Annual report pursuant to Section 13 and 15(d)

FEDERAL INCOME TAXES

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FEDERAL INCOME TAXES
 12 Months Ended
Dec. 31, 2012
FEDERAL INCOME TAXES [Abstract]  
FEDERAL INCOME TAXES
NOTE 14 - FEDERAL INCOME TAXES

Income tax expense (benefit) was as follows (dollars in thousands):
 
   
2012
    
2011
  
             
Current
   $ 275     $ (198 )
Deferred
     ---       198  
Valuation allowance – change in estimate
     (18,858 )     ---  
                 
Tax expense (benefit)
   $ (18,583 )   $ ---  

The difference between the financial statement tax expense (benefit) and amount computed by applying the statutory federal tax rate to pretax income was reconciled as follows (dollars in thousands):

   
2012
    
2011
  
             
Statutory rate
     35 %     35 %
Statutory rate applied to income before taxes
   $ 5,917     $ 2,040  
Add (deduct)
                
Change in valuation allowance
     (24,026 )     (1,624 )
Tax-exempt interest income
     (103 )     (10 )
Bank-owned life insurance
     (297 )     (330 )
Other, net
     (74 )     (76 )
    $ (18,583 )   $ ---  

The realization of deferred tax assets (net of a recorded valuation allowance) is largely dependent upon future taxable income, future reversals of existing taxable temporary differences and the ability to carryback losses to available tax years. In assessing the need for a valuation allowance, we consider all positive and negative evidence, including taxable income in carry-back years, scheduled reversals of deferred tax liabilities, expected future taxable income and tax planning strategies.

We established an $18.0 million valuation allowance on deferred tax assets in 2009 based primarily on our net operating losses for 2009 and 2008. As a result of losses incurred in 2010, we increased the valuation allowance to $25.6 million at December 31, 2010. At December 31, 2011, a valuation allowance of $24.0 million was maintained.

Over the past several quarters, the positive evidence has been increasing, while the negative evidence has been decreasing. The most significant negative evidence at December 31, 2012 was the level of other real estate owned at $51.6 million, which was down $14.8 million from December 31, 2011. We achieved our 11th consecutive quarter of profit as of December 31, 2012. With the positive results of the fourth quarter of 2012, we moved into a cumulative income position for the most recent three year period. In the first quarter of 2012, the FDIC and OFIR terminated the Bank's Consent Order and, in the fourth quarter of 2012, the FRB terminated its Written Agreement with the Company, reducing regulatory uncertainty. Based on this, sustained improvement in asset quality and our projected results, our analysis at December 31, 2012 concluded that it is "more likely than not" that we will continue to produce earnings and that the positive evidence outweighs the negative evidence regarding our ability to utilize our deferred tax assets. As such, the full valuation allowance of $18.9 million was reversed to federal income tax expense at December 31, 2012.

The net deferred tax asset recorded included the following amounts of deferred tax assets and liabilities (dollars in thousands):

   
December 31,
2012
    
December 31,
2011
  
Deferred tax asset
            
Allowance for loan losses
   $ 8,309     $ 11,074  
Nonaccrual loan interest
     1,023       839  
Valuation allowance on other real estate owned
     6,356       6,029  
Net operating loss carryforward
     4,188       7,673  
Other
     1,794       1,137  
Gross deferred tax assets
     21,670       26,752  
Valuation allowance
     ---       (24,026 )
Total net deferred tax assets
     21,670       2,726  
                 
Deferred tax liabilities
                
Depreciation
     (1,693 )     (1,758 )
Purchase accounting adjustments
     ---       (22 )
Unrealized gain on securities available for sale
     (517 )     (204 )
Prepaid expenses
     (308 )     (407 )
Other
     (372 )     (335 )
Gross deferred tax liabilities
     (2,890 )     (2,726 )
                 
Net deferred tax asset
   $ 18,780     $ ---  

At December 31, 2012, we had federal net operating loss carryforwards of $12.0 million that expire through 2030.

There were no unrecognized tax benefits at December 31, 2012 or 2011 and the Company does not expect the total amount of unrecognized tax benefits to significantly increase or decrease in the next twelve months. The Company is no longer subject to examination by the Internal Revenue Service for years before 2009.