Heritage Financial 10-Q 2012 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, 2012

Commission File Number 001-34902

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.  Yesx   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 x  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  x  Non-accelerated filer  o  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).  Yeso No  x

Indicate the number of shares outstanding of each issuer’s classes of common equity, as of the latest practicable date:  At August 9, 2012, there were 8,490,247 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, 2012 AND DECEMBER 31, 2011	3
		CONSOLIDATED STATEMENTS OF OPERATIONS FOR THE THREE AND SIX MONTHS ENDED JUNE 30, 2012 AND 2011	4
		CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME FOR THE THREE AND SIX MONTHS ENDED JUNE 30, 2012 AND 2011	5
		CONSOLIDATED STATEMENTS OF STOCKHOLDERS’ EQUITY FOR THE SIX MONTHS ENDED JUNE 30, 2012 AND THE YEAR ENDED DECEMBER 31, 2011	6
		CONSOLIDATED STATEMENTS OF CASH FLOWS FOR THE SIX MONTHS ENDED JUNE 30, 2012 AND 2011	8
		CONDENSED NOTES TO CONSOLIDATED FINANCIAL STATEMENTS.	10
	ITEM 2.	MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS	44
	ITEM 3.	QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK	65
	ITEM 4.	CONTROLS AND PROCEDURES	68
PART II – OTHER INFORMATION
	ITEM 1	LEGAL PROCEEDINGS	69
	ITEM 1A	RISK FACTORS	69
	ITEM 2	UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS	69
	ITEM 3	DEFAULTS UPON SENIOR SECURITIES	69
	ITEM 5	OTHER INFORMATION	69
	ITEM 6	EXHIBITS	70

HERITAGE FINANCIAL GROUP, INC. AND SUBSIDIARY

CONSOLIDATED BALANCE SHEETS

(Dollars in Thousands)

	Unaudited June 30, 2012			Audited December 31, 2011
Assets
Cash and due from banks	$	22,499		$	34,521
Interest-bearing deposits in banks		32,153			43,101
Federal funds sold		10,571			21,753
Securities available for sale, at fair value		227,984			259,017
Federal Home Loan Bank Stock, at cost		3,397			4,067
Other equity securities, at cost		1,010			1,010
Loans held for sale		6,017			7,471
Loans		517,615			453,163
Covered loans		87,386			107,457
Less allowance for loan losses		8,099			7,494
Loans, net		596,902			553,126
Other real estate owned		1,719			3,362
Covered other real estate owned		7,571			10,047
Total other real estate owned		9,290			13,409
FDIC loss-share receivable		76,294			83,901
Premises and equipment, net		32,337			29,532
Premises held for sale		1,080			1,080
Accrued interest receivable		4,056			4,689
Goodwill and intangible assets		4,621			4,848
Cash surrender value of bank-owned life insurance		22,962			15,611
Other assets		12,253			12,716
	$	1,063,426		$	1,089,852
Liabilities and Stockholders' Equity
Deposits
Noninterest-bearing	$	87,815		$	78,823
Interest-bearing		772,453			805,364
Total deposits		860,268			884,187
Federal funds purchased and securities sold under repurchase agreements		31,746			35,049
Other borrowings		35,000			35,000
Accrued interest payable		721			972
Other liabilities		12,400			10,508
Total liabilities		940,135			965,716
Stockholders' equity
Preferred stock, par value; $0.01; 5,000,000 shares authorized; none issued		-			-
Common stock, par value $0.01; 45,000,000 shares authorized;8,490,247 and 8,712,031  shares issued, respectively		85			87
Capital surplus		86,152			88,393
Retained earnings		44,016			42,374
Accumulated other comprehensive loss, net of tax of $1,749  and $1,384		(2,623	)		(2,076	)
Unearned employee stock ownership plan (ESOP) shares, 412,487  and 439,138 shares		(4,339	)		(4,642	)
Total stockholders' equity		123,291			124,136
	$	1,063,426		$	1,089,852

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, 2012 and 2011

(Dollars in Thousands)

	For the Three Months						For the Six Months
	Ended June 30,						Ended June 30,
	2012			2011			2012			2011
Interest income
Interest and fees on loans	$	10,532		$	7,564		$	20,680		$	14,709
Interest on loans held for sale		204			46			387			54
Interest on taxable securities		1,016			1,221			1,995			2,428
Interest on nontaxable securities		295			211			593			422
Interest on federal funds sold		4			16			18			29
Interest on deposits in other banks		26			51			63			91
		12,077			9,109			23,736			17,733
Interest expense
Interest on deposits		1,246			1,983			2,509			3,831
Interest on other borrowings		672			684			1,344			1,427
		1,918			2,667			3,853			5,258
Net interest income		10,159			6,442			19,883			12,475
Provision for loan losses		1,091			700			1,491			1,300
Net interest income after provision		9,068			5,742			18,392			11,175
Noninterest income
Service charges on deposit accounts		1,135			1,222			2,156			2,273
Bankcard services income		831			674			1,654			1,260
Other service charges, commissions and fees		73			69			158			144
Brokerage fees		462			406			908			760
Mortgage banking fees		938			624			1,627			892
Bank-owned life insurance		211			149			351			294
Gain on sales of securities		27			453			70			453
Gain (loss) on acquisitions		34			(117	)		34			2,217
Accretion FDIC loss share receivable		(133	)		5			(630	)		5
Other		101			75			135			103
		3,679			3,560			6,463			8,401
Noninterest expense
Salaries and employee benefits		5,460			4,923			10,995			9,251
Equipment and occupancy		1,395			964			2,718			1,760
Advertising and marketing		214			220			395			384
Professional fees		340			365			578			754
Information services expenses		1,163			819			2,216			1,482
(Gain) loss on sales and write-downs of other real estate owned		(141	)		535			(148	)		937
Gain on sales and write-downs of FDIC
acquired other real estate owned		(249	)		(45	)		(75	)		(45	)
Foreclosed asset expenses		218			245			440			415
Foreclosed FDIC acquired asset expenses		466			-			628			-
FDIC insurance and other regulatory fees		265			354			509			647
Acquisition related expenses		69			474			400			757
Deposit intangible expense		195			207			396			302
Other operating		1,279			979			2,423			1,794
		10,674			10,040			21,475			18,438
Income (loss) before income taxes		2,073			(738	)		3,380			1,138
Applicable income tax (benefit)		713			(257	)		1,049			404
Net income (loss)	$	1,360		$	(481	)	$	2,331		$	734
Earnings (loss) per common share:
Basic earnings (loss) per share	$	0.17		$	(0.06	)	$	0.29		$	0.09
Diluted earnings (loss) per share	$	0.17		$	(0.06	)	$	0.29		$	0.09
Weighted average-common shares outstanding:
Basic		8,071,354			8,213,761			8,107,868			8,200,207
Diluted		8,072,935			8,215,090			8,109,356			8,201,633

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, 2012 and 2011

(Dollars in Thousands)

	For the Three Months Ended June 30,						For the Six Months Ended June 30,
	2012			2011			2012			2011
Net income (loss)	$	1,360		$	(481	)	$	2,331		$	734
Other comprehensive income (loss):
Accretion of realized gain on terminated cash flow hedge, net of tax of $20 and $25 for the quarter and $39 and $60 for the year to date, respectively		(29	)		(37	)		(59	)		(90	)
Unrealized loss on cash flow hedge, net of tax of $(1,185) and $0 for the quarter and $(984) and $0 for year to date, respectively		(1,779	)		-			(1,476	)		-
Unrealized holding gains on investments arising during the period, net of tax of $557  and $927 for the quarter and $687 and $1,423 for the year to date, respectively		836			1,391			1,030			2,135
Reclassification adjustment for investment gains included in net income, net of tax of $11 and $181 for the quarter and $42 and $181 for the year to date, respectively		(16	)		(272	)		(42	)		(272	)
Total other comprehensive income  (loss)		(988	)		1,083			(547	)		1,773
Comprehensive income	$	372		$	602		$	1,784		$	2,507

See Notes to Consolidated Financial Statements.

5

HERITAGE FINANCIAL GROUP, INC. AND SUBSIDIARY

CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY

For the Six Months Ended June 30, 2012 (Unaudited)

And The Year Ended December 31, 2011

(Dollars in Thousands, except per share data)

																Accumulated
																Other
													Unearned			Compre-
	Common Stock						Capital			Retained			ESOP			hensive
	Shares			Par Value			Surplus			Earnings			Shares			Loss			Total
Balance, December 31, 2010		8,710,511		$	87		$	88,876		$	39,536		$	(5,245	)	$	(3,914	)	$	119,340
Net income		-			-			-			3,825			-			-			3,825
Cash dividend declared,$0.12 per share		-			-			-			(987	)		-			-			(987	)
Issuance of  121,530  shares of restricted common stock		121,530			1			(1	)		-			-			-			-
Forfeiture of  3,068  of restricted common stock		(3,068	)		-			-			-			-			-			-
Repurchase of  116,942 shares of common stock		(116,942	)		(1	)		(1,309	)		-			-			-			(1,310	)
Stock-based compensation expense		-			-			728			-			-						728
Other comprehensive income		-			-			-			-			-			1,838			1,838
Tax benefit from stock-based compensation plans		-			-			(8	)		-			-			-			(8	)
ESOP shares earned, 53,182 shares		-			-			17			-			603			-			620
Tax benefit on ESOP expense		-			-			90			-			-			-			90
Balance, December 31, 2011		8,712,031		$	87		$	88,393		$	42,374		$	(4,642	)	$	(2,076	)	$	124,136

See Notes to Consolidated Financial Statements.

6

HERITAGE FINANCIAL GROUP, INC. AND SUBSIDIARY

CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY (Continued)

For the Six Months Ended June 30, 2012 (Unaudited)

And The Year Ended December 31, 2011

(Dollars in Thousands, except per share data)

																Accumulated
																Other
													Unearned			Compre-
	Common Stock						Capital			Retained			ESOP			hensive
	Shares			Par Value			Surplus			Earnings			Shares			Loss			Total
Balance, December 31, 2011		8,712,031		$	87		$	88,393		$	42,374		$	(4,642	)	$	(2,076	)	$	124,136
Net income		-			-			-			2,331			-			-			2,331
Cash dividend declared,$0.08  per share		-			-			-			(689	)		-			-			(689	)
Repurchase of  221,784  shares of common stock		(221,784	)		(2	)		(2,712	)		-			-			-			(2,714	)
Stock-based compensation expense		-			-			415			-			-						415
Other comprehensive loss		-			-			-			-			-			(547	)		(547	)
Tax benefit from stock-based compensation plans		-			-			(1	)		-			-			-			(1	)
ESOP shares earned, 26,650 shares		-			-			14			-			303			-			317
Tax benefit on ESOP expense		-			-			43			-			-			-			43
Balance, June 30, 2012		8,490,247		$	85		$	86,152		$	44,016		$	(4,339	)	$	(2,623	)	$	123,291

See Notes to Consolidated Financial Statements.

7

HERITAGE FINANCIAL GROUP, INC. AND SUBSIDIARY

CONSOLIDATED STATEMENTS OF CASH FLOWS

(Unaudited)

 (Dollars in thousands)

	Six Months Ended June 30,
	2012			2011
OPERATING ACTIVITIES	$	2,331		$	734
Net income
Adjustments to reconcile net income to net cash provided by operating activities:
Depreciation and amortization		1,017			609
Deposit premium amortization		396			302
Provision for loan losses		1,491			1,300
ESOP compensation expense		317			325
Provision (benefit) for deferred taxes		(1,594	)		1,351
Stock-based compensation expense		415			412
Accretion of gain on termination of cash flow hedge		(98	)		(150	)
Amortization of available for sale discounts and premiums, net		2,139			933
Gain on sales of securities available for sale		(70	)		(453	)
(Gain) loss on sales and write-downs of other real estate owned		(148	)		937
Gain on sales and write-downs of FDIC acquired other real estate owned		(75	)		(45	)
Increase in bank-owned life insurance		(351	)		(293	)
Excess tax benefit related to stock-based compensation plans		1			8
Excess (tax) benefit related to ESOP		(43	)		15
Decrease in FDIC loss share receivable		6,964			420
Accretion  of FDIC loss share receivable		630			(5	)
Decrease (increase) in interest receivable		676			(559	)
(Decrease) increase in interest payable		(276	)		363
Decrease (increase) in loans held for sale		1,454			(5,355	)
Decrease in prepaid FDIC assessment		344			581
Gain on acquisitions		(34	)		(2,217	)
Net other operating activities		1,518			3,542
Total adjustments		14,673			2,021
Net cash provided by operating activities		17,004			2,755
INVESTING ACTIVITIES
Decrease (increase) in interest-bearing deposits in banks		10,948			(89,398	)
Purchases of securities available for sale		(41,626	)		(30,216	)
Proceeds from sales of securities available for sale		12,980			36,034
Proceeds from maturities and calls of securities available for sale		59,257			61,691
Purchase of bank owned life insurance		(7,000	)		-
Decrease in Federal Home Loan Bank stock		670			78
Decrease (increase) in federal funds sold		11,182			(23,919	)
Increase in loans, net		(36,719	)		(12,890	)
Purchases of premises and equipment		(2,082	)		(6,742	)
Net cash received from acquisition activity		5,831			57,900
Proceeds from sales of premises and equipment		-			12
Proceeds from sales of other real estate owned		6,613			1,686
Net cash (used in) provided by investing activities		20,054			(5,764	)

See Notes to Consolidated Financial Statements.

