10-Q

UNITED STATES
SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-Q

QUARTERLY REPORT UNDER SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended September 30, 2008 — Commission File Number 000-51305

HERITAGE FINANCIAL GROUP

(A United States Corporation)

IRS Employer Identification Number 45-0479535

721 N. Westover Blvd., Albany, GA 31707
229-420-0000

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

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

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

APPLICABLE ONLY TO CORPORATE ISSUERS

State the number of shares outstanding of each issuer’s classes of common equity, as of the latest practicable date:

At November 1, 2008 there were 10,606,882 shares of issuer’s common stock outstanding.

HERITAGE FINANCIAL GROUP

INDEX

	Page
	Number
PART I — FINANCIAL INFORMATION
ITEM 1. UNAUDITED FINANCIAL STATEMENTS
CONSOLIDATED BALANCE SHEETS AS OF SEPTEMBER 30, 2008 AND DECEMBER 31, 2007		3
CONSOLIDATED STATEMENTS OF OPERATIONS FOR THE THREE AND NINE MONTHS ENDED SEPTEMBER 30, 2008 AND 2007		4
CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME FOR THE THREE AND NINE MONTHS ENDED SEPTEMBER 30, 2008 AND 2007		5
CONSOLIDATED STATEMENTS OF STOCKHOLDERS’ EQUITY FOR THE NINE MONTHS ENDED SEPTEMBER 30, 2008 AND THE YEAR ENDED DECEMBER 31, 2007		6
CONSOLIDATED STATEMENTS OF CASH FLOWS FOR THE NINE MONTHS ENDED SEPTEMBER 30, 2008 AND 2007		7
CONDENSED NOTES TO CONSOLIDATED FINANCIAL STATEMENTS.		8
ITEM 2. MANAGEMENT’S DISCUSSION AND ANALYSIS		11
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK		23
ITEM 4. CONTROLS AND PROCEDURES		24
PART II — OTHER INFORMATION		25
SIGNATURES		27
EXHIBITS
31.1 Rule 13a—14(a) Certification of Chief Executive Officer
31.2 Rule 13a—14(a) Certification of Chief Financial Officer
32 Section 1350 Certification
EX-31.1
EX-31.2
EX-32

HERITAGE FINANCIAL GROUP AND SUBSIDIARY

Consolidated Balance Sheets
September 30, 2008 and December 31, 2007

	Unaudited			Audited
	September 30,			December 31,
	2008			2007
Assets
Cash and due from banks	$	16,133,167		$	8,953,836
Interest-bearing deposits in banks		583,340			379,961
Federal funds sold		13,825,000			14,505,000
Securities available for sale, at fair value		115,925,389			107,867,192
Federal home loan bank stock, at cost		3,410,800			2,969,700
Other equity securities, at cost		1,010,000			—
Loans		312,766,771			304,673,138
Less allowance for loan losses		5,206,161			4,415,669
Loans, net		307,560,610			300,257,469
Premises and equipment, net		16,835,815			14,815,520
Accrued interest receivable		2,816,955			2,586,357
Intangible assets		1,000,000			1,000,000
Foreclosed assets		2,221,867			364,999
Cash surrender value of bank owned life insurance		13,984,826			8,640,647
Other assets		7,595,181			6,331,560
	$	502,902,950		$	468,672,241
Liabilities and Stockholders’ Equity
Deposits
Noninterest-bearing	$	16,527,041		$	21,058,567
Interest-bearing		321,366,496			309,570,843
Total deposits		337,893,537			330,629,410
Federal funds purchased and securities sold under repurchase agreements		38,714,711			15,288,452
Other borrowings		57,500,000			50,000,000
Accrued interest payable		890,214			947,352
Other liabilities		6,277,803			6,214,877
Total liabilities		441,276,265			403,080,091
Commitments and contingencies
Stockholders’ equity
Preferred stock, par value $0.01; 1,000,000 shares authorized; no shares issued		—			—
Common stock, par value $0.01; 25,000,000 shares authorized; 11,453,228 and 11,443,723 issued		114,532			114,437
Capital surplus		39,668,653			39,009,323
Retained earnings		41,313,441			42,406,483
Accumulated other comprehensive loss		(4,372,729	)		(3,303,342	)
Unearned employee stock ownership plan (ESOP) shares, 297,473 and 330,525 shares		(2,974,725	)		(3,305,250	)
		73,749,172			74,921,651
Treasury stock, at cost, 846,318 and 615,934 shares		(12,122,487	)		(9,329,501	)
Total stockholders’ equity		61,626,685			65,592,150
	$	502,902,950		$	468,672,241

See Notes to Consolidated Financial Statements.

3

HERITAGE FINANCIAL GROUP AND SUBSIDIARY

Consolidated Statements of Operations (Unaudited)
For the Three and Nine Months Ended September 30, 2008 and 2007

	For the Three Months						For the Nine Months
	2008			2007			2008			2007
Interest income
Interest and fees on loans	$	5,179,786		$	5,701,464		$	15,945,925		$	16,451,101
Interest on taxable securities		1,268,420			1,122,206			3,623,502			3,100,273
Interest on nontaxable securities		277,951			286,710			902,814			753,161
Interest on federal funds sold		37,566			115,207			160,934			492,265
Interest on deposits in other banks		3,636			6,065			14,507			22,773
		6,767,359			7,231,652			20,647,682			20,819,573
Interest expense
Interest on deposits		2,099,516			2,810,852			6,753,882			8,190,573
Interest on other borrowings		875,147			717,661			2,608,850			1,780,009
		2,974,663			3,528,513			9,362,732			9,970,582
Net interest income		3,792,696			3,703,139			11,284,950			10,848,991
Provision for loan losses		1,218,000			58,000			2,400,000			553,000
Net interest income after provision for loan losses		2,574,696			3,645,139			8,884,950			10,295,991
Noninterest income
Service charges on deposit accounts		1,046,544			1,061,419			2,949,962			2,835,921
Other service charges, commissions and fees		314,847			268,633			973,650			884,908
Brokerage fees		264,662			293,257			770,493			734,664
Mortgage origination fees		108,894			90,351			314,602			284,662
Bank owned life insurance		151,360			90,673			344,199			259,729
Gain (loss) on sale of securities		—			(20,768	)		19,745			(49,163	)
Impairment loss on securities		(3,019,181	)		—			(3,019,181	)		—
Other		33,435			72,080			311,554			201,862
		(1,099,439	)		1,855,645			2,665,024			5,152,583
Noninterest expense
Salaries and employee benefits		2,353,230			3,469,295			6,878,605			8,123,504
Equipment		294,381			280,238			914,439			834,740
Occupancy		303,118			253,377			866,913			757,633
Advertising and marketing		86,800			103,657			343,476			299,468
Legal and accounting		129,632			141,564			398,435			332,463
Consulting & other professional fees		73,821			236,322			252,511			523,403
Directors fees and retirement		147,310			338,351			460,507			597,755
Telecommunications		63,003			55,874			198,180			169,910
Supplies		34,383			50,104			147,235			160,815
Data processing fees		333,276			303,237			974,736			854,773
Other operating		870,581			323,774			1,786,958			1,153,880
		4,689,535			5,555,793			13,221,995			13,808,304
Income (loss) before income taxes		(3,214,278	)		(55,009	)		(1,672,021	)		1,640,270
Applicable income tax benefits		(1,452,505	)		(1,217,683	)		(1,177,618	)		(790,356	)
Net income (loss)	$	(1,761,773	)	$	1,162,674		$	(494,403	)	$	2,430,626
Basic earnings (loss) per share	$	(0.17	)	$	0.11		$	(0.05	)	$	0.24
Diluted earnings (loss) per share	$	(0.17	)	$	0.11		$	(0.05	)	$	0.23

See Notes to Consolidated Financial Statements.

