Income Taxes

The following table presents the provision for income taxes for the six months ended June 30, 2012 and 2011:



	2012			2011
	(in thousands)
Current:
Federal	$	45		$	485
State				—
	45			485
Deferred:
Federal	1,196			(5,912		)
State	376			(1,052		)
	1,572			(6,964		)
Increase (decrease) in valuation allowance for deferred tax assets	(11,000		)	11,000
Total income taxes	$	(9,383	)	$	4,521

The following table presents the tax effects of significant components of the Company's net deferred tax assets as of June 30, 2012 and December 31, 2011:



	June 30,			December 31,
	2012			2011
	(in thousands)
Deferred tax assets:
Allowance for loan losses	$	11,288		$	12,880
Other than temporary impairment	807			807
Accrued liabilities	224			276
OREO property	1,259			1,268
Net operating loss	7,145			7,281
Sidus goodwill	986			1,050
Other	1,791			1,798
	23,500			25,360
Less: Valuation Allowance	—			(11,000		)
	$	23,500		$	14,360

Deferred tax liabilities:
Unrealized gain on available-for-sale securities	$	(2,758	)	$	(2,387	)
FMV adjustment related to mergers	(177		)	(255		)
Depreciation	(1,980		)	(1,980		)
Prepaid expenses	(327		)	(327		)
Core deposit intangible	(1,250		)	(1,468		)
Noncompete intangible	(149		)	(149		)
Other	(204		)	(195		)
	$	(6,845	)	$	(6,761	)
Net deferred tax asset	$	16,655		$	7,599

Our net deferred tax asset was $16.7 million at June 30, 2012 and $7.6 million at December 31, 2011, respectively. A valuation allowance is recognized if, based on the weight of available evidence, it is more likely than not (a likelihood of more than 50 percent) that some portion or all of the deferred tax assets will not be realized. All available evidence, both positive and negative, is used in the consideration to determine whether, based on the weight of that evidence, a valuation allowance is required. The Company considered the following negative and positive evidence in its evaluation of deferred tax assets:


•	The Company was in a cumulative tax loss position for the 3-year period ending June 30, 2012 of $(3.9) million.



	June 30, 2012 Cumulative Loss Test
	2009*			2010			2011			2012**		Total
Income (loss) before income taxes	$	(66,429	)	$	(1,402	)	$	(7,701	)	$	5,086	$	(70,446	)
Goodwill impairment	61,566			—			4,944			—		66,510
	$	(4,863	)	$	(1,402	)	$	(2,757	)	$	5,086	$	(3,936	)

*3rd and 4th quarter of 2009

**First six months of 2012

Although the three year cumulative loss position provides negative evidence, the following items represent positive evidence that management considered:


•	The Company's strong history of earnings since the inception of the Bank, and particularly over the 10 year period prior to the current economic cycle, shows the Company has historically been profitable and has no history of expiration of loss carryforwards.


•	The Company is projecting income on a pretax basis, as well as taxable income, for the future periods 2012-2014 and expects to be in a 3-year cumulative income position in the third quarter of 2012.


•	Management is not aware of any unsettled circumstances that, if resolved, would adversely affect future operations or earnings.


•	Credit quality has improved over the past twelve months, including significant decreases in classified loans and nonperforming loans. Credit losses have shown a dramatic reduction in the second half of 2011 and continuing into 2012, with only $25.3 million in gross charge-offs over the past twelve months as compared to $39.8 million in the twelve prior months.

•

Federal net operating losses can be deducted over the twenty year carryforward period. Currently, management is projecting full utilization of these tax benefits within 3 years from December 31, 2011. The Company's loss carryforwards for the tax period ending December 31, 2011 include net operating loss carryforwards generated in the acquisition of Cardinal State Bank in 2008 and American Community Bank in 2009, as well as net operating loss carryforwards for the Company. The expiration of the loss carryforwards for the tax period ending December 31, 2011 are as follows:



	Net Operating Loss Carryforward at December 31, 2011		Expiration
	(in thousands)
Cardinal State Bank acquisition	$	2,424	2029
American Community Bank acquisition	345		2030
Yadkin Valley Federal Tax	16,228		2031
Yadkin Valley State Tax	17,074		2031
Total Loss Carryforwards	$	36,071

After review of all available evidence and based on the weight of such evidence, the Company believes the realization of the deferred tax asset is, more likely than not and has reversed a previously recorded $11.0 million valuation allowance. The reversal of the allowance was based primarily on a return to profitability as the Company has reported four consecutive quarters of net income. Based on net income trends, projected net income over the next 12 months and improving credit quality metrics, no valuation allowance was deemed necessary as of June 30, 2012 so the Company reversed the $11.0 million valuation allowance for the quarter.

The following table presents a reconciliation of applicable income taxes for the six months ended June 30, 2012 and 2011 to the amount of tax expense computed at the statutory federal income tax rate of 35%:



	2012			2011
	(in thousands)
Tax expense (benefit) at statutory rate on income before income taxes	$	1,780		$	(5,767	)
Increases (decreases) resulting from:
Tax-exempt interest on investments	(409		)	(442		)
State income tax, net of federal benefits	245			(684		)
Income from bank-owned life insurance	(110		)	(113		)
Valuation allowance on deferred tax assets	(11,000		)	11,000
Other	111			527
Total income taxes	$	(9,383	)	$	4,521