8

HERITAGE FINANCIAL GROUP, INC. AND SUBSIDIARY

CONSOLIDATED STATEMENTS OF CASH FLOWS (Continued)

(Unaudited)

 (Dollars in thousands)

FINANCING ACTIVITIES
(Decrease) increase  in deposits		(42,416	)		23,153
Decrease in federal funds purchased and securities sold under repurchase agreements		(3,303	)		(432	)
Repayment of other borrowings		-			(32,744	)
Excess tax benefit related to stock-based compensation plans		(1	)		(8	)
Excess tax (benefit) related to ESOP		43			(15	)
Repurchase of common stock		(2,714	)		-
Dividends paid to stockholders		(689	)		(523	)
Net cash used in financing activities		(49,080	)		(10,569	)
Net decrease in cash and due from banks		(12,022	)		(13,578	)
Cash and due from banks at beginning of period		34,521			28,803
Cash and due from banks at end of period	$	22,499		$	15,225
SUPPLEMENTAL DISCLOSURES OF CASH FLOW INFORMATION
Cash paid during the year for:
Interest	$	4,105		$	4,894
Income taxes	$	2,597		$	-
NONCASH TRANSACTIONS
Principal balances of loans transferred to other real estate owned	$	2,226		$	843

See Notes to Consolidated Financial Statements.

9

HERITAGE FINANCIAL GROUP, INC. AND SUBSIDIARY

CONDENSED NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

NOTE 1. BASIS OF PRESENTATION AND 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, 2012, 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, 2011.

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, 2012 and for the three and six months ended June 30, 2012 and 2011 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 1. BASIS OF PRESENTATION AND ACCOUNTING ESTIMATES (continued)

Recently Adopted Accounting Pronouncements

In May 2011, the FASB issued Accounting Standards Update (ASU) No. 2011-04, Fair Value Measurement (Topic 820): Amendments to Achieve Common Fair Value Measurement and Disclosure Requirements in U.S. GAAP and IFRSs to amend the Fair Value Measurement topic of the Accounting Standards Codification by clarifying the application of existing fair value measurement and disclosure requirements and by changing particular principles or requirements for measuring fair value or for disclosing information about fair value measurements. The amendments were effective for the Company beginning January 1, 2012 and did not have a material impact on the Company’s financial position, results of operations or cash flows.

In June 2011, the FASB issued ASUNo. 2011-05, Presentation of Comprehensive Income.  ASU 2011-05 requires entities to present net income and other comprehensive income in either a single continuous statement or in two separate, but consecutive statements of net income and other comprehensive income. The option to present items of other comprehensive income in the statement of changes in equity is eliminated. The guidance is effective for the Company for the first quarter of 2012, and did not have a material impact on the Company’s results of operations or financial position. It did not result in a change of disclosure, as the Company currently presents other comprehensive income in the separate statement following the Consolidated Statements of Income.

In September 2011, the FASB issued ASU No. 2011-08, Intangibles—Goodwill and Other (Topic 350): Testing Goodwill Impairment. The new guidance provides an entity the option to first perform a qualitative assessment to determine whether it is more likely than not that the fair value of a reporting unit is less than its carrying amount. If an entity determines that this is the case, it is required to perform the currently prescribed two-step goodwill impairment test to identify potential goodwill impairment and measure the amount of goodwill impairment loss to be recognized for that reporting unit (if any). Based on the qualitative assessment, if an entity determines that the fair value of a reporting unit is more than its carrying amount, the two-step goodwill impairment test is not required. The new guidance is effective for the Company beginning January 1, 2012, and did not have a material impact on the Company’s results of operations or financial position.

In December 2011, the FASB issued ASU No. 2011-11, Balance Sheet (Topic 210): Disclosures about Offsetting Assets and Liabilities which is intended to enhance disclosures resulting in improved information being available to users of financial information about financial instruments and derivative instruments that are subject to offsetting (“netting”) in statements of financial position whether the statements are prepared using U.S. GAAP or International Financial Reporting Standards. ASU 2011-11 requires disclosure of both gross information and net information about instruments and transactions eligible for offset or subject to an agreement similar to a master netting agreement. In addition to the quantitative disclosures, reporting entities also are required to provide a description of rights of setoff associated with recognized assets and recognized liabilities subject to enforceable master netting arrangements or similar agreements. ASU 2011-11 is effective for annual reporting periods beginning on or after January 1, 2013 and interim periods within those annual periods. The required disclosures should be provided retrospectively for all comparative periods presented. The Company is evaluating the impact that the adoption of ASU 2011-11 will have on its financial position, results of operations and cash flows.

11

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 and unvested shares of issued restricted stock. For the three and six months ended June 30, 2012, potential common shares of 558,816 and 1,005,416, respectively, were not included in the calculation of diluted earnings per share because the assumed exercise of such shares would be anti-dilutive.

 The table below sets forth our earnings (loss) per share:

	Three Months Ended June 30,					Six Months Ended June 30,
	2012		2011			2012		2011
	(dollars in thousands, except per share amounts)
Basic earnings (loss) per share:
Net income (loss)	$	1,360	$	(481	)	$	2,331	$	734
Weighted average common shares outstanding		8,071,354		8,213,761			8,107,868		8,200,207
Basic earnings (loss) per common share	$	0.17	$	(0.06	)	$	0.29	$	0.09
Diluted earnings (loss) per share:
Net income (loss)	$	1,360	$	(481	)	$	2,331	$	734
Weighted average common shares outstanding		8,071,354		8,213,761			8,107,868		8,200,207
Effect of dilutive stock options and restricted stock		1,581		1,329			1,488		1,426
Weighted average dilutive common shares outstanding		8,072,935		8,215,090			8,109,356		8,201,633
Diluted earnings (loss) per common share	$	0.17	$	(0.06	)	$	0.29	$	0.09

12

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.  As of June 30, 2012, there were approximately 12,634 restricted stock awards and 42,514 options available to be granted from the 2006 Plan.

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 and 163,852 were available as restricted stock awards.  On July 1, 2011, the Company granted 117,530 restricted stock awards and 334,870 stock options from this plan.  There were no awards granted from this plan during the six months ended June 30, 2012.

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, 2012, there was approximately $1.2 million of unrecognized compensation associated with these awards.  For the three months ended June 30, 2012 and 2011, we recognized compensation expense associated with these awards of approximately $75,000 and $124,000, respectively.  For the six months ended June 30, 2012 and 2011, we recognized compensation expense associated with these awards of approximately $150,000 and $248,000, respectively.

The Company recognized compensation expense related to stock options of approximately $131,000 and $101,000 for each of the six months ended June 30, 2012 and 2011, and approximately $265,000 and $164,000 for the six months ended June 30, 2012 and 2011, respectively.  At June 30, 2012, there was approximately $2.1 million of unrecognized compensation related to stock options.

13

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, 2012 (unaudited):	(dollars in thousands)
U. S. Government sponsored agencies (GSEs)	$	29,773	$	523	$	(8	)	$	30,288
State and municipal securities		49,315		2,014		(239	)		51,090
Corporate debt securities		2,155		-		(182	)		1,973
GSE residential mortgage-backed securities		142,499		2,095		(131	)		144,463
Total debt securities		223,742		4,632		(560	)		227,814
Equity securities		207		31		(68	)		170
Total securities	$	223,949	$	4,663	$	(628	)	$	227,984

			Gross		Gross
	Amortized		Unrealized		Unrealized			Fair
	Cost		Gains		Losses			Value
December 31, 2011:	(dollars in thousands)
U. S. Government sponsored agencies (GSEs)	$	45,141	$	598	$	(2	)	$	45,737
State and municipal securities		47,167		1,494		(457	)		48,204
Corporate debt securities		2,160		-		(204	)		1,956
GSE residential mortgage-backed securities		161,954		1,461		(452	)		162,963
Total debt securities		256,422		3,553		(1,115	)		258,860
Equity securities		207		66		(116	)		157
Total securities	$	256,629	$	3,619	$	(1,231	)	$	259,017

* At June 30, 2012 and December 31, 2011, 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.

14

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, 2012 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 in one year or less	$	1,155		$	1,098
Due from one to five years		3,301			3,236
Due from five to ten years		22,760			23,321
Due after ten years		54,333			55,866
Mortgage-backed securities		142,499			144,463
	$	223,949		$	227,984

Securities with a carrying value of $100.3 million and $96.3 million at June 30, 2012 and December 31, 2011, respectively, were pledged to secure public deposits, repurchase agreements and for other purposes required or permitted by law.  The balance of pledged securities in excess of the pledging requirements was $24.8 million and $26.0 million at June 30, 2012 and December 31, 2011, respectively.

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

	For the three months ended June 30,
	2012				2011
	(dollars in thousands)
Gross gains recognized on sales of securities		$	234			$	453
Gross losses recognized on sales of securities			(207	)			-
Net realized gains on sales of securities available for sale		$	27			$	453

	For the six months ended June 30,
	2012				2011
	(dollars in thousands)
Gross gains recognized on sales of securities		$	277			$	453
Gross losses recognized on sales of securities			(207	)			-
Net realized gains on sales of securities available for sale		$	70			$	453

15

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, 2012 and December 31, 2011.

	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, 2012 (unaudited):
U.S. Government sponsored agencies
(GSEs)	$	3,203	$	-		$	27,085	$	(8	)	$	30,288	$	(8	)
State and municipal securities		12,151		(213	)		38,939		(26	)		51,090		(239	)
Corporate debt securities		1,973		(182	)		-		-			1,973		(182	)
GSE residential mortgage-backed Securities		43,912		-			100,551		(131	)		144,463		(131	)
Subtotal, debt securities		61,239		(395	)		166,575		(165	)		227,814		(560	)
Equity securities		170		(68	)		-		-			170		(68	)
Total temporarily impaired securities	$	61,409	$	(463	)	$	166,575	$	(165	)	$	227,984	$	(628	)

	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)
December 31, 2011 :
U.S. Government sponsored agencies
(GSEs)	$	2,498	$	(2	)	$	-	$	-		$	2,498	$	(2	)
State and municipal securities		2,976		(64	)		2,047		(393	)		5,023		(457	)
Corporate debt securities		920		(80	)		1,036		(124	)		1,956		(204	)
GSE residential mortgage-backed securities		58,883		(452	)		-		-			58,883		(452	)
Subtotal, debt securities		65,277		(598	)		3,083		(517	)		68,360		(1,115	)
Equity securities		-		-			91		(116	)		91		(116	)
Total temporarily impaired securities	$	65,277	$	(598	)	$	3,174	$	(633	)	$	68,451	$	(1,231	)

16

HERITAGE FINANCIAL GROUP, INC. AND SUBSIDIARY

CONDENSED NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

NOTE 4. SECURITIES (Continued)

Other-Than-Temporary Impairment

The Company reviews its investment portfolio on a quarterly basis judging each investment for other-than-temporary impairment (“OTTI”).  Management does not have the intent to sell any of the temporarily impaired investments and believes it is more likely than not that the Company will not have to sell any such securities before a recovery of cost. The OTTI analysis focuses on the duration and amount a security is below book value and assesses a calculation for both a credit loss and a non credit loss for each measured security considering the security’s type, performance, underlying collateral, and any current or potential debt rating changes.  The OTTI calculation for credit loss is reflected in the income statement while the non credit loss is reflected in other comprehensive income (loss).

The Company holds Freddie Mac (“FHLMC”) preferred stock, and OTTI was recorded in the amount of the investment after the U.S. Government placed the company into conservatorship in September 2008.  The preferred stock has been reduced to a nominal book value for tracking purposes.  The investment is currently valued at $31,000. During the twelve months ended December 30, 2008 the Company recognized a write-down of $1.5 million through non-interest income representing other-than-temporary impairment on the investment.

The Company holds a single issue trust preferred security issued by Royal Bank of Scotland (“RBS”).  The security suspended payments under the EU agreement for 24 months beginning April 1, 2011.  The Company valued the security by projecting estimated cash flows using the Moody’s Ba2 marginal default rate.  The difference in the present value and the carrying value of the security was the OTTI credit portion.  The security is currently booked at a fair value of $139,000 at June 30, 2012 and during the twelve months ended December 30, 2011; the Company recognized a write-down of $43,000 through non-interest income representing other-than-temporary impairment on the security.

The following table presents more detail on selective Company security holdings as June 30, 2012.  These details are listed separately due to the inherent level of risk for OTTI on these securities.

			Current Credit	Book		Fair		Unrealized			Present Value Discounted
Description	Cusip#		Rating	Value		Value		Loss			Cash Flow
Marketable equity securities
FHLMC Preferred Stock		313400657	Ca	$	-	$	31	$	-		$	31
Trust preferred securities
RBS Capital Fund		74928K208	B3	$	207	$	139	$	(68	)	$	207

The following table presents a roll-forward of the cumulative amount of credit losses on the Company’s investment securities that have been recognized through earnings as of June 30, 2012 and December 31, 2011.