4

HERITAGE FINANCIAL GROUP AND SUBSIDIARY

Consolidated Statements of Comprehensive Income (Unaudited)
For the Three and Nine Months Ended September 30, 2008 and 2007

	For the Three Months					For the Nine Months
	2008			2007		2008			2007
Net income (loss)	$	(1,761,773	)	$	1,162,674	$	(494,403	)	$	2,430,626
Other comprehensive income (loss):
Net unrealized gain (loss) on cash flow hedge arising during the period, net of tax (benefit) of $114,665 for the quarter and ($17,810) for the year to date		162,206			—		(26,713	)		—
Net realized gain on termination of cash flow hedge during the period, net of tax of $359,490		—			—		539,235			—
Elimination of unrealized gain on cash flow hedge terminated during the period, net of tax of $156,558		—			—		(234,838	)		—
Accretion of realized gain on terminated cash flow hedge, net of tax of $19,609 for the quarter and $39,217 the year to date		(29,413	)		—		(58,826	)		—
Unrealized holding gains (losses) arising during the period, net of tax (benefit) of ($1,016,806) and $433,326 for the quarter and ($2,058,604) and ($508,750) for the year to date		(1,525,210	)		659,266		(3,087,907	)		(774,017	)
Reclassification adjustment for losses included in net income, net of tax benefit of $1,207,672 and $8,237 for the quarter and $1,199,774 and $19,498 for the year to date		1,811,509			12,531		1,799,662			29,665
Total other comprehensive income (loss)		419,092			671,797		(1,069,387	)		(744,352	)
Comprehensive income (loss)	$	(1,342,681	)	$	1,834,471	$	(1,563,790	)	$	1,686,274

See Notes to Consolidated Financial Statements.

5

HERITAGE FINANCIAL GROUP AND SUBSIDIARY

Consolidated Statements of Stockholders’ Equity (Unaudited)
For the Nine Months Ended September 30, 2008 and
The Year Ended December 31, 2007

																			Accumulated
																			Other
	Common Stock						Capital			Retained			Unearned			Treasury			Comprehensive
	Shares			Par Value			Surplus			Earnings			ESOP Shares			Stock			Loss			Total
Balance, December 31, 2006		11,449,155		$	114,492		$	37,807,784		$	40,248,349		$	(3,745,950	)	$	(8,518,017	)	$	(3,097,880	)	$	62,808,778
Net income		—			—			—			2,921,105			—			—			—			2,921,105
Cash dividend declared, $0.24 per share		—			—			—			(762,971	)		—			—			—			(762,971	)
Stock-based compensation expense								811,781			—			—			—			—			811,781
Repurchase of 61,106 shares of stock for the treasury		—			—			—									(816,227	)					(816,227	)
Issuance of 310 shares of common stock from the treasury		—			—			432									4,743						4,853
Forfeiture of 14,632 shares of restricted stock		(14,632	)		(147	)		147			—			—			—			—			—
Other comprehensive loss		—			—			—			—			—			—			(205,462	)		(205,462	)
Excess tax benefit from stock based compensation plans								64,119			—			—			—			—			64,119
Exercise of stock options		9,200			92			115,276			—			—			—			—			115,368
ESOP shares earned, 44,070 shares		—			—			210,106			—			440,700			—			—			650,806
Balance, December 31, 2007		11,443,723			114,437			39,009,323			42,406,483			(3,305,250	)		(9,329,501	)		(3,303,342	)		65,592,150
Net loss		—			—			—			(494,403	)		—			—			—			(494,403	)
Cash dividend declared, $0.21 per share		—			—			—			(598,639	)		—			—			—			(598,639	)
Repurchase of 230,654 shares of stock for the treasury		—			—			—						—			(2,796,565	)		—			(2,796,565	)
Issuance of 270 shares of treasury stock		—			—			(533	)		—			—			3,579			—			3,046
Other comprehensive loss		—			—			—			—			—			—			(1,069,387	)		(1,069,387	)
Stock-based compensation expense		—			—			608,808			—			—			—			—			608,808
Issuance of restricted stock		9,505			95			(95	)		—												—
Excess tax from stock based compensation plans								(1,780	)		—												(1,780	)
ESOP shares earned, 33,052 shares		—			—			52,930			—			330,525			—			—			383,455
Balance, September 30, 2008		11,453,228		$	114,532		$	39,668,653		$	41,313,441		$	(2,974,725	)	$	(12,122,487	)	$	(4,372,729	)	$	61,626,685

See Notes to Consolidated Financial Statements.

6

HERITAGE FINANCIAL GROUP AND SUBSIDIARY

Consolidated Statements of Cash Flows (Unaudited)
For the Nine Months Ended September 30, 2008 and 2007

	For the Nine Months
	2008			2007
OPERATING ACTIVITIES
Net income (loss)	$	(494,403	)	$	2,430,626
Adjustments to reconcile net income to net cash provided by operating activities:
Depreciation and amortization		733,986			733,800
Provision for loan losses		2,400,000			553,000
ESOP compensation expense		383,455			502,533
Stock-based compensation expense		608,808			616,067
Provision for deferred taxes		(2,249,432	)		(99,256	)
Net (gain) loss on sale of securities available for sale		(19,745	)		49,163
Impairment loss on securities available for sale		3,019,181			—
Net gain on termination of cash flow hedge		898,725			—
Accretion of gain on termination of cash flow hedge		(98,043	)		—
Net increase in foreclosed assets		(1,856,868	)		(23,758	)
Increase in bank owned life insurance		(344,179	)		(259,730	)
Increase in interest receivable		(230,598	)		(838,291	)
Increase (decrease) in interest payable		(57,138	)		169,438
Increase (decrease) in taxes payable		1,067,296			(1,935,588	)
Net other operating activities		258,446			1,529,474
Total adjustments		4,513,894			996,852
Net cash provided by operating activities		4,019,491			3,427,478
INVESTING ACTIVITIES
(Increase) decrease in interest-bearing deposits in banks		(203,379	)		1,740,453
Purchases of securities available for sale		(44,536,347	)		(51,143,567	)
Proceeds from maturities of securities available for sale		10,879,670			6,690,640
Proceeds from sale of securities available for sale		20,451,970			12,490,449
Purchase of bank owned life insurance		(5,000,000	)		—
Net change in Federal home loan bank stock		(441,100	)		(470,300	)
Purchase of other equity securities		(1,010,000	)		—
Decrease in federal funds sold		680,000			10,411,000
Increase in loans, net		(9,703,141	)		(20,278,275	)
Proceeds from sale of fixed assets		—			249,622
Purchase of premises and equipment		(2,754,281	)		(2,481,949	)
Net cash used in investing activities		(31,636,608	)		(42,791,927	)
FINANCING ACTIVITIES
Increase in deposits		7,264,127			18,120,845
Increase in federal funds purchased and securities sold under agreement to repurchase		23,426,259			12,291,371
Repayment of other borrowings		(20,500,000	)		—
Proceeds from other borrowings		28,000,000			10,000,000
Excess tax related to stock-based compensation plans		(1,780	)		—
Purchase of treasury stock, net		(2,793,519	)		(811,755	)
Dividends paid to stockholders		(598,639	)		(585,438	)
Net cash provided by financing activities		34,796,448			39,015,023
Net increase (decrease) in cash and due from banks		7,179,331			(349,426	)
Cash and due from banks at beginning of period		8,953,836			9,781,232
Cash and due from banks at end of period	$	16,133,167		$	9,431,806
SUPPLEMENTAL DISCLOSURES OF CASH FLOW INFORMATION
Cash paid during the period for:
Interest	$	9,419,870		$	9,801,144
Taxes		6,300			1,147,254
NONCASH TRANSACTIONS
Increase in unrealized losses on securities available for sale	$	5,146,511		$	1,282,776
Decrease in unrealized gain on termination of cash flow hedges		391,396			—
Increase in unrealized losses on cash flow hedges		44,523			—

See Notes to Consolidated Financial Statements.

7

HERITAGE FINANCIAL GROUP AND SUBSIDIARY

CONDENSED NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Unaudited)

NOTE 1 — BASIS OF PRESENTATION AND ACCOUNTING ESTIMATES

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 nine months ended September 30, 2008, 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, 2007.

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, contingent assets and liabilities and deferred tax assets.

