Income Taxes

A. Components of Net Deferred Tax Asset:



	December 31,
(dollars in thousands)	2018		2017
Deferred tax assets:
Loan and lease loss reserve	$	4,476	$	3,948
Other reserves	2,919		3,169
Net operating loss carry-forward	9,728		11,113
Alternative minimum tax credits	1,100		1,116
Unrealized depreciation of available for sale securities	1,656		761
Defined benefit plans	1,377		1,361
RBPI Merger Fair Values	2,580		4,726
Total deferred tax asset	$	23,836	$	26,194
Deferred tax liabilities:
Intangibles and other amortizing fair value adjustments	$	5,290	$	970
Originated MSRs	1,105		1,253
Deferred loan costs	1,105		—
Other reserves	535		72
Total deferred tax liability	$	8,035	$	2,295
Total net deferred tax asset	$	15,801	$	23,899

Not included in the table above are deferred tax assets for state net operating losses and unrealized capital losses for partnership investments and their respective valuation allowance of $705 thousand and $616 thousand. The state net operating losses of our leasing subsidiary as of December 31, 2018 will expire between 2023 and 2036.

As a result of the RBPI Merger, deferred tax assets were initially increased by $33.1 million related to purchase accounting adjustments and net deferred tax assets carried over from RBPI. During 2018, adjustments were made to the original purchase accounting adjustments that resulted in an incremental deferred tax asset of $1.1 million.

B. The provision for income taxes consists of the following:



	December 31,
(dollars in thousands)	2018		2017		2016
Current	$	4,326	$	13,812	$	16,492
Deferred	9,839		20,418		1,676
Total	$	14,165	$	34,230	$	18,168

C. Applicable income taxes differed from the amount derived by applying the statutory federal tax rate to income as follows:



(dollars in thousands)	2018			Tax Rate		2017			Tax Rate		2016			Tax Rate
Computed tax expense at statutory federal rate	$	16,371		21.0	%	$	20,036		35.0	%	$	18,972		35.0	%
Tax-exempt income	(470		)	(0.6	)%	(600		)	(1.0	)%	(758		)	(1.4	)%
State tax (net of federal tax benefit)	874			1.1	%	303			0.5	%	425			0.8	%
Non-deductible merger expense	—			—	%	455			0.8	%	—			—	%
Excess tax benefit – stock based compensation	(848		)	(1.1	)%	(1,049		)	(1.8	)%	(565		)	(1.0	)%
Adjustment to net deferred tax assets for enacted changes in tax laws, rates and return to provision adjustments	(1,895		)	(2.4	)%	15,193			26.5	%	—			—	%
Other, net	133			0.2	%	(108		)	(0.2	)%	94			0.1	%
Total income tax expense	$	14,165		18.2	%	$	34,230		59.8	%	$	18,168		33.5	%

D. Tax Law Changes – Impact to Tax Expense

With the enactment of the Tax Cuts and Jobs Act (“Tax Reform” or the “Tax Act”) on December 22, 2017, the federal corporate income tax rate was reduced from 35% to 21% effective January 1, 2018. The Corporation's 2017 financial results included a charge of $15.2 million to income tax expense, primarily resulting from re-measuring the Corporation's net deferred tax assets to reflect the recently enacted lower tax rate effective January 1, 2018.

During 2018, we recorded certain tax provision to tax return true-up adjustments associated with items that were finalized as part of our 2017 tax return filing. We recorded a $2.5 million tax benefit in 2018, primarily for deferred tax temporary difference items that were claimed on the 2017 tax return at a 35% federal tax rate that were recorded at December 31, 2017 as anticipating to be deducted at a 21% federal tax rate. Also during 2018, as a result of additional purchase accounting adjustments during the year, $611 thousand of such purchase accounting adjustments were charged to income tax expense as a result of reducing their original 35% tax benefit to the new 21% tax rate in effect for 2018. There are no remaining provisional items as of December 31, 2018.

Under ASC 740, Income Taxes, the effect of income tax law changes on deferred taxes should be recognized as a component of income tax expense related to continuing operations in the period in which the law is enacted. This requirement applies not only to items initially recognized in continuing operations, but also to items initially recognized in other comprehensive income. The income tax expense recognized as a result of Tax Reform is as follows:



	Year Ended December 31,
(dollars in thousands)	2018			2017
Deferred taxes related to items recognized in continuing operations	$	(1,895	)	$	14,411
Deferred taxes on net actuarial loss on defined benefit post-retirement benefit plans	—			275
Deferred taxes on net unrealized losses on available for sale investment securities	—			507
Total income tax (benefit) / expense related to Tax Reform	$	(1,895	)	$	15,193

Because ASC 740 requires the effect of income tax law changes on deferred taxes to be recognized as a component of income tax expense related to continuing operations rather than backward tracing the adjustment through the accumulated other comprehensive income component of shareholders' equity, the net adjustment to deferred taxes for the year ending December 31, 2017 detailed above included a net expense totaling $782 thousand related to items recognized in other comprehensive income.

E. Other Income Tax Information

In accordance with the provisions of ASC 740, “Accounting for Uncertainty in Income Taxes”, management recognizes the financial statement benefit of a tax position only after determining that the Corporation would more likely than not sustain the position following an examination. For tax positions meeting the more-likely-than-not threshold, the amount recognized in the financial statements is the largest benefit that has a greater than 50 percent likelihood of being realized upon settlement with the relevant tax authority. Management applied these criteria to tax positions for which the statute of limitations remained open.

There were no reserves for uncertain tax positions recorded during the years ended December 31, 2018, 2017 or 2016.

The Corporation is subject to income taxes in the U.S. federal jurisdiction, and in multiple state jurisdictions. The Corporation is no longer subject to U.S. federal income tax examination by tax authorities for the years before 2015.

The Corporation’s policy is to record interest and penalties on uncertain tax positions as income tax expense. No interest or penalties were accrued in 2018.

As of December 31, 2018, the Corporation has net operating loss (“NOL”) carry-forwards for federal income tax purposes of $46.3 million, all of which relate to the RBPI Merger which are subject to an annual usage limitation of approximately $2.7 million. Management estimates it will be able to utilize an additional $5.0 million per year of the NOLs acquired in the RBPI Merger for a five-year period subsequent to December 15, 2017 due to the existence of net unrealized built-in gains (“NUBIG”) under IRC Section 382, these NOLs will begin to expire in 2030. In addition, the Corporation has alternative minimum tax (“AMT”) credits of $1.1 million, approximately $532 thousand of which are related to the RBPI Merger. The credit amounts do not expire. The amount of AMT credits that can be used per year are limited under IRC section 383. The Corporation has determined that it is more likely than not that the results of future operations will generate sufficient taxable income to realize the deferred tax asset related to these amounts.

As a result of the July 1, 2010 merger with FKF, the Corporation succeeded to $2.5 million of tax bad debt reserves that existed at FKF as of June 30, 2010. As of December 31, 2018, the Corporation has not recognized a deferred income tax liability with respect to these reserves. These reserves could be recognized as taxable income and create a current and/or deferred tax liability at the income tax rates then in effect if one of the following conditions occurs: (1) the Bank’s retained earnings represented by this reserve are used for distributions, in liquidation, or for any other purpose other than to absorb losses from bad debts; (2) the Bank fails to qualify as a bank, as provided by the Internal Revenue Code; or (3) there is a change in federal tax law.