	June 30, 2012		December 31, 2011
Beginning balance of credit losses	$	1,543	$	1,500
Other-than-temporary impairment credit losses		-		43
Ending balance of cumulative credit losses recognized in earnings	$	1,543	$	1,543

17

HERITAGE FINANCIAL GROUP, INC. AND SUBSIDIARY

CONDENSED NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

NOTE 5. LOANS AND ALLOWANCE FOR LOAN LOSSES

The composition of loans is summarized as follows:

	June 30,			December 31,
	2012				2011
Commercial real estate:
Nonresidential	$	177,307			$	138,970
Multifamily		19,639				15,797
Farmland		18,121				17,921
Total commercial real estate loans		215,067				172,688
Construction and land		31,134				26,804
Consumer real estate:
Mortgage loans, 1-4 families		148,162				129,745
Home equity		25,289				26,154
Total consumer real estate loans		173,451				155,899
Consumer and other:
Indirect auto loans		2,232				3,741
Direct auto loans		6,786				6,430
Other		15,154				13,701
Total consumer loans		24,172				23,872
Commercial and industrial loans		58,589				55,179
		502,413				434,442
Loans acquired through FDIC-assisted acquisitions
Non-Covered		15,202				18,721
Covered		87,386				107,457
Total FDIC acquired loans		102,588				126,178
Total loans	$	605,001			$	560,620
Total allowance for loan losses		(8,099	)			(7,494	)
Loans, net	$	596,902			$	553,126

18

HERITAGE FINANCIAL GROUP, INC. AND SUBSIDIARY

CONDENSED NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

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

Commercial Real Estate

Commercial real estate lending includes real estate loans secured primarily by multifamily dwellings, retail establishments, hotels, motels, warehouses, small office buildings, farmland, and other nonresidential properties located in our market areas.

These loans typically involve large balances to single borrowers or groups of related borrowers.  Because payments on loans secured by nonresidential and multifamily real estate properties are often dependent on the successful operation or management of the properties, repayment of these loans may be subject to adverse conditions in the real estate market or the economy.  If the cash flow from the project is reduced, or if leases are not obtained or renewed, the borrower's ability to repay the loan may be impaired.

Loans secured by farmland typically involve large balances, and repayments are often dependent on the successful operation of the farm, making them subject to adverse weather and economic conditions.  If the cash flow from the farm operations declines, the borrower’s ability to repay the loan may be impaired.

Construction and Land

Construction and land lending consist of loans for the construction of one- to four-family residences, multifamily residences and commercial properties.  Construction loans also involve additional risks because funds are advanced upon the security of the project under construction, which is of uncertain value prior to the completion of construction.  Moreover, because of the uncertainties inherent in estimating construction costs, delays arising from labor problems, material shortages, and other unpredictable contingencies, it is relatively difficult to evaluate accurately the total loan funds required to complete a project, and the related loan-to-value ratios.

Consumer Real Estate

Consumer real estate lending consist of loans secured by first mortgages on one- to four-family residences, including home equity lines of credit, in our lending area, and on occasion, outside our lending area for customers whose primary residences are within the Company’s lending area.

Consumer and Other Lending

Consumer and other lending includes a variety of secured consumer loans, new and used auto loans, boat and recreational vehicle loans, and loans secured by deposit accounts. Consumer loans may entail greater risk, particularly in the case of consumer loans that are secured by rapidly depreciable assets, such as automobiles and recreational vehicles.  In these cases, any repossessed collateral for a defaulted loan may not provide an adequate source of repayment of the outstanding loan balance.  As a result, consumer loan collections are dependent on the borrower's continuing financial stability and, thus, are more likely to be adversely affected by job loss, divorce, illness, or personal bankruptcy.

Commercial and Industrial Lending

Commercial and industrial lending activities encompass loans with a variety of purposes and security, including loans to finance accounts receivable, inventory and equipment.  Commercial business loans are generally secured by business assets, such as accounts receivable, equipment and inventory.  This collateral may depreciate over time, may be difficult to appraise and may fluctuate in value based on the success of the business.

19

HERITAGE FINANCIAL GROUP, INC. AND SUBSIDIARY

CONDENSED NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

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

Activity in the allowance for loan losses and recorded investment in loans, excluding FDIC acquired, by segment:

	Commercial Real Estate			Consumer Real Estate			Construction and Land			Commercial and Industrial			Consumer and Other			Total
	(dollars in thousands)
Balance, January 1, 2012	$	1,878		$	2,440		$	1,270		$	1,551		$	355		$	7,494
Add (deduct):
Charge-offs		(47	)		(398	)		(15	)		(98	)		(103	)		(661	)
Recoveries		-			30			1			32			53			116
Provision*		229			1,070			(125	)		(41	)		17			1,150
Balance, June  30, 2012	$	2,060		$	3,142		$	1,131		$	1,444		$	322		$	8,099
Allowance:
Ending balance: specific	$	93		$	615		$	11		$	240		$	-			959
Ending balance: collective	$	1,967		$	2,527		$	1,120		$	1,204		$	323		$	7,141
Loans:
Ending balance: individually evaluated for impairment	$	3,002		$	8,240		$	853		$	2,061		$	-		$	14,156
Ending balance: collectively evaluated for impairment	$	212,065		$	165,211		$	30,281		$	56,528		$	24,172		$	488,257

*Refer to FDIC-assisted transactions section of this footnote for details on provision expense related to the covered and noncovered FDIC acquired loan portfolio.

20

HERITAGE FINANCIAL GROUP, INC. AND SUBSIDIARY

CONDENSED NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

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

	Commercial Real Estate			Consumer Real Estate			Construction and Land			Commercial and Industrial			Consumer  and Other			Total
	(dollars in thousands)
Balance, January 1, 2011	$	1,721		$	2,197		$	1,977		$	1,601		$	605		$	8,101
Add (deduct):
Charge-offs		(573	)		(3,177	)		(18	)		(330	)		(264	)		(4,362	)
Recoveries		495			18			2			-			148			663
Credit mark transfer in		197			-			-			-			-			197
Provision		38			3,402			(691	)		280			(134	)		2,895
Balance, December 31, 2011	$	1,878		$	2,440		$	1,270		$	1,551		$	355		$	7,494
Allowance:
Ending balance: specific	$	8		$	352		$	341		$	-		$	-		$	701
Ending balance: collective	$	1,870		$	2,088		$	929			1,551		$	355		$	6,793
Loans:
Ending balance: individually evaluated for impairment	$	1,938		$	9,035		$	4,326		$	1,368		$	-		$	16,667
Ending balance: collectively evaluated for impairment	$	170,750		$	146,864		$	22,478		$	53,811		$	23,872		$	417,775

Impaired Loans

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.

21

HERITAGE FINANCIAL GROUP, INC. AND SUBSIDIARY

CONDENSED NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

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

Impaired loans, excluding FDIC acquired, by class are presented below as of June 30, 2012:

										Interest
				Unpaid				Average		Income
	Recorded			Principal		Related		Recorded		Recognized
	Investment			Balance		Allowance		Investment		YTD 2012
	(dollars in thousands)
Commercial real estate:
Nonresidential		$	1,603	$	1,667	$	136	$	1,645	$	32
Multifamily			-		-		-		-		-
Farmland			112		114		112		111		5
Total commercial real estate loans			1,715		1,781		248		1,756		37
Construction and land			4,057		4,060		129		4,069		32
Consumer real estate:
Mortgage loans, 1-4 families			6,465		8,736		1,218		6,794		124
Home equity			215		247		203		219		2
Total consumer real estate loans			6,680		8,983		1,421		7,013		126
Consumer and other:
Indirect auto loans			57		70		-		60		2
Direct auto loans			21		38		15		26		1
Other			23		24		22		23		-
Total consumer and other loans			101		132		37		109		3
Commercial and industrial loans			912		981		99		913		6
Total		$	13,465	$	15,937	$	1,934	$	13,860	$	204

22

HERITAGE FINANCIAL GROUP, INC. AND SUBSIDIARY

CONDENSED NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

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

Impaired loans, excluding FDIC acquired, by class are presented below as of December 31, 2011:

										Interest
				Unpaid				Average		Income
	Recorded			Principal		Related		Recorded		Recognized
	Investment			Balance		Allowance		Investment		YTD 2011
	(dollars in thousands)
Commercial real estate:
Nonresidential		$	981	$	993	$	99	$	985	$	34
Multifamily			2		4		1		89		6
Farmland			111		114		-		112		-
Total commercial real estate loans			1,094		1,111		100		1,186		40
Construction and land			3,961		3,961		525		3,984		167
Consumer real estate:
Mortgage loans, 1-4 families			6,759		8,937		710		7,534		130
Home equity			105		138		101		112		4
Total consumer real estate loans			6,864		9,075		811		7,646		134
Consumer and other:
Indirect auto loans			83		98		-		103		4
Direct auto loans			55		67		41		65		2
Other			39		40		38		42		2
Total consumer and other loans			177		205		79		210		8
Commercial and industrial loans			1,179		1,323		389		1,301		20
Total		$	13,275	$	15,675	$	1,904	$	14,327	$	369

23

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, excluding FDIC acquired, that are past due as of June 30, 2012.

	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:
Nonresidential	$	2,621	$	-	$	1,603	$	4,224	$	173,083	$	177,307
Multifamily		-		-		-		-		19,639		19,639
Farmland		41		-		112		153		17,968		18,121
Total commercial real estate loans		2,662		-		1,715		4,377		210,690		215,067
Construction and land		19		132		566		717		30,417		31,134
Consumer real estate:
Mortgage loans, 1-4 families		213		-		6,456		6,669		141,493		148,162
Home equity		36		-		215		251		25,038		25,289
Total consumer real estate loans		249		-		6,671		6,920		166,531		173,451
Consumer and other:
Indirect auto loans		4		-		57		61		2,171		2,232
Direct auto loans		-		-		21		21		6,765		6,786
Other		3		-		23		26		15,128		15,154
Total consumer and other loans		7		-		101		108		24,064		24,172
Commercial and industrial loans		116		30		912		1,058		57,531		58,589
Total	$	3,053	$	162	$	9,965	$	13,180	$	489,233	$	502,413

24

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, excluding FDIC acquired, that are past due as of December 31, 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:
Nonresidential	$	111	$	-	$	361	$	472	$	138,498	$	138,970
Multifamily		-		-		2		2		15,795		15,797
Farmland		-		-		111		111		17,810		17,921
Total commercial real estate loans		111		-		474		585		172,103		172,688
Construction and land		-				442		442		26,362		26,804
Consumer real estate:
Mortgage loans, 1-4 families		93		-		4,667		4,760		124,985		129,745
Home equity		54		24		105		183		25,971		26,154
Total consumer real estate loans		147		24		4,772		4,943		150,956		155,899
Consumer and other:
Indirect auto loans		23		-		83		106		3,635		3,741
Direct auto loans		-		-		55		55		6,375		6,430
Other		6		-		38		44		13,657		13,701
Total consumer and other loans		29		-		176		205		23,667		23,872
Commercial and industrial loans		60				1,179		1,239		53,940		55,179
Total	$	347	$	24	$	7,043	$	7,414	$	427,028	$	434,442

There were no accruing loans that were greater than 90 days past due at June 30, 2012 and December 31, 2011.

25

HERITAGE FINANCIAL GROUP, INC. AND SUBSIDIARY

CONDENSED NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

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

Troubled Debt Restructuring (TDR) Modifications

Impaired loans include loans modified in troubled debt restructuring where concessions have been granted to borrowers experiencing financial difficulties.  These concessions are a part of the Company’s loss mitigation activities and could include a reduction in the interest rate on the loan, payment extensions, forgiveness of principal, forbearance or other actions intended to maximize collection.  Certain TDR’s are classified as nonperforming at the time of restructure and may only be returned to performing status after considering the borrower’s sustained repayment performance for a reasonable period, typically considered six to twelve months.

Included in certain loan categories are troubled debt restructurings that were classified as impaired.  At June 30, 2012, the Company had troubled debt restructurings totaling $9.9 million, which involved 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, 2012 are troubled debt restructurings of $6.4 million.  In addition, at that date the Company had troubled debt restructurings totaling $3.5 million that were performing in accordance with their modified terms and are not included in nonaccruing loans.

At December 31, 2011, the Company had troubled debt restructurings totaling $10.4 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, 2011, are troubled debt restructurings of $4.2 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.

The following tables include the recorded investment and number of modifications for modified loans.  The Company reports the recorded investment in the loans prior to a modification and also the recorded investment in the loans after the loans were restructured.  Management has also disclosed the recorded investment and number of modifications for troubled debt restructurings within the last year where a concession has been made that then defaulted in the current reporting period.

Troubled Debt Restructurings for the periods ended:

	June 30, 2012
	Number of Modifications		Recorded Investment Prior to Modifications			Recorded Investment
	(dollars in thousands)
Commercial real estate		3		$	1,071		$	1,013
Consumer real estate		5			7,268			4,557
Construction and land		1			3,574			3,488
Commercial and industrial loans		2			936			831
Consumer and other		-			-			-
Total		11		$	12,849		$	9,889

26

HERITAGE FINANCIAL GROUP, INC. AND SUBSIDIARY

CONDENSED NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

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

	December 31, 2011
	Number of Modifications		Recorded Investment Prior to Modifications			Recorded Investment
	(dollars in thousands)
Commercial real estate		2		$	852		$	843
Consumer real estate		5			7,268			5,206
Construction and land		1			3,574			3,519
Commercial and industrial loans		1			920			839
Consumer and other		-			-			-
Total		9		$	12,614		$	10,407

Troubled Debt Restructuring Modifications that Subsequently Defaulted for the periods ended:

	June 30, 2012
	Number
	of		Recorded Investment
	Modifications
	(dollars in thousands)
Commercial real estate		3		$	1,013
Consumer real estate		4			4,548
Construction and land		-			-
Commercial and industrial loans		2			831
Consumer and other		-			-
Total		9		$	6,392

	December 31, 2011
	Number
	of		Recorded Investment
	Modifications
	(dollars in thousands)
Commercial real estate		1		$	223
Consumer real estate		3			3,114
Construction and land		-			-
Commercial and industrial loans		1			839
Consumer and other		-			-
Total		5		$	4,176

27

HERITAGE FINANCIAL GROUP, INC. AND SUBSIDIARY

CONDENSED NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

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

Credit Quality

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 the Bank’s 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.