NOTE 2 — EARNINGS PER SHARE

Basic earnings per share represent income available to common shareholders divided by the weighted-average number of common shares outstanding during the period, excluding unallocated shares of the Employee Stock Ownership Plan. The table below sets forth our earnings per share for the three months and nine months ended September 30, 2008 and 2007:

	Three Months					Nine Months
	2008			2007		2008			2007
Basic earnings per share:
Net income (loss)	$	(1,761,773	)	$	1,162,674	$	(494,403	)	$	2,430,626
Weighted average common shares outstanding		10,215,179			10,349,924		10,236,257			10,337,310
Total basic earnings per common share	$	(0.17	)	$	0.11	$	(0.05	)	$	0.24
Diluted earnings per share:
Net income (loss)	$	(1,761,773	)	$	1,162,674	$	(494,403	)	$	2,430,626
Weighted average common shares outstanding		10,215,179			10,349,924		10,236,257			10,337,310
Effect of dilutive stock options and restricted stock		—			52,389		—			67,020
Weighted average dilutive common shares outstanding		10,215,179			10,402,313		10,236,257			10,404,330
Total diluted earnings per common share	$	(0.17	)	$	0.11	$	(0.05	)	$	0.23

8

HERITAGE FINANCIAL GROUP AND SUBSIDIARY
CONDENSED NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)

NOTE 3 — SHARE BASED COMPENSATION

On May 17, 2006, our 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, to provide directors, advisory directors, officers and employees of Heritage Financial Group 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. Under the Plan, the Compensation Committee of the Board of Directors has discretion to award up to 771,149 shares, of which 550,281 were available as stock options or stock appreciation rights and 220,328 shares were available as restricted stock awards. During 2006, the Compensation Committee of the Board of Directors granted stock options and tandem stock appreciation rights totaling 520,605 shares and granted restricted stock awards totaling 207,905 shares. During the first quarter of 2008, an additional 19,750 of tandem stock option and stock appreciation rights, and 9,505 of restricted stock awards were granted to employees. All stock options, stock appreciation rights and restricted stock awards vest over a period of five years.

The Company granted restricted awards that may not be sold or otherwise transferred until certain restrictions have lapsed. The share based expense for these awards was determined based on the market price of our 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 September 30, 2008, there was approximately $1,383,000 of unrecognized compensation associated with these awards. For the three and nine months ended September 30, 2008, we recognized compensation expense of approximately $125,000 and $375,000, respectively.

We recognized compensation expense related to stock options of approximately $78,000 for the three months and $234,000 for the nine months ended September 30, 2008. At September 30, 2008, there was approximately $858,000 of unrecognized compensation related to stock options.

NOTE 4 — DERIVATIVE FINANCIAL INSTRUMENTS

In October and November of 2007, the Company entered into three, 5-year interest rate swap agreements totaling $20 million in notional amount to hedge against interest rate risk in a declining rate environment. On March 17, 2008, the Company terminated its three interest rate swap agreements with its counterparty for a total gain of $898,725. This gain will be deferred and recognized as a component of interest and fees on loans on a straight-line basis over the next fifty-four months, which was the remaining term on the interest rate swap agreements.

In May of 2008, the Company entered into two, 3-year interest rate swap agreements totaling $20 million in notional amount to hedge against interest rate risk in a flat or declining interest rate environment. As a cash flow hedge, the portion of the change in the fair value of the derivative that has been deemed highly effective is recognized in other comprehensive income until the related cash flows from the hedged item are recognized in earnings.

As of September 30, 2008, the Company recognized interest income of approximately $201,000 year to date and $89,000 quarter to date on derivative financial instruments. There were no derivative financial instruments outstanding as of September 30, 2007.

9

HERITAGE FINANCIAL GROUP AND SUBSIDIARY
CONDENSED NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)

NOTE 5 — FAIR VALUE MEASUREMENTS

On January 1, 2008, the Company adopted FASB No. 157, Fair Value Measurements. FASB No. 157 defines fair value, establishes a framework for measuring fair value, and expands disclosures about fair value measurements. FASB No. 157 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.

FASB No. 157 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, FASB No. 157 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 September 30, 2008, aggregated by the level in the fair value hierarchy within which those measurements fall.

	Quoted Prices		Significant
	in Active		Other		Significant
	Markets for		Observable		Unobservable
	Identical Assets		Inputs		Inputs
	(Level 1)		(Level 2)		(Level 3)		Total
Assets
Available for sale investment securities	$	—	$	115,925,389	$	—	$	115,925,389
Total assets at fair value	$	—	$	115,925,389	$	—	$	115,925,389
Liabilities
Derivative financial instruments	$	—	$	44,523	$	—	$	44,523
Total liabilities at fair value	$	—	$	44,523	$	—	$	44,523

10

ITEM 2. MANAGEMENT’S DISCUSSION AND ANALYSIS

Forward-Looking Statements.

This report contains certain ‘forward-looking statements’ that may be identified by the use of such words as “believe,” “expect,” “anticipate,” “should,” “planned,” “estimated” with respect to our financial condition. Results of operations and business are subject to various factors that could cause actual results to differ materially from these estimates and most other statements that are not historical in nature. These factors include, but are not limited to, general and local economic conditions, changes in interest rates, deposit flows, demand for mortgage, consumer and other loans, real estate values, competition, changes in accounting principles, policies or guidelines, changes in legislation or regulation, and other economic, competitive, governmental, regulatory and technological factors affecting our operations, pricing, products and services.

General

Heritage Financial Group (“the Company”) is the parent holding company of HeritageBank of the South (“the Bank”). The Company is in a mutual holding company structure and 74% of its outstanding common stock is owned by Heritage, MHC (“MHC”), a federal mutual holding company.

The principal business of the Company is operating our wholly owned subsidiary, the Bank. Our results of operations depend primarily on our net interest income. Net interest income is the difference between the interest income we earn on our interest-earning assets, consisting primarily of loans and investments, and the interest we pay on our interest-bearing liabilities, consisting of savings and checking accounts, money market accounts, time deposits, federal funds purchased and securities sold under agreements to repurchase and other borrowings. Our results of operations also are affected by our provisions for loan losses, noninterest income and noninterest expense. Noninterest income consists primarily of service charges on deposit accounts, mortgage origination fees, transaction fees, bank-owned life insurance, and commissions from investment services. Noninterest expense consists primarily of salaries and employee benefits, occupancy, equipment and data processing, advertising, professional fees and other costs. Our results of operations also may be affected significantly by general and local economic and competitive conditions, changes in market interest rates, governmental policies and actions of regulatory authorities.

Evolution of Business Strategy

We originally were chartered as a federal credit union in 1955. In 1998, we became a community chartered credit union. We accepted deposits and made loans to members who lived, worked or worshiped in the approved counties for the credit union charter. In 2001, we converted to a mutual thrift charter in order to better serve our customers and communities through a broader lending ability and an expanded customer base beyond the field of membership permitted for our credit union. The mutual holding company structure was established in 2002, and we converted from a thrift charter to a state savings bank charter in 2005. We feel this structure best suits our continued efforts to grow and expand our commercial business.

The Company completed an initial public stock offering on June 29, 2005. We sold 3,372,375 shares of common stock in that offering for $10.00 per share. The Company’s employee stock ownership plan (the “ESOP”) purchased 440,700 shares with the proceeds of a loan from the Company. The Company received net proceeds of $32.4 million in the public offering, 50% of which was contributed to the Bank and $4.4 million of which was loaned to the ESOP for its purchase of shares in the offering. The Company also issued an additional 7,867,875 shares of common stock to MHC, so that MHC would own 70% of the outstanding common stock at the close of the offering.

Our current business strategy is to operate a well-capitalized and profitable commercial and retail financial institution dedicated to serving the needs of our customers. We strive to be the primary financial institution in the market areas we serve. We offer a broad range of products and services, while stressing personalized and efficient customer service and convenient access to these products and services. We intend to continue to operate as a commercial and consumer lender. We have structured operations around a branch system that is staffed with

11

knowledgeable and well-trained employees. Subject to capital requirements and our ability to grow in a reasonable and prudent manner, we may open 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.

