  The net interest spread decreased 17 basis points from 3.50% for the second quarter of 2010 compared with 3.33% for the second quarter of 2011.  The net interest margin decreased 22 basis points to 3.39% for the first six months of 2011 from 3.61% for first the six months of 2010.  Also see -Average Balances, Net Interest Income, Yields Earned and Rates Paid and – Rate/Volume Analysis presented earlier in this section.

Our asset-liability management policy seeks to mitigate interest rate risk by making our balance sheet as neutral as possible to changes in interest rates. Although our goal is to be neutral to changes in rates, we will not take undue risk to achieve this goal.  Therefore, we remain exposed to fluctuation in interest rates. For more information on the effect of changes in interest rates, see Item 3. - Quantitative and Qualitative Disclosures About Market Risk.

Provision for Loan Losses.  During the quarter ended June 30, 2011, we recorded a $700,000 provision for loan losses, which was an increase compared to the $650,000 provision recorded during the same period in 2010. For the six months ended June 30, 2011, we recorded $1.3 million provisions compared to $1.2 million for first six months in 2010.

48

ITEM 2.   MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

The Company establish provisions for loan losses, which are charged to operations, at a level we believe will reflect probable credit losses based on historical loss trends and an evaluation of specific credits in the loan portfolio.  In evaluating the level of the allowance for loan losses, we consider the types of loans and the amount of loans in the loan portfolio, historical loss experience, adverse situations that may affect the borrower’s ability to repay, estimated value of any underlying collateral, prevailing economic conditions, and past due status and trends.

The Company assess the allowance for loan losses on a quarterly basis and make provisions for loan losses as necessary in order to maintain the proper level of allowance. While the Company uses available information to recognize losses on loans, future loan loss provisions may be necessary based on changes in economic conditions. In addition, various regulatory agencies, as an integral part of their examination process, periodically review the allowance for loan losses and may require the Company to recognize additional provisions based on their judgment of information available to them at the time of their examination. The allowance for loan losses is maintained at a level that represents management's best estimate of inherent losses in the loan portfolio, and such losses were both probable and reasonably estimable.  The level of the allowance is based on estimates and the ultimate losses may vary from the estimates.

For further information on the loan portfolio and allowance for loan losses, see “Delinquencies and Non-performing Assets” and see Note 5 of the Condensed Notes to Consolidated Financial Statements contained in this 10-Q.

49

ITEM 2.   MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

Noninterest Income.  Noninterest income increased $1.6 million, or 80.1%, from $2.0 million for the three months ended June 30, 2010 to $3.6 million for the three months ended June 30, 2011 and increased $4.6 million, or 121.1%, from $3.8 million for the six months ended June 30, 2010 to $8.4 million for the six months ended June 30, 2011.  Noninterest income, excluding securities transactions and bargain purchased gain, increased $1.3 million, or 65.6%, from $1.9 million for the three months ended June 30, 2010 to $3.2 million for the three months ended June 30, 2011 and increased $2.1 million, or 58.9%, from $3.6 million for the six months ended June 30, 2010 to $5.7 million for the six months ended June 30, 2011.

A summary of noninterest income, excluding the gain on securities and bargain purchase gain, is as follows:

	Three Months Ended June 30,
	2011			2010			$ Chg		Chg %
	(Dollars in thousands)
Service charges on deposit accounts	$	1,222		$	982		$	240		24.4	%
Other service charges, commissions and fees		749			466			283		60.7
Brokerage fees		406			257			149		58.0
Mortgage origination fees		624			71			553		778.9
Bank owned life insurance		149			154			(5		(3.2
Other		74			17			57		335.3
Total noninterest income	$	3,224		$	1,947		$	1,277		65.6	%
Noninterest income as a percentage of average assets (annualized)		1.32	%		1.26	%

	Six Months Ended June 30,
	2011			2010			$ Chg		Chg %
	(Dollars in thousands)
Service charges on deposit accounts	$	2,273		$	1,806		$	467		25.9	%
Other service charges, commissions and fees		1,409			868			541		62.3
Brokerage fees		760			479			281		58.7
Mortgage origination fees		892			110			782		710.9
Bank owned life insurance		294			306			(12		(3.9
Other		103			38			65		171.1
Total noninterest income	$	5,731		$	3,607		$	2,124		58.9	%
Noninterest income as a percentage of average assets (annualized)		1.25	%		1.22	%