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.

28

HERITAGE FINANCIAL GROUP, INC. AND SUBSIDIARY

CONDENSED NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

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

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 will be placed on non-accrual.

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 for loans, excluding FDIC acquired, by class are presented below:

	As of June 30, 2012
							Construction
	Non-						and
	Residential		Multifamily		Farmland		Land
	(dollars in thousands)
Commercial Real Estate Credit Exposure
Pass 1	$	-	$	-	$	-	$	119
Pass 2		-		-		-		72
Pass 3		84,538		8,997		8,104		8,878
Pass 4		84,511		8,393		8,940		17,696
Special Mention 5		686		2,109		80		3,569
Substandard 6		7,572		140		997		710
Doubtful 7		-		-		-		90
Loss 8		-		-		-		-
Total	$	177,307	$	19,639	$	18,121	$	31,134

29

HERITAGE FINANCIAL GROUP, INC. AND SUBSIDIARY

CONDENSED NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

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

	As of December 31, 2011
							Construction
	Non-						and
	Residential		Multifamily		Farmland		Land
	(dollars in thousands)
Commercial Real Estate Credit Exposure
Pass 1	$	-	$	-	$	-	$	-
Pass 2		-		-		-		76
Pass 3		64,303		5,336		8,014		11,032
Pass 4		67,135		8,568		9,230		11,168
Special Mention 5		5,064		1,753		161		135
Substandard 6		2,468		140		516		4,393
Doubtful 7		-		-		-		-
Loss 8		-		-		-		-
Total	$	138,970	$	15,797	$	17,921	$	26,804

	As of June 30, 2012
	Commercial
	(dollars in thousands)
Commercial Credit Exposure
Pass 1	$	792
Pass 2		728
Pass 3		27,888
Pass 4		25,852
Special Mention 5		476
Substandard 6		2,853
Doubtful 7		-
Loss 8		-
Total	$	58,589

30

HERITAGE FINANCIAL GROUP, INC. AND SUBSIDIARY

CONDENSED NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

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

	As of December 31, 2011
	Commercial
	(dollars in thousands)
Commercial Credit Exposure
Pass 1	$	1,101
Pass 2		299
Pass 3		30,515
Pass 4		20,428
Special Mention 5		986
Substandard 6		1,850
Doubtful 7		-
Loss 8		-
Total	$	55,179

	As of June 30, 2012
	Mortgage		Home Equity
	(dollars in thousands)
Consumer Real Estate Credit Exposure
Pass 1-4	$	136,997	$	24,840
Special Mention 5		1,033		90
Substandard 6		10,132		359
Doubtful 7		-		-
Loss 8		-		-
Total	$	148,162	$	25,289

	As of December 31, 2011
	Mortgage		Home Equity
	(dollars in thousands)
Consumer Real Estate Credit Exposure
Pass 1-4	$	118,125	$	25,684
Special Mention 5		973		262
Substandard 6		10,647		208
Doubtful 7		-		-
Loss 8		-		-
Total	$	129,745	$	26,154

31

HERITAGE FINANCIAL GROUP, INC. AND SUBSIDIARY

CONDENSED NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

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

	As of June 30, 2012
	Indirect			Direct
	Auto			Auto			Other
	(dollars in thousands)
Consumer and Other Credit Exposure
Pass 1-4		$	2,131		$	6,765		$	15,072
Special Mention 5			15			-			7
Substandard 6			86			21			75
Doubtful 7			-			-			-
Loss 8			-			-			-
Total		$	2,232		$	6,786		$	15,154

	As of December 31, 2011
	Indirect			Direct
	Auto			Auto			Other
	(dollars in thousands)
Consumer and Other Credit Exposure
Pass 1-4		$	3,590		$	6,374		$	13,594
Special Mention 5			18			-			20
Substandard 6			133			56			87
Doubtful 7			-			-			-
Loss 8			-			-			-
Total		$	3,741		$	6,430		$	13,701

32

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

The Company elected to account for loans acquired in Tattnall Bank, Citizens Bank of Effingham (“Citizens”) and First Southern National Bank (“First Southern”) acquisitions 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.  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 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 ASC 310. The following tables detail the fair value of loans covered and not covered under loss share agreements accounted under ASC 310-30.

Loans not covered by loss -sharing agreements:	June 30,
(dollars in thousands)	2012
Commercial real estate	$	7,684
Consumer real estate		1,939
Construction and land		722
Commercial and industrial		2,711
Consumer and other		2,147
	$	15,203

Loans covered by loss-sharing agreements:	June 30,
(dollars in thousands)	2012
Commercial real estate	$	25,609
Consumer real estate		38,724
Construction and land		16,495
Commercial and industrial		5,074
Consumer and other		1,484
	$	87,386

The Bank entered into loss-sharing agreements as part of the acquisitions of Citizens and First Southern.  The covered loans above are covered pursuant to the FDIC loss-share agreements.  Those agreements provide for the FDIC to reimburse the Company for 80% of covered losses associated with these loans, pursuant to the terms of the agreements.

33

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 represents the loans receivable as of June 30, 2012 and reflects reclassifications from the balances reported at December 31, 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	$	159,600		$	44,509		$	204,109
Non-accretable difference		(44,048	)		(22,507	)		(66,555	)
Cash flows expected to be collected		115,552			22,002			137,554
Accretable yield		(31,105	)		(3,861	)		(34,966	)
Basis in acquired loans	$	84,447		$	18,141		$	102,588

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, December 31, 2011	$	29,146	$	1,950	$	31,096
Net Accretion		1,959		1,911		3,870
Balance, June  30, 2012	$	31,105	$	3,861	$	33,829

The following is a summary of the allowance for loan and lease losses for the FDIC acquired loans for the period ended June 30, 2012:

	Commercial Real Estate			Consumer Real Estate			Construction and Land		Commercial and Industrial			Consumer  and  Other			Total
	(dollars in thousands)
		-			-
Balance, January 1, 2012	$	-		$	-		$	-	$	-		$	-		$	-
Add (deduct):
Charge-offs		(144	)		(1	)		-		(193	)		(3	)		(341	)
Recoveries		-			-			-		-			-			-
Provision for loan losses - noncovered		-			-			-		-			3			3
Provision for loan losses - covered		144			1			-		193			-			338
Balance, June  30, 2012	$	-		$	-				$	-		$	-		$	-

34

HERITAGE FINANCIAL GROUP, INC. AND SUBSIDIARY

CONDENSED NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

NOTE 6. FDIC LOSS SHARE RECEIVABLE

The following tables provide changes in the loss-share receivable from the FDIC for the periods indicated.

For the six months ended June 30, 2012:
	(dollars in thousands)
Balance, December 31, 2011	$	83,901
Claimable losses on covered  assets under agreement		(1,770	)
Reimbursable expense claimed		1,313
Accretion of discounts and premiums, net		(1,046	)
Reimbursements from FDIC		(6,104	)
Balance, June  30, 2012	$	76,294

For the twelve months ended December 31, 2011:
	(dollars in thousands)
Balance, December 31, 2010	$	-
FDIC Loss share receivable recorded for Citizens		58,164
FDIC Loss share receivable recorded for First Southern		30,464
Claimable losses on covered assets under agreement		(3,140	)
Reimbursable expense claimed		1,208
Accretion of discounts and premiums, net		381
Reimbursements from FDIC		(3,176	)
Balance, December 31, 2011	$	83,901

35

HERITAGE FINANCIAL GROUP, INC. AND SUBSIDIARY

CONDENSED NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

NOTE 7. OTHER REAL ESTATE OWNED

The following table provides a summary of information pertaining to OREO for periods ended June 30, 2012 and December 31, 2011.

	OREO			Covered  OREO			Total
	(dollars in thousands)
Balance, December 31, 2011	$	3,362		$	10,047		$	13,409
Additions		556			2,028			2,584
Sales		(2,142	)		(4,210	)		(6,352	)
Writedowns		(57	)		(294	)		(351	)
Balance, June 30, 2012	$	1,719		$	7,571		$	9,290

	OREO			Covered  OREO			Total
	(dollars in thousands)
Balance, December 31, 2010	$	3,689		$	-		$	3,689
Acquired in Citizens acquisition		-			7,540			7,540
Acquired in First Southern acquisition		-			4,644			4,644
Additions		2,230			1,610			3,840
Sales		(1,699	)		(3,747	)		(5,446	)
Writedowns		(858	)		-			(858	)
Balance, December 31, 2011	$	3,362		$	10,047		$	13,409

36

HERITAGE FINANCIAL GROUP, INC. AND SUBSIDIARY

CONDENSED NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

NOTE 8. 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.

The table below presents the Company’s assets and liabilities measured at fair value on a recurring basis as of June 30, 2012, aggregated by the level in the fair value hierarchy within which those measurements fall.

	Level 1		Level 2			Level 3		Total
	(dollars in thousands)
Assets
Available for sale investment securities	$	31	$	227,953		$	-	$	227,984
Total assets at fair value	$	31	$	227,953		$	-	$	227,984
Liabilities
Interest rate swap – cash flow hedge	$	-	$	(2,461	)	$	-	$	(2,461	)
Total liabilities at fair value	$	-	$	(2,641	)	$	-	$	(2,461	)

37

HERITAGE FINANCIAL GROUP, INC. AND SUBSIDIARY

CONDENSED NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

NOTE 8. FAIR VALUE MEASUREMENTS (Continued)

The table below presents the Company’s other financial instruments at fair value as of June 30, 2012, aggregated by the level in the fair value hierarchy within which those measurements fall.

	Level 1		Level 2			Level 3		Total
	(dollars in thousands)
Assets
Loans, net	$	-	$	583,482		$	-	$	583,482
Total assets at fair value	$	-	$	583,482		$	-	$	583,482
Liabilities
Deposits	$	-	$	(853,315	)	$	-	$	(853,315	)
Federal funds purchased and securities
Sold under repurchase agreements		-		(31,758	)		-		(31,758	)
Other borrowings		-		(39,227	)		-		(39,227	)
Total liabilities at fair value	$	-	$	(924,300	)	$	-	$	(924,300	)

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 (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.

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, 2012, there were no impaired loans reported at fair value utilizing Level 2 valuation inputs.  Impaired loans with a carrying value of $13.5 million were reduced by valuation allowance allocations totaling $1.9 million for a total reported fair value of $11.6 million on collateral valuations utilizing Level 3 valuation inputs at June 30, 2012.

38

HERITAGE FINANCIAL GROUP, INC. AND SUBSIDIARY

CONDENSED NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

NOTE 8. FAIR VALUE MEASUREMENTS (Continued)

Fair Value Option

Fair Value Measurements and Disclosures (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.

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:  Securities in an active market where quoted prices are available are classified within Level 1 of the valuation hierarchy.  Level 1 securities include highly liquid government securities and certain other financial products.  If quoted market prices are not available, then fair values are estimated by using pricing models that use observable inputs or quoted prices of securities with similar characteristics and are classified within Level 2 of the valuation hierarchy. In certain cases where there is limited activity or less transparency around inputs to the valuation and more complex pricing models or discounted cash flows are used, securities are classified within Level 3 of the valuation hierarchy.

Federal Home Loan Bank Stock and other equity securities:  The carrying amount of Federal Home Loan Bank Stock and other equity securities 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.

39

HERITAGE FINANCIAL GROUP, INC. AND SUBSIDIARY

CONDENSED NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

NOTE 8. FAIR VALUE MEASUREMENTS (Continued)

Disclosures about Fair Value of Financial Instruments (continued)

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 by changes in estimated cash flows associated with these loans.

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.

Derivatives. The fair values of derivative instruments are based primarily on a net present value calculation of the cash flows related to the interest rate swaps using primarily observable market inputs such as interest rate yield curves. The discounted net present value calculated represents the cost to terminate the swap if the Bank should choose to do so on the applicable measurement date. The credit valuation adjustment is recorded as an adjustment to the fair value of the derivative asset or liability on the applicable measurement date. Derivative instruments are classified as Level 2 in the fair value hierarchy.