We continue to implement our business strategy, as set forth in our Form 10-K, which was filed with the Securities and Exchange Commission on March 31, 2008. A critical component of this strategy includes increasing our commercial loan portfolio. During the first nine months of 2008, our commercial real estate, business and multifamily loans increased $7.4 million or 4.8% to $162.3 million at September 30, 2008. Our ability to continue to grow our commercial loan portfolio is an important element of our long-term business strategy.

Another key component of our business strategy is the expansion of our operations outside of the Southwest Georgia market. In January of 2008, we opened our second branch in Ocala, Florida. As of September 30, 2008, we had total loans of $38.5 million and total deposits of $44.9 million at our Ocala, Florida branches. We are currently operating two permanent branches in Ocala.

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

For more information on risk factors please see Item IA under Part II of this 10-Q.

Critical Accounting Policies

We have not changed any of our critical accounting policies since those disclosed in our Form 10-K, which was filed with the Securities and Exchange Commission on March 31, 2008. Those accounting policies relate to the judgments and estimates used in the preparation of our financial statements in the calculation of the allowance for loan losses, the accounting for impaired loans and the provision for income taxes.

Off Balance Sheet Liabilities

The Company is a party to financial instruments with off-balance-sheet risk in the normal course of business to meet the financing needs of our customers. These financial instruments include commitments to extend credit and standby letters of credit. We use the same credit policies in making these commitments as we do for on-balance sheet instruments. A summary of the Company’s commitments as of September 30, 2008, is as follows:

	(In thousands)
Commitments to extend credit	$	39,437
Financial stand-by letters of credit		4,986
	$	44,423

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Comparison of Financial Condition at September 30, 2008 and December 31, 2007

Total assets increased $34.2 million or 7.3% to $502.9 million at September 30, 2008, from $468.7 million at December 31, 2007. Total interest earning assets increased $15.7 million or 3.7% to $443.1 million at September 30, 2008, from $427.4 million at December 31, 2007. Total loans increased $8.1 million or 2.7% to $312.8 million at September 30, 2008. Approximately $9.5 million of the loans outstanding at September 30, 2008 were related to our investment in the Chattahoochee Bank of Georgia (“Chattahoochee”). Chattahoochee commenced operations during the third quarter, and we expect the majority of these loans to be paid off in the fourth quarter of this year. During the first nine months of 2008, loans outstanding in the North Central Florida region increased by $11.9 million to $38.4 million. Loans outstanding in the Southwest Georgia region decreased by $13.3 million during the first nine months of 2008. This decrease in loans was approximately evenly divided between commercial and retail loans. The weakened economic environment in the country, the Southeastern United States, and in our markets is resulting in very limited loan demand. In addition, as economic factors have deteriorated, we have tightened our credit standards. Therefore, we expect loan volume to be very limited for the remainder of 2008 unless economic trends improve significantly.

Securities increased $8.1 million at September 30, 2008 as compared to December 31, 2007. During the first nine months of the year, we took advantage of a steepened yield curve to prefund some investments that will mature over the next twelve months. Other earning assets, consisting of interest bearing deposits in banks and federal funds sold, decreased slightly to $14.4 million from $14.9 million at December 31, 2007.

Other equity securities increased to $1,010,000 as we funded our investment in Chattahoochee during the second quarter of 2008.

Premises and equipment increased by $2.0 million, primarily due to the construction of our second permanent location in Ocala. This branch opened in July of this year.

Foreclosed assets increased $1.9 million to $2.2 million. The majority of this increase was the foreclosure of a residential development in the Florida panhandle. This loan was a participation purchased by the Bank’s commercial lending division in Albany.

Cash surrender value of bank owned life insurance (“BOLI”) increased by $5.3 million, primarily due to the purchase of $5 million of additional BOLI in June of this year. This purchase was made due to an advantageous interest rate environment compared to other investment alternatives. In addition, this purchase allowed us to cover many new officers of the Bank that were not covered under existing BOLI policies which were purchased in 2001.

Total liabilities increased $38.2 million or 9.5% to $441.3 million at September 30, 2008 compared with $403.1 million at December 31, 2007. The increase was due to an increase of $7.5 million in other borrowings, $23.4 million in federal funds purchased and repurchase agreements, and $7.3 million in deposits. The total amount of other borrowings increased to $57.5 million during the first nine months of 2008. Federal funds purchased and repurchase agreements increased to $38.7 million at September 30, 2008 from $15.3 million in December 31, 2007. Deposits increased $7.3 million or 2.2% to $337.9 million compared with $330.6 at December 31, 2007. During the year, we have faced tremendous competitive pressures on deposit rates. As deposit rates continue to be extremely competitive, we have begun to offer higher rates on deposit products, despite the decrease in market interest rates. Although this will have a negative impact on our net interest margin, we believe it is important to maintain strong deposit funding during these uncertain economic times.

Total equity decreased $4.0 million to $61.6 million at September 30, 2008, compared with $65.6 million at December 31, 2007. Net losses of $494,000 for the first nine months of 2008, other comprehensive loss of $1.1 million, dividends of $599,000 and the purchase of treasury stock for $2.8 million decreased equity, while the allocation of $330,000 in ESOP shares and stock based compensation of $609,000 increased equity.

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Comparison of Operating Results

General

For the three months ended September 30, 2008 and 2007

During the quarter ended September 30, 2008, we recorded a net loss of $1.8 million compared to net income of $1.2 million for the quarter ended September 30, 2007. The decrease in income was due primarily to a $3.0 million impairment charge and $1.2 million provision expense during the 2008 quarter.

For the nine months ended September 30, 2008 and 2007

During the first nine months of 2008, we recorded a net loss of $494,000 compared to net income of $2.4 million during the first nine months of 2007. The decrease in income was due primarily to a $3.0 million impairment charge and a $1.8 million increase in provision expense during the first nine months of 2008.

Reconciliation of net income to adjusted net income

During the third quarter of 2008 and 2007, we had unusual items affect our earnings. Due to the nature of these items, management feels that our operating results should also be viewed excluding these items to analyze the results of our core operations. Below is an analysis of our results excluding these items:

Unaudited Reconciliation of Net Income to Adjusted Net Income
(In thousands, except per share amounts)

	Three Months Ended						Nine Months Ended
	September 30,						September 30,
	2008			2007			2008			2008
Net income (loss)	$	(1,762	)	$	1,163		$	(494	)	$	2,431
Impairment loss on securities, net of tax		1,812			—			1,812			—
Charges to accelerate vesting on retirement plans, after tax		—			947			—			947
Reversal of contingent income tax liability		—			(1,060	)		—			(1,060	)
Adjusted net income	$	50		$	1,050		$	1,318		$	2,318
Diluted earnings (loss) per share	$	(0.17	)	$	0.11		$	(0.05	)	$	0.23
Impairment loss on securities, net of tax		0.18						0.17
Charges to accelerate vesting on retirement plans, after tax		—			0.09			—			0.09
Reversal of contingent income tax liability		—			(0.10	)	$	—		$	(0.10	)
Adjusted earnings per diluted share	$	0.01		$	(0.10	)	$	0.12		$	0.22

Net income and basic and diluted earnings per share are presented in accordance with generally accepted accounting principals (“GAAP”). Adjusted net income and adjusted basic and diluted earnings per share are non-GAAP financial measures. We believe that these non-GAAP measures aid in understanding and comparing current year results, which include unusual items, to those of the prior year. These non-GAAP measures should be viewed in addition to, and not as a substitute for, our reported results.

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Interest Income

For the three months ended September 30, 2008 and 2007

Total interest income for the three months ended September 30, 2008, decreased $464,000 or 6.4% to $6.8 million, compared to $7.2 million during the third quarter of 2007. The decrease was the result of a 87 basis points decrease in yield on average earning assets to 6.20% during the third quarter of 2008 as compared to the yield of 7.07% earned during the same period in 2007. This decrease was due to an overall fall in interest rates. We expect the yield on our earning assets to continue to decrease during the remainder of 2008 as we continue to see the effects of the Federal Reserve rate cuts from 2007 and 2008. Average interest earning assets increased $27.9 million for the quarter ending September 30, 2008, compared with the same period in 2007.

