INCOME TAXES

The following table summarizes significant components of income tax expense (benefit) for the periods presented:



	Successor Company			Predecessor Company
	February 1 to December 31, 2012			January 1 to January 31, 2012		Year Ended December 31, 2011
Current tax expense:
Federal	$	69		$	—	$	—
State	—			—		—
	69			—		—
Deferred tax expense (benefit):
Federal	(209		)	208		276
State	(46		)	62		60
	(255		)	270		336
Provision for income tax expense (benefit) before adjustment to deferred tax asset valuation allowance	(186		)	270		336
Deferred tax asset valuation allowance	(3,300		)	—		(148		)
Income tax expense (benefit)	$	(3,486	)	$	270	$	188

Income tax expense (benefit) is reconciled to the amount computed by applying the statutory federal income tax rate of 34 percent to net income before income taxes as follows:



	Successor Company			Predecessor Company
	February 1 to December 31, 2012			January 1 to January 31, 2012			Year Ended December 31, 2011

Tax computed at statutory rate of 34%	$	91		$	272		$	15
Effect of state income taxes	(30		)	41			(43		)
Non-taxable interest income	(174		)	(15		)	(21		)
Non-taxable bank-owned life insurance	(226		)	(21		)	(31		)
Non-deductible merger costs	488			—			71
Deferred tax asset valuation allowance	(3,300		)	—			(148		)
Other	(335		)	(7		)	345
	$	(3,486	)	$	270		$	188

Significant components of deferred taxes as of December 31, 2012 and 2011 were as follows:



	Successor Company		Predecessor Company
	2012		2011
Deferred tax assets:
Net operating loss carryforward	$	16,278	$	15,869
Recognized built-in loss carryforward	13,571		1,037
Purchase accounting fair value adjustments	6,038		19,976
Allowance for loan losses	1,164		282
Stock based compensation	563		241
Organizational expenses	324		357
Deferred compensation	—		296
Other	965		479
Total deferred tax assets	38,903		38,537
Valuation allowance	—		(4,173		)
Net deferred tax assets	38,903		34,364

Deferred tax liabilities:
Unrealized gains on securities	1,227		170
Foreclosed assets	722		—
Premises and equipment	122		108
Prepaid expenses	173		151
Total deferred tax liabilities	2,244		429
Net deferred tax asset	$	36,659	$	33,935

Piedmont's acquisition of Crescent Financial in November 2011 was considered a change in control under Internal Revenue Code Section 382 (“Section 382”) and the Regulations thereunder. Accordingly, the Company is required to evaluate potential limitation or deferral of its ability to carryforward pre-acquisition net operating losses ("NOLs") and to determine the amount of net unrealized built-in losses (“NUBIL”), which may be subject to similar limitation or deferral. Under the Internal Revenue Code and Regulations, NUBIL recognized within five years of the change in control are subject to potential limitation, which for the Company is November 18, 2016. Through that date, management will continue to analyze the Company's ability to utilize such losses to offset anticipated future taxable income, however, this amount will not be known until the five-year recognition period expires. Recognized built-in losses are generally limited to a carryforward period of twenty years, subject to the annual limitation and expire if not used by the end of that period. The Company believes that all of these benefits from the NOLs and built-in losses will ultimately be realized, however, that amount is subject to continuing analysis and will not be finalized until the five-year recognition period expires. There are no Section 382 limitations on utilization of Legacy VantageSouth or Rowan's pre-acquisition NOLs.

As of December 31, 2012, the Company had NOLs available for carryforward of $41,619 that will expire, if unused, from 2026 through 2031. The Company also had recognized built-in losses in excess of annual limitations of $35,200 that will expire, if unused, in 2031 and 2032.

In the fourth quarter of 2012, due to the improvement in the Company's recent earnings and earnings forecasts, a valuation allowance related to Legacy VantageSouth's deferred taxes generated before and after its acquisition by Piedmont was reversed, which resulted in a $3,300 tax benefit. Prior to reversing the valuation allowance, management evaluated the Company's deferred tax assets (“DTAs”) to determine whether a valuation allowance was necessary as of December 31, 2012. In conducting this evaluation, all available evidence was considered, both positive and negative, based on the more-likely-than-not criteria that such assets will be realized. Some of the positive and negative evidence management considered is summarized below.

Positive evidence regarding the Company's DTAs is as follows:

1. Earnings trends and forecasts

The Company generated income before taxes of $307 in the 2012 successor period, $799 in the 2012 predecessor period, and $1,156 in predecessor 2011 on strong net interest margins as well as SBA and mortgage income. This income was generated despite merger, conversion and re-branding costs of $3,500 in 2012. Legacy VantageSouth, which was the predecessor company to Crescent Financial, incurred a net loss before income taxes of $4,811 in 2010 as it took provision and other loan related charges of $4,700 to resolve legacy problem assets.