The increase in service charges and fees was primarily due to an increase in overdraft fees and an increase in ATM and debit card income, as a result of our expanded branch network.  Recent regulatory changes to the offering of overdraft privileges on ATM and debit cards, as well as limits on how overdraft fees may be assessed  could cause significant decreases in our overdraft fees. In addition, the Dodd-Frank Act has placed restrictions on the amount of fees that can be charged on debit card transactions.  At this time, we are unable to accurately estimate the effect this legislation, and other potential legislation, may have on our overdraft income. We are currently analyzing our options to replace this income stream if it is significantly affected by legislation or a change in consumer behavior. These options will most likely result in a major change in the fees we charge to our deposit customers.

50

ITEM 2.   MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

Brokerage fees increased due to an increase in assets under management, as well as improvements in the domestic equity markets.

Mortgage origination fees increased due to the expansion of the mortgage division.  We expect to continue to see increases in this revenue as we expand our mortgage operations to other markets.

Bank owned life insurance decreased due to a decrease in market rates of interest on our cash surrender value of these policies.

51

ITEM 2.   MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

Noninterest Expense.  Noninterest expense increased $4.0 million, or 66.6%, from $6.0 million for the three months ended June 30, 2010 to $10.0 million for the three months ended June 30, 2011 and increased $7.7 million or 71.8%, from $10.7 million for the six months ended June 30, 2010 to $18.4 million for the six months ended June 30, 2011.

A summary of noninterest expense follows:

	Three Months Ended June 30,
	2011			2010			$ Chg			% Chg
	(Dollars in thousands)
Salaries and employee benefits	$	4,923		$	2,974		$	1,949			65.5	%
Equipment		428			252			176			69.8
Occupancy		536			329			207			62.9
Advertising and marketing		220			124			96			77.4
Legal and accounting		167			179			(12	)		(6.7	)
Consulting & other professional fees		198			66			132			200.0
Directors fees and retirement		161			139			22			15.8
Telecommunications		204			103			101			98.1
Supplies		145			96			49			51.0
Data processing fees		615			511			104			20.4
(Gain) Loss on sale and write-downs of other real estate owned		535			(112	)		647			(577.7	)
Foreclosed asset and collection expenses		245			427			(182	)		(42.6	)
FDIC insurance and other regulatory fees		354			228			126			55.3
Acquisition related expenses		474			267			207			77.5
Other operating		835			443			392			88.5
Total noninterest expenses	$	10,040		$	6,026		$	4,014			66.6	%
Noninterest expenses as a percentage of average assets (annualized)		4.15	%		4.87	%

	Six Months Ended June 30,
	2011			2010			$ Chg			% Chg
	(Dollars in thousands)
Salaries and employee benefits	$	9,251		$	5,539		$	3,712			67.0	%
Equipment		779			507			272			53.6
Occupancy		981			636			345			54.2
Advertising and marketing		384			244			140			57.4
Legal and accounting		377			328			49			14.9
Consulting & other professional fees		377			137			240			175.2
Directors fees and retirement		388			277			111			40.1
Telecommunications		349			173			176			101.7
Supplies		240			153			87			56.9
Data processing fees		1,133			991			142			14.3
Loss on sale and write-downs of other real estate owned		937			(344	)		1,281			(372.4	)
Foreclosed asset and collection expenses		415			598			(183	)		(30.6	)
FDIC insurance and other regulatory fees		647			399			248			62.2
Acquisition related expenses		757			267			490			183.5
Other operating		1,423			825			598			72.5
Total noninterest expenses	$	18,438		$	10,730		$	7,708			71.8	%
Noninterest expenses as a percentage of average assets (annualized)		4.04	%		3.33	%

52

ITEM 2.   MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

The increase in salaries and employee benefits was primarily due the increase in FTE’s related to our acquisition activity.  In addition, we incurred $116,000 of severance related expenses as a result of a restructuring of our staffing in the Ocala, Florida market.

The increase in equipment, occupancy, advertising and marketing, telecommunications, supplies, data processing, and FDIC and other regulatory expenses is due to the expanded branch network.  The increase in legal and accounting fees is due primarily to an increase associated with our expansion activity, as well as a continued increase in legal costs for the collection of problem assets.