For the nine months ended September 30, 2008 and 2007

Total interest income for the nine months ended September 30, 2008, decreased $172,000 or 0.8% to $20.7 million, compared to $20.8 million during the third quarter of 2007. The decrease was the result of a 59 basis point decrease in yield on average interest earning assets to 6.41% compared to 7.00% during the first nine months of 2007. Average interest earnings assets increased by $34.6 million during the 2008 period.

Interest Expense

For the three months ended September 30, 2008 and 2007

Total interest expense decreased $554,000 or 15.7% to $3.0 million for the quarter ended September 30, 2008, compared to $3.6 million during the same period in 2007. The average cost of interest bearing liabilities decreased 95 basis points to 2.90% during the third quarter of 2008 compared with 3.85% during the same period in 2007. The average balance of interest bearing liabilities during the third quarter of 2008 was $407.6 million, an increase of $43.8 million compared to $363.8 million during the third quarter of 2007.

For the nine months ended September 30, 2008 and 2007

Total interest expense decreased $608,000 or 6.1% to $9.4 million for the nine months ended September 30, 2008. The average cost of interest bearing liabilities decreased 62 basis points to 3.16% during the first nine months of 2008 compared with 3.78% during the same period in 2007. The average balance of interest bearing liabilities was $395.2 million for the first nine months of 2008, an increase of $42.6 million compared to $352.6 million during the first nine months of 2007. The market for deposit products is extremely competitive and if it remains at this competitive level for the remainder of 2008, it will have a negative impact on the cost of our interest bearing liabilities.

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Net Interest Income

For the three months ended September 30, 2008 and 2007

Net interest income of $3.8 million was an increase from the $3.7 million shown during the same period in 2007. The net interest spread increased 8 basis points for the third quarter of 2008 to 3.31% compared with 3.23% during the same period in 2007. The net interest margin fell 16 basis points to 3.54% for the three months ended September 30, 2008 compared to 3.70% during the same period in 2007.

For the nine months ended September 30, 2008 and 2007

Net interest income of $11.3 million was an increase from the $10.9 million shown during the same period in 2007. The net interest spread increased 3 basis points for the first nine months of 2008 to 3.25% compared to 3.22% during the same period in 2007. The net interest margin fell 14 basis points to 3.57% for the nine months ended September 30, 2008 compared to 3.71% during the first nine months of 2007.

General Comments on Interest Rates

During the first nine months of 2008, we saw dramatic drops in interest rates as the Federal Reserve lowered the federal funds target rate four times for a total of 225 basis points. These cuts were in addition to the reduction of 100 basis points during the last four months of 2007. These reductions in rates have put extreme downward pressure on our margins, as our loans tend to reprice more quickly than our deposit products. In addition, many of our competitors face extreme pressure on liquidity, and have therefore priced their deposit products aggressively. Most of this pressure has come from large regional and national banks that have been forced to seek deposit funding for their balance sheets when other sources of funding became more difficult to obtain. We expect this irrational pricing to continue, which will put pressure on our margins for the foreseeable future.

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 never achieve this without taking undue risk. Therefore, we remain exposed to further reductions in interest rates. For more information on the effect of changes in interest rates, see Item 3 of this Form 10-Q.

Provision for Loan Losses

For the three months and nine months ended September 30, 2008 and 2007

During the quarter ended September 30, 2008, we recorded a $1.2 million provision for loan losses, which was a significant increase compared to the $58,000 provision during the same period in 2007. For the year to date period, we recorded a $2.4 million provision for loan losses, which was $1.8 million higher than the $553,000 of provision expense we incurred for the first nine months of 2007. As general economic treads have declined, we have experienced increases in internally criticized and classified loans, as well as increases in nonperforming and past due loans.

Annualized net charge-offs to average outstanding loans increased to 0.15% for the three months ending September 30, 2008 compared to 0.10% during the same period of 2007. Annualized net charge-offs to average outstanding loans increased to 0.69% for the nine months ending September 30, 2008 compared to 0.06% during the same period of 2007.

Nonperforming loans increased $1.9 million to $5.4 million at September 30, 2008 compared to $3.5 at September 30, 2007. Nonperforming loans to total loans increased to 1.72% at September 30, 2008 from 1.12% at September 30, 2007. Nonperforming assets increased $3.7 million to $7.6 million at September 30, 2008 compared to $3.9 million at September 30, 2007. Nonperforming assets to total assets increased to 1.51% at September 30, 2008 as compared to 0.85% at September 30, 2007. The allowance for loan losses as a percentage of total loans increased to 1.66% at September 30, 2008 compared with 1.51% at September 30, 2007.

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Loans past due 30 days and still accruing totaled $1.5 million, or 0.50% of total loans at September 30, 2008. This compares to $1.9 million at December 31, 2007, or 0.65% of loans. At September 30, 2007, past due loans totaled $857,000 or 0.29% of loans.

Our internally criticized and classified assets totaled $26.0 million at September 30, 2008, compared to $13.4 million at December 31, 2007 and $12.8 million at September 30, 2007. These balances include the aforementioned nonperforming loans, other real estate, and repossessed assets. 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.

We continue to see weakness in our loan portfolio, and as economic conditions remain difficult, we expect this trend to continue until we see improvement in the overall economy. We have taken actions to prevent losses in our current portfolio, including a weekly meeting of members of management and lenders to discuss the status and action plan on each problem loan. We have also taken steps to better evaluate the capital and liquidity positions of our commercial loan guarantors, particularly those involved in commercial real estate construction and development.

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

We assess the allowance for loan losses on a quarterly basis and make provisions for loan losses as necessary in order to maintain the proper level of allowance. While we use 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 us 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.

Impairment Losses on Securities

During the quarter ended September 30, 2008, we determined that the securities of three issuers whose securities were held in our available for sale portfolio were other than temporarily impaired. The total impairment charge recorded was $3.0 million. The securities included a $1.5 million investment in the preferred stock of Freddie Mac, which we impaired to a value of $100,000 subsequent to the government intervention into the entity. In addition, we impaired the corporate bonds of General Motors, in which we had an investment of $1.2 million that was written down to $220,000, and the corporate bonds of Ford Motor Credit, in which we held an investment of $1.0 million that was written down to $400,000. Subsequent to September 30, 2008, we saw a significant increase in the value of our corporate bonds. Based on this change in value, we sold our investments in General Motors and Ford Motor Credit for an approximate $200,000 gain from the values the securities were written down to as of September 30, 2008. We currently still hold our investment in the preferred stock of Freddie Mac.

As of September 30, 2008, approximately 97% of our investment portfolio had a rating of investment grade, with 81% of the portfolio having a rating of AAA. Approximately 3% of our investment portfolio is not rated by the major credit rating agencies.

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Noninterest Income

A summary of noninterest income, excluding securities transactions, follows:

	Three Months Ended September 30,
	2008			2007			$ Chg			% Chg
Service charges on deposit accounts	$	1,046,544		$	1,061,419		$	(14,875	)		-1.40	%
Other service charges, commissions and fees		314,847			268,633			46,214			17.20	%
Brokerage fees		264,662			293,257			(28,595	)		-9.75	%
Mortgage origination fees		108,894			90,351			18,543			20.52	%
Bank owned life insurance		151,360			90,673			60,687			66.93	%
Other		33,435			72,080			(38,645	)		-53.61	%
Total noninterest income	$	1,919,742		$	1,876,413		$	43,329			2.31	%
Noninterest income as a percentage of average assets (annualized)		1.55	%		1.66	%

	Nine Months Ended September 30,
	2008			2007			$ Chg		% Chg
Service charges on deposit accounts	$	2,949,962		$	2,835,921		$	114,041		4.02	%
Other service charges, commissions and fees		973,650			884,908			88,742		10.03	%
Brokerage fees		770,493			734,664			35,829		4.88	%
Mortgage origination fees		314,602			284,662			29,940		10.52	%
Bank owned life insurance		344,199			259,729			84,470		32.52	%
Other		311,554			201,862			109,692		54.34	%
Total noninterest income	$	5,664,460		$	5,201,746		$	462,714		8.90	%
Noninterest income as a percentage of average assets (annualized)		1.56	%		1.57	%

We have continued to see an increase in service charges on deposit accounts for the year, despite a slight decline this quarter. The increase for the year was made up primarily of a $130,000 increase in non-sufficient fund charges. This increase is due to our implementation of a program that allows customers to receive cash ATM withdrawals and make debit card purchases on overdrawn accounts within defined limits for a fee. This product is increasing overdraft fees, which is responsible for the increase in our service charges on deposit accounts in the current quarter and for the year. The increase in other service charges, commissions and fees was due primarily to an increase in fees from debit and ATM transactions of $166,000 for the year to date. We expect to continue to see strong income from debit and ATM transactions as our customers are increasing debit and ATM usage compared with traditional check writing. In addition, we saw a significant decrease in check printing commissions in the first nine months of 2008 when compared to the same period in 2007. This decrease was due entirely to a one time payment from our vendor on renegotiation of our check printing contract in 2007.

