Quarterly report pursuant to Section 13 or 15(d)

FEDERAL INCOME TAXES

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FEDERAL INCOME TAXES
 9 Months Ended
Sep. 30, 2013
FEDERAL INCOME TAXES [Abstract]  
FEDERAL INCOME TAXES
NOTE 9 - FEDERAL INCOME TAXES

Income tax expense (benefit) was as follows (dollars in thousands):

 
Three Months
  
Three Months
  
Nine Months
  
Nine Months
  
 
Ended
  
Ended
  
Ended
  
Ended
  
 
September 30,
  
September 30,
  
September 30,
  
September 30,
  
 
2013
  
2012
  
2013
  
2012
  
Current
  
$
40
    
$
275
    
$
95
    
$
275
  
Deferred (benefit) expense
    
935
      
---
      
3,218
      
---
  
 
  
$
975
    
$
275
    
$
3,313
    
$
275
  
 
The difference between the financial statement tax expense and amount computed by applying the statutory federal tax rate to pretax income was reconciled as follows (dollars in thousands):
 
 
  
Three Months
    
Three Months
    
Nine Months
    
Nine Months
  
 
  
Ended
    
Ended
    
Ended
    
Ended
  
 
  
September 30,
    
September 30,
    
September 30,
    
September 30,
  
 
  
2013
    
2012
    
2013
    
2012
  
Statutory rate
    
35
%
    
35
%
    
35
%
    
35
%
Statutory rate applied to income before taxes
    
1,124
      
2,401
    
$
3,720
    
$
5,086
  
Add (deduct)
                                
Change in valuation allowance
    
---
      
(1,761
)
    
---
      
(4,056
)
Tax-exempt interest income
    
(70
)
    
(32
)
    
(166
)
    
(64
)
Bank-owned life insurance
    
(63
)
    
(73
)
    
(188
)
    
(230
)
Other, net
    
(16
)
    
(260
)
    
(53
)
    
(461
)
 
  
$
975
    
$
275
    
$
3,313
    
$
275
  

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 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.

Throughout 2012, the positive evidence increased, while the negative evidence decreased.  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 profitability 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 DIFS 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 was “more likely than not” that we will continue to produce earnings and that the positive evidence outweighed 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.  In the second quarter of 2013, the FDIC and DIFS released the Bank’s MOU and we achieved our 14th consecutive quarter of profitability in the third quarter of 2013.  We concluded that no valuation allowance on our net deferred tax asset was necessary at September 30, 2013.
 
The net deferred tax asset recorded included the following amounts of deferred tax assets and liabilities (dollars in thousands):
 
 
  
September 30,
    
December 31,
  
 
  
2013
    
2012
  
Deferred tax assets
  
   
 
Allowance for loan losses
  
$
7,445
    
$
8,309
  
Nonaccrual loan interest
    
828
      
1,023
  
Valuation allowance on other real estate owned
    
6,224
      
6,356
  
Net operating loss carryforward
    
2,088
      
4,188
  
Unrealized loss on securities available for sale
    
780
      
---
  
Other
    
1,776
      
1,794
  
Gross deferred tax assets
    
19,141
      
21,670
  
Valuation allowance
    
---
      
---
  
Total net deferred tax assets
    
19,141
      
21,670
  
 
                
Deferred tax liabilities
                
Depreciation
    
(1,592
)
    
(1,693
)
Unrealized gain on securities available for sale
    
---
      
(517
)
Prepaid expenses
    
(308
)
    
(308
)
Other
    
(382
)
    
(372
)
Gross deferred tax liabilities
    
(2,282
)
    
(2,890
)
Net deferred tax asset
  
$
16,859
    
$
18,780
  

At September 30, 2013, we had federal income tax net operating loss carry forwards of $6.0 million that expire through 2030.

There were no unrecognized tax benefits at September 30, 2013 or December 31, 2012 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.