The increase in consulting and other professional fees is related to consultants hired to assist with the integration and conversion of our acquisitions.

The increase in directors fees and retirements is due to the addition of advisory board members in new markets, as well as incentives paid to these advisory directors for business development activity.  We have changed this structure and expect this to decrease going forward.

During 2010, we recorded gains on the sale of OREO.  These gains related to the disposition of several properties we acquired in our FDIC-assisted acquisition of The Tattnall Bank.    During 2011, we recorded losses on sales and write-downs of OREO.  We expect this trend to continue as long as problem assets remain at elevated levels.

53

ITEM 2.   MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

The increase in other operating expenses was due to a $196,000 increase in amortization of deposit intangibles due to our acquisition activity, a $99,000 increase in travel and training as a result of our growth, a $35,000 increase in postage associated with our increased branch network, and a $27,000 increase in deposit charge-offs.

Income Tax Expense.  For the quarter ended June 30, 2011, we recorded tax benefit of $257,000 compared to $153,000 during the same period in 2010.  For the six months ended June 30, 2011, we recorded tax expense of $404,000 compared to $66,000 for the same period in 2010.   Our effective tax rate was 35.5% for the first six months in 2011 compared to 6.7% for the first six months of 2010.  The increase in effective rate for the six months ended June 30, 2011 was primarily due to the bargain purchase gain recognized in the Citizens acquisition.

Liquidity and Capital Resources

Liquidity management involves the matching of cash flow requirements of customers, who may be either depositors desiring to withdraw funds or borrowers needing assurance that sufficient funds will be available to meet their credit needs and the ability of the Company to manage those requirements.  The Company strives to maintain an adequate liquidity position by managing the balances and maturities of interest earning assets and interest-bearing liabilities so that the balance it has in short-term investments at any given time will adequately cover any reasonably anticipated immediate need for funds.  Additionally, the Bank maintains relationships with correspondent banks, which could provide funds on short-term notice if needed.

The liquidity and capital resources of the Company are monitored continuously by the Company’s Board-authorized Asset Liability Management Committee and on a periodic basis by state and federal regulatory authorities.  As determined under guidelines established by these regulatory authorities, the Company’s and the Bank’s liquidity ratios at June 30, 2011, were considered satisfactory.  At that date, the Bank’s short-term investments were adequate to cover any reasonably immediate need for funds.  The Company is aware of no events or trends likely to result in a negative material change in liquidity.

54

ITEM 2.   MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

The consolidated statement of cash flows for the six months ended June 30, 2011 and 2010, detail cash flows from operating, investing and financing activities.  For the six months ended June 30, 2011, net cash used in investing activities was $4.8 million while net cash used in financing activities was $10.6 million, partially offset by net cash provided by operating activities of $6.5 million  resulting in a net decrease in cash during the three month period of $13.6 million.

The decrease in cash flow provided by financing activities related to the repayment of other borrowings of $32.7 million partially offset by growth in deposits.

Regulatory Capital Ratios for the Company and HeritageBank of the South at June 30, 2011

The Company’s and the Bank’s regulatory capital levels exceed the minimums required by state and federal authorities.  The following table reflects the Company’s and the Bank’s compliance at June 30, 2011, with regulatory capital requirements.  These calculations are based on total risk weighted assets of $455.9 million consolidated and $446.9 million for HeritageBank of the South as of June 30, 2011, and average total assets of $712.7 million consolidated and $685.9 million for HeritageBank of the South for the three months ended June 30, 2011.

	Actual					For Capital Adequacy Purposes					Minimum Required to Be Well Capitalized Under Prompt Corrective Action Provisions
	Amount		Ratio			Amount		Ratio			Amount		Ratio
	(Dollars in thousands)
Total Capital to Risk Weighted Assets
Consolidated	$	122,997		23.4	%	$	42,013		8.0	%		N/A
HeritageBank of the South		90,224		18.4	%		39,316		8.0	%	$	49,146		10.0	%
Tier I Capital to Risk Weighted Assets
Consolidated		116,845		22.2	%		21,007		4.0	%		N/A
HeritageBank of the South		84,004		17.1	%		19,658		4.0	%		29,487		6.0	%
Tier I Capital to Average Total Assets
Consolidated		116,845		12.1	%		38,674		4.0	%		N/A
HeritageBank of the South		84,004		8.8	%		38,237		4.0	%		47,796		5.0	%

