Income Taxes

Income tax expense for the three and nine months ended September 30, 2011 was $2.4 million and $6.9 million, respectively, compared to income tax benefit of $1.3 million for the three months ended September 30, 2010, and $566,000 for the nine months ended September 30, 2010. The significant increase in income tax expense for the nine months ended September 30, 2011 is attributable to valuation allowances for deferred tax assets of $11.0 million recorded in the second quarter of 2011. The following table presents the provision for income taxes for the nine months ended September 30, 2011 and 2010:



	2011			2010
	(in thousands)
Current:
Federal	$	1,627		$	(3,314	)
State	—			—
	1,627			(3,314		)
Deferred:
Federal	(5,120		)	2,943
State	(602		)	(195		)
	(5,722		)	2,748
Increase in valuation allowance for deferred tax assets	11,000			—
Total income taxes	$	6,905		$	(566	)

The following table presents the tax effects of significant components of the Company's net deferred tax assets as of September 30, 2011 and December 31, 2010:



	September 30,			December 31,
	2011			2010
	(in thousands)
Deferred tax assets:
Allowance for loan losses	$	13,205		$	14,809
Other than temporary impairment	807			467
Accrued liabilities	272			529
OREO property	1,264			680
Net operating loss	7,699			4,652
Other	1,835			515
	25,082			21,652
Less: Valuation Allowance	(11,000		)	—
	$	14,082		$	21,652

Deferred tax liabilities:
Unrealized gain on available-for-sale securities	$	(2,459	)	$	(333	)
FMV adjustment related to mergers	(233		)	(50		)
Depreciation	(1,980		)	(2,215		)
Prepaid expenses	(327		)	(357		)
Core deposit intangible	(1,579		)	(1,929		)
Noncompete intangible	(232		)	(232		)
Goodwill	1,083			(764		)
Other	(125		)	(137		)
	$	(5,852	)	$	(6,017	)
Net deferred tax asset	$	8,230		$	15,635

As of September 30, 2011, deferred tax assets of $25.1 million reduced by a valuation allowance of $11.0 million and $5.9 million in deferred tax liabilities, resulted in a net deferred tax asset of approximately $8.2 million. Deferred tax assets of $21.6 million as of December 31, 2010, reduced by $6.0 million in deferred tax liabilities, resulted in a net deferred tax asset of approximately $15.6 million.

In evaluating whether the Company will realize the full benefit of its net deferred tax asset, it considers both positive and negative evidence, including recent earnings trends and projected earnings, asset quality, etc. A valuation allowance is provided when it is more likely than not that some portion of the deferred tax asset will not be realized. Due to a cumulative three-year, pre-tax loss position, significant net operating losses in 2011, and ongoing stress on the Company's financial performance from elevated credit losses, the Company has reserved $11.0 million against deferred tax assets as of September 30, 2011. In future periods, the Company may be able to reduce some or all of the valuation allowance upon a determination that it will be able to realize such tax savings.

The Company is currently considering and implementing a variety of tax planning strategies in an attempt to increase after tax income and taxable earnings, which will increase the likelihood of the Company to recognize its deferred tax assets. These tax planning strategies include repositioning the Company's municipal securities portfolio to taxable securities and sale of various assets.

The Company's loss carryforwards for the tax period ending September 30, 2011 include net operating loss carryforwards generated in the acquisition of Cardinal State Bank in 2008 and American Community Bank in 2009. The expiration of the loss carryforwards for the tax period ending September 30, 2011 are as follows:



	Net Operating Loss Carryforward at September 30, 2011		Expiration
	(in thousands)
Cardinal State Bank acquisition	$	2,424	2029
American Community Bank acquisition	345		2030
Yadkin Valley Federal Tax	17,151		2031
Yadkin Valley State Tax	19,290		2031
Total Loss Carryforwards	$	39,210

The following table presents a reconciliation of applicable income taxes for the nine months ended September 30, 2011 and 2010 to the amount of tax expense computed at the statutory federal income tax rate of 35%:



	2011			2010
	(in thousands)
Tax expense at statutory rate on income before income taxes	$	(3,645	)	$	(503	)
Increases (decreases) resulting from:
Tax-exempt interest on investments	(651		)	(603		)
State income tax, net of federal benefits	(391		)	(127		)
Income from bank-owned life insurance	(172		)	(227		)
Valuation allowance on deferred tax assets	11,000			—
Other	764			894
Total income taxes	$	6,905		$	(566	)