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

40

HERITAGE FINANCIAL GROUP, INC. AND SUBSIDIARY

CONDENSED NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

NOTE 8. FAIR VALUE MEASUREMENTS (Continued)

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

	June 30, 2012				December 31, 2011
	Carrying Amount		Fair Value		Carrying Amount		Fair Value
Financial assets:	(dollars in thousands)
Cash, due from banks and interest-bearing deposits in banks	$	54,652	$	54,652	$	77,622	$	77,622
Federal funds sold	$	10,571	$	10,571	$	21,753	$	21,753
Securities available for sale	$	227,984	$	227,984	$	259,017	$	259,017
Federal Home Loan Bank stock	$	3,397	$	3,397	$	4,067	$	4,067
Other equity securities	$	1,010	$	1,010	$	1,010	$	1,010
Loans held for sale	$	6,017	$	6,017	$	7,471	$	7,471
Non covered loans	$	517,615	$	496,096	$	453,163	$	437,737
Covered loans		87,386		87,386		107,457		107,457
Allowance for loan losses		8,099		-		7,494		-
Loans, net	$	596,902	$	583,482	$	553,126	$	545,194
Accrued interest receivable	$	4,056	$	4,056	$	4,689	$	4,689
FDIC loss-share receivable	$	76,294	$	76,294	$	83,901	$	83,901
Financial liabilities:
Deposits	$	860,268	$	853,315	$	884,187	$	875,317
Federal funds purchased and securities sold under repurchase agreements	$	31,746	$	31,758	$	35,049	$	35,049
Other borrowings	$	35,000	$	39,227	$	35,000	$	38,161
Accrued interest payable	$	721	$	721	$	972	$	972
Interest rate swap – cash flow hedge	$	2,461	$	2,461	$	-	$	-

41

HERITAGE FINANCIAL GROUP, INC. AND SUBSIDIARY

CONDENSED NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

NOTE 9. DERIVATIVE FINANCIAL INSTRUMENTS

The Company is exposed to interest rate risk in the course of its business operations and manages a portion of this risk through the use of a derivative financial instrument, in the form of an interest rate swap (cash flow hedge). The Company accounts for its interest rate swap in accordance with ASC 815, Derivatives and Hedging, which requires that all derivatives be recognized as assets or liabilities in the balance sheet at fair value. The only type of derivative currently used by the Company is an interest rate swap agreement.

The Company utilizes the interest rate swap agreement to essentially convert a portion of its variable-rate debt to a fixed rate (cash flow hedge). For derivatives designated as hedging exposure to variable cash flows of a forecasted transaction (cash flow hedge), the effective portion of the derivative’s gain or loss is initially reported as a component of other comprehensive income and subsequently reclassified into earnings when the forecasted transaction affects earnings or when the hedge is terminated. The ineffective portion of the gain or loss is reported in earnings immediately. For derivatives that are not designated as hedging instruments, changes in the fair value of the derivatives are recognized in earnings immediately. In applying hedge accounting for derivatives, the Company establishes a method for assessing the effectiveness of the hedging derivative and a measurement approach for determining any ineffective aspect of the hedge upon the inception of the hedge.

Cash Flow Hedge of Interest Rate Risk

During the first quarter 2012, the Company entered into a forward starting interest rate swap agreement with a notional amount of $50.0 million to protect against variability in the expected future cash flows attributed to changes in the benchmark interest rate Libor beginning February 1, 2016 and ending February 1, 2024 on the designated notional amount of the variable rate bank debt.

The Company recognized an after-tax unrealized loss on its cash flow hedge in other comprehensive income of $1.5 million for the six months ended June 30, 2012 compared to an after-tax unrealized gain of $301,000 for the three months ended March 31, 2012.

The Company recognized a $2.5 million cash flow hedge liability in other liabilities on the balance sheet at June 30, 2012 compared to a cash flow hedge asset of $502,000 in other assets on the balance sheet at March 31, 2012. There was no ineffectiveness in the cash flow hedge during the six months ended June 30, 2012.

Credit risk related to the derivative arises when amounts receivable from the counterparty (derivative dealer) exceed those payable. The Company controls the risk of loss by only transacting with derivative dealers that are national market makers whose credit ratings are strong. Each party to the interest rate swap is required to provide collateral in the form of cash or securities to the counterparty when the counterparty’s exposure to a mark-to-market replacement value exceeds certain negotiated limits. These limits are typically based on current credit ratings and vary with ratings changes.  As of June 30, 2012, the Company was required to provide collateral of $2.5 million for the derivative.  Also, the Company has a netting agreement with the counterparty.

42

HERITAGE FINANCIAL GROUP, INC. AND SUBSIDIARY

CONDENSED NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

NOTE 10. ACQUISITION ACTIVITY

Single Branch of AB&T National Bank

On June 30, 2012, the Company completed an acquisition of a single branch of AB&T National Bank located in Auburn, Alabama.  The following table summarizes the estimated fair value of the assets acquired and liabilities assumed at the date of acquisition:

	Acquired		Fair Value and Other Adjustments				As Recorded by Heritage Financial Group
Assets	(dollars in thousands)
Cash and cash equivalents	$	146	$	5,685		(a)	$	5,831
Premises and equipment		1,741		-				1,741
Loans		10,890		(117	)	(b)		10,773
Core deposit intangibles		-		168		(c)		168
Other assets		43		-				43
Total Assets	$	12,820	$	5,736		(e)	$	18,556
Liabilities
Noninterest-bearing deposits	$	1,636					$	1,636
Interest-bearing deposits		16,810		50		(d)		16,860
Other liabilities		26						26
Total Liabilities	$	18,472	$	50		(e)	$	18,521

Explanations

(a) The adjustment represents the cash received from AB&T to reflect the acquisition of excess liabilities assumed over assets purchased.

(b) The adjustment represents the adjustment to fair market value of the loans assumed in the transaction.

(c) The adjustment represents the consideration paid for the value of the core deposit base assumed in the acquisition.  The core deposit asset was recorded as an identifiable intangible asset and will be amortized on an accelerated basis over the average life of the deposit base, estimated to be ten years.

(d) The adjustment is necessary because the weighted average interest rate of the CD's acquired exceeded the cost of similar funding at the time of acquisition.  The fair value adjustment will be amortized to reduce interest expense on a declining basis over the average life of the portfolio.

(e) The difference in total assumed assets and liabilities represents the $34,000 bargain purchase gain recognized in the second quarter 2012.

The Company did not acquire any loans with deteriorated credit quality as of the acquisition date this transaction.  Accordingly, the Company accounts for the loans acquired in this transaction under FASB ASC 805, Business Combinations.

NOTE 11.  SUBSEQUENT EVENTS

Subsequent events and transactions that occurred after June 30, 2012 but prior to August 9, 2012, the date these financial statements were available to be issued, have been evaluated for potential recognition or disclosure in these financial statements.

43

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; (xii) costs and effects of litigation, including settlements and judgments; (xiii) compliance risk with the FDIC loss-share agreements; (xiv) competition; and (xv) performance risk of mortgage loans sold on the secondary market.  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 $1.1 billion bank holding company headquartered in Albany, Georgia.  The principal business of Heritage is operating its wholly owned subsidiary, HeritageBank of the South (“HeritageBank” or the “Bank”).  Heritage primarily conducts commercial banking, retail banking and wealth management activities through its bank subsidiary.  As of June 30, 2012, HeritageBank operated in south Georgia, north central Florida and eastern Alabama through 22 full-service branch locations, 11 mortgage offices and 3 investment offices.HeritageBank provides credit based products, deposit accounts, corporate cash management, investment support and other services to commercial and retail clients.

Evolution of Business Strategy.  Our current business strategy is to operate a well-capitalized and profitable 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.

44

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

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, eastern Alabama 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.  Many troubled financial institutions throughout our market footprint have closed or curtailed their lending activities, decreased their assets or sold branches to improve their capital which has given us the opportunity to expand through organic loan demand and attractive branch acquisitions.  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.

2011 marked a milestone in our expansion activity with the purchase and assumption of two FDIC-assisted acquisitions near Savannah, Georgia and in Statesboro, Georgia.   In April 2012, we opened a commercial banking office in Macon, Georgia, and in June 2012, we completed the purchase of a single branch in Auburn, Alabama.  The Auburn, Alabama branch purchase resulted in the transfer of $12 million in loans and $19 million in deposits.

Critical Accounting Policies

We have established various accounting policies that govern the application of accounting principles generally accepted in the United States in the preparation of our financial statements.  Significant accounting policies are described in the audited consolidated financial statements in our Annual Report on Form 10-K for the year ended December 31, 2011.  These policies may involve significant judgments and estimates that have a material impact on the carrying value of certain assets and liabilities.  Different assumptions made in the application of these policies could result in material changes in our financial position and results of operations.

The following is a summary of the more judgmental estimates and complex accounting principles, which represent our critical accounting policies.

Acquisition Accounting.Generally accepted accounting principles require the use of fair value accounting in determining the carrying values of certain assets and liabilities acquired in business combinations and accordingly we recorded assets purchased and liabilities assumed in our FDIC-assisted acquisitions at their fair values. The fair value of the loan portfolios acquired in these transactions was recorded and is being accounted for under the principles prescribed by ASC Topic 310.

On the date of acquisition all loans acquired are either assigned to a pool or individually assessed and assigned a fair value based on the present value of projected future cash flows. An accretable discount is determined based on the timing of the projected cash flows and is taken into income over the projected life of the loans. Such accretion is included in interest income. Expected cash flows are re-estimated at each reporting date. Subsequent decreases to the expected cash flows will generally result in a provision for loan losses and individually assessed loans are more likely to need provision expense as compared to pooled loans.

Subsequent increases in cash flows result in a reversal of the provision for loan losses to the extent of prior charges and adjusted the accretable discount, which will have a positive effect on interest income.

45

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

Because we record loans acquired in connection with FDIC-assisted acquisitions at fair value, we record no allowance for loan losses related to the acquired covered loans on the acquisition date, given that the fair value of the loans acquired incorporates assumptions regarding credit risk.

FDIC Receivable for Loss-Share Agreements.  A significant portion of our loan and other real estate assets are covered under loss share agreements with the FDIC in which the FDIC has agreed to reimburse us 80% of all covered losses as well as certain expenses incurred in connection with those assets. We estimated the amount that we will receive from the FDIC under the loss share agreements that will result from losses incurred as we dispose of covered assets, and we recorded the estimate as a receivable from the FDIC. We discounted the receivable for the expected timing and receipt of those cash flows using a risk free rate plus a premium for risk. The accretion of the FDIC receivable discount is recorded into noninterest income using the level yield method over the estimated life of the receivable.

The FDIC receivable for loss share agreements is measured separately from the related covered assets because it is not contractually embedded in the assets and is not transferable if we sell the assets. We will review and update the fair value of the FDIC receivable at each reporting date in conjunction with the re-estimation of cash flows. The FDIC receivable will fluctuate as loss estimates and expected cash flows related to covered loans and other real estate owned change.

Allowance for Loan and Lease Losses (ALLL).The Company establishes 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.

We analyze the non-FDIC acquired loan portfolios through the use of pools of homogenous loan types and through a specific quarterly review of larger problem loans. It is expected that a certain percentage of loans will move through the asset quality grades from pass, to classified and ultimately loss.  Asset quality grades are described in detail in Footnote 5- Loans and Allowance for loan losses.   We evaluate our non-FDIC loan portfolio through review of four loan pool categories.

1. Pass credits with risk ratings 1-4

2. Other assets especially mentioned with risk rating 5

3. Substandard with risk rating 6 and still accruing

4. Impaired Loans – Nonaccrual and troubled debt restructurings

The allowance consists of two components:

1. A general amount – We analyze the historical migration of loans through each risk rating category and analyze the history of losses as it relates to the various loan types and collateral types in order to evaluate and estimate the volume, magnitude and direction these events. These risk factors and other factors are applied to our review of the loan Pass credits with risk ratings 1-4 pool and other assets especially mentioned with risk rating 5 pool. These factors are applied to the substandard pool; however, in addition to reviewing the pool, a select group of individual loans are reviewed.  The results of the individual review are factored in with the historical loss analysis and applied to the pool.

2. A specific amount – Impaired loans, in addition to the general amount and review described above, are reviewed individually for specific amounts that are representative of identified credit exposures that are readily predictable by the current performance of the borrower and underlying collateral;

46

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

Even though the ALLL is composed of two components, the entire ALLL is available to absorb any credit losses.

The Company assesses the allowance for loan losses on a quarterly basis and makes 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.

Income Taxes.  The calculation of our income tax expense requires significant judgment and the use of estimates. We periodically assess tax positions based on current tax developments, including enacted statutory, judicial and regulatory guidance. In analyzing our overall tax position, we consider the amount and timing of recognizing income tax liabilities and benefits. In applying the tax and accounting guidance to the facts and circumstances, we adjust income tax balances appropriately through the income tax provision. We maintain reserves for income tax uncertainties at levels we believe are adequate to absorb probable payments and actual amounts paid, if any, could differ significantly from income tax estimates.

Deferred Income Taxes. We use the asset and liability method of accounting for income taxes. Under this method, we recognize deferred tax assets and liabilities for the future tax consequences attributable to differences between the financial statement carrying amounts of existing assets and liabilities and their respective tax bases. We measure deferred tax assets and liabilities using enacted tax rates expected to apply to taxable income in the years in which those temporary differences are expected to be recovered or settled. We assess deferred tax assets based on expected realizations, and we establish a valuation allowance for any amounts we do not expect to realize. No valuation allowance is currently recorded.

47

Off-Balance Sheet Arrangements, Contractual Obligations and Commitments.  The following table presents our longer term, non-deposit related, contractual obligations and commitments to extend credit to our borrowers, in aggregate and by payment due dates.  In addition to the commitments below, we had overdraft protection available in the amounts of $11.8 million at June 30, 2012.

