Income Taxes

The following table presents the provision for income taxes for the three months ended March 31, 2013 and 2012:



	2013			2012
	(in thousands)
Current:
Federal	$	(200	)	$	—
State	—			—
	(200		)	—
Deferred:
Federal	2,307			954
State	501			251
	2,808			1,205
Increase (decrease) in valuation allowance for deferred tax assets	—			(1,205		)
Total income taxes	$	2,608		$	—

The following table presents the tax effects of significant components of the Company's net deferred tax assets as of March 31, 2013 and December 31, 2012:



	March 31,			December 31,
	2013			2012
	(in thousands)
Deferred tax assets:
Allowance for loan losses	$	9,595		$	9,853
Other than temporary impairment	842			827
Accrued liabilities	199			220
OREO property	900			3,767
Net operating loss	20,063			19,627
Mortgage goodwill	888			921
Other	1,979			2,160
	34,466			37,375
Less: Valuation Allowance	—			—
	$	34,466		$	37,375

Deferred tax liabilities:
Unrealized gain on available-for-sale securities	$	(2,350	)	$	(2,583	)
FMV adjustment related to mergers	(154		)	(181		)
Depreciation	(1,561		)	(1,561		)
Prepaid expenses	(358		)	(358		)
Core deposit intangible	(973		)	(1,043		)
Noncompete intangible	(149		)	(149		)
Other	(139		)	(142		)
	$	(5,684	)	$	(6,017	)
Net deferred tax asset	$	28,782		$	31,358

Our net deferred tax asset was $28.8 million at March 31, 2013 and $31.4 million at December 31, 2012. 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.

At March 31, 2013, the Company considered the following negative and positive evidence in its evaluation of deferred tax assets:


•	The Company is in a cumulative tax loss position for the 3-year period ending March 31, 2013 of $(31.2) million. Significance: High



	March 31, 2013
	Cumulative Loss Test
	2010*			2011			2012			2013**		Total
Income (loss) before income taxes	$	(3,072	)	$	(7,701	)	$	(32,635	)	$	7,257	$	(36,151	)
Goodwill impairment	—			4,944			—			—		4,944
	$	(3,072	)	$	(2,757	)	$	(32,635	)	$	7,257	$	(31,207	)

*2nd, 3rd and 4th quarter of 2010

**First three months of 2013

Positive Evidence

•

The Company reported $7.3 million in net income before taxes for the quarter ended March 31, 2013 as provisions for loan losses were $237,000 for the quarter. 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 $22 million in pre-tax income for six previous consecutive quarters as credit quality has improved and net interest margin has increased over the past year. 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 2010, 2011 and 2012 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. Also, as discussed below, credit quality metrics have significantly improved. 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. 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 March 31, 2013, the Company's leverage ratio, Tier 1 risk-based capital ratio, and total risk-based capital ratio were 10.0%, 12.6%, and 13.8%. 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 first quarter of 2013 and overall nonperforming loans are down $42.4 million since March 31, 2012. Nonperforming assets to total assets were 1.58% as of March 31, 2013 as compared to 4.80% as of March 31, 2012. In addition, allowance for loan losses to nonperforming loans increased from 45.49% at March 31, 2012 to 103.29% at March 31, 2013. 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 March 31, 2013. 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 March 31, 2013 based primarily on a return to profitability, 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 three months ended March 31, 2013 and 2012 to the amount of tax expense computed at the statutory federal income tax rate of 35%:



	2013			2012
	(in thousands)
Tax expense at statutory rate on income before income taxes	$	2,540		$	1,215
Increases (decreases) resulting from:
Tax-exempt interest on investments	(219		)	(156		)
State income tax, net of federal benefits	326			163
Income from bank-owned life insurance	(53		)	(55		)
Valuation allowance on deferred tax assets	—			(1,205		)
Other	14			38
Total income taxes	$	2,608		$	—