55

ITEM 3.   QUANTITAVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

Asset and Liability Management and Market Risk

Our Risk When Interest Rates Change.  The rates of interest we earn on assets and pay on liabilities generally are established contractually for a period of time.  Market rates change over time.  Like other financial institutions, our results of operations are impacted by changes in interest rates and the interest rate sensitivity of our assets and liabilities.  The risk associated with changes in interest rates and our ability to adapt to these changes is known as interest rate risk and is our most significant market risk.

How We Measure Our Risk of Interest Rate Changes.  As part of our attempt to manage our exposure to changes in interest rates and comply with applicable regulations, we monitor our interest rate risk.  In doing so, we analyze and manage assets and liabilities based on their interest rates and payment streams, timing of maturities, repricing opportunities, and sensitivity to actual or potential changes in market interest rates.

To manage the potential for adverse effects of material and prolonged increases in interest rates on our results of operations, we adopted asset and liability management policies to understand, measure, monitor, and control the risk.  These policies are designed to allow us to implement strategies to minimize the effects of interest rate changes to net income and capital position by properly matching the maturities and repricing terms of our interest earning assets and interest bearing liabilities.  These policies are implemented by the risk management committee, which is composed of senior management and board members.  The risk management committee establishes guidelines for and monitors the volume and mix of assets and funding sources, taking into account relative costs and spreads, interest rate sensitivity and liquidity requirements.  The objectives are to manage assets and funding sources to produce results that limit negative changes in net income and capital while supporting liquidity, capital adequacy, growth, risk and profitability goals.  Senior managers oversee the process on a daily basis.  The risk management committee meets quarterly to review, among other things, economic conditions and interest rate outlook, current and projected needs and capital position, anticipated changes in the volume and mix of assets and liabilities, interest rate risk exposure, liquidity position and net portfolio present value.  The committee also recommends strategy changes, as appropriate, based on their review.  The committee is responsible for reviewing and reporting the effects of the policy implementations and strategies to the board of directors on a quarterly basis.

In order to manage our assets and liabilities and achieve the desired liquidity, credit quality, interest rate risk, profitability and capital targets, we have focused our strategies on:

· Limiting the percentage of long-term fixed-rate loans within our portfolio;

· Originating a mix of variable-rate and shorter term fixed-rate loans;

· Originating prime-based home equity lines of credit;

· Managing deposit relationships for stability and a lower cost of funds position;

·  Using Federal Home Loan Bank advances and other funding sources to align maturities and repricing terms of funding sources with loans; and

· Continuing the origination of consumer loans.

56

ITEM 3.   QUANTITAVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

Asset and Liability Management and Market Risk (continued)

The risk management committee has oversight over the asset-liability management of the Company.  This committee regularly reviews interest rate risk by forecasting the impact of alternative interest rate environments on net income and the market value of portfolio equity.  Market value of portfolio equity is a measurement of the value of the balance sheet at a fixed point in time.  It is summarized as the fair value of assets less the fair value of liabilities.  The committee reviews computations of the value of capital at current interest rates and alternative interest rates.  The variance in the net portfolio value between current interest rate computations and alternative rate computations represents the potential impact on capital if rates were to change.

The Company is exposed only to U.S. dollar interest rate changes, and, accordingly, the Company manages exposure by considering the possible changes in the net interest margin. The Company does not have any trading instruments nor does it classify any portion of the investment portfolio as held for trading. The Company monitors its sensitivity to changes in interest rates and may use derivative instruments to hedge this risk. The Company does not enter into derivatives or other financial instruments for trading or speculative purposes. Finally, the Company has no exposure to foreign currency exchange rate risk and commodity price risk.

Interest rates play a major part in the net interest income of a financial institution. The sensitivity to rate changes is known as “interest rate risk”. The repricing of interest-earning assets and interest-bearing liabilities can influence the changes in net interest income.