The decrease in brokerage fees during the third quarter of 2008 was due to a decrease in assets under management during the quarter, due entirely to the decreases seen in both debt and equity markets. For the year to date, brokerage fees have increased as we have continued to add new customers and increase assets under management over 2007 levels.

Mortgage fees have increased despite an increase in long term rates, credit tightening in the overall secondary mortgage market due to the collapse of sub-prime lending programs and a general slow down in the housing market. Although we did not participate in sub-prime mortgage lending, we do believe the tightening of the secondary market for these loans will have a negative impact on the overall housing market, and thus cause us to see mortgage activity below normal levels. However, we do believe we are benefiting from a decrease in the number of competing mortgage brokers in the markets we serve.

The increase in earnings on bank owned life insurance is due to an increased level of interest earned on our policies, due to a rise in longer term interest rates and exchanges we have made into higher yielding policies. In addition, we invested an additional $5 million in bank owned life insurance at the end of the second quarter of 2008.

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The majority of the increase in other noninterest income is a gain of approximately $100,000 on the sale of a ¹/2 interest in a partnership which owns an office building located in the same office complex as our main office. This interest was sold to a related party.

Noninterest Expense

A summary of noninterest expense follows:

	Three Months Ended September 30,
	2008			2007			$ Chg			% Chg
Salaries and employee benefits	$	2,353,230		$	3,469,295		$	(1,116,065	)		-32.17	%
Equipment		294,381			280,238			14,143			5.05	%
Occupancy		303,118			253,377			49,741			19.63	%
Advertising and marketing		86,800			103,657			(16,857	)		-16.26	%
Legal and accounting		129,632			141,564			(11,932	)		-8.43	%
Consulting & other professional fees		73,821			236,322			(162,501	)		-68.76	%
Directors fees and retirement		147,310			338,351			(191,041	)		-56.46	%
Telecommunications		63,003			55,874			7,129			12.76	%
Supplies		34,383			50,104			(15,721	)		-31.38	%
Data processing fees		333,276			303,237			30,039			9.91	%
Other operating		870,581			323,774			546,807			168.89	%
Total noninterest expenses	$	4,689,535		$	5,555,793		$	(866,258	)		-15.59	%
Noninterest expenses as a percentage of average assets (annualized)		3.78	%		4.90	%

	Nine Months Ended September 30,
	2008			2007			$ Chg			% Chg
Salaries and employee benefits	$	6,878,605		$	8,123,504		$	(1,244,899	)		-15.32	%
Equipment		914,439			834,740			79,699			9.55	%
Occupancy		866,913			757,633			109,280			14.42	%
Advertising and marketing		343,476			299,468			44,008			14.70	%
Legal and accounting		398,435			332,463			65,972			19.84	%
Consulting & other professional fees		252,511			523,403			(270,892	)		-51.76	%
Directors fees and retirement		460,507			597,755			(137,248	)		-22.96	%
Telecommunications		198,180			169,910			28,270			16.64	%
Supplies		147,235			160,815			(13,580	)		-8.44	%
Data processing fees		974,736			854,733			120,003			14.04	%
Other operating		1,786,958			1,153,880			633,078			54.87	%
Total noninterest expenses	$	13,221,995		$	13,808,304		$	(586,309	)		-4.25	%
Noninterest expenses as a percentage of average assets (annualized)		3.63	%		4.18	%

The decrease is salaries and employee benefits is due primarily to the $1.2 million charge we took in the third quarter of 2007 to accelerate vesting under our senior executive retirement plans. Other salaries and employee benefits declined despite cost of living increases and the addition of new staff for our first permanent branch in Ocala. The efficiency project we undertook in the first half of 2007 has allowed us to reduce our branch and back office staff through attrition. In addition, our ESOP expense has been reduced because of our lower stock price. Expenses under our senior executive retirement plans have also been eliminated for 2008 due to the acceleration of vesting that took place in the third quarter of 2007.

Equipment and occupancy expenses increased primarily because of the two branches we opened in Ocala in the first and third quarters of 2008.

The increase year to date in advertising and marketing is due to additional marketing expenses incurred with our expansion into Ocala and the implementation of a branding campaign in our Albany market. During the third quarter, we decreased these marketing initiatives.

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The increase in legal and accounting fees year to date was primarily due to increased legal fees associated with our investment in the Chattahoochee Bank of Georgia and an increase in legal fees associated with bad debt collections.

Consulting and other professional fees decreased due to the elimination of consulting fees incurred from our efficiency project that was undertaken during the first two quarters of 2007.

The decrease in directors fees is due to the $186,000 charge we took in the third quarter of 2007 to accelerate vesting under our directors’ retirement plan. This decrease was partially offset by an increase in directors’ compensation for directors of the Bank who have served on the board for more than one year.

The increase in telecommunications expenses is related to the addition of the new branches in Ocala.

Expenses for supplies decreased as we have implemented better internal controls related to the purchase of supplies, and we have also renegotiated our supply contract with a major vendor.

Data processing fees increased for the year due to two factors. First, as debit card usage and ATM fees have increased, the cost of facilitating these transactions has also increased. These fees are more than offset by the income we receive on these transactions. Also, during the first quarter of 2007, we resolved a billing dispute with our core processing provider, which resulted in lower than normal processing fees. During 2008, those fees returned to normal levels.

The increase in other operating expenses for the year was due primarily to increases in regulatory fees for deposit insurance and expenses related to foreclosures and other real estate, including a write down in the value of other real estate during the third quarter of 2008 of $272,000.

Income Tax Expense

During the quarter ended September 30, 2008, the Company recorded a tax benefit of $1.5 million. This compares to a tax benefit of $1.2 million during the third quarter of 2007, which was primarily due to the reversal of a contingent income tax liability of $1.1 million during the period. For the nine months ended September 30, 2008, the Company reported a tax benefit of $1.2 million, compared with a tax benefit of $790,000 during the same period in 2007.

Due to the unusual nature of the items that occurred during the third quarter of 2008 and 2007, a comparison of income tax rates for the time periods is not meaningful. Excluding these unusual items, the Company estimates its effective income tax rate to be approximately 20%. This effective rate is significantly below the statutory federal and state tax rates due to the significant amount of interest the Company receives on nontaxable investment securities and bank owned life insurance. In addition, a significant portion of the Company’s Georgia income tax liability is satisfied by tax credits received by the Company based on occupational taxes the Company pays to municipalities for its Georgia banking locations.

Liquidity and Capital Resources

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

The liquidity and capital resources of the Company are monitored continuously by the Company’s Board-authorized Asset Liability Management Committee and on a periodic basis by state and federal regulatory authorities. As determined under guidelines established by these regulatory authorities, the Company’s and the

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Bank’s liquidity ratios at September 30, 2008, 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 material change in liquidity.

The consolidated statement of cash flows for the nine months ended September 30, 2008 and 2007, detail cash flows from operating, investing and financing activities. For the nine months ended September 30, 2008, net cash provided by operating activities was $4.0 million while investing activities used $31.6 million, primarily for the purchase of securities, BOLI and to fund loan growth, and financing activities provided $34.8 million primarily from an increase in deposits, other borrowings and repurchase agreements, resulting in a net increase in cash during the nine month period of $7.2 million.

