Income taxes

3 Months Ended

Mar. 31, 2017

Note 31 – Income taxes

The reason for the difference between the income tax expense applicable to income before provision for income taxes and the amount computed by applying the statutory tax rate in Puerto Rico, were as follows:

		Quarters ended
		March 31, 2017				March 31, 2016
(In thousands)		Amount	% of pre-tax income			Amount	% of pre-tax income
Computed income tax expense at statutory rates	$	49,121	39	%	$	45,733	39	%
Net benefit of tax exempt interest income		(18,004)	(14)			(15,584)	(13)
Deferred tax asset valuation allowance		5,056	4			5,273	5
Difference in tax rates due to multiple jurisdictions		(959)	(1)			(864)	(1)
Effect of income subject to preferential tax rate		(3,019)	(3)			(3,414)	(3)
State and local taxes		1,279	1			2,927	3
Others		(468)	-			(1,806)	(2)
Income tax expense	$	33,006	26	%	$	32,265	28	%

The following table presents a breakdown of the significant components of the Corporation’s deferred tax assets and liabilities.

(In thousands)			March 31, 2017		December 31, 2016
Deferred tax assets:
Tax credits available for carryforward		$	20,220	$	18,510
Net operating loss and other carryforward available			1,235,780		1,238,222
Postretirement and pension benefits			93,054		94,741
Deferred loan origination fees			6,065		6,622
Allowance for loan losses			634,690		649,107
Deferred gains			4,676		4,884
Accelerated depreciation			10,115		9,828
Intercompany deferred gains			2,328		2,496
Difference between the assigned values and the tax basis of assets and liabilities
	recognized in purchase business combinations		11,344		13,160
Other temporary differences			29,922		31,127
	Total gross deferred tax assets		2,048,194		2,068,697
Deferred tax liabilities:
FDIC-assisted transaction			56,331		58,363
Indefinite-lived intangibles			76,576		73,974
Unrealized net gain on trading and available-for-sale securities			20,851		21,335
Other temporary differences			8,959		8,477
	Total gross deferred tax liabilities		162,717		162,149
Valuation allowance			669,335		664,287
Net deferred tax asset		$	1,216,142	$	1,242,261

The net deferred tax asset shown in the table above at March 31, 2017 is reflected in the consolidated statements of financial condition as $1.2 billion in net deferred tax assets in the “Other assets” caption (December 31, 2016 - $1.2 billion) and $1.4 million in deferred tax liabilities in the “Other liabilities” caption (December 31, 2016 - $1.4 million), reflecting the aggregate deferred tax assets or liabilities of individual tax-paying subsidiaries of the Corporation.

A deferred tax asset should be reduced by a valuation allowance if based on the weight of all available evidence, it is more likely than not (a likelihood of more than 50%) that some portion or the entire deferred tax asset will not be realized. The valuation allowance should be sufficient to reduce the deferred tax asset to the amount that is more likely than not to be realized. The determination of whether a deferred tax asset is realizable is based on weighting all available evidence, including both positive and negative evidence. The realization of deferred tax assets, including carryforwards and deductible temporary differences, depends upon the existence of sufficient taxable income of the same character during the carryback or carryforward period. The analysis considers all sources of taxable income available to realize the deferred tax asset, including the future reversal of existing taxable temporary differences, future taxable income exclusive of reversing temporary differences and carryforwards, taxable income in prior carryback years and tax-planning strategies.