The Company uses simulation analysis to monitor changes in net interest income due to changes in market interest rates. The simulation of rising, declining and flat interest rate scenarios allows management to monitor and adjust interest rate sensitivity to minimize the impact of market interest rate swings. The analysis of the impact on net interest income over a twelve-month period is subjected to a shock in interest rates of 100, 200, 300  and 400 basis point increase or decrease in market rates on net interest income and is monitored on a quarterly basis. We also monitor regulatory required interest rate risk analysis which simulates more dramatic changes to rates.

The Company’s strategy is to mitigate interest risk to the greatest extent possible. Based on our analysis of the Company’s overall risk to changes in interest rates, we structure investment and funding transactions to reduce this risk. These strategies aim to achieve neutrality to interest rate risk. Although we strive to have our net interest income neutral to changes in rates, due to the inherent nature of our business, we will never be completely neutral to changes in rates.  As of June 30, 2011, a drop in interest rates would increase our net interest income and an increase in rates would decrease our net interest income, also known as being “ liability sensitive”.  The liability sensitivity position was driven by interest rate floors for our prime-based floating rate loans which are generally 200 to 300 basis points above their current index rate.  These floors allow us to earn higher rates of interest than we otherwise would; however, due to these floors, many of our loans will not reprice when rates rise, until the increase in rates exceeds the loan floor.  This lag in repricing is part of the reason we are liability sensitive over the next year in a rising rate environment.  We feel the level of interest rate risk is at an acceptable level, and is within our internal policy limits.

The Company maintains a risk management committee which monitors and analyzes interest rate risk. This committee is comprised of members of senior management and outside directors. This committee meets on a monthly basis and reviews the simulations listed above, as well as other interest rate risk reports.

57

ITEM 3.   QUANTITAVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

The following table sets forth the distribution of the repricing of our earning assets and interest-bearing liabilities as of June 30, 2011, the interest rate sensitivity gap (i.e., interest rate sensitive assets divided by interest rate sensitivity liabilities), the cumulative interest rate sensitivity gap ratio (i.e., interest rate sensitive assets divided by interest rate sensitive liabilities) and the cumulative sensitivity gap ratio. The table also sets forth the time periods in which earning assets and liabilities will mature or may reprice in accordance with their contractual terms. However, the table does not necessarily indicate the impact of general interest rate movements on the net interest margin since the repricing of various categories of assets and liabilities is subject to competitive pressures and the needs of our customers. In addition, various assets and liabilities indicated as repricing within the same period may in fact reprice at different times within such period and at different rates.

	June 30, 2011
	Maturing or Repricing Within
	Zero to Three Months			Three Months to One Year			One to Five Years			Over Five Years			Total
	(Dollars in thousands)
Earning assets:
Short-term assets	$	100,309		$	-		$	-		$	-		$	100,309
Investment securities		8,995			31,400			90,139			56,333			186,867
Loans held for sale		5,579			-			-			-			5,579
Loans including gross covered		116,754			122,755			260,809			407			500,725
		231,637			154,155			350,948			56,740			793,480
Interest-bearing liabilities:
Interest-bearing demand deposits		(115,340	)		-			-			-			(115,340	)
Savings and money market		(277,432	)		-			-			-			(277,432	)
Time deposits		(61,600	)		(141,348	)		(94,571	)		-			(297,519	)
Other borrowings		(31,989	)		-			-			-			(31,989	)
Federal Home Loan Bank advances		-			-			(10,000	)		(25,000	)		(35,000	)
		(486,361	)		(141,348	)		(104,571	)		(25,000	)		(757,280	)
Interest rate sensitivity gap	$	(254,724	)	$	12,807		$	246,377		$	31,740		$	36,200
Cumulative interest rate sensitivity gap	$	(254,724	)	$	(241,917	)	$	4,460		$	36,200
Interest rate sensitivity gap ratio		(0.48	)		(1.09	)		(3.36	)		(2.27	)
Cumulative interest rate sensitivity gap ratio		(0.48	)		(0.61	)		(1.01	)		(1.05	)

58

ITEM 3.   QUANTITAVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

The following table shows the results of our projections for net interest income expressed as a percentage change over net interest income in a flat rate scenario for an immediate change or “shock” in market interest rates over a twelve month period.  Due to the historically low level of interest rates, we do not believe downward shocks greater than 50 basis points are relevant.  In addition, due to the historically low interest rate environment, there is concern that we may say dramatic increases in interest rates when they begin to rise.  To address this concern, we increased our upward interest rates shocks to include a shock of 400 basis points.

