Tax Credit Investments

3 Months Ended

Mar. 31, 2019

Valley’s tax credit investments are primarily related to investments promoting qualified affordable housing projects, and other investments related to community development and renewable energy sources. Some of these tax-advantaged investments support Valley’s regulatory compliance with the Community Reinvestment Act (CRA). Valley’s investments in these entities generate a return primarily through the realization of federal income tax credits, and other tax benefits, such as tax deductions from operating losses of the investments, over specified time periods. These tax credits and deductions are recognized as a reduction of income tax expense.

Valley’s tax credit investments are carried in other assets on the consolidated statements of financial condition. Valley’s unfunded capital and other commitments related to the tax credit investments are carried in accrued

expenses and other liabilities on the consolidated statements of financial condition. Valley recognizes amortization of tax credit investments, including impairment losses, within non-interest expense of the consolidated statements of income using the equity method of accounting. After initial measurement, the carrying amounts of tax credit investments with non-readily determinable fair values, are increased to reflect Valley's share of income of the investee and are reduced to reflect its share of losses of the investee, dividends received and other-than-temporary impairments, if applicable (See "Other-Than-Temporary Impairment Analysis" section below).

The following table presents the balances of Valley’s affordable housing tax credit investments, other tax credit investments, and related unfunded commitments at March 31, 2019 and December 31, 2018:



	March 31, 2019		December 31, 2018
	(in thousands)
Other Assets:
Affordable housing tax credit investments, net	$	35,278	$	36,961
Other tax credit investments, net	55,669		68,052
Total tax credit investments, net	$	90,947	$	105,013
Other Liabilities:
Unfunded affordable housing tax credit commitments	$	2,781	$	4,520
Unfunded other tax credit commitments	8,756		8,756
Total unfunded tax credit commitments	$	11,537	$	13,276

The following table presents other information relating to Valley’s affordable housing tax credit investments and other tax credit investments for the three months ended March 31, 2019 and 2018:



	Three Months Ended March 31,
	2019		2018
	(in thousands)
Components of Income Tax Expense:
Affordable housing tax credits and other tax benefits	$	1,713	$	1,821
Other tax credit investment credits and tax benefits	2,803		5,485
Total reduction in income tax expense	$	4,516	$	7,306
Amortization of Tax Credit Investments:
Affordable housing tax credit investment losses	$	673	$	986
Affordable housing tax credit investment impairment losses	730		587
Other tax credit investment losses	987		537
Other tax credit investment impairment losses	4,783		3,164
Total amortization of tax credit investments recorded in non-interest expense	$	7,173	$	5,274

Other-Than-Temporary Impairment Analysis

An impairment loss is recognized when the fair value of the tax credit investment is less than its carrying value. The determination of whether a decline in value of a tax credit investment is other-than-temporary requires significant judgment and is performed separately for each investment. The tax credit investments are reviewed for impairment quarterly, or whenever events or changes in circumstances indicate that the carrying amount of the investment might not be recoverable. These circumstances can include, but are not limited to, the following factors:


•	Evidence that we do not have the ability to recover the carrying amount of the investment;


•	The inability of the investee to sustain earnings;


•	A current fair value of the investment based upon cash flow projections that is less than the carrying amount; and


•	Change in the economic or technological environment that could adversely affect the investee’s operations

On a quarterly basis, Valley obtains financial reporting on the underlying investment assets for each fund from the Fund Manager who is independent of us and the Fund Sponsor. The financial reporting is reviewed for deterioration in the financial condition of the fund, the level of cash flows and any significant losses or impairment charges. Valley also regularly reviews the condition and continuing prospects of the underlying operations of the investment with the Fund Manager, including any observations from site visits and communications with the Fund Sponsor, if available. Annually, Valley obtains the audited financial statements prepared by an independent accounting firm for each investment, as well as the annual tax returns. Generally, none of the aforementioned review factors are individually conclusive and the relative importance of each factor will vary based on facts and circumstances. However, the longer the expected period of recovery, the stronger and more objective the positive evidence needs to be in order to overcome the presumption that the impairment is other than temporary. If management determines that a decline in value is other than temporary per its quarterly and annual reviews, including current probable cash flow projections, the applicable tax credit investment is written down to its fair value through an impairment charge to earnings, which establishes the new cost basis of the investment.

