Income taxes

6 Months Ended

Jun. 30, 2022

Income Tax Disclosure

Income Taxes

Note 30 – 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
		June 30, 2022				June 30, 2021
(In thousands)		Amount	% of pre-tax income			Amount	% of pre-tax income
Computed income tax expense at statutory rates	$	103,362	38	%	$	109,189	38	%
Net benefit of tax exempt interest income		(41,336)	(15)			(36,840)	(13)
Deferred tax asset valuation allowance		2,047	-			5,832	2
Difference in tax rates due to multiple jurisdictions		(6,817)	(3)			(4,881)	(2)
Effect of income subject to preferential tax rate		(3,097)	(1)			(1,405)	(1)
Adjustment due to estimate on the annual effective rate		6,939	3			(405)	-
State and local taxes		3,566	1			2,530	1
Others		(452)	-			(927)	-
Income tax expense	$	64,212	23	%	$	73,093	25	%

		Six months ended
		June 30, 2022				June 30, 2021
(In thousands)		Amount	% of pre-tax income			Amount	% of pre-tax income
Computed income tax expense at statutory rates	$	201,674	38	%	$	236,488	38	%
Net benefit of tax exempt interest income		(77,825)	(15)			(71,003)	(11)
Deferred tax asset valuation allowance		5,938	1			16,153	3
Difference in tax rates due to multiple jurisdictions		(13,310)	(3)			(15,829)	(3)
Effect of income subject to preferential tax rate		(7,042)	(1)			(4,734)	(1)
Adjustment due to estimate on the annual effective rate		559	-			(10,733)	(2)
State and local taxes		7,231	1			2,591	-
Others		(2,534)	-			(3,009)	-
Income tax expense	$	114,691	21	%	$	149,924	24	%

For the quarter and six months ended June 30, 2022, the Corporation recorded an income tax expense of $64.2 million and $114.7 million, respectively, compared to $73.1 million and $149.9 million for the respective periods of 2021. The decrease in income tax expense was primarily due to lower pre-tax income and higher tax exempt income for the quarter and six months ended June 30, 2022.

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

			June 30, 2022
(In thousands)			PR		US		Total
Deferred tax assets:
Tax credits available for carryforward		$	261	$	2,781	$	3,042
Net operating loss and other carryforward available			119,891		652,204		772,095
Postretirement and pension benefits			52,779		-		52,779
Deferred loan origination fees/cost			21		-		21
Allowance for credit losses			233,382		31,025		264,407
Accelerated depreciation			5,246		7,268		12,514
FDIC-assisted transaction			152,665		-		152,665
Intercompany deferred gains			2,477		-		2,477
Lease liability			30,152		21,967		52,119
Unrealized net gain on trading and available-for-sale securities			196,221		16,138		212,359
Difference in outside basis from pass-through entities			46,112		-		46,112
Other temporary differences			33,701		8,291		41,992
	Total gross deferred tax assets		872,908		739,674		1,612,582
Deferred tax liabilities:
Indefinite-lived intangibles			78,300		52,874		131,174
Right of use assets			27,927		18,499		46,426
Deferred loan origination fees/cost			1,431		3,661		5,092
Other temporary differences			43,044		1,530		44,574
	Total gross deferred tax liabilities		150,702		76,564		227,266
Valuation allowance			134,495		434,471		568,966
Net deferred tax asset		$	587,711	$	228,639	$	816,350
			December 31, 2021
(In thousands)			PR		US		Total
Deferred tax assets:
Tax credits available for carryforward		$	261	$	2,781	$	3,042
Net operating loss and other carryforward available			112,331		665,164		777,495
Postretirement and pension benefits			57,002		-		57,002
Deferred loan origination fees/cost			2,788		-		2,788
Allowance for credit losses			233,500		31,872		265,372
Deferred gains			1,642		-		1,642
Accelerated depreciation			5,246		7,422		12,668
FDIC-assisted transaction			152,665		-		152,665
Lease liability			31,211		23,894		55,105
Difference in outside basis from pass-through entities			54,781		-		54,781
Other temporary differences			38,512		8,418		46,930
	Total gross deferred tax assets		689,939		739,551		1,429,490
Deferred tax liabilities:
Indefinite-lived intangibles			76,635		51,150		127,785
Unrealized net gain (loss) on trading and available-for-sale securities			4,329		2,817		7,146
Right of use assets			29,025		20,282		49,307
Deferred loan origination fees/cost			-		3,567		3,567
Other temporary differences			43,856		1,530		45,386
	Total gross deferred tax liabilities		153,845		79,346		233,191
Valuation allowance			128,557		410,970		539,527
Net deferred tax asset		$	407,537	$	249,235	$	656,772