Market Rate Change	Effect on Net Interest Income
+400		-2.1	%
+300		-5.2	%
+200		-7.0	%
+100		-3.3	%
-100		5.0	%

ITEM 4.   CONTROLS AND PROCEDURES

(a)             Evaluation of Disclosure Controls and Procedures

An evaluation of our disclosure controls and procedures (as defined in Rule 13(a)-14(c) under the Securities Exchange Act (the “Exchange Act”)) as of June 30, 2011, was carried out under the supervision and with the participation of our Chief Executive Officer, Chief Financial Officer and several other members of our senior management within the 45-day period preceding the filing date of this quarterly report.  Our Chief Executive Officer and Chief Financial Officer concluded that, as of June 30, 2011, the Company’s disclosure controls and procedures were effective in ensuring that the information required to disclosed by the Company in the reports it files or submits under the Exchange Act is: (i) accumulated and communicated to the Company’s management (including its Chief Executive Officer and Chief Financial Officer) in a timely manner; and (ii) recorded, processed, summarized and reported within the time periods specified in the SEC’s rules and forms.

The Company does not expect that its disclosure controls and procedures over financial reporting will prevent all errors and all fraud.  A control procedure, no matter how well conceived and operated, can provide only reasonable, not absolute, assurance that the objectives of the control procedure are met.  Because of the inherent limitations in all control procedures, no evaluation of controls can provide absolute assurance that all control issues and instances of fraud, if any, within the Company have been detected.  These inherent limitations include the realities that judgments in decision-making can be faulty and that breakdowns in controls or procedures can occur because of simple error or mistake.  Additionally, controls can be circumvented by the individual acts of some persons, by collusion of two or more people, or by management override of the control.  The design of any control procedure also is based in part upon certain assumptions about the likelihood of future events, and there can be no assurance that any design will succeed in achieving its stated goals under all potential future conditions; over time, controls may become inadequate because of change in conditions, or the degree of compliance with the policies or procedures may deteriorate.  Because of the inherent limitations in a cost-effective control procedure, misstatements due to error or fraud may occur and not be detected.

59

(b)             Internal Control Over Financial Reporting

There were no changes in our internal control over financial reporting (as defined in Rule 13a-15(f) under the Act) that occurred during the quarter ended June 30, 2011, that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.

60

PART II – OTHER INFORMATION

ITEM 1.   LEGAL PROCEEDINGS

In the normal course of business, the Company occasionally becomes involved in various legal proceedings.  In our opinion, any liability from such proceedings would not have a material adverse effect on the business or financial condition of the Company.

ITEM 1A. RISK FACTORS

There have been no material changes to the risk factors disclosed in Item 1A. of Part 1 in our Annual Report on Form 10-K for the year ended December 31, 2010.

ITEM 2.   UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS

None.

ITEM 3.    DEFAULTS UPON SENIOR SECURITIES

None.

ITEM 4.    (REMOVED AND RESERVED)

None.

ITEM 5.    OTHER INFORMATION

None.

