Note 11—Income Taxes

The Company and its subsidiary are subject to U.S. federal and state income taxes. Income tax expense is the total of the current year income tax due or refundable and the change in deferred tax assets and liabilities. Deferred tax assets and liabilities are recognized for the future tax consequences attributable to differences between the financial statement carrying amounts of existing assets and liabilities and their respective tax bases and operating loss and tax credit carry-forwards. Deferred tax assets and liabilities are measured using enacted tax rates expected to apply to taxable income in the years in which those temporary differences are expected to be recovered or settled. The effect on deferred tax assets and liabilities of a change in tax rates is recognized in income in the period that includes the enactment date.

Income tax expense was as follows:

	2015			2014
	(In thousands)
Current
Federal	$	—		$	—
State		20			3
Deferred
Federal		1,238			530
State		505			324
Change in valuation allowance		(6,337	)		(854	)

Total	$	(4,574	)	$	3

Effective tax rates differ from the federal statutory rate of 34% applied to income before income taxes due to the following:

	2015			2014
	(In thousands)
Federal statutory rate times financial statement net income	$	1,529		$	861
Effect of:
State taxes, net of federal benefit		323			183
Earnings from bank owned life insurance		(25	)		(27	)
Low income housing credits		(212	)		(212	)
Change in valuation allowance		(6,337	)		(854	)
Other, net		148			52

Total	$	(4,574	)	$	3

Year-end deferred tax assets and liabilities were due to the following:

	2015			2014
	(In thousands)
Deferred tax assets:
Allowance for loan losses	$	311		$	1,833
Accrued liabilities		222			286
State income taxes		51			44
Deferred compensation		475			513
Stock compensation		110			275
Net operating loss carryforward		6,141			7,341
Non-accrual loan interest		14			58
Partnership investment		125			60
General business credit		1,091			938
Alternative minimum tax credit		185			113
Other		531			33

Total deferred tax assets		9,256			11,494

Valuation allowance		(2,527	)		(8,806	)

Deferred tax liabilities:
Deferred loan fees/costs		(1,246	)		(1,633	)
Real estate owned		(15	)		(86	)
Basis difference on fixed assets		(59	)		(80	)
Net unrealized appreciation on available-for-sale securities		(164	)		(222	)
FHLB stock dividends		(574	)		(574	)
Mortgage servicing rights		(17	)		(26	)
Prepaid expenses		(60	)		(67	)

Total deferred tax liabilities		(2,135	)		(2,688	)

Net deferred tax assets	$	4,594		$	—

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 asset will not be realized. In assessing the realization of deferred tax assets, management evaluates both positive and negative evidence, including the existence of cumulative losses in the current year and the prior two years, the amount of taxes paid in available carry-back years, the forecasts of future income and tax planning strategies. This analysis is updated quarterly. Based on this analysis, the Company anticipates partial realization of its net deferred tax assets and has reduced its valuation allowance to $2.5 million at December 31, 2015. As a result, the Company reported $4.6 million in net deferred tax assets as of December 31, 2015. The Company recorded a valuation allowance of $8.8 million and $0 net deferred tax assets as of December 31, 2014.

As of December 31, 2015, the Company has federal net operating loss carryforwards of $11.9 million and California net operating loss carryforwards of $29.2 million, which begin expiring in 2031 through 2034. The Company also has federal general business credits of $1.1 million, expiring beginning in 2031 through 2035, and alternative minimum tax credit carryforwards of $172 thousand, which can be carried forward indefinitely.

Federal income tax laws previously allowed the Company additional bad debt deductions based on the reserve method of computing the federal bad debt deduction. This method of computing the Company's federal bad debt deduction was permitted to be used by the Company until the end of 1987. As of December 31, 1987, the tax bad debt reserve balance totaled $3.0 million. Accounting standards do not require a deferred tax liability to be recorded on this amount, which otherwise would total approximately $1.0 million at year end 2015 and 2014. If the Bank were liquidated, or otherwise ceases to be a bank, the $3.0 million tax bad debt reserve may need to be recaptured into taxable income and income tax expense would need to be provided.

A reconciliation of the beginning and ending amount of unrecognized tax benefits is as follows:

	2015		2014
	(In thousands)
Balance at beginning of year	$	475	$	488
Additions based on tax positions related to the current year		—		—
Additions for tax positions of prior year		—		—
Reductions for tax positions of prior years		—		(13	)
Settlements		—		—

Balance at end of year	$	475	$	475

The $475 thousand balance at December 31, 2015 represents the amount of unrecognized tax benefits that, if recognized, would favorably affect the income tax provision in future periods. The Company expects that the total amount of unrecognized tax benefits may decrease significantly within the next twelve months due to expected settlement with the state taxing authorities. During 2015 and 2014, $5 thousand and $3 thousand were accrued during each period for potential interest related to these unrecognized tax benefits.

Federal tax years 2012 through 2015 remain open for the assessment of Federal income tax. California tax years 2010 through 2015 remain open for the assessment of California income tax. The Company is currently under examination by the California Franchise Tax Board ("FTB") for the 2009, 2010, and 2011 tax years. The FTB has adjusted the Company's California net operating loss carryforwards for items which the Company has established an unrecognized tax benefit. The Company has protested the adjustments and does not expect that significant additional tax expense will result.