The aggregate unamortized investment related to three federal renewable energy tax credit funds sponsored by DC Solar represented approximately $2.4 million (or approximately $800 thousand for each fund) of the $68.1 million of net other tax credit investments reported as of December 31, 2018. These funds are described in detail in Note 15 below. During the first quarter of 2019, Valley determined that future cash flows related to the remaining investments in all three funds were not probable based upon new information available, including the sponsor’s current bankruptcy proceeding which were reclassified to Chapter 7 in late March 2019. As a result, we recognized an other-than-temporary impairment charge for the entire aggregate unamortized investment of $2.4 million within amortization of tax credit investments for the three months ended March 31, 2019.Income Taxes

A reconciliation of Valley’s gross unrecognized tax benefits at March 31, 2019 and 2018 are presented in the table below:



	Three Months Ended March 31,
	2019		2018

Beginning balance	$	—	$	4,238
Additions based on tax positions related to prior years	12,100		—
Ending balance	$	12,100	$	4,238

The entire balance of unrecognized tax benefits, if recognized, would favorably affect our effective income tax rate. Valley’s policy is to report interest and penalties, if any, related to unrecognized tax benefits in income tax expense. Valley accrued approximately $1.9 million and $1.8 million of interest associated with Valley’s uncertain tax positions at March 31, 2019 and 2018, respectively.

From 2013 to 2015, Valley invested in three federal renewable energy tax credit funds (Fund VI, Fund XII and Fund XIX) sponsored by DC Solar and claimed the related federal tax credit benefits of approximately $22.8 million in its consolidated financial statements during the same period. All three funds own mobile solar generator units leased to DC Solar Distributions, which stated its intention to sublease the units to third parties.

An entity shall initially recognize the financial statement effects of a tax position when it is more likely than not (or a likelihood of more than 50 percent), based on the technical merits, that the position will be sustained upon examination. The level of evidence that is necessary and appropriate to support an entity's assessment of the technical merits of a tax position is a matter of judgment that depends on all available information. At each of the

investment dates, Valley obtained two tax opinions from national law firms that should successfully support the recognition of the tax credits in its tax returns if challenged by the IRS. Based upon management's review of the tax opinions on the investment’s legal structure, Valley recognized and measured each tax position at a 100 percent of the tax credit.

Valley's subsequent measurement of a tax position is based on management’s best judgment given the facts, circumstances, and information available at quarterly reporting date. A change in judgment that results in subsequent derecognition or change in measurement of a tax position taken in a prior annual period (including any related interest and penalties) is recognized as a discrete item in the period in which the change occurs.

In late February 2019, Valley learned of Federal Bureau of Investigation (FBI) allegations of fraudulent conduct by DC Solar, including information about asset seizures of DC Solar property and assets of its principals and ongoing federal investigations. Since learning of the allegations, Valley has conducted an ongoing investigation coordinated with 10 other DC Solar fund investors, investors' outside counsel and a third party specialist. The facts uncovered to date by the investor group impact each investor differently, affecting their likelihood of loss and the ultimate amount of tax benefit likely to be recaptured. To date, over 91 percent of the 512 solar generator units owned by Valley's three funds have been positively identified by a third party specialist at several leasee and other locations throughout the United States. Valley has also learned through its investigation that the IRS has challenged the valuation appraisals of similar solar generator units that were used to determine the federal renewable energy tax credits related to another DC Solar fund owned by an unrelated investor.

Given the circumstances at this time and management's best judgments regarding the settlement of the tax positions that it would ultimately accept with the IRS, Valley currently expects a partial loss and tax benefit recapture. As a result of this assessment, Valley's first quarter of 2019 net income includes an increase to the provision for income taxes of $12.1 million, reflecting the reserve for uncertain tax liability position (shown in the table above) related to renewable energy tax credits and other tax benefits previously recognized from the investments in the DC Solar funds plus interest. Valley can provide no assurance that it will not recognize additional tax provisions related to this uncertain tax liability as management learns additional facts and information, or that Valley will not ultimately incur a complete loss on the related tax positions, which is currently estimated to be $28.8 million (inclusive of the $12.1 million provision for the first quarter of 2019).

Valley continuously monitors its tax positions for the underlying facts, circumstances, and information available including the federal investigation of DC Solar and changes in tax laws, case law and regulations that may necessitate subsequent de-recognition of previous tax benefits.