61

ITEM 6.    EXHIBITS

Exhibit Number	Document	Reference to Prior Filing or Exhibit Number Attached Hereto
2.1	Plan of Conversion and Reorganization of Heritage MHC	a
2.2	Form of Agreement and Plan of Merger by and among Heritage Financial Group, Heritage MHC and Heritage Financial Group, Inc.	a
3.1	Articles of Incorporation of Heritage Financial Group, Inc.	a
3.2	Bylaws of Heritage Financial Group, Inc.	a
4	Form of Heritage Financial Group, Inc. Common Stock Certificate	a
10.1	Employment Agreement between O. Leonard Dorminey and HeritageBank
10.2	Employment Agreement between O. Leonard Dorminey and Heritage Financial Group, Inc.
10.3	Employment Agreement between Carol W. Slappey and HeritageBank	b
10.4	Deferred Compensation and Excess/Matching Contribution Plans	b
10.5	Supplemental Executive Retirement Plan	b
10.6	Directors’ Retirement Plan	b
10.7	Employee Stock Ownership Plan	b
10.8	Purchase and Assumption Agreement dated September 1, 2009, between HeritageBank of the South and Atlantic Coast Federal Bank	c
10.9	Definitive Whole-bank Purchase and Assumption Agreement dated December 4, 2009, between HeritageBank of the South and the Federal Deposit Insurance Corporation	d
10.10	Purchase and Assumption Agreement dated February 23, 2010, between HeritageBank of the South and The Park Avenue Bank	e
10.11	Employment Agreement between T. Heath Fountain and HeritageBank	f
10.12	Employment Agreement between O. Mitchell Smith and HeritageBank	f
10.13	Definitive Whole-bank Purchase and Assumption Agreement dated February 18, 2011, between HeritageBank of the South and the Federal Deposit Insurance Corporation	h
10.14	Employment Agreement between David Durland and HeritageBank	j
10.15	Heritage Financial Group, Inc 2011 Equity Incentive Plan	i
10.16	Awards made to directors and executive officers under the Heritage Financial Group, Inc. 2011 Incentive Plan on July 1, 201 and the forms and agreement in Exibit 10.17.	10.16
10.17	Forms of agreements for stock options (including incentive stock options), stock apprection rights, restricted stock and restricted share units under the Heritage Financial Group, Inc. 2011 Equity Incentive Plan.	10.17
11	Statement re: computation of per share earnings	None
18	Letter re: change in accounting principles	None
19	Report furnished to security holders	None
22	Published report regarding matters submitted to vote of security holders	None
23	Consent of Accountants	None
24	Power of Attorney	None
31.1	Rule 13a-14(a)/15d-14(a) Certifications of Chief Executive Officer	31.1
31.2	Rule 13a-14(a)/15d-14(a) Certifications of Chief Financial Officer	31.2
32	Section 1350 Certifications	32
101	Financial Statements from the Heritage financial Group, Inc Form 10Q for the quarter ended June 30, 2011, formatted in Extensive Business Reporting Language (XBRL); (i) Consolidated Balance Sheets; (i) Consolidated Balance Sheets, (ii) Consoidated Statements of Operations, (iii) Consolidated Statements of Comprehensive Income, (iv) Consolidated Statements of Stockholders Equity, (v) Consolidated Statements of Cash Flows, and (vi) Condensed Notes to Consolidated Financial Statements, as follows:
101.INS	XBRL Instance Document	101.INS
101.SCH	XBRL Taxonomy Extension Schema Document	101.SCH
101.CAL	XBRL Taxonomy Extension Calculation Linkbase Document	101.CAL
101.LAB	XBRL Taxonomy Extension Labels Linkbase Document	101.LAB
101.PRE	XBRL Taxonomy Extension Presentation Linkbase Document	101.PRE
101.DEF	XBRL Taxonomy Extension Definition Linkbase Document	101.DEF

62

a	Filed as an exhibit to the Company’s Registration Statement on Form S-1 (File No. 333-123581) filed on June 22, 2010.
b	Filed as an exhibit to the Registration Statement of Heritage Financial Group on Form SB-2 (File No. 333-123581)filed on March 25, 2005.
c	Included as an exhibit to the Form 8-K filed by Heritage Financial Group with the SEC on September 2, 2009.
d	Included as an exhibit to the Form 8-K filed by Heritage Financial Group with the SEC on December 8, 2009.
e	Included as an exhibit to the Form 8-K filed by Heritage Financial Group with the SEC on February 25, 2010.
f	Filed as an exhibit to Pre-Effective Amendment No. 1 to the Company’s Registration Statement on Form S-1 (File No. 333-123581) filed on August 9, 2010.
h	Included as an exhibit to the Form 8-K filed by Heritage Financial Group, Inc. with the SEC on February 24, 2011.
i	Included as an exhibit to the Registration Statement on Form S-8 (File No. 333-175154)
j	Included as an exhibit to the Form 8-K filed by Heritage Financial Group with the SEC on April 21, 2011.

63

SIGNATURES

Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.

	HERITAGE FINANCIAL GROUP, INC.
Date:     August 15, 2011	By:	/s/ O. Leonard Dorminey
	O. Leonard Dorminey
	President and Chief Executive Officer
Date:     August 15, 2011	By:	/s/ T. Heath Fountain
	T. Heath Fountain
	Executive Vice President,
	Chief Administrative Officer and
	Chief Financial Officer
	(Principal Financial and Accounting Officer)

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