Regulatory Capital Ratios for HeritageBank of the South at September 30, 2008

The Company’s and the Bank’s regulatory capital levels exceed the minimums required by state and federal authorities. The following table reflects the Bank’s compliance at September 30, 2008, with regulatory capital requirements. These calculations are based on total risk weighted assets of $372.1 million as of September 30, 2008, and average total assets of $487.4 million for the nine months ended September 30, 2008.

											Minimum Required
											to Be Well Capitalized
						For Capital					Under Prompt
						Adequacy					Corrective Action
	Actual					Purposes					Provisions
	Amount		Ratio			Amount		Ratio			Amount		Ratio
	(Dollars in thousands)
Total Capital to Risk Weighted Assets	$	59,937		16.1	%	$	29,772		8.0	%	$	37,215		10.0	%
Tier I Capital to Risk Weighted Assets		55,278		14.9			14,886		4.0			22,329		6.0
Tier I Capital to Average Total Assets		55,278		11.3			19,496		4.0			24,370		5.0

Heritage Financial Group is subject to Georgia capital requirements for bank holding companies. At September 30, 2008, Heritage Financial Group had total equity of $61.6 million or 12.3% of total assets as of that date. Under Georgia capital requirements for holding companies, Heritage Financial Group had Tier I leverage capital of $63.3 million or 12.8%, which was $43.5 million above the 4.0% requirement.

Recent Legislative and Regulatory Initiatives to Address Financial and Economic Crises

The Congress, Treasury Department and the federal banking regulators, including the FDIC, have taken broad action since early September to address volatility in the U.S. banking system.

The Emergency Economic Stabilization Act of 2008 (“EESA”) authorizes the Treasury Department to purchase from financial institutions and their holding companies up to $700 billion in mortgage loans, mortgage-related securities and certain other financial instruments, including debt and equity securities issued by financial institutions and their holding companies in a troubled asset relief program (“TARP”). The purpose of TARP is to restore confidence and stability to the U.S. banking system and to encourage financial institutions to increase their lending to customers and to each other. The Treasury Department has allocated $250 billion towards the TARP Capital Purchase Program (“CPP”). Under the CPP, Treasury will purchase debt or equity securities from participating institutions. The TARP also will include direct purchases or guarantees of troubled asset of financial institutions. Participants in the CPP are subject to executive compensation limits and are encouraged to expand their lending and mortgage loan modifications.

EESA also increased FDIC deposit insurance on most accounts from $100,000 to $250,000. This increase is in place until the end of 2009 and is not covered by deposit insurance premiums paid by the banking industry.

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Following a systemic risk determination, the FDIC established a Temporary Liquidity Guarantee Program (“TLGP”) on October 14, 2008. The TLGP includes the Transaction Account Guarantee Program, which provides unlimited deposit insurance coverage through December 31, 2009 for noninterest-bearing transaction accounts (typically business checking accounts) and certain funds swept into noninterest-bearing savings accounts (“TAGP”). Institutions participating in the TAGP pay a 10 basis points fee (annualized) on the balance of each covered account in excess of $250,000, while the extra deposit insurance is in place. The TLGP also includes the Debt Guarantee Program, under which the FDIC guarantees certain senior unsecured debt of FDIC-insured institutions and their holding companies (“DGP”). The unsecured debt must be issued on or after October 14, 2008 and not later than June 30, 2009, and the guarantee is effective through the earlier of the maturity date or June 30, 2012. The DGP coverage limit is generally 125% of the eligible entity’s eligible debt outstanding on September 30, 2008 and scheduled to mature on or before June 30, 2009. The nonrefundable DGP fee is 75 basis points (annualized) for covered debt outstanding during the period from November 14, 2008 until the earlier of maturity or June 30, 2012. The TAGP and DGP are in effect for all eligible entities, unless the entity opted out on or before December 5, 2008. At this time, we plan to participate in the TAGP and DGP programs.

Our deposit insurance premiums during the nine months ended September 30, 2008 were $195,000. Those premiums are expected to increase significantly in 2009 due to recent strains on the FDIC deposit insurance fund due to the cost of large bank failures and increase in the number of troubled banks. The current rates for FDIC assessments have ranged from 5 to 43 basis points, depending on the health of the insured institution. The FDIC has proposed increasing that assessment range to 12 to 50 basis points for the first quarter of 2009. For the remainder of 2009, it has proposed a range of 10 to 45 basis points for institutions that do not trigger risk factors for brokered deposits and unsecured debt and higher rates for those that do trigger those risk factors. The FDIC also proposed that it could increase assessment rates in the future without formal rulemaking.

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ITEM 3. QUANTITAVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

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 100, 200 and 300 basis point increases and decreases in market rates on net interest income and is monitored on a quarterly basis.

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. In addition, we may enter into off-balance sheet transactions to mitigate 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.

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

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.

Market Rate	Effect on Net
Change	Interest Income
+300		7.66	%
+200		8.24	%
+100		7.27	%
-100		-9.47	%
-200		-14.51	%
-300		-16.50	%

Additional information required by Item 305 of Regulation S-K is set forth under Item 2 of this report.

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ITEM 4. CONTROLS AND PROCEDURES

An evaluation of the Company’s disclosure controls and procedures as defined in Rule 13a -15(e) under the Securities Exchange Act of 1934 (the “Act”) as of September 30, 2008, was carried out under the supervision and with the participation of the Company’s Chief Executive Officer, Chief Financial Officer and several other members of the Company’s senior management. The Chief Executive Officer and Chief Financial Officer concluded that, as of September 30, 2008, the Company’s disclosure controls and procedures were effective in ensuring that the information required to be disclosed by the Company in the reports it files or submits under the Act is: (i) accumulated and communicated to the Company’s management (including the Chief Executive Officer and the 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. 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 September 30, 2008, that has materially affected, or is likely to materially affect our internal control over financial reporting.

The Company does not expect that its disclosure controls and procedures will prevent all error 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 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 is also 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 changes in conditions, or the degree of compliance with the policies and 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.

The Company intends to continually review and evaluate the design and effectiveness of its disclosure controls and procedures and to improve its controls and procedures over time and to correct any deficiencies that it may discover in the future. The goal is to ensure that senior management has timely access to all material financial and non-financial information concerning the Company’s business. While the Company believes the present design of its disclosure controls and procedures is effective to achieve its goal, future events affecting its business may cause the Company to modify its disclosure controls and procedures.

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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

The following risk factors are in addition to the risk factors contained in the Company’s 2007 Annual Report on Form 10-K for the fiscal year ended December 31, 2007.

Difficult market conditions and economic trends have adversely affected our industry and our business.

Dramatic declines in the housing market, with decreasing home prices and increasing delinquencies and foreclosures, have negatively impacted the credit performance of mortgage and construction loans and resulted in significant writedowns of assets by many financial institutions. General downward economic trends, reduced availability of commercial credit and increasing unemployment have negatively impacted the credit performance of commercial and consumer credit, resulting in additional writedowns. Concerns over the stability of the financial markets and the economy have resulted in decreased lending by financial institutions to their customers and to each other. This market turmoil and tightening of credit has led to increased delinquencies, lack of customer confidence, increased market volatility and widespread reduction in general business activity. Financial institutions have experienced decreased access to deposits or borrowings.

The resulting economic pressure on consumers and businesses and the lack of confidence in the financial markets has adversely affected our business, financial condition, and results of operations.

Our ability to assess the creditworthiness of customers and to estimate the losses inherent in our credit exposure is made more difficult and complex under these difficult market and economic conditions. We also expect to face increased regulation and government oversight as a result of these downward trends. This increased government action may increase our costs and limit our ability to pursue certain business opportunities. We also may be required to pay even higher FDIC premiums than the recently increased level, because financial institution failures resulting from the depressed market conditions have depleted and may continue to deplete the FDIC insurance fund and reduce the FDIC’s ratio of reserves to insured deposits.

We do not expect these difficult conditions to improve in the near future. A worsening of these conditions would likely exacerbate the adverse effects of these difficult market and economic conditions on us, our customers and the other financial institutions in our market. As a result, we may experience increases in foreclosures, delinquencies and customer bankruptcies, as well as more restricted access to funds.