	June 30,2012
	Less than One Year		One through Three Years		Four through Five Years		After Five Years		Total
	(In thousands)
Contractual obligations:
Federal Home Loan Bank advances		-		5,000		20,000		10,000		35,000
Repurchase agreement		-		-		15,000		15,000		30,000
Other borrowings		1,746		-		-		-		1,746
Operating leases (premises)		341		294		34		721		1,390
Total advances and operating leases		2,087		5,294		35,034		25,721		68,136
Off-balance sheet loan commitments:
Undisbursed portions of loans closed		-		-		-		-		-
Commitments to originate loans		-		-		-		-		-
Unused lines of credit		58,735		6,303		3,132		17,515		85,685
Total loan commitments		58,735		6,303		3,132		17,515		85,685
Total contractual obligations and loan commitments		60,822		11,597		38,166		43,236		153,821

48

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

Comparison of Financial Condition at June 30, 2012 and December 31, 2011

General.  Total assets decreased by $26.4 million or -2.4% to $1.063 billion at June 30, 2012, from $1.090 billion at December 31, 2011.  Cash and due from banks, interest-bearing deposits and federal funds sold decreased $12.0 million, $10.9 million and $11.2 million, respectively from December 31, 2011 to June 30, 2012.  Securities available for sale declined $31.0 million or -12.0% from December 31, 2011 to June 30, 2012. Total loans, including loans held for sale increased by $42.9 million from December 31, 2011 to June 30, 2012, which included organic loan growth of $52.3 million and acquired loans of $12.2 million from the Auburn branch acquisition in part offset by a decrease in covered loans of $20.1 million and a decline in loans held for sale by $1.5 million.

Cash and Securities.The Company decreased the liquidity position, which includes bank deposits and federal funds sold, by $65.2 million or -18.2% to $293.2 million at June 30, 2012, from $358.4 million at December 31, 2011.

At June 30, 2012, our $228.0 million securities portfolio included $30.3 million in US government agency securities, $51.1 million in state and municipal securities, $2.0 million in corporate debt securities and $144.5 million in GSE residential mortgage-backed securities.  Although securities classified as available for sale may be sold from time to time to meet liquidity or other needs, it is not our normal practice to trade this segment of the investment securities portfolio. While management generally holds these assets on a long-term basis or until maturity, any short-term investments or securities available for sale could be converted at an earlier point, depending partly on changes in interestrates and alternative investment opportunities.  Based on our quarterly impairment analysis of these securities and their issues, we believe it is probable that we will be able to collect all amounts due under their contracts, net of previously recorded impairments.  The aggregate decrease in cash and due from banks, interest-bearing deposits and fed funds sold was primarily due to the use of excess liquidity to fund organic loans.

In 2012, we expect to maintain cash, funds due from banks, federal funds sold and securities at elevated levels for three purposes.  First, we believe it is prudent to maintain higher liquidity during uncertain economic times.  Second, we believe excess liquidity gives us additional flexibility in our expansion strategy.  Third, we believe 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 the net interest margin.  We continue to anticipate additional organic loan growth in 2012 and plan to fund the growth with investment balance runoff gradually reducing liquid assets and liquidity at the same time we increase loans.  Future investment runoff will likely occur as a result of pay-downs, maturities, or calls.

Loans.Our net loan portfolio increased $44.4 million, or 7.9%, to $605.0 million at June 30, 2012, from $560.6 million at December 31, 2011.  The increase was caused by $52.3 million of organic growth and acquired loans of $12.2 million from the Auburn branch acquisition, partially offset by a decrease in covered loans of $20.1 million.  We expect the loan portfolio to continue to grow as planned organic loan growth is expected to exceed pay downs in the portfolio.

49

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

Delinquencies and Non-performing Assets.As of June 30, 2012, loans past due for 30 to 89 days, excluding loans acquired in FDIC-assisted transactions, was $3.2 million or 0.64%, of non-FDIC acquired loans, compared to $371,000 or 0.09%, of non-FDIC acquired loans, at December 31, 2011.  The increase was primarily related to one $2.5 million commercial relationship that is in bankruptcy.  The loan is secured by real estate and equipment.  The Company is currently pursuing all available options for collection.

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, 2012		December 31, 2011		Amount Change			Percent Change
	(Dollars in thousands)
Non-accruing loans	$	9,965	$	7,043	$	2,922			41.5	%
Foreclosed assets		1,519		3,356		(1,837	)		-54.7	%
Total	$	11,484	$	10,399	$	1,085			10.4	%

At June 30, 2012, our largest non-performing loan was $2.1 million secured by various residential and commercial properties.  Our second largest non- performing loan was $1.9 million secured by various residential and commercial properties.  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 third largest non- performing loan was $1.3 million secured by various residential and commercial properties. Our fourth largest non- performing loan was $1.0 million secured by various residential properties.   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 to $1.5 million at June 30, 2012, from $3.4 million at December 31, 2011.  At June 30, 2012, our largest foreclosed asset was $1.1 million of undeveloped property.  The remainder of our foreclosed assets consists of various properties with no single property having a book value over $1.0 million.  All of these properties are being marketed actively for disposition.

Our internally criticized (watch list) and classified assets, excluding FDIC assisted transactions, decreased $2.0 million and totaled $31.2 million at June 30, 2012, compared to $33.2 million at December 31, 2011.  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, but do not include other real estate or 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.

Non-performing assets for the current quarter increased $1.1 million and totaled $11.5 million at June 30, 2012, compared to $10.4 million at December 31, 2011.  We remain cautiously optimistic this increase in nonperforming assets was driven by already identified and classified assets moving through the resolution process as we aggressively identify and resolve problem assets.  We have taken actions to prevent losses in our current portfolio by actively managing problem assets through a special assets committee.  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.

50

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

Allowance for Loan Losses.  The allowance for loan and lease losses, net of FDIC acquired loans, was $8.1 million as of June 30, 2012 compared to $7.5 million as of December 31, 2011.  As a percentage of period-end loans excluding FDIC acquired, the allowance for loan and lease losses was 1.61% as of June 30, 2012 compared to 1.72% as of December 31, 2011.  The FDIC acquired loans did not have an allowance for loan and lease losses as of June 30, 2012 or December 31, 2011.

Second quarter 2012 provision expense for loans and leases was $1.1 million as compared to $400,000 during the linked quarter and $700,000 during the comparable year-over-year quarter. Second quarter 2012 provision expense included $441,000 of expense for FDIC acquired loans with $338,000 related to the covered loans as compared to no provision expense for FDIC acquired loans for the linked quarter or the comparable year-over-year quarter.  The increase in provision expense for loans and leases, excluding FDIC acquired loans, relative to the linked quarter was driven primarily by organic loan growth during the quarter.  The increase in provision expense for FDIC acquired loans relative to the linked quarter was driven primarily by charge-offs in excess of loan discounts during the quarter.

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

	Loans by Type as of
	June 30, 2012		December 31, 2011		June 30, 2011
	(dollars in thousands)
Non-FDIC acquired loans:
Non Residential	$	177,307	$	138,970	$	131,027
Multifamily		19,639		15,797		12,755
Farmland		18,121		17,921		13,276
Construction and land		31,134		26,804		26,688
Mortgage loans, 1-4 families		148,162		129,745		131,596
Home equity		25,289		26,154		26,140
Consumer and other		24,172		23,872		23,592
Commercial and industrial		58,589		55,179		50,997
		502,413		434,442		416,071
Loans acquired through FDIC-assisted acquisitions:
Non covered loans		15,202		18,721		24,227
Covered loans		87,386		107,457		60,427
	$	605,001	$	560,620	$	500,725

51

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
	June 30, 2012			December 31, 2011			June 30, 2011
	(dollars in thousands)
Allowance for loan losses to total loans		1.61	%		1.72	%		1.58	%
Allowance for loan losses to average loans		1.70	%		1.32	%		1.48	%
Allowance for loan losses to non-performing loans		81.27	%		106.40	%		76.67	%
Accruing loans past due 30-89 days	$	3,215		$	371		$	727
Nonaccrual loans		9,965			7,043			8,589
Loans - 90 days past due & still accruing		-			-			-
Total non-performing loans		9,965			7,043			8,589
OREO and repossessed assets		1,519			3,356			2,725
Total non-performing assets		11,484			10,399			11,314
Non-performing loans to total loans		1.98	%		1.62	%		1.72	%
Non-performing assets to total assets		o			0.95	%		1.17	%
Net charge-offs QTD to average loans (annualized)		0.23	%		0.04	%		0.26	%
Net charge-offs QTD	$	279		$	37		$	253

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 Form 10-Q.

Premises and Equipment.  Premises and equipment increased approximately $2.8 million or 9.5% at June 30, 2012 to $32.3 million.  A large part of the increase was related to the Auburn, Alabama branch purchase of $1.7 million.  In addition, we have branches under construction in Valdosta, Georgia and Macon, Georgia which accounted for $1.2 million of the increase.

Intangible, Goodwill and Other Assets.   Intangible assets and goodwill decreased $227,000 or -4.7% to $4.6 million resulting from the amortization of the intangible assets in part offset by the addition of a deposit intangible of $168,000 related to the Auburn branch acquisition..

Deposits.  Total deposits decreased $23.9 million or -2.7% to $860.3 million at June 30, 2012 compared with $884.2 million at December 31, 2011.  The decrease was primarily driven by planned time deposit runoff of $30.8 million in part offset by acquired deposits of $18.7 million related to the Auburn branch acquisition.

Federal Home Loan Bank Advances, Other Borrowings and Other Liabilities.  The total amount of Federal Home Loan Bank advances remained the same at $35.0 million at June 30, 2012 and December 31, 2011.  Federal funds purchased and securities sold under agreements to repurchase decreased to $31.7 million at June 30, 2012 compared with $35.0 million at December 31, 2011.

Equity.  Total equity decreased $845,000 or -0.7 % to $123.3 million at June 30, 2012, compared with $124.1 million at December 31, 2011, primarily the result of net income of $2.3 million for the six months ended June 30, 2012, stock-based compensation of $415,000, and the allocation of $360,000 in ESOP shares which increased equity, partially offset by the repurchase of stock of $2.7 million, the payment of dividends of $689,000 and other comprehensive loss of $547,000.

52

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 and interest income 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,
	2012								2011
	(Dollars in Thousands)
	Average Outstanding Balance			Interest Earned/ Paid		Yield/ Rate			Average Outstanding Balance			Interest Earned/ Paid		Yield/ Rate
Interest-Earning Assets:
Loans	$	588,564		$	10,738		7.34	%	$	505,807		$	7,610		6.03	%
Investment Securities		252,894			1,411		2.24			210,261			1,432		2.73
Other short-term investments		27,935			30		0.43			64,972			67		0.41
Total interest-earning assets		869,393			12,179		5.63			781,040			9,109		4.73
Non-interest earning assets		183,747								186,819
Total assets		1,053,140								966,859
Interest-Bearing Liabilities:
Interest checking, money market, savings		470,902			345		0.29	%		403,230			861		0.86	%
Time deposits		289,507			901		1.25			277,194			1,122		1.62
Total interest-bearing deposits		760,409			1,246		0.66			680,424			1,983		1.17
Securities sold under repurchase agreements and short-term borrowings		67,043			672		4.03			85,807			684		4.06
Total interest bearing liabilities		827,452			1,918		0.93			766,231			2,667		1.40
Non-interest bearing liabilities:
Demand deposits		89,763								70,333
Other liabilities		10,842								7,764
Total non-interest bearing liabilities		100,605								78,097
Total liabilities		928,057								844,328
Shareholder’s equity		125,083								122,531
Total liabilities and shareholder’s equity		1,053,140								966,859
Net interest income				$	10,261							$	6,442
Net interest rate spread							4.70	%							3.33	%
Net earning assets	$	41,941							$	14,809
Net interest margin							4.75	%							3.36	%
Average interest-earning assets to average interest-bearing Liabilities		1.05	x							1.02	x

53

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

	Six Months Ended June 30,
	2012								2011
	(Dollars in Thousands)
	Average Outstanding Balance			Interest Earned/ Paid		Yield/ Rate			Average Outstanding Balance			Interest Earned/ Paid		Yield/ Rate
Interest-Earning Assets:
Loans	$	576,602		$	21,071		7.35	%	$	481,697		$	14,763		6.18	%
Investment Securities		256,884			2,791		2.18			219,396			2,850		2.62
Other short-term investments		44,083			81		0.37			52,617			120		0.46
Total interest-earning assets		877,569			23,943		5.49			753,710			17,733		4.80
Non-interest earning assets		185,897								158,800
Total assets		1,063,466								912,510
Interest-Bearing Liabilities:
Interest checking, money market, savings		467,821			756		0.33	%		379,443			1,674		0.89	%
Time deposits		304,897			1,753		1.16			253,834			2,157		1.71
Total interest-bearing deposits		772,718			2,509		0.65			633,277			3,831		1.22
Securities sold under repurchase agreements and short-term borrowings		67,926			1,344		3.98			89,562			1,427		3.09
Total interest bearing liabilities		840,644			3,853		0.92			722,839			5,258		1.47
Non-interest bearing liabilities:
Demand deposits		87,325								61,483
Other liabilities		10,209								6,804
Total non-interest bearing liabilities		97,534								62,287
Total liabilities		938,178								791,126
Shareholder’s equity		125,288								121,384
Total liabilities and shareholder’s equity		1,063,466								912,510
Net interest income				$	20,090							$	12,475
Net interest rate spread							4.56	%							3.33	%
Net earning assets	$	36,925							$	30,871
Net interest margin							4.60	%							3.39	%
Average interest-earning assets to average interest-bearing Liabilities		1.04	x							1.04	x

