INCOME TAXES

12 Months Ended

Dec. 31, 2020

Income Tax Disclosure [Abstract]

INCOME TAXES [Text Block]

NOTE 27 – INCOME TAXES

Income tax expense includes Puerto Rico and USVI income taxes, as well as applicable U.S. federal and state taxes. The Corporation is subject to Puerto Rico income tax on its income from all sources. As a Puerto Rico corporation, FirstBank is treated as a foreign corporation for U.S. and USVI income tax purposes and, accordingly, is generally subject to U.S. and USVI income tax only on its income from sources within the U.S. and USVI or income effectively connected with the conduct of a trade or business in those jurisdictions. Any such tax paid in the U.S. and USVI is also creditable against the Corporation’s Puerto Rico tax liability, subject to certain conditions and limitations.

Under the Puerto Rico Internal Revenue Code of 2011, as amended (the “2011 PR Code”), the Corporation and its subsidiaries are treated as separate taxable entities and are not entitled to file consolidated tax returns and, thus, the Corporation is generally not entitled to utilize losses from one subsidiary to offset gains in another subsidiary. Accordingly, in order to obtain a tax benefit from a net operating loss (“NOL”), a particular subsidiary must be able to demonstrate sufficient taxable income within the applicable NOL carry-forward period. Pursuant to the 2011 PR Code, the carry-forward period for NOLs incurred during taxable years that commenced after December 31, 2004 and ended before January 1, 2013 is 12 years; for NOLs incurred during taxable years commencing after December 31, 2012, the carryover period is 10 years. The 2011 PR Code provides a dividend received deduction of 100% on dividends received from “controlled” subsidiaries subject to taxation in Puerto Rico and 85% on dividends received from other taxable domestic corporations.

On December 10, 2018, the Governor of Puerto Rico signed into law Act 257 (“Act 257”) to amend some of the provisions of the 2011 PR Code, as amended. Act 257 introduced various changes to the income tax regime in the case of individuals and corporations, and the sales and use taxes, which took effect on January 1, 2019, including, among others, (i) a reduction in the Puerto Rico maximum corporate tax rate from 39% to 37.5%; (ii) an increase in the net operating and capital losses usage limitation from 80% to 90%; (iii) amendments to the provisions related to “pass-through” entities that provide that corporations that own 50% or more of a partnership will not be able to claim a current or carryover non-partnership NOL deduction against a partnership distributable share, adversely impacting a tax action taken in 2017 under which the Corporation and the Bank were previously allowed to offset pass-through income earned by pass-through entities with non-partnership net operating losses at the parent company level, more significantly in connection with the pass-through income earned by FirstBank Insurance; and (iv) other limitations on certain deductions, such as meals and entertainment deductions.

The Corporation has maintained an effective tax rate lower than the maximum statutory rate mainly by investing in government obligations and MBS exempt from U.S. and Puerto Rico income taxes and by doing business through an IBE unit of the Bank, and through the Bank’s subsidiary, FirstBank Overseas Corporation, whose interest income and gains on sales is exempt from Puerto Rico income taxation. The IBE unit and FirstBank Overseas Corporation were created under the International Banking Entity Act of Puerto Rico, which provides for total Puerto Rico tax exemption on net income derived by IBEs operating in Puerto Rico on the specific activities identified in the IBE Act. An IBE that operates as a unit of a bank pays income taxes at the corporate standard rates to the extent that the IBE’s net income exceeds 20% of the bank’s total net taxable income.

The CARES Act of 2020 includes several provisions to stimulate the U.S. economy in the midst of the COVID-19 pandemic. Among these, are tax provisions that temporarily modified the taxable income limitations for NOL usage to offset future taxable income, NOL carryback provisions and other related income and non-income based tax laws. The Corporation has evaluated such provisions and determined that the impact of the CARES Act of 2020 on the income tax provision and deferred tax assets as of December 31, 2020 was not significant.

The components of income tax expense (benefit) are summarized below for the indicated periods:

		Year Ended December 31,
		2020		2019		2018
(In thousands)
Current income tax expense	$	18,421	$	16,986	$	14,073
Deferred income tax expense (benefit):
Adjustment for enacted changes in tax law		-		-		15,402
Reversal of deferred tax asset valuation allowance		(8,000)		-		(63,228)
Other deferred income tax expense		3,629		55,009		22,783
Total income tax expense (benefit)	$	14,050	$	71,995	$	(10,970)