Management monitors the Company’s performance against its business plan and forecast on a regular basis. Based on the business plan and forecast, which consider certain improvements to the Company’s business, management currently expects the Company's net income before taxes to build to levels sufficient to fully absorb the existing DTA. The improvements in the Company's business and earnings prospects include expected cost savings from the Crescent State Bank/Legacy VantageSouth merger and system conversion; the Company's significant recent and expected loan growth; and new earnings initiatives which include the creation of the Builder Finance division, increased focus on SBA lending and secondary marketing, continued emphasis on the mortgage banking business, and other revenue generating opportunities.

2. Robust capital levels and access to capital

The Bank's tier 1 capital and total risk-based capital ratios were 11.45 percent and 14.96 percent, respectively, as of December 31, 2012, which were both in excess of the regulatory definition of a "well capitalized" bank. Additionally, Piedmont has demonstrated its ability to source new capital by raising approximately $153,500 in capital from its investors since its first bank acquisition in 2010.

3. Sufficient liquidity

The Bank was in compliance with all liquidity policy requirements as of December 31, 2012 and maintained high levels of off balance sheet liquidity.

4. Declining problem asset levels

Nonperforming loans to total loans declined from 5.09 percent as of December 31, 2011 to 2.44 percent as of December 31, 2012, and nonperforming assets to total assets declined from 3.44 percent to 1.71 percent that period. The Bank's classified asset ratio to tier 1 capital plus allowance for loan losses improved to approximately 35 percent as of December 31, 2012 from 55 percent as of December 31, 2011. The Company has developed a strong underwriting culture and requires all loans to be approved by the credit administration function. Credit administrators have been designated for each line of business, i.e., commercial real estate, commercial and industrial, SBA, Builder Finance, mortgage, and consumer.

5. Sufficient carryforward period

The Company's NOL carryforward periods were evaluated to determine whether the Company has sufficient time to execute on its business plan, which will allow it generate taxable income to fully realize NOLs. Based on management's evaluation, the NOLs have been incurred in recent years and are described as follows.

•Legacy VantageSouth's earliest NOL year was 2006, and this 2006 NOL is available to be used through 2026.


•	Rowan's earliest NOL year was 2011, and this 2011 NOL is available to be used through 2031.

•Crescent Financial's earliest NOL year was 2010, and this 2010 NOL is available to be used through 2030.

6. Tax planning strategies

Reasonable tax planning strategies were considered, which included liquidation of non-taxable municipal bonds and bank-owned life insurance investments. If so desired, the Company could reinvest the proceeds in taxable securities or other earning assets. Liquidation of bank-owned life insurance would likely reduce future book income and would also result in a tax penalty but could potentially provide additional taxable income in future years that would allow the Company to more quickly realize its DTA. In the first quarter of 2013, the Company executed on part of this strategy by liquidating its non-taxable municipal bonds at a gain. The proceeds from this sale were reinvested in taxable securities. Another tax planning strategy is a possible sale-leaseback transaction involving certain of the Company's branch offices.

Negative evidence regarding the necessity of a DTA valuation allowance is as follows:

1. Size of DTA relative to the size of the company

Given the NOLs and realized built-in losses that have already been incurred, the Company needs to execute on its business plan over the next several years to avoid potential concerns regarding the loss of those tax benefits.

2. Limited track record of profits

Piedmont acquired its first bank in 2010, and the combined Company first became profitable in 2011. Because of its recent formation, the Company has a relatively limited track record of generating taxable income and executing on its business plan.

3. Uncertain regulatory environment

The risks from an uncertain regulatory environment negatively affect nearly all financial institutions.

4. Merger risks

The Company's business plan calls for significant growth over the coming years through organic activity as well as merger and acquisition activity. Future mergers may significantly impact the Company's ability to realize its current tax benefits, both positively and negatively.

5. Limitation on bank-owned life insurance tax planning strategies

Potential benefits of liquidating the Company's bank-owned life insurance are limited by significant one-time tax penalties that would be incurred.

Based on the Company's evaluation which considered the weight of the positive evidence compared to the negative evidence, management concluded that a valuation allowance was not necessary as of December 31, 2012 and that reversal of its partial valuation allowance in the fourth quarter of 2012 was appropriate.

The Company’s federal income tax returns are currently under examination from the 2008 through the 2010 tax return years. The Company’s state income tax returns are open and subject to examination from the 2008 tax return year and forward.