54

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,
	2012 vs. 2011
	Increase (Decrease) Due to						Total Increase
	Volume			Rate			(Decrease)
	(Dollars in Thousands)
Interest-earning assets:
Loans	$	4,994		$	(1,866	)	$	3,128
Investment Securities		1,165			(1,186	)		(21	)
Other short-term investments		(153	)		116			(37	)
Total interest-earning assets	$	6,006		$	2,936		$	3,070
Interest-bearing liabilities:
Interest checking, money market, savings		580			(1,096	)		(516	)
Time deposits		200			(421	)		(221	)
Securities sold under repurchase agreements and short-term borrowings		(762	)		750			(12	)
Total interest bearing liabilities	$	18		$	(767	)		(749	)
Net interest income							$	3,819

55

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

	Six Months Ended June 30,
	2012 vs. 2011
	Increase (Decrease) Due to						Total Increase
	Volume			Rate			(Decrease)
Interest-earning assets:
Loans	$	5,865		$	443		$	6,308
Investment Securities		982			(1,041	)		(59	)
Other short-term investments		(39	)		-			(39	)
Total interest-earning assets	$	6,808		$	598		$	6,210
Interest-bearing liabilities:
Interest checking, money market, savings		786			(1,703	)		(917	)
Time deposits		875			(1,279	)		(404	)
Securities sold under repurchase agreements and short-term borrowings		(669	)		587			(82	)
Total interest-bearing liabilities	$	992		$	(2,395	)		(1,403	)
Net interest income							$	7,613

56

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

Comparison of Operating Results for the Three and Six Month Periods Ended June 30, 2012 and 2011

General.  During the three and six months ended June 30, 2012, we recorded net income of $1.4 million and $2.3 million, respectively, compared to a net loss of $481,000 and net income of $734,000, respectively, for the same periods in 2011.  Basic and diluted earnings per share for the three and six months ended June 30, 2012 were $0.17 and $0.29, respectively, compared to a loss per share of $0.06 and earnings per share of $0.09, respectively, for the same periods in 2011.The improvement in operating results for the three and six months ended June 30, 2012 was primarily driven by growth in net interest income partially offset by increased noninterest expense.

Interest Income.  Total interest income for the three and six months ended June 30, 2012, increased $3.0 million and $6.0 million, respectively, or 33.0% and 33.9%, respectively, compared to the same periods in 2011.  The increase was due to growth in average interest-earning assets for the three and six months ended June 30, 2012 of $88.4 million and $123.9 million, respectively, or 11.3% and 16.4%, respectively, compared to the same periods in 2011.  These increases in the average balance of earning assets for the three and six months ended June 30, 2012 were coupled with an increase of 90 basis points and 69 basis points, respectively, in the yield on average-earning assets to 5.63% and 5.49%, respectively, as compared to 4.73% and 4.80%, respectively, for the same periods in 2011.

The increase in average interest-earning assets was due primarily to organic and FDIC-assisted loan growth as compared to the prior year.  Our overall yield on average interest-earning assets increased in 2012 primarily driven by the increase in loans acquired in FDIC-assisted acquisitions compared to the prior year which carry a higher interest rate as compared to traditional loans.

Interest income on loans, including loans held for sale, for the three and six months ended June 30, 2012 was $10.7 million and $21.1 million, respectively, compared to $7.6 million and $14.8 million, respectively, for the same periods in 2011.  The increase in interest income on loans was primarily the result of the loans acquired in our FDIC-assisted transactions and our expansion into the Valdosta, Statesboro and Macon markets, which was reflected in the increase of average loans for the three and six months ended June 30, 2012 of $82.8 million and $94.9 million, respectively.  Also, positively impacting the increase in interest income on loans was a solid increase in the weighted average yield on loans for the three and six months ended June 30, 2012 of 130 basis points and 117 basis points, respectively, to 7.34% and 7.35%, respectively.

Interest income on investment securities for the three and six months ended June 30, 2012 was $1.4 million and $2.8 million, respectively, compared to $1.5 million and $3.0 million, respectively, for the same periods in 2011.  The decrease in interest income on investments was primarily the result of a decline in the weighted average yield on investments for the three and six months ended June 30, 2012 of 49 basis points and 43 basis points, respectively, to 2.24% and 2.18%, respectively.  However, growth in the average balance of investment securities for the three and six months ended June 30, 2012 of $42.6 million and $37.5 million, respectively, to $252.9 million and $256.9 million, respectively, positively impacted the interest income on investment securities as we invest excess liquidity.  We continue to anticipate the yield on our investment portfolio to decline during this low interest rate environment as maturing investments are replaced with lower yielding investments.

57

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

Interest Expense.  Total interest expense for the three and six months ended June 30, 2012 decreased $750,000 and $1.4 million, respectively, or 28.1% and 26.7%, respectively, compared to the same periods in 2011.  The decrease in interest expense was primarily the result of a decline in the weighted average cost of interest-bearing liabilities for the three and six months ended June 30, 2012 of 46 basis points and 54 basis points, respectively, to 0.93% and 0.92%, respectively.  The decrease in interest expense was in part offset by growth in the average balance of interest-bearing liabilities for the three and six months ended June 30, 2012 of $61.2 million and $117.8 million, respectively, or 8.0% and 16.3%, respectively, compared to the same periods in 2011.  We expect the decline in the cost of interest-bearing liabilities to continue but at a slower pace since the rates cannot go below zero.

Interest expense on deposits for the three and six months ended June 30, 2012 was $1.2 million and $2.5 million, respectively, compared to $2.0 million and $3.8 million, respectively, compared to the same periods in 2011.  The decrease in interest expense on deposits for the three and six months ended June 30, 2012 was driven by a decline in the weighted average cost on deposits of 51 basis points and 57 basis points, respectively, compared to the same periods in 2011, due to a decrease in market rates of interest.  The decrease in interest expense was in part offset by growth in interest-bearing deposits primarily the result of the deposits acquired in our FDIC-assisted transactions and our expansion into the Valdosta, Statesboro and Macon markets, which was reflected in the increase in the average balance of the interest-bearing deposits portfolio for the three and six months ended June 30, 2012 of $80.0 million and $139.4 million, respectively.

Interest expense on other borrowings, consisting of Federal Home Loan Bank advances, federal funds purchased and securities sold under agreement to repurchase, for the three and six months ended June 30, 2012 decreased $11,000 and $81,000, respectively, compared to the same periods in 2011.  The decrease in the interest expense on other borrowings was primarily driven by a decline in the average other borrowings for the three and six months ended June 30, 2012 of $18.8 million and $21.6 million, respectively, compared to the same periods in 2011.  The decrease in interest expense was offset in part by an increase in the weighted average rate paid on these borrowings for the three and six months ended June 30, 2012 of 3 basis points and 89 basis points, respectively, to 4.03% and 3.98%, respectively, compared to the same periods in 2011.

Net Interest Income.  Net interest income for the three and six months ended June 30, 2012 increased $3.7 million and $7.5 million, respectively, or 57.5% and 59.2%, respectively, compared to the same periods in 2011.  The overall increase was primarily driven by an increase in the yield and balance of interest-earning assets on top of a decline in the cost of interest-bearing liabilities partially offset by balance growth in interest-bearing liabilities.  The net interest spread for the three and six months ended June 30, 2012 increased 137 basis points and 123 basis points, respectively, to 4.70% and 4.56%, respectively, as compared to the same periods in 2011.  The net interest margin for the three and six months ended June 30, 2012 improved 139 basis points and 121 basis points, respectively, to 4.75% and 4.60%, respectively, for the same periods in 2011.  The primary reason the net interest margin for the three and six months ended June 30, 2012 increased significantly was the result of increased loan accretion for FDIC acquired loans increasing the weighted average yield on loans 130 basis points and 117 basis points, respectively, as compared to the same periods in 2011.  We also expect loan accretion for FDIC acquired loans to continue to positively impact the net interest margin for the remainder of 2012.

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.

58

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

Provision for Loan Losses.  During the three and six months ended June 30, 2012, we recorded provision for loan losses expense of $1.1 million and $1.5 million, respectively, which was an increase compared to $700,000 and $1.3 million, respectively, for the same periods in 2011.  The increase in provision expense was primarily driven by organic loan growth as compared to the same periods in 2011. The following table presents the provision for loan expense in more detail for the periods indicated.

	For the Three Months Ended June 30,					For the Six Months Ended June 30,
	2012		2011			2012			2011
			(Dollars in thousands)
Provision for loan losses – noncovered(1)	$	750		$	700		$	1,150	$	1,300
Provision for loan losses – FDIC acquired noncovered		3			-			3		-
Provision for loan losses – noncovered		753			700			1,153		1,300
Provision for loan losses- FDIC acquired covered		338			-			338		-
Provision for loan losses	$	1,091		$	700		$	1,491	$	1,300

(1) The amounts exclude the impact of provision expense for noncovered FDIC acquired loans.

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

Noninterest Income.  Noninterest income increased $119,000, or 3.3%, to $3.7 million for the three months ended June 30, 2012 compared to $3.6 million for the same period in 2011. Noninterest income, excluding securities transactions, gain on acquisitions and accretion FDIC loss-share receivable, increased $532,000, or 16.5%, to $3.8 million for the three months ended June 30, 2012 compared to $3.2 million for the same period in 2011.

A summary of noninterest income, excluding the gain on securities, gain on acquisitions and accretion FDIC loss-share receivable, is as follows for the periods indicated:

	Three Months Ended June  30,
	2012			2011			$ Chg			% Chg
	(Dollars in thousands)
Service charges on deposit accounts	$	1,135		$	1,222		$	(87	)		-7.1	%
Bankcard services income		831			674			157			23.3
Other service charges, commissions and fees		73			69			4			5.8
Brokerage fees		462			406			56			13.8
Mortgage banking fees		938			624			314			50.3
Bank owned life insurance		211			149			62			41.6
Other		101			75			26			34.7
Total noninterest income	$	3,751		$	3,219		$	532			16.5	%
Noninterest income as a percentage of average assets (annualized)		1.42	%		1.33	%

The decrease in service charges on deposit accounts was primarily driven by a per account reduction in overdraft fees offset in part by an increase in customer accounts, as a result of our expanded branch network.

The bankcard services income was primarily driven by our increased customer base.

59

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

Mortgage banking fees increased due to the expansion of the mortgage division compared to the prior year.

Noninterest income decreased $1.9 million, or 23.1%, to $6.5 million for the six months ended June 30, 2012 compared to $8.4 million for the same period in 2011.  However, after excluding securities transactions, gain on acquisitions and accretion FDIC loss-share receivable from noninterest income, noninterest income increased $1.3 million, or 22.1%, to $7.0 million for the six months ended June 30, 2012 compared to $5.7 million for the same period in 2011.

A summary of noninterest income, excluding the gain on securities, gain on acquisitions and accretion FDIC loss-share receivable, is as follows for the periods indicated:

	Six  Months Ended June 30,
	2012			2011			$ Chg			% Chg
	(Dollars in thousands)
Service charges on deposit accounts	$	2,156		$	2,273		$	(117	)		-5.2	%
Bankcard services income		1,654			1,260			394			31.3
Other service charges, commissions and fees		158			144			14			9.7
Brokerage fees		908			760			148			19.5
Mortgage banking fees		1,627			892			735			82.4
Bank owned life insurance		351			294			57			19.4
Other		135			103			32			31.1
Total noninterest income	$	6,989		$	5,726		$	1,263			22.1	%
Noninterest income as a percentage of average assets (annualized)		1.31	%		1.25	%

The decrease in service charges on deposit accounts was primarily driven by a per account reduction in overdraft fees offset in part by an increase in customer accounts, as a result of our expanded branch network.

The bankcard services income was primarily driven by our increased customer base.

Mortgage banking fees increased due to the expansion of the mortgage division compared to the prior year.

Accretion for FDIC loss-share receivable for the three and six months ended June 30, 2012 turned negative $133,000 and $630,000, respectively, compared to $5,000 for both the three and six months ended for the same periods in 2011.  The accretion turned negative as a result of improvement in the expected cash flows of the loss-share performing portfolios in part offset by increased provision expense on covered loans.

60

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

Noninterest Expense.  Noninterest expense increased $634,000, or 6.3%, to $10.7 million for the three months ended June 30, 2012 compared to $10.0 million for the same period in 2011.