	The differences between the income tax expense applicable to income before the provision for income taxes and the amount computed by applying the statutory tax rate in Puerto Rico were as follows for the indicated periods:
		Year Ended December 31,
		2020					2019					2018
		Amount		% of Pretax Income			Amount		% of Pretax Income			Amount		% of Pretax Income
(Dollars in thousands)
Computed income tax at statutory rate		$	43,621		37.5	%	$	89,764		37.5	%	$	74,349		39.0	%
Federal and state taxes			4,944		4.2	%		4,467		1.6	%		3,768		2.0	%
Benefit of net exempt income			(26,780)		(23.0)	%		(24,811)		(10.4)	%		(22,782)		(12.0)	%
Disallowed NOL carryforward resulting from
	net exempt income		9,054		7.8	%		15,887		6.6	%		14,904		7.8	%
Deferred tax valuation allowance			(12,095)		(10.4)	%		(14,108)		(5.9)	%		(90,521)		(47.5)	%
Adjustments in net deferred tax assets due to changes
	in enacted tax rates		-		-	%		-		-	%		15,402		8.1	%
Share-based compensation windfall			157		0.1	%		(1,165)		(0.5)	%		(1,595)		(0.8)	%
Nondeductible expenses
	and other permanent differences		(387)		(0.3)	%		(1,712)		(0.7)	%		(839)		(0.4)	%
Tax return to provision adjustments			597		0.5	%		1,846		0.8	%		4		-	%
Other-net			(5,061)		(4.3)	%		1,827		1.1	%		(3,660)		(1.9)	%
Total income tax expense (benefit)		$	14,050		12.1	%	$	71,995		30.1	%	$	(10,970)		(5.7)	%

Deferred income taxes reflect the net tax effects of temporary differences between the carrying amounts of assets and liabilities for financial reporting purposes and their tax bases. Significant components of the Corporation's deferred tax assets and liabilities as of December 31, 2020 and 2019 were as follows:
		December 31,
		2020		2019
(In thousands)
Deferred tax asset:
NOL carryforward	$	220,496	$	259,717
Allowance for credit losses		151,586		58,793
Alternative Minimum Tax credits available for carryforward		27,396		13,813
Unrealized loss on OREO valuation		13,426		13,963
Settlement payment-closing agreement		7,031		7,031
Legal and other reserves		4,120		2,791
Reserve for insurance premium cancellations		941		613
Differences between the assigned values and tax bases of assets and
liabilities recognized in purchase business combinations		11,956		-
Other		8,647		9,722
Total gross deferred tax assets	$	445,599	$	366,443
Deferred tax liabilities:
Differences between the assigned values and tax bases of assets
and liabilities recognized in purchase business combinations		-		3,823
Servicing assets		9,571		8,906
Unrealized gain on available-for-sale securities, net		4,730		1,808
Other		53		511
Total gross deferred tax liabilities		14,354		15,048
Valuation allowance		(101,984)		(86,553)
Net deferred tax asset	$	329,261	$	264,842

Accounting for income taxes requires that companies assess whether a valuation allowance should be recorded against their deferred tax asset based on an assessment of the amount of the deferred tax asset that is “more likely than not” to be realized. Valuation allowances are established, when necessary, to reduce deferred tax assets to the amount that is more likely than not to be realized. Management assesses the valuation allowance recorded against deferred tax assets at each reporting date. The determination of whether a valuation allowance for deferred tax assets is appropriate is subject to considerable judgment and requires the evaluation of positive and negative evidence that can be objectively verified. Consideration must be given to all sources of taxable income available to realize the deferred tax asset, including, as applicable, the future reversal of existing temporary differences, future taxable income forecasts exclusive of the reversal of temporary differences and carryforwards, and tax planning strategies. In estimating taxes, management assesses the relative merits and risks of the appropriate tax treatment of transactions taking into account statutory, judicial, and regulatory guidance.

On January 1, 2020, the Corporation increased its deferred tax assets by $31.3 million in connection with the transitional adjustment resulting from the adoption of the CECL accounting standard. In addition, the BSPR acquisition added $28.9 million of net deferred tax assets as of the acquisition date. In connection with the acquisition of BSPR, the Corporation re-evaluated the forecast of its projected taxable income, and, after consideration of the available positive and negative evidence, a partial release of the valuation allowance of $8.0 million was recorded in the third quarter of 2020.

After completion of the deferred tax asset valuation allowance analysis for the fourth quarter of 2020, management concluded that, as of December 31, 2020, it is more likely than not that FirstBank, the banking subsidiary, will generate sufficient taxable income to realize $144.7 million of its deferred tax assets related to NOLs within the applicable carry-forward periods. The net deferred tax assets of FirstBank amounted to $329.1 million as of December 31, 2020, net of a valuation allowance of $59.9 million, compared to a deferred tax asset of $264.8 million, net of a valuation allowance of $55.6 million, as of December 31, 2019. The positive evidence considered by management in arriving at its conclusion included factors such as: FirstBank’s three-year cumulative income position; sustained periods of profitability; management’s proven ability to forecast future income accurately and execute tax strategies; forecasts of future profitability, under several potential scenarios that support the partial utilization of NOLs prior to their expiration

from 2021 through 2024; and the utilization of NOLs over the past three-years. The negative evidence considered by management included: uncertainties about the state of the Puerto Rico economy, including considerations on the impact of hurricane and pandemic recovery funds together with Puerto Rico government debt renegotiation efforts and the ultimate sustainability of the latest fiscal plan certified by the PROMESA oversight board.

