INCOME TAXES

The following table presents the provision for income taxes for the years ended December 31, 2013, 2012 and 2011:



	2013			2012			2011
	(in thousands)
Current:
Federal	$	(93	)	$	(210	)	$	712
State	—			—			—
	(93		)	(210		)	712
Deferred:
Federal	8,027			(10,755		)	(4,600		)
State	2,467			(1,996		)	(418		)
	10,494			(12,751		)	(5,018		)
Increase (decrease) in valuation allowance for deferred tax assets	—			(11,000		)	11,000
Total income taxes	$	10,401		$	(23,961	)	$	6,694

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



	December 31,			December 31,
	2013			2012
	(in thousands)
Deferred tax assets:
Allowance for loan losses	$	6,956		$	9,853
Other than temporary impairment	829			827
Accrued liabilities	55			220
OREO property	178			3,767
Net operating loss	14,375			19,627
Mortgage banking goodwill	779			921
Other	3,243			2,160
	26,415			37,375
Less: Valuation Allowance	—			—
	$	26,415		$	37,375

Deferred tax liabilities:
Unrealized gain on available-for-sale securities	$	(3	)	$	(2,583	)
FMV adjustment related to mergers	(97		)	(181		)
Depreciation	(1,753		)	(1,561		)
Prepaid expenses	(342		)	(358		)
Core deposit intangible	(765		)	(1,043		)
Noncompete intangible	(24		)	(149		)
Other	(6		)	(142		)
	(2,990		)	(6,017		)
Net deferred tax asset	$	23,425		$	31,358

Our net deferred tax asset was $23.4 million at December 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.

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, 2013, the Company has failed the three-year cumulative loss test, after recording a $38.5 million loss before income taxes in the fourth quarter of 2012 as part of the accelerated asset disposition plan. 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, 2013 of $6.2 million. Significance: High



	December 31, 2013 Cumulative Loss Test
	2011			2012			2013		Total
	(in thousands)
Income (loss) before income taxes	$	(7,701	)	$	(32,635	)	$	29,227	$	(11,109	)
Goodwill impairment	4,944			—			—		$	4,944
	$	(2,757	)	$	(32,635	)	$	29,227	$	(6,165	)

Positive Evidence

•

The Company reported $29.2 million in net income before taxes for the year 2013. Excluding losses of $49 million sustained in the fourth quarter of 2012 related to the accelerated asset disposition plan, the Company has recorded $43.9 million in pre-tax income for nine 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 2014 through 2016. The budgeted provision for loan losses is a key driver of the resulting income. Also, as discussed below, credit quality metrics have significantly improved. 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 which is discussed in the following paragraphs. 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, 2013, the Company's leverage ratio, Tier 1 risk-based capital ratio, and total risk-based capital ratio were 11.5%, 13.5%, and 14.6%. 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 2013 as net loan charge-offs (recoveries) were $4.4 million, or 0.33% of average loans for the year ended December 31, 2013, as compared to $48.1 million, or 3.43% of average loans for the year ended December 31, 2012. Nonperforming loans were also down $7.4 million since December 31, 2012. Nonperforming assets to total assets were 1.03%% as of December 31, 2013 as compared to 1.64% as of December 31, 2012 and 4.78% as of December 31, 2011 . In addition, allowance for loan losses to nonperforming loans increased from 110.22%% at December 31, 2012 to 117.34%% at December 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 December 31, 2013. The Company's loss carryforwards for the tax period ending December 31, 2013 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. Significance: Moderate



	Net Operating Loss Carryforward at December 31, 2013		Expiration
	(in thousands)
Cardinal State Bank acquisition	$	2,424	2029
American Community Bank acquisition	345		2030
Yadkin Valley Federal Tax	35,582		2031
Yadkin Valley State Tax	28,623		2031
Total Loss Carryforwards	$	66,974

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, 2013 based primarily on a return to profitability as the Company has reported nine consecutive quarters of net income (excluding losses in the fourth quarter of 2012 related to management's accelerated asset disposition plan), net income trends, projected net income for the years 2014 through 2016 and improving credit quality metrics.

The following table presents a reconciliation of applicable income taxes for the years ended December 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 benefit at statutory rate on income before income taxes	$	10,230		$	(11,422	)
Increases (decreases) resulting from:
Tax-exempt interest on investments	(1,055		)	(737		)
State income tax, net of federal benefits	1,604			(1,298		)
Income from bank-owned life insurance	(210		)	(221		)
Valuation allowance on deferred tax assets	—			(11,000		)
Other	(168		)	717
Total income taxes	$	10,401		$	(23,961	)