Note 12 – Income Taxes

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


(dollars in thousands)	2011			2010			2009
Current:
Federal	$	—		$	(105	)	$	(416	)
State		—			(22	)		(21	)

Total current taxes		—			(127	)		(437	)


Deferred
Federal		(43,001	)		(36,996	)		(15,530	)
State		(8,657	)		(7,544	)		(2,964	)

Total deferred taxes		(51,658	)		(44,540	)		(18,494	)

Increase in valuation allowance		52,299			45,926			22,345

Total income tax (benefit)/expense - continuing operations	$	641		$	1,259		$	3,414

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)
	2011			2010			2009

Amount of tax computed using Federal statutory tax rate of 35% in 2011, 2010 and 2009	$	(45,807	)	$	(38,589	)	$	(34,701	)
Increases/(decreases) resulting from effects of:
Non-taxable income		(196	)		(418	)		(713	)
State income taxes, net of federal benefit		(5,627	)		(4,919	)		(1,927	)
Goodwill impairment		—			—			18,338
Valuation allowance on deferred tax assets		52,299			45,926			22,345
Other		(28	)		(741	)		72

Total income tax (benefit)/expense - continuing operations	$	641		$	1,259		$	3,414

Deferred taxes are provided using the asset and liability method whereby deferred tax assets are recognized for deductible temporary differences and operating loss and tax credit carryforwards and deferred tax liabilities are recognized for taxable temporary differences. Temporary differences are the differences between the reported amounts of assets and liabilities and their tax basis. Deferred tax assets are reduced by a valuation allowance when, in the opinion of management, it is more likely than not that some portion or all of the deferred tax assets will not be realized. Deferred tax assets and liabilities are adjusted for the effects of changes in tax laws and rates on the date of enactment. Excluding unrealized losses on available-for-sale securities, FNB has recorded a 100% deferred tax valuation allowance related to various temporary differences, principally consisting of the provision for loan losses and its net operating loss carryforwards.

As of December 31, 2011 and December 31, 2010, net deferred income tax assets totaling $1.8 million and $0.9 million, respectively, are recorded on FNB's balance sheet. No valuation allowance is recorded for unrealized losses on investment securities because it is not more likely than not that FNB will have to sell these securities at a loss.

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


(dollars in thousands)	December 31, 2011			December 31, 2010
Deferred tax assets:
Allowance for loan losses	$	17,395		$	37,388
Net operating loss		119,446			36,902
Compensation and benefit plans		2,098			2,102
Fair value basis on securities		1,392			—
Fair value basis of loans		12,099			—
Fair value basis on deposits		859			—
Pension and other post-retirement benefits		2,017			1,451
Other real estate owned		16,904			3,815
Gross unrealized securities losses		446			925
Interest on non-performing loans		1,382			—
Other		1,759			701

Subtotal deferred tax assets		175,797			83,284
Less: Valuation allowance		(167,011	)		(75,735	)

Total deferred tax assets		8,786			7,549

Deferred tax liabilities:
Core deposit intangible		3,229			1,648
Mortgage servicing rights		—			931
Depreciable basis of premises and equipment		1,151			1,251
Net deferred loan fees and costs		871			898
Gross unrealized securities gains		631			582
SAB 109 valuation		6			265
Other		1,096			1,049

Total deferred tax liabilities		6,984			6,624

Net deferred tax assets	$	1,802		$	925

Changes in net deferred tax asset were as follows:


(dollars in thousands)	December 31, 2011			December 31, 2010
Balance at beginning of year	$	925		$	447
Income tax effect from change in unrealized gains on available-for-sale securities		(528	)		2,212
Employee benefit plan		710			(427	)
Deferred income tax benefit on continuing operations		53,740			52,083
Deferred income tax benefit on discontinued operations		213			—
Net deferred tax asset in acquired subsidiary		1,382			—
Valuation allowance on deferred tax assets		(54,640	)		(53,390	)

Balance at end of period	$	1,802		$	925

Under GAAP, FNB is not required to provide a deferred tax liability for the tax effect of additions to the tax bad debt reserve through 1987, the base year. Retained earnings at December 31, 2011 include approximately $2.7 million for which no provision for federal income tax has been made. These amounts represent allocations of income to bad debt deductions for tax purposes only. Reductions of such amounts for purposes other than bad debt losses could create income for tax purposes in certain remote instances, which would then be subject to the then current corporate income tax rate.

The Merger was considered a change in control for Granite Corp. under Internal Revenue Code Section 382 and the Regulations, thereunder. Accordingly, we are required to evaluate potential limitation or deferral of its ability to carryforward pre-acquisition net operating losses and to determine the amount of net unrealized built-in losses ("NUBIL"), which may be subject to similar limitation or deferral. Under the Internal Revenue Code and Regulations, NUBIL realized within 5 years of the change in control are subject to potential limitation, which for us is October 20, 2016. Through that date, we will continue to analyze our ability to utilize such losses to offset anticipated future taxable income, however, this estimate will not be known until the five-year recognition period expires. Losses limited under these provisions are generally limited to a carryforward period of 20 years, subject to the annual limitation and expire if not used by the end of that period. As of December 31, 2011, total deferred tax assets attributable to Granite Corp. and subsidiaries were approximately $40.4 million which is offset by a valuation allowance of $39.0 million. We anticipate that some of these benefits from the net operating losses and built-in losses will not ultimately be realized; however, that amount is subject to continuing analysis and has not yet been determined.