NOTE 18—INCOME TAXES

The provision for income taxes was $130.8 million in 2013, representing an effective tax rate of 30.7%, compared to $143.9 million, representing an effective tax rate of 33.8% and $138.1 million, representing an effective tax rate of 36.0% for 2012 and 2011, respectively. Included in the income tax recognized during 2013 is $35.0 million in tax credits generated from our investments in affordable housing partnerships and other investments and other federal tax credits. In comparison, included in the income tax recognized during 2012 and 2011 are $18.7 million and $11.1 million, respectively, in tax credits generated from our investments in affordable housing partnerships and other investments.

Management regularly reviews the Company’s tax positions and deferred tax assets. Factors considered in this analysis include future reversals of existing temporary differences, future taxable income exclusive of reversing differences, taxable income in prior carryback years, and tax planning strategies. The Company accounts for income taxes using the asset and liability approach, the objective of which is to establish deferred tax assets and liabilities for the temporary differences between the financial reporting basis and the tax basis of the Company’s assets and liabilities at enacted rates expected to be in effect when such amounts are realized and settled. Based on the available evidence, Management has concluded that it is more likely than not that all of the benefit of the deferred tax assets will be realized, with the exception of the deferred tax assets related to certain state net operating loss carryforwards and certain foreign losses. Accordingly, a valuation allowance has been recorded for these amounts.

As of December 31, 2013, the Company had a net deferred tax asset of $255.5 million.

The provision for income taxes consists of the following components:

	Year Ended December 31,
	2013		2012		2011
	(Dollars in thousands)
Current income tax expense (benefit):
Federal	$	131,236	$	148,572	$	(86,157)
State	44,389		2,316		34,760
Foreign	208		5,704		—
Total current income tax expense (benefit)	175,833		156,592		(51,397)
Deferred income tax (benefit) expense:
Federal	(32,963)		(38,749)		193,834
State	(13,677)		26,099		(7,706)
Foreign	1,612		—		3,369
Total deferred income tax (benefit) expense	(45,028)		(12,650)		189,497
Provision for income taxes	$	130,805	$	143,942	$	138,100

The difference between the effective tax rate implicit in the consolidated financial statements and the statutory federal income tax rate can be attributed to the following:

	Year Ended December 31,
	2013	2012	2011
Federal income tax provision at statutory rate	35.0%	35.0%	35.0%
State franchise taxes, net of federal tax effect	4.7	4.3	4.3
Tax credits	(8.4)	(5.3)	(2.7)
Other, net	(0.6)	(0.2)	(0.6)
Effective income tax rate	30.7%	33.8%	36.0%

The Company recognizes investment tax credits from low income housing and other investments in the year the credit arises under the flow-through method of accounting. The tax effects of temporary differences that give rise to significant portions of the deferred tax assets (liabilities) are presented below:

	December 31,
	2013								2012
	Federal		State		Foreign		Total		Federal		State		Foreign		Total
	(In thousands)
Deferred tax liabilities:
Core deposit intangibles	$	(16,422)	$	(4,642)	$	—	$	(21,064)	$	(15,755)	$	(4,635)	$	133	$	(20,257)
Affordable housing partnerships and other investments	(14,158)		(1,730)		—		(15,888)		(16,221)		(4,337)		—		(20,558)
Fixed assets	(15,594)		(3,879)		—		(19,473)		(17,201)		(4,289)		—		(21,490)
FHLB stock	(11,337)		(3,224)		—		(14,561)		(17,670)		(9,140)		—		(26,810)
Deferred loan fees	(1,976)		(557)		—		(2,533)		(2,523)		(719)		—		(3,242)
Purchased loan discounts	(98)		(28)		—		(126)		(126)		(36)		—		(162)
State taxes	(1,079)		—		—		(1,079)		(7,894)		—		—		(7,894)
Mortgage servicing assets	—		—		—		—		(1,812)		(517)		—		(2,329)
Section 597 gain	(48,370)		(1,317)		—		(49,687)		(94,231)		(2,684)		—		(96,915)
FDIC receivable	(245,907)		(6,695)		—		(252,602)		(318,741)		(9,405)		—		(328,146)
Acquired debt	(10,812)		(1,042)		—		(11,854)		(10,812)		(1,061)		(300)		(12,173)
Other, net	(6,805)		923		—		(5,882)		(604)		627		—		23
Total gross deferred tax (liabilities)	(372,558)		(22,191)		—		(394,749)		(503,590)		(36,196)		(167)		(539,953)
Deferred tax assets:
Allowance for loan losses and REO reserves	93,018		23,046		—		116,064		93,924		23,281		(5,220)		111,985
Deferred compensation	13,322		3,824		—		17,146		18,213		5,262		—		23,475
Mortgage servicing assets	287		81		—		368		—		—		—		—
Purchased loan premium	424		120		—		544		485		139		—		624
Unrealized loss on securities	62,535		19,177		—		81,712		47,567		12,816		—		60,383
Net operating loss carryforwards	—		993		—		993		—		698		—		698
Acquired loans and REOs	366,290		26,959		959		394,208		478,825		29,796		7,957		516,578
Other, net	30,768		8,716		97		39,581		9,021		3,177		97		12,295
Total gross deferred tax assets	566,644		82,916		1,056		650,616		648,035		75,169		2,834		726,038
Valuation allowance	—		(337)		—		(337)		—		(372)		—		(372)
Net deferred tax assets	$	194,086	$	60,388	$	1,056	$	255,530	$	144,445	$	38,601	$	2,667	$	185,713