A summary of noninterest expense is as follows for the periods indicated:

		Three Months Ended  June 30,
		2012			2011			$ Chg		% Chg
		(Dollars in thousands)
Salaries and employee benefits	$	5,460		$	4,923		$	537		10.9	%
Equipment		707			428			279		65.2
Occupancy		688			536			152		28.4
Advertising and marketing		214			220			(6	)	-2.7
Legal and accounting		222			167			55		32.9
Consulting & other professional fees		118			198			(80	)	-40.4
Directors fees and retirement		126			161			(35	)	-21.7
Telecommunications		288			204			84		41.2
Supplies		145			145			-		-
Data processing fees		875			615			260		42.3
(Gain) Loss on sales and write-downs of other real estate owned		(141	)		535			(676	)	NM	(1)
Gain on sales and write-downs of FDIC acquired other real estate owned		(249	)		(45	)		(204	)	NM	(1)
Foreclosed asset expenses		218			245			(27	)	-11.0
Foreclosed FDIC acquired asset expenses		466			-			466		NM
FDIC insurance and other regulatory fees		265			354			(89	)	-25.1
Acquisition related expenses		69			474			(405	)	-85.4
Deposit intangible expenses		195			207			(12	)	-5.8
Other operating		1,008			673			335		49.8
Total noninterest expenses	$	10,674		$	10,040		$	634		6.3	%
Noninterest expenses as a percentage of average assets (annualized)		4.05	%		4.15	%

(1) NM – The percentage change is not considered meaningful.

The increase in salaries and employee benefits was primarily due the increase of 24 full-time equivalent employees (“FTE’s”), or 7.5%, from the prior year related to our acquisition activity.

The increase in equipment, occupancy, data processing, and other operating expenses is due to the expanded branch network.

The decrease in acquisition related expenses is result of elevated expenses experienced in the same period for 2011 related to the Citizens FDIC-assisted acquisition.

During 2011, we recorded losses on the sale of OREO compared to modest gains recorded in 2012.  For the OREO losses on FDIC acquired assets, we recorded gains in 2012 greater than the same period in 2011.

Foreclosed asset expense for FDIC acquired assets was up from the prior year related to the improved resolution process for these assets.

61

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

A summary of noninterest expense is as follows for the periods indicated:

		Six Months Ended  June 30,
		2012			2011			$ Chg		% Chg
		(Dollars in thousands)
Salaries and employee benefits	$	10,995		$	9,251		$	1,744		18.9	%
Equipment		1,374			779			595		76.4
Occupancy		1,344			981			363		37.0
Advertising and marketing		395			384			11		2.9
Legal and accounting		341			377			(36	)	-9.6
Consulting & other professional fees		237			377			(140	)	-37.1
Directors fees and retirement		290			388			(98	)	-25.3
Telecommunications		520			349			171		49.0
Supplies		299			240			59		24.6
Data processing fees		1,696			1,133			563		49.7
(Gain) Loss on sales and write-downs of other real estate owned		(148	)		937			(1,085	)	NM	(1)
Loss on sales and write-downs of FDIC acquired other real estate owned		(75	)		(45	)		(30	)	66.7
Foreclosed asset expenses		440			415			25		6.0
Foreclosed FDIC acquired asset expenses		628			-			628		NM	(1)
FDIC insurance and other regulatory fees		509			647			(138	)	-21.3
Acquisition related expenses		400			757			(357	)	-47.2
Deposit intangible expenses		396			302			94		31.1
Other operating		1,834			1,166			668		57.3
Total noninterest expenses	$	21,475		$	18,438		$	3,037		16.5	%
Noninterest expenses as a percentage of average assets (annualized)		4.04	%		4.04	%

(1) NM – The percentage change is not considered meaningful.

The increase in salaries and employee benefits was primarily due the increase of 37 full-time equivalent employees (“FTE’s”), or 13.0%, from the prior year related to our acquisition activity.

The increase in equipment, occupancy, data processing, and other operating expenses is due to the expanded branch network.

The decrease in acquisition related expenses is result of elevated expenses experienced in the same period for 2011 related to the Citizens FDIC-assisted acquisition.

During 2011, we recorded losses on the sale of OREO compared to modest gains recorded in 2012.

Foreclosed asset expense for FDIC acquired assets was up from the prior year related to the improved resolution process for these assets.

Income Tax Expense.  Income tax expense for the three and six months ended June 30, 2012 was $713,000 and $1.0 million, respectively, compared to a tax benefit of $481,000 and tax expense of $734,000, respectively, for the same periods in 2011.  Our effective tax rate for the three and six months ended June 30, 2012 was 34.4% and 31.0%, respectively, compared to 34.8% and 35.5%, respectively, for the same periods in 2011.

62

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

Liquidity and Capital Resources

We are required to have enough cash and investments that qualify as liquid assets in order to maintain sufficient liquidity to ensure a safe and sound operation.  Liquidity may increase or decrease depending upon the availability of funds and comparative yields on investments in relation to the return on loans.  Historically, we have maintained liquid assets above levels believed to be adequate to meet the requirements of normal operations, including potential deposit outflows.  Cash flow projections are regularly reviewed and updated to assure that adequate liquidity is maintained.

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.

Our liquidity, represented by cash and cash equivalents, is a product of our operating, investing and financing activities.  Liquidity management is both a daily and long-term function of business management.  Excess liquidity is generally invested in short-term investments, such as overnight deposits and federal funds.  On a longer term basis, we maintain a strategy of investing in various lending products and investment securities, including mortgage-backed securities.

If additional liquidity were needed, the Bank would turn to short-term borrowings as an alternative immediate funding source and would consider other appropriate actions such as promotions to increase core deposits or the sale of a portion of our unpledged investment portfolio.  In addition, we could draw on additional alternative immediate funding sources from lines of credit extended to us from our correspondent banks and/or the FHLB.  At June 30, 2012, the Bank had total federal funds credit lines with seven correspondent banks of $72.0 million, with no outstanding advances.  The Bank also maintains a credit facility with the FHLB of $111.0 million with total outstanding advances of $35.0 million at June 30, 2012.

At June 30, 2012, total deposits decreased $8.5 million, or 1.0%, to $860.3 million for the second quarter of 2012 compared to $868.8 million for the linked quarter primarily driven by planned runoff of time deposit customers.  However, total deposits increased $96.6 million, or 12.6%, from $763.7 million for the same period in 2011 primarily driven by FDIC acquired deposits.  Federal funds purchased and securities sold under agreements to repurchase decreased $5.5 million, or 14.8%, to $31.7 million for the second quarter of 2012 as compared to $37.2 million for the linked quarter and decreased $300,000 from $32.0 million for the same period in 2011.  Also, FHLB advances were unchanged at $35 million for the second quarter of 2012 compared to the linked quarter and the same period in 2011.

The liquidity and capital resources of the Company are monitored continuously by the Company’s Board-authorized Risk Management Committee with day to day responsibility delegated to the Asset/ Liability Management Committee (“ALCO”) 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, 2012, 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.

The consolidated statement of cash flows for the six months ended June 30, 2012 and 2011, detail cash flows from operating, investing and financing activities.  For the six months ended June 30, 2012, net cash used for financing activities was $49.1 million offset in part by net cash provided from operating and investing activities of $17.0 million and $20.1 million, respectively, resulting in a net decrease in cash of $12.0 million as compared to the same period in 2011.

63

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

Regulatory Capital Ratios for the Company and HeritageBank of the South at June 30, 2012

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, 2012, with regulatory capital requirements.  These calculations are based on total risk weighted assets of $616.9 million consolidated and $596.0 million for the Bank as of June 30, 2012, and average total assets of $1.1 billion consolidated and $1.1 billion for the Bank for the three months ended June 30, 2012.  These consolidated capital ratios are based on the capital requirements for bank holding companies issued by the Board of Governors of the Federal Reserve System.  The Georgia Department of Banking and Finance, by policy, requires the Bank to maintain 4% of Tier 1 capital to average total assets of the Federal Reserve Requirements included in the table.

	Actual					For Capital Adequacy Purposes					Minimum Required to Be Well Capitalized Under Prompt Corrective Action Provisions
	Amount		Ratio			Amount		Ratio			Amount		Ratio
Total Capital to Risk Weighted Assets
Consolidated	$	125,470		20.3	%	$	49,352		8.0	%		N/A
HeritageBank of the South		104,492		17.5	%		47,680		8.0	%	$	59,600		10.0	%
Tier I Capital to Risk Weighted Assets
Consolidated		117,999		19.1	%		24,676		4.0	%		N/A
HeritageBank of the South		97,020		16.3	%		23,840		4.0	%		35,760		6.0	%
Tier I Capital to Average Total Assets
Consolidated		117,999		11.2	%		42,126		4.0	%		N/A
HeritageBank of the South		97,020		9.3	%		41,698		4.0	%		52,122		5.0	%

64

ITEM 3.  QUANTITATIVE 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 ALCO, which is composed of senior management members.  The ALCO 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 ALCO meets monthly 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;

· Continuing the origination of consumer loans.

65

ITEM 3.  QUANTITATIVE 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, 2012, a drop in interest rates would increase our net interest income, also known as being “liability sensitive”, and an increase in rates would also increase our net interest income, also known as being “asset sensitive”.  The modest asset sensitivity position was in part driven by our decision to start booking loans without interest rate floors.  Booking loans without floors lowers the interest that we otherwise would collect with floors; however, due to the absence of floors, these loans will reprice when rates rise.  We feel the level of interest rate risk is at an acceptable level, and is within our internal policy limits.

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

66

ITEM 3.  QUANTITATIVE 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, 2012, 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, 2012
	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	$	42,724		$	-		$	-		$	-		$	42,724
Investment securities		34,588			81,836			80,538			31,022			227,984
Loans held for sale		6,017			-			-			-			6,017
Loans including covered		49,243			123,820			312,390			119,548			605,001
		132,572			205,656			392,928			150,570			881,726
Interest-bearing liabilities:
Interest-bearing demand deposits		(162,360	)		-			-			-			(162,360	)
Savings and money market		(332,087	)		-			-			-			(332,087	)
Time deposits		(45,787	)		(137,760	)		(94,459	)		-			(278,006	)
Federal funds purchased and securities sold under repurchase agreements		(31,746	)		-			-			-			(31,746	)
Federal Home Loan Bank advances		-			-			(25,000	)		(10,000	)		(35,000	)
		(571,980	)		(137,760	)		(119,459	)		(10,000	)		(839,199	)
Interest rate sensitivity gap	$	(439,408	)	$	67,896		$	273,469		$	140,570		$	42,527
Cumulative interest rate sensitivity gap	$	(439,408	)	$	(371,512	)	$	(98,043	)	$	42,527
Interest rate sensitivity gap ratio		0.23			1.49			3.29			15.06
Cumulative interest rate sensitivity gap ratio		0.23			0.48			0.88			1.05

67

ITEM 3.  QUANTITATIVE 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 100 basis points are relevant.  In addition, due to the historically low interest rate environment, there is concern that we may see a dramatic increase in interest rates at some point.  To address this concern, we increased our upward interest rate shocks to include a shock of 400 basis points.

Market Rate Change	Effect on Net Interest Income
+400	2.1%
+300	0.4%
+200	-0.6%
+100	2.6%
-100	3.4%

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, 2012, 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 40-day period preceding the filing date of this quarterly report.  Our Chief Executive Officer and Chief Financial Officer concluded that, as of June 30, 2012, 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.

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, 2012, that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.

68

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, 2011.

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

There were no unregistered sales of equity securities during the quarter ended June 30, 2012.

On July 25, 2011, the Company announced that in connection with the 2011 Equity Incentive 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.  As of June 30, 2012, the Company had purchased all 163,852 shares at a weighted average price of $11.43 per share under the plan for a total of $1.9 million.

In December 2011, the Company’s Board of Directors authorized another stock repurchase program.  The program authorizes the Company to repurchase up to 435,000 shares.  As of June 30, 2012, the Company had purchased 174,874 shares at a weighted average price of $12.30 per share under the plan for a total of $2.2 million.  The program will expire in December 2012 unless completed sooner or otherwise extended.

The repurchases may be made from time to time in open-market or negotiated transactions as deemed appropriate by the Company and will depend on market conditions.

	Total Number of Shares Purchased		Average Price Paid Per Share	Number of Shares Purchased as Part of Publicly Announced Plans or Programs	Maximum Number of Shares that may yet be Purchased Under the Plans or Programs
April	-	$	-	-	438,631
May	70,000	$	12.20	70,000	368,631
June	108,505	$	12.35	108,505	260,126
Total	178,505	$	12.29	178,505	260,126

ITEM 3. DEFAULTS UPON SENIOR SECURITIES

None.

ITEM 5. OTHER INFORMATION

None.

69

ITEM 6. EXHIBITS

Exhibit Number		Document	Reference to Prior Filing or Exhibit Number Attached Hereto
	2.7	Purchase and Assumption Agreement dated April 6, 2012, between HeritageBank of the South and AB&T National Bank	a
	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.INS	XBRL Instance Document
	101.SCH	XBRL Taxonomy Extension Schema Document
	101.CAL	XBRL Taxonomy Extension Calculation Linkbase Document
	101.DEF	XBRL Taxonomy Extension Definition Linkbase Document
	101.LAB	XBRL Taxonomy Extension Labels Linkbase Document
	101.PRE	XBRL Taxonomy Extension Presentation Linkbase Document

_______________________

a Included as an exhibit to the Form 8-K filed by Heritage Financial Group, Inc.  with the SEC on April 11, 2012.

70

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 9, 2012	By:	/s/ O. Leonard Dorminey
			O. Leonard Dorminey
			President and Chief Executive Officer
Date:	August 9, 2012	By:	/s/ T. Heath Fountain
			T. Heath Fountain
			Executive Vice President,
			Chief Administrative Officer and
			Chief Financial Officer
			(Principal Financial and Accounting Officer)

71