Income Taxes

The components of income tax expense for the years ended December 31 are as follows:



(dollars in thousands)	2012			2011			2010
Current:
Federal	$	—		$	—		$	(105	)
State	—			—			(22		)
Total current taxes	—			—			(127		)
Deferred
Federal	(13,709		)	(43,001		)	(36,996		)
State	(2,721		)	(8,657		)	(7,544		)
Total deferred taxes	(16,430		)	(51,658		)	(44,540		)
Increase in valuation allowance	15,391			52,299			45,926
Total income tax (benefit)/expense - continuing operations	$	(1,039	)	$	641		$	1,259

A reconciliation of income tax expense computed at the statutory federal income tax rate to actual income tax expense is presented in the following table as of December 31:



(dollars in thousands)
	2012			2011			2010
Amount of tax computed using Federal statutory tax rate of 35% in all years	$	(14,365	)	$	(45,807	)	$	(38,589	)
Increases/(decreases) resulting from effects of:
Non-taxable income	(169		)	(196		)	(418		)
State income taxes, net of federal benefit	(1,768		)	(5,627		)	(4,919		)
Valuation allowance on deferred tax assets	15,391			52,299			45,926
Other	(128		)	(28		)	(741		)
Total income tax (benefit)/expense - continuing operations	$	(1,039	)	$	641		$	1,259

Deferred taxes are provided using the asset and liability method whereby deferred tax assets are recognized for deductible temporary differences and operating loss and tax credit carryforwards and deferred tax liabilities are recognized for taxable temporary differences. Temporary differences are the differences between the reported amounts of assets and liabilities and their tax basis. 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 assets will not be realized. Deferred tax assets and liabilities are adjusted for the effects of changes in tax laws and rates on the date of enactment. Excluding unrealized losses on available-for-sale securities, FNB has recorded a 100% deferred tax valuation allowance related to various temporary differences, principally consisting of the provision for loan losses and its net operating loss carryforwards.

As of December 31, 2012 and December 31, 2011, net deferred income tax assets totaling $0.8 million and $1.8 million, respectively, are recorded on FNB’s balance sheet. No valuation allowance is recorded for unrealized losses on investment securities because it is not more likely than not that FNB will have to sell these securities at a loss.

The components of deferred tax assets and liabilities and the tax effect of each are as follows:



(dollars in thousands)	December 31, 2012			December 31, 2011
Deferred tax assets:
Allowance for loan losses	$	11,754		$	17,395
Net operating loss	145,472			119,446
Compensation and benefit plans	805			2,098
Fair value basis on securities	1,199			1,392
Fair value basis of loans	9,742			12,099
Fair value basis on deposits	187			859
Pension and other post-retirement benefits	2,754			2,017
Other real estate owned	16,650			16,904
Gross unrealized securities losses	838			446
Interest on non-performing loans	1,382			1,382
Other	811			1,759
Subtotal deferred tax assets	191,594			175,797
Less: Valuation allowance	(182,402		)	(167,011		)
Total deferred tax assets	9,192			8,786
Deferred tax liabilities:
Core deposit intangible	2,673			3,229
Depreciable basis of premises and equipment	721			1,151
Net deferred loan fees and costs	1,010			871
Gross unrealized securities gains	3,220			631
SAB 109 valuation	2			6
Other	728			1,096
Total deferred tax liabilities	8,354			6,984
Net deferred tax assets	$	838		$	1,802

Under GAAP, FNB is not required to provide a deferred tax liability for the tax effect of additions to the tax bad debt reserve through 1987, the base year. Retained earnings at December 31, 2012 include approximately $5.0 million for which no provision for federal income tax has been made. These amounts represent allocations of income to bad debt deductions for tax purposes only. Reductions of such amounts for purposes other than bad debt losses could create income for tax purposes in certain remote instances, which would then be subject to the then current corporate income tax rate.

The Merger was considered a change in control for Granite Corp. under Internal Revenue Code Section 382 and the Regulations, thereunder. Accordingly, we are required to evaluate potential limitation or deferral of its ability to carryforward pre-acquisition net operating losses and to determine the amount of net unrealized built-in losses (“NUBIL”), which may be subject to similar limitation or deferral. Under the Internal Revenue Code and Regulations, NUBIL realized within 5 years of the change in control are subject to potential limitation, which for us is October 20, 2016. Through that date, we will continue to analyze our ability to utilize such losses to offset anticipated future taxable income, however, this estimate will not be known until the five-year recognition period expires. Losses limited under these provisions are generally limited to a carryforward period of 20 years, subject to the annual limitation and expire if not used by the end of that period. As of December 31, 2012, total deferred tax assets attributable to Granite Corp. and subsidiaries were approximately $34.6 million which is offset by a valuation allowance of $33.8 million. We anticipate that some of these benefits from the net operating losses and built-in losses will not ultimately be realized; however, that amount is subject to continuing analysis and has not yet been determined.