Management believes that it is more likely than not that all of the deferred tax assets recorded at December 31, 2013 will be realized (except to the extent of the recorded valuation allowance) because it expects to have sufficient taxable income in future years to fully realize them. A valuation allowance has been provided for the state net operating losses (“NOLs”) (for states other than California, Georgia, Massachusetts and New York) since management believes that these NOLs may not be fully utilized. At December 31, 2013, the Bank had state net operating loss carryforwards of approximately $6.0 million.

The following table summarizes the activity related to our unrecognized tax benefits:

	Year Ended December 31,
	2013		2012
	(Dollars in thousands)
Balance, beginning of year	$	3,457	$	3,332
Additions for tax positions of prior years	232		—
Reductions for tax positions of prior years	—		—
Additions for tax positions of current year	988		1,060
Settlements	—		(935)
Balance, end of year	$	4,677	$	3,457

For the years ended December 31, 2013 and 2012, the Company increased the unrecognized tax benefits reserve by $1.2 million and $1.1 million, respectively, for the California enterprise zone net interest deduction. There were no reductions in unrecognized tax benefits for 2013. As of December 31, 2013 and 2012, the liability for uncertain tax positions was $6.3 million and $6.1 million, respectively. Also, for the years ended December 31, 2013 and 2012, the total amount of unrecognized tax benefits that, if recognized, would impact the effective tax rate is $3.0 million and $2.2 million, respectively.

During 2013, the Company closed the Internal Revenue Service (“IRS”) examination of the 2011 tax year with no material changes. In 2012, the Company executed a Memorandum of Understanding (“MOU”) with the IRS for the 2012 tax year to voluntarily participate in the IRS Compliance Assurance Process (“CAP”) where the IRS will assist the Company in identifying and resolving any tax issues that may arise throughout the 2012 tax year. The objective of the CAP is to resolve issues in a timely and contemporaneous manner and eliminate the need for a lengthy post-filing examination. The 2012 tax return filed in September 2013 received a full acceptance of all tax matters from the IRS. The Company has entered a MOU with the IRS for the 2013 and 2014 tax years. For federal tax purposes, tax years from 2010 and beyond remain open. For California franchise tax purposes, tax years from 2003 and beyond remain open. The states of Alabama, Florida, New York, Ohio and Texas have initiated audits of East West Bank’s corporate income tax returns through the 2012 tax year. The Company does not believe that the outcome of unresolved issues or claims in any tax jurisdiction is likely to be material to the Company’s financial position, cash flows or results of operations. The Company further believes that adequate provisions have been made for all income tax uncertainties. The Company does not anticipate that the total amount of unrecognized tax benefits will significantly change during the year ending December 31, 2014.

The Company recognizes interest and penalties, if applicable, related to the underpayment of income taxes as a component of income tax expense in the consolidated statement of operations. The Company accrued interest and penalties of ($744) thousand, $1.2 million and $287 thousand for its unrecognized tax positions as of December 31, 2013, 2012 and 2011, respectively. Total interest and penalties accrued as of December 31, 2013 and 2012 were $1.6 million and $2.7 million, respectively.