Management’s estimate of future taxable income is based on internal projections that consider historical performance, multiple internal scenarios and assumptions, as well as external data that management believes is reasonable. If events are identified that affect the Corporation’s ability to utilize its deferred tax assets, the analysis will be updated to determine if any adjustments to the valuation allowance are required. If actual results differ significantly from the current estimates of future taxable income, even if caused by adverse macro-economic conditions, the remaining valuation allowance may need to be increased. Such an increase could have a material adverse effect on the Corporation’s financial condition and results of operations. Conversely, a higher than projected proportion of taxable income to exempt income could lead to a higher usage of available NOLs and a lower amount of disallowed NOLs from projected levels of tax-exempt income, per the 2011 PR code, which in turn could result in further releases of the deferred tax valuation allowance; any such decreases could have a material positive effect on the Corporation’s financial condition and results of operations.

As of December 31, 2020, approximately $210.7 million of the deferred tax assets of the Corporation are attributable to temporary differences or tax credit carryforwards that have no expiration date, compared to $92.0 million in 2019. The valuation allowance attributable to FirstBank’s deferred tax assets of $59.9 million as of December 31, 2020 is related to the estimated NOL disallowance attributable to projected levels of tax-exempt income, NOLs attributable to the Virgin Islands jurisdiction, and capital losses. The remaining balance of $43 million of the deferred tax asset valuation allowance non-attributable to FirstBank is mainly related to NOLs and capital losses at the holding company level. The Corporation will continue to provide a valuation allowance against its deferred tax assets in each applicable tax jurisdiction until the need for a valuation allowance is eliminated. The need for a valuation allowance is eliminated when the Corporation determines that it is more likely than not the deferred tax assets will be realized. The ability to recognize the remaining deferred tax assets that continue to be subject to a valuation allowance will be evaluated on a quarterly basis to determine if there are any significant events that would affect the ability to utilize these deferred tax assets.

The Corporation has U.S. and USVI sourced NOL carryforwards. Section 382 of the U.S. Internal Revenue Code (“Section 382”) limits the ability to utilize U.S. and USVI NOLs for income tax purposes in such jurisdictions following an event that is considered to be an “ownership change”. Generally, an “ownership change” occurs when certain shareholders increase their aggregate ownership by more than 50 percentage points over their lowest ownership percentage over a three-year testing period. Upon the occurrence of a Section 382 ownership change, the use of NOLs attributable to the period prior to the ownership change is subject to limitations and only a portion of the U.S. and USVI NOLs may be used by the Corporation to offset its annual U.S. and USVI taxable income, if any.

In 2017, the Corporation completed a formal ownership change analysis within the meaning of Section 382 covering a comprehensive period and concluded that an ownership change had occurred during such period. The Section 382 limitation has resulted in higher U.S. and USVI income tax liabilities than we would have incurred in the absence of such limitation. The Corporation has mitigated to an extent the adverse effects associated with the Section 382 limitation as any such tax paid in the U.S. or USVI is creditable against Puerto Rico tax liabilities or taken as a deduction against taxable income. However, our ability to reduce our Puerto Rico tax liability through such a credit or deduction depends on our tax profile at each annual taxable period, which is dependent on various factors. For 2020 and 2019, the Corporation incurred an income tax expense of approximately $4.9 million and $4.5 million, respectively, related to its U.S. operations. The limitation did not impact the USVI operations in 2020 and 2019.

The Corporation accounts for uncertain tax positions under the provisions of ASC Topic 740. The Corporation’s policy is to report interest and penalties related to unrecognized tax benefits in income tax expense. As of December 31, 2020, the Corporation had an expense of $117 thousand of interest and penalties related to uncertain tax positions in the amount of $1.0 million that it acquired from BSPR, which, if recognized, would decrease the effective income tax rate in future periods. The amount of unrecognized tax benefits may increase or decrease in the future for various reasons, including adding amounts for current tax year positions, expiration of open income tax returns due to the statute of limitations, changes in management’s judgment about the level of uncertainty, the status of examinations, litigation, and legislative activity, and the addition or elimination of uncertain tax positions. The statute of limitations under the 2011 PR code is four years; the statute of limitations for U.S. and USVI income tax purposes is three years after a tax return is due or filed, whichever is later. The completion of an audit by the taxing authorities or the expiration of the statute of limitations for a given audit period could result in an adjustment to the Corporation’s liability for income taxes. Any such adjustment could be material to the results of operations for any given quarterly or annual period based, in part, upon the results of operations for the given period. For U.S. and USVI income tax purposes, all tax years subsequent to 2016 remain open to examination. For Puerto Rico tax purposes, all tax years subsequent to 2015 remain open to examination.