INCOME TAXES

The following table presents the provision for income taxes for the years ended December 31, 2012, 2011 and 2010:



	2012			2011			2010
	(in thousands)
Current:
Federal	$	(210	)	$	712		$	(6,681	)
State	—			—			—
	(210		)	712			(6,681		)
Deferred:
Federal	(10,755		)	(4,600		)	4,756
State	(1,996		)	(418		)	536
	(12,751		)	(5,018		)	5,292
Increase (decrease) in valuation allowance for deferred tax assets	(11,000		)	11,000			—
Total income taxes	$	(23,961	)	$	6,694		$	(1,389	)

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



	December 31,			December 31,
	2012			2011
	(in thousands)
Deferred tax assets:
Allowance for loan losses	$	9,853		$	12,880
Other than temporary impairment	827			807
Accrued liabilities	220			276
OREO property	3,767			1,268
Net operating loss	19,627			7,281
Sidus goodwill	921			1,050
Other	2,160			1,798
	37,375			25,360
Less: Valuation Allowance	—			(11,000		)
	$	37,375		$	14,360

Deferred tax liabilities:
Unrealized gain on available-for-sale securities	$	(2,583	)	$	(2,387	)
FMV adjustment related to mergers	(181		)	(255		)
Depreciation	(1,561		)	(1,980		)
Prepaid expenses	(358		)	(327		)
Core deposit intangible	(1,043		)	(1,468		)
Noncompete intangible	(149		)	(149		)
Other	(142		)	(195		)
	$	(6,017	)	$	(6,761	)
Net deferred tax asset	$	31,358		$	7,599

Our net deferred tax asset was $31.4 million at December 31, 2012 and $7.6 million at December 31, 2011. 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.

As of June 30, 2012, the Company reversed a previously recorded $11 million valuation allowance which had been established in 2011. After review of all available evidence at June 30, 2012 and based on the weight of such evidence, the Company believed the realization of the deferred tax asset was more likely than not and reversed the previously recorded $11.0 million valuation allowance. The reversal of the allowance was based primarily on a return to profitability as the Company had reported four consecutive quarters of net income and the Company come out of a 3-year cumulative loss position. Based on net income trends, projected net income over the next 36 months and improving credit quality metrics, no valuation allowance was deemed necessary as of June 30, 2012.

At December 31, 2012, the Company has failed the 3-year cumulative loss test again due to losses incurred in the fourth quarter. The Company considered the following negative and positive evidence in its evaluation of deferred tax assets:

Negative Evidence


•	The Company is in a cumulative tax loss position for the 3-year period ending December 31, 2012 of $36.8 million. Significance: High



	December 31, 2012 Cumulative Loss Test
	2010			2011			2012**			Total
	(in thousands)
Income (loss) before income taxes	$	(1,401	)	$	(7,701	)	$	(32,635	)	$	(41,737	)
Goodwill impairment	—			4,944			—			4,944
	$	(1,401	)	$	(2,757	)	$	(32,635	)	$	(36,793	)

Positive Evidence

•

Losses for the fourth quarter of 2012 involved the sale and writedown of certain substandard and nonperforming loans and foreclosed properties in the amount of approximately $49 million. The Company incurred losses of approximately $35 million on loan sales and $7 million on sales of foreclosed assets in the fourth quarter of 2012 related to the implementation of this accelerated disposition plan. Excluding losses sustained in the fourth quarter of 2012 related to the accelerated asset disposition plan, the Company has recorded $14.7 million in pre-tax income for five previous consecutive quarters as credit quality has improved and net interest margin has increased over the past year. In addition, excluding the accelerated asset disposition losses, the Company would have been in a 3-year cumulative income position of $4.7 million at December 31, 2012. Significance: High

•

The Company is projecting income on a pretax basis, as well as taxable income, for the future periods 2013-2015. The budgeted provision for loan losses is a key driver of the resulting income. While management believes the 2009, 2010 and 2011 levels of provision are indicative of the worst economic downturn in recent history and will not be repeated, it is important to understand why future losses are not projected at these levels. In the three year period ended December 31, 2012, management was proactive in charging down collateral dependent loans that are impaired to current market values. The year of 2011 showed improvement in certain credit metrics that caused management to have lower provisions in 2012. Although the Company incurred losses in the fourth quarter of 2012 related to the disposition of assets, these losses are part of a purposeful and managed plan to substantially reduce loan risk Losses on the disposition are driven by a liquidity factor and all loans held for sale and foreclosed properties are properly recorded at the lower of cost or fair market value at December 31, 2012. There are no other plans at this time to sell additional assets at a loss. Significance: Moderate

•

In 2012, the Company completed a $45 million private placement offering pursuant to which several institutional investors and members of the Board and management purchased shares of preferred stock. In connection with this private placement, the Company converted approximately $21 million of its outstanding Series T and Series T-ACB preferred shares to common shares. As of December 31, 2012, the Company's leverage ratio, Tier 1 risk-based capital ratio, and total risk-based capital ratio were 9.2%, 12.2%, and 13.3%, respectively as compared to a leverage ratio, Tier 1 risk-based capital ratio and total risk-based capital ratio of 8.3%, 10.6% and 11.8%, respectively, as of December 31, 2011. Significance: Moderate

•

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, and overall nonperforming loans are down $47.5 million since December 31, 2011. Nonperforming loans to total assets were 1.19% as of December 31, 2012 as compared to 3.53% as of December 31, 2011. In addition, allowance for loan losses to nonperforming loans increased from 46.69% at December 31, 2011 to 110.22% at December 31, 2012. Significance: High


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

•

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, 2012. The Company's loss carryforwards for the tax period ending December 31, 2012 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, 2012 are as follows:

Significance: Moderate



	Net Operating Loss Carryforward at December 31, 2012		Expiration
	(in thousands)
Cardinal State Bank acquisition	$	2,424	2029
American Community Bank acquisition	345		2030
Yadkin Valley Federal Tax	47,892		2031
Yadkin Valley State Tax	46,324		2031
Total Loss Carryforwards	$	96,985

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 no valuation allowance is deemed necessary at December 31, 2012 based primarily on a return to profitability as the Company has reported five consecutive quarters of net income (excluding losses related to management's accelerated asset disposition plan), net income trends, projected net income for the years 2013-2015 and improving credit quality metrics.

The following table presents a reconciliation of applicable income taxes for the years ended December 31, 2012 and 2011 to the amount of tax expense computed at the statutory federal income tax rate of 35%:



	2012			2011
	(in thousands)
Tax benefit at statutory rate on income before income taxes	$	(11,422	)	$	(2,696	)
Increases (decreases) resulting from:
Tax-exempt interest on investments	(737		)	(847		)
State income tax, net of federal benefits	(1,298		)	(271		)
Income from bank-owned life insurance	(221		)	(230		)
Valuation allowance on deferred tax assets	(11,000		)	11,000
Other	717			(262		)
Total income taxes	$	(23,961	)	$	6,694