The net deferred tax asset shown in the table above at June 30, 2022 is reflected in the consolidated statements of financial condition as $0.8 billion in net deferred tax assets in the “Other assets” caption (December 31, 2021 - $0.7 billion) and $1.5 million in deferred tax liabilities in the “Other liabilities” caption (December 31, 2021 - $825 thousand), reflecting the aggregate deferred tax assets or liabilities of individual tax-paying subsidiaries of the Corporation in their respective tax jurisdiction, Puerto Rico or the United States.

At June 30, 2022 the net deferred tax asset of the U.S. operations amounted to $663 million with a valuation allowance of approximately $434 million, for a net deferred tax asset after valuation allowance of approximately $229 million. The Corporation evaluates the realization of the deferred tax asset by taxing jurisdiction. The U.S. operation had sustained profitability for the year ended December 31, 2021, and the period ended June 30, 2022. Years 2020 and 2021 have been impacted by the COVID-19 pandemic and other events. Year 2020 was unfavorably impacted by the ACL reserve build-ups and the impairment of expenses on the branch closures in the New York region. Year 2021 has been favorably impacted by a strong economic recovery that resulted in ACL reserve releases, reversing the year 2020 build-up. The financial results for the period ended June 30, 2022 demonstrate financial stability for the U.S. operations, despite the climate of uncertainty as a result of recent global geopolitical and health challenges. These historical financial results are objectively verifiable positive evidence, evaluated together with the positive evidence of stable credit metrics, in combination with the length of the expiration of the NOLs. On the other hand, the Corporation evaluated the negative evidence accumulated over the years, including financial results lower than expectations and challenges to the economy due to global geopolitical uncertainty. As of June 30, 2022, after weighting all positive and negative evidence, the Corporation concluded that it is more likely than not that approximately $229 million of the 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 available to realize the deferred tax asset for the remaining carryforward period, together with the historical level of book income adjusted by permanent differences. Management will continue to monitor and review the U.S. operation’s results and the pre-tax earnings forecast on a quarterly basis to assess the future realization of the deferred tax asset. Management will closely monitor factors, including, net income versus forecast, targeted loan growth, net interest income margin, allowance for credit losses, charge offs, NPLs inflows and NPA balances. If our U.S. operations continue to show strong financial results during year 2022 together with the additional income expected from the recent acquisition of K2 assets, along with new tax initiatives, this could be considered additional positive evidence that could overcome totally or partially the negative evidence evaluated as of June 30, 2022, that could increase the amount of benefit from net operating losses that the Corporation estimates to be realized in the future resulting in future adjustments to the valuation allowance.

At June 30, 2022, the Corporation’s net deferred tax assets related to its Puerto Rico operations amounted to $588 million.

The Corporation’s Puerto Rico Banking operation is not in a cumulative loss position and has sustained profitability for the three year period ended June 30, 2022. This is considered a strong piece of objectively verifiable positive evidence that outweighs 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 years period ending June 30, 2022. Management expects these losses will be a trend in future years. This objectively verifiable negative evidence is considered by management strong negative evidence that will suggest that income in future years will be insufficient to support the realization of all deferred tax assets. 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, the Corporation has maintained a valuation allowance on the deferred tax asset of $134 million as of June 30, 2022.

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

(In millions)		2022		2021
Balance at January 1	$	3.5	$	14.8
Balance at March 31	$	3.5	$	14.8
Balance at June 30	$	3.5	$	14.8

At June 30, 2022, the total amount of accrued interest recognized in the statement of financial condition approximated $2.9 million (December 31, 2021 - $2.8 million). The total interest expense recognized at June 30, 2022 was $165 thousand, (June 30, 2021 - $727 thousand). Management determined that at June 30, 2022 and December 31, 2021 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, while 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 $5.7 million at June 30, 2022 (December 31, 2021 - $5.5 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 June 30, 2022, the following years remain subject to examination in the U.S. Federal jurisdiction: 2018 and thereafter; and in the Puerto Rico jurisdiction, 2017 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 $1.5 million, including interest.