At March 31, 2017 the net deferred tax asset of the U.S. operations amounted to $1.1 billion with a valuation allowance of approximately $617 million, for a net deferred tax asset after valuation allowance of approximately $520 million. During the year ended December 31, 2015, after weighting all positive and negative evidence, the Corporation concluded that it is more likely than not that a portion of the total deferred tax asset from the U.S. operations, comprised mainly of net operating losses, will be realized. The Corporation based this determination on its estimated earnings for the remaining carryforward period of eighteen years beginning with the 2016 fiscal year, available to utilize the deferred tax asset, to reduce its income tax obligations. The historical level of book income adjusted by permanent differences, together with the estimated earnings after the reorganization of the U.S. operations and additional estimated earnings from the Doral Bank Transaction were objective positive evidence considered by the Corporation. As of December 31, 2015 the U.S. operations were not in a three year loss cumulative position, taking into account taxable income exclusive of reversing temporary differences. All of these factors led management to conclude that it is more likely than not that a portion of the deferred tax asset from its U.S. operations will be realized. Accordingly, the Corporation recorded a partial reversal of the valuation allowance on the deferred tax asset from the U.S. operations amounting to approximately $589 million. As of March 31, 2017, management estimated that the U.S. operations would earn enough pre-tax Income during the carryover period to realize the total amount of net deferred tax asset after valuation allowance. After weighting all available positive and negative evidence, management concluded that is more likely than not that a portion of the deferred tax asset from the U.S. operation, amounting to approximately $520 million, will be realized. Management will continue to evaluate the realization of the deferred tax asset each quarter and adjust as any changes arises.

At March 31, 2017, the Corporation’s net deferred tax assets related to its Puerto Rico operations amounted to $697 million.

The Corporation’s Puerto Rico Banking operation is not in a cumulative three year loss position and has sustained profitability for the three year period ended March 31, 2017.This is considered a strong piece of objectively verifiable positive evidence that outweights any negative evidence considered by management in the evaluation of the realization of the deferred tax asset. Based on this evidence and management’s estimate of future taxable income, the Corporation has concluded that it is more likely than not that such net deferred tax asset of the Puerto Rico Banking operations will be realized.

The Holding Company operation is in a cumulative loss position taking into account taxable income exclusive of reversing temporary differences, for the three year period ended March 31, 2017. Management expects these losses will be a trend in future years. This objectively verifiable negative evidence is considered by management a strong negative evidence that will suggest that income in future years will be insufficient to support the realization of all deferred tax asset. After weighting of all positive and negative evidence management concluded, as of the reporting date, that it is more likely than not that the Holding Company will not be able to realize any portion of the deferred tax assets, considering the criteria of ASC Topic 740. Accordingly, a full valuation allowance is recorded on the deferred tax asset at the Holding Company, which amounted to $52 million as of March 31, 2017.

The reconciliation of unrecognized tax benefits, excluding interest, was as follows:

(In millions)		2017		2016
Balance at January 1	$	7.4	$	9.0
Additions for tax positions -January through March		0.2		0.4
Balance at March 31	$	7.6	$	9.4

At March 31, 2017, the total amount of interest recognized in the statement of financial condition approximated $3.0 million (December 31, 2016 - $2.9 million). The total interest expense recognized during the quarter ended March 31, 2017 was $145 thousand (December 31, 2016 - $1.2 million). Management determined that at March 31, 2017 and December 31, 2016 there was no need to accrue for the payment of penalties. The Corporation’s policy is to report interest related to unrecognized tax benefits in income tax expense, whiles the penalties, if any, are reported in other operating expenses in the consolidated statements of operations.

After consideration of the effect on U.S. federal tax of unrecognized U.S. state tax benefits, the total amount of unrecognized tax benefits, including U.S. and Puerto Rico, that if recognized, would affect the Corporation’s effective tax rate, was approximately $9.3 million at March 31, 2017 (December 31, 2016 - $9.0 million).

The amount of unrecognized tax benefits may increase or decrease in the future for various reasons including adding amounts for current tax year positions, expiration of open income tax returns due to the statutes of limitation, changes in management’s judgment about the level of uncertainty, status of examinations, litigation and legislative activity and the addition or elimination of uncertain tax positions.

The Corporation and its subsidiaries file income tax returns in Puerto Rico, the U.S. federal jurisdiction, various U.S. states and political subdivisions, and foreign jurisdictions. At March 31, 2017, the following years remain subject to examination in the U.S. Federal jurisdiction: 2013 and thereafter; and in the Puerto Rico jurisdiction, 2012 and thereafter. The Corporation anticipates a reduction in the total amount of unrecognized tax benefits within the next 12 months, which could amount to approximately $4.9 million.