Income Taxes

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



(dollars in thousands)	2013			2012			2011
Current:
Federal	$	—		$	—		$	—
State	—			—			—
Total current taxes	—			—			—
Deferred
Federal	21,030			(13,709		)	(43,001		)
State	14,655			(2,722		)	(8,657		)
Total deferred taxes	35,685			(16,431		)	(51,658		)
Increase (decrease) in valuation allowance	(34,359		)	15,392			52,299
Total income tax (benefit) expense - continuing operations	$	1,326		$	(1,039	)	$	641

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)
	2013			2012			2011
Amount of tax computed using Federal statutory tax rate of 35% in all years	$	(55	)	$	(14,365	)	$	(45,807	)
Increases (decreases) resulting from effects of:
Non-taxable income	(88		)	(169		)	(196		)
State income taxes, net of federal benefit	9,526			(1,769		)	(5,627		)
Valuation allowance on deferred tax assets	(34,359		)	15,392			52,299
Reduction of deferred tax assets at Granite	28,293			—			—
Other	(1,991		)	(128		)	(28		)
Total income tax (benefit) expense - continuing operations	$	1,326		$	(1,039	)	$	641

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, COB 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, 2013 and December 31, 2012, net deferred income tax assets totaling $10.2 million and $0.8 million, respectively, are recorded on COB’s balance sheet. No valuation allowance is recorded for unrealized losses on investment securities because it is not more likely than not that COB 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, 2013			December 31, 2012
Deferred tax assets:
Allowance for loan losses	$	10,364		$	11,754
Net operating loss	135,050			145,472
Compensation and benefit plans	995			805
Fair value basis on securities	918			1,199
Fair value basis of loans	(951		)	9,742
Fair value basis on deposits	—			187
Pension and other post-retirement benefits	1,080			2,754
Other real estate owned	4,091			16,649
Gross unrealized securities losses	10,215			838
Interest on nonperforming loans	1,339			1,382
Other	529			812
Subtotal deferred tax assets	163,630			191,594
Less: Valuation allowance	(148,043		)	(182,402		)
Total deferred tax assets	15,587			9,192
Deferred tax liabilities:
Core deposit intangible	2,051			2,673
Depreciable basis of premises and equipment	495			721
Net deferred loan fees and costs	1,077			1,010
Gross unrealized securities gains	1,249			3,220
SAB 109 valuation	—			2
Other	500			728
Total deferred tax liabilities	5,372			8,354
Net deferred tax assets	$	10,215		$	838

Under GAAP, COB 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, 2013 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. During 2013, COB reduced its deferred tax asset by $28.3 million based on its inability to use the Granite Corp. net operating losses and built in losses that are limited due to the change in ownership that occurred at acquisition. The net reduction in DTA is offset by a corresponding reduction in the valuation allowance. The Company believes the remaining DTA of $2.9 million related to NOL carryforwards from Granite Corp. will be realized on a go forward basis.

The State of North Carolina passed legislation to reduce the income tax rates from 6.90% to 6.0% in 2014 and to 5.0% in 2015. The DTA has been reduced by $5.3 million to account for the reduction in income tax rates to 5%. The net reduction in DTA is offset by a corresponding reduction in the valuation allowance. Beginning in the third quarter, the Company will use an effective tax rate of 38.25%, from 39.485%, based on the reduction in the North Carolina income tax rate.