Income Taxes

The components of income tax expense for the years ended December 31 are as follows:



(dollars in thousands)	2014			2013			2012
Current:
Federal	$	—		$	—		$	—
State	—			—			—
Total current taxes	—			—			—
Deferred
Federal	3,714			21,276			(13,709		)
State	537			14,628			(2,722		)
Total deferred taxes	4,251			35,904			(16,431		)
Increase (decrease) in valuation allowance	(146,743		)	(34,578		)	15,392
Total income tax (benefit) expense - continuing operations	$	(142,492	)	$	1,326		$	(1,039	)

A reconciliation of income tax expense computed at the statutory federal income tax rate to actual income tax expense is presented in the following table as of December 31:



(dollars in thousands)
	2014			2013			2012
Amount of tax computed using Federal statutory tax rate of 35% in all years	$	2,788		$	(55	)	$	(14,365	)
Increases (decreases) resulting from effects of:
Non-taxable income	(54		)	(88		)	(169		)
State income taxes, net of federal benefit	349			9,508			(1,769		)
Valuation allowance on deferred tax assets	(146,743		)	(34,578		)	15,392
Bank-owned life insurance	(403		)	(375		)	—
Reduction of deferred tax assets at Granite	—			28,293			—
Other	1,571			(1,379		)	(128		)
Total income tax (benefit) expense - continuing operations	$	(142,492	)	$	1,326		$	(1,039	)

The components of deferred tax assets and liabilities and the tax effect of each are as follows:



(dollars in thousands)	December 31, 2014			December 31, 2013
Deferred tax assets:
Allowance for loan losses	$	8,037		$	10,364
Net operating loss	137,412			135,050
Compensation and benefit plans	1,277			995
Fair value basis on securities	656			919
Pension and other post-retirement benefits	1,470			1,080
Other real estate owned	2,256			4,090
Gross unrealized securities losses	2,560			10,215
Interest on nonperforming loans	—			1,339
Other	851			529
Subtotal deferred tax assets	154,519			164,581
Less: Valuation allowance	(1,300		)	(148,043		)
Total deferred tax assets	153,219			16,538
Deferred tax liabilities:
Core deposit intangible	1,513			2,051
Depreciable basis of premises and equipment	563			495
Net deferred loan fees and costs	1,306			1,077
Gross unrealized securities gains	490			1,249
Fair value basis of loans	2,473			951
Other	441			500
Total deferred tax liabilities	6,786			6,323
Net deferred tax assets	$	146,433		$	10,215

As of December 31, 2014 and December 31, 2013, net deferred income tax assets totaling $146.4 million and $10.2 million, respectively, are recorded on COB’s balance sheet. In 2013 the Company’s gross deferred tax assets were offset by a valuation allowance of $148.0 million. During 2014 management reevaluated the continuing need for this allowance in accordance with the procedures described in the “Income Taxes” section of Note 1 and as more fully described below, and applied its judgment to determine that it is more likely than not that all but $1.3 million of the Company’s deferred tax assets will be realized.

The Company’s deferred tax assets consist primarily of consolidated federal and Bank-originated North Carolina loss carryforwards from prior periods. The consolidated federal net operating loss carryforwards are $355.9 million and $349.6 million and the North Carolina net economic loss carryforwards are $371.8 million and $365.8 million at December 31, 2014 and 2013, respectively. The remaining federal and North Carolina carryforward periods range between fifteen and nineteen years and fourteen and ten years, respectively, at December 31, 2014.

Management regularly evaluates the likelihood that the Company will be able to realize its deferred tax assets and the continuing need for a valuation allowance. In 2013 and prior years management determined that sufficient evidence was not available to conclude that it was more likely than not that all of its deferred tax assets could be realized, requiring a valuation allowance for certain of its deferred tax assets. At December 31, 2014 management determined, based on all available positive and negative evidence, that it is more likely than not that future taxable income will be available during the carryforward periods to absorb all of the consolidated federal net operating loss carryforward and all but a small portion of the Bank’s North Carolina net economic loss carryforward. As a result of this determination, $142.5 million of valuation allowance against the Company's deferred tax assets was reversed. A number of factors played a critical role in this determination, including:


•	Improvements in the asset quality of the loan portfolio and diminishment of credit-related losses that were the source of the Company's losses;


•	Implementation of strong internal controls making it unlikely that the large volume of troubled loans leading to the Company’s losses between 2008 and 2012 will reoccur;


•	The increased remoteness and diminished relevance of such losses;


•	Continued improvement of the Company’s financial metrics and six consecutive quarters of earnings;


•	A credible forecast of future taxable income based on management’s demonstrated forecasting accuracy;


•	Various cost-reduction initiatives that will have a continuing positive effect on earnings in future periods;


•	Availability of tax planning strategies, and


•	Long-dated carryforward periods.

Accordingly, upon consideration of all available objectively verifiable positive and negative evidence, management has applied its judgment to conclude that the Company’s valuation allowance should be reduced from $148.0 million at December 31, 2013 to $1.3 million at December 31, 2014.

Management will continue to regularly assess the Company’s ability to realize its deferred tax assets. Changes in earnings performance and future earnings projections may, among other factors, require the Company to adjust its valuation allowance, which would impact the Company's income tax expense in the period of adjustment.

Under GAAP, COB is not required to provide a deferred tax liability for the tax effect of additions to the tax bad debt reserve accumulating through 1987. Retained earnings at December 31, 2014 include approximately $5.0 million for which no provision for federal income tax has been made. In the remote possibility that circumstances occur requiring a reduction of the reserve such reduction could be taxable and subject to the then-current corporate income tax rate.

The merger of COB and Granite Corp. in 2011 resulted in an ownership change for Granite Corp. under Internal Revenue Code Section 382 and the Regulations thereunder. Accordingly, the Company is required to apply a limitation against Granite Corp.’s pre-acquisition net operating loss carryforwards and net unrealized built-in losses. During 2013, COB determined that it would be able to use only $2.9 million of the Granite Corp. net operating loss carryforwards and built in losses and reduced both its deferred tax asset and related valuation allowance by $28.3 million.

The State of North Carolina passed legislation to reduce the income tax rates from 6.9% to 6.0% in 2014 and to 5.0% in 2015. The DTA has been reduced by $5.3 million to account for the reduction in income tax rates to 5%. The net reduction in DTA is offset by a corresponding reduction in the valuation allowance.