Recent legislative and regulatory initiatives to address these difficult market and economic conditions may not stabilize the U.S. banking system.

The recently enacted Emergency Economic Stabilization Act of 2008 (“EESA”) authorizes the Treasury Department to purchase from financial institutions and their holding companies up to $700 billion in mortgage loans, mortgage-related securities and certain other financial instruments, including debt and equity securities issued by financial institutions and their holding companies in a troubled asset relief program (“TARP”). The purpose of TARP is to restore confidence and stability to the U.S. banking system and to encourage financial institutions to increase their lending to customers and to each other. The Treasury Department has allocated $250 billion towards the TARP Capital Purchase Program (“CPP”). Under the CPP, Treasury will purchase debt or equity securities from participating institutions. The TARP also will include direct purchases or guarantees of troubled asset of financial institutions.

25

EESA also increased FDIC deposit insurance on most accounts from $100,000 to $250,000. This increase is in place until the end of 2009 and is not covered by deposit insurance premiums paid by the banking industry. In addition, the FDIC has implemented two temporary programs to provide deposit insurance for the full amount of most non-interest bearing transaction accounts through the end of 2009 and to guarantee certain unsecured debt of financial institutions and their holding companies through June 2012. Financial institutions have until December 5, 2008 to opt out of these two programs. The purpose of these legislative and regulatory actions is to stabilize the volatility in the U.S. banking system.

EESA, TARP and the FDIC’s recent regulatory initiatives may not have the desired effect. If the volatility in the market and the economy continue or worsen, our business, financial condition, results of operations, access to funds and the price of our stock could be materially and adversely impacted.

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

There were no unregistered sales of equity securities during the quarter ended September 30, 2008.

Below is a summary of issuer purchases of equity securities during the quarter ended September 30, 2008.

					Number of		Maximum
	Total				Shares Purchased		Number of Shares
	Number				as Part of		that may yet be
	of Shares		Average Price		Publicly Announced		Purchased Under the
	Purchased		Paid Per Share		Plans or Programs		Plans or Programs
July		11,621	$	10.38		11,621		45,533
August		—		—		—		45,533
September		37,293		10.29		37,293		8,240
Total		48,914	$	10.31		48,914		8,240

On October 22, 2008, we announced that our board of directors had approved an additional stock purchase plan. Under the terms of the plan, we are authorized to repurchase up to 125,000 shares, which represents approximately 5% of the public shares outstanding. This plan will expire in October 2009 unless completed sooner or otherwise extended.

ITEM 3. DEFAULTS UPON SENIOR SECURITIES

None.

ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS

None.

ITEM 5. OTHER INFORMATION

None.

ITEM 6. EXHIBITS

		Reference to
		Prior Filing
Regulation S-K		or Exhibit Number
Exhibit Number	Document	Attached Hereto
31	Rule 13a-14(a)/15d-14(a) Certifications		31
32	Section 1350 Certifications		32

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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
Date: November 14, 2008	By:	/s/ O. Leonard Dorminey
		O. Leonard Dorminey
		President and Chief Executive Officer
Date: November 14, 2008	By:	/s/ T. Heath Fountain
		T. Heath Fountain
		Senior Vice President and Chief Financial Officer

27

EX-31.1

EXHIBIT 31.1

RULE 13a-14(a) CERTIFICATION

I, O. Leonard Dorminey, certify that:

1. I have reviewed this quarterly report on Form 10-Q of Heritage Financial Group;

2. Based on my knowledge, this report does not contain any untrue statement of material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this report;

3. Based on my knowledge, the financial statements, and other financial information included in this report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this report;

4. The registrant’s other certifying officer and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-15(e) and 15d-15(e) and internal control over financial reporting (as defined in Exchange Act Rules 13a-15(f) and 15d-15(f)) for the registrant and have;

(a)	designed such disclosure controls and procedures, or caused such disclosure controls and procedures to be designed under our supervision, to ensure that material information relating to the Registrant, including its consolidated subsidiary, is made known to us by others within those entities, particularly during the period in which this report is being prepared; and
(b)	Designed such internal control over financial reporting, or caused such internal control over financial reporting to be designed under our supervision, to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principals; and
(c)	evaluated the effectiveness of the Registrant’s disclosure controls and procedures and presented in this report our conclusions about the effectiveness of the disclosure controls and procedures as of the end of the period covered by this report based on such evaluations; and
(d)	disclosed in this report any change in the Registrant’s internal control over financial reporting that occurred during the Registrant’s most recent fiscal quarter that has materially affected, or is reasonably likely to materially affect, the Registrant’s internal control over financial reporting; and

5. The Registrant’s other certifying officer and I have disclosed, based on our most recent evaluation of internal control over financial reporting, to the Registrant’s auditors and the audit committee of Registrant’s board of directors (or persons performing the equivalent functions):

(e)	all significant deficiencies and material weaknesses in the design or operation of internal controls over financial reporting which are reasonably likely to adversely affect the Registrant’s ability to record, process, summarize and report financial information; and
(f)	any fraud, whether or not material, that involves management or other employees who have a significant role in the Registrant’s internal control over financial reporting.

Date: November 14, 2008	By:	/s/ O. Leonard Dorminey
		O. Leonard Dorminey
		President and Chief Executive Officer

EX-31.2

EXHIBIT 31.2

RULE 13a-14(a) CERTIFICATION

I, T. Heath Fountain, certify that:

1.	I have reviewed this quarterly report on Form 10-Q of Heritage Financial Group;
2.	Based on my knowledge, this report does not contain any untrue statement of material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this report;
3.	Based on my knowledge, the financial statements, and other financial information included in this report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this report;
4.	The registrant’s other certifying officer and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-15(e) and 15d-15(e) and internal control over financial reporting (as defined in Exchange Act Rules 13a-15(f) and 15d-15(f)) for the registrant and have;

(g)	designed such disclosure controls and procedures, or caused such disclosure controls and procedures to be designed under our supervision, to ensure that material information relating to the Registrant, including its consolidated subsidiary, is made known to us by others within those entities, particularly during the period in which this report is being prepared; and
(h)	Designed such internal control over financial reporting, or caused such internal control over financial reporting to be designed under our supervision, to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principals; and
(i)	evaluated the effectiveness of the Registrant’s disclosure controls and procedures and presented in this report our conclusions about the effectiveness of the disclosure controls and procedures as of the end of the period covered by this report based on such evaluations; and
(j)	disclosed in this report any change in the Registrant’s internal control over financial reporting that occurred during the Registrant’s most recent fiscal quarter that has materially affected, or is reasonably likely to materially affect, the Registrant’s internal control over financial reporting; and

5. The Registrant’s other certifying officer and I have disclosed, based on our most recent evaluation of internal control over financial reporting, to the Registrant’s auditors and the audit committee of Registrant’s board of directors (or persons performing the equivalent functions):

(k)	all significant deficiencies and material weaknesses in the design or operation of internal controls over financial reporting which are reasonably likely to adversely affect the Registrant’s ability to record, process, summarize and report financial information; and
(l)	any fraud, whether or not material, that involves management or other employees who have a significant role in the Registrant’s internal control over financial reporting.

Date: November 14, 2008	By:	/s/ T. Heath Fountain
		T. Heath Fountain
		Senior Vice President and Chief Financial Officer

EX-32

EXHIBIT 32

SECTION 1350 CERTIFICATION

Each of the undersigned hereby certifies in his or her capacity as an officer of Heritage Financial Group (the “Company”) that the Quarterly Report of the Company on Form 10-Q for the period ended September 30, 2008, fully complies with the requirements of Section 13(a) of the Securities and Exchange Act of 1934, as amended, and that the information contained in such report fairly presents, in all material respects, the financial condition and results of operations of the Company as of the dates and periods presented in the financial statements included in such report.

Date: November 14, 2008	By:	/s/ O. Leonard Dorminey
		O. Leonard Dorminey
		President and Chief Executive Officer
Date: November 14, 2008	By:	/s/ T. Heath Fountain
		T. Heath Fountain
		Senior Vice President and Chief Financial Officer