Income Taxes

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



(dollars in thousands)	2015			2014			2013
Current:
Federal	$	—		$	—		$	—
State	—			—			—
Total current taxes	—			—			—
Deferred
Federal	3,967			3,714			21,276
State	4,457			537			14,628
Total deferred taxes	8,424			4,251			35,904
Decrease in valuation allowance	(1,300		)	(146,743		)	(34,578		)
Total income tax (benefit) expense	$	7,124		$	(142,492	)	$	1,326

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



(dollars in thousands)
	2015			2014			2013
Amount of tax computed using federal statutory tax rate of 35% in all years	$	4,913		$	2,788		$	(55	)
Increases (decreases) resulting from effects of:
Non-taxable income	(39		)	(54		)	(88		)
State income taxes, net of federal benefit	2,897			349			9,508
Valuation allowance on deferred tax assets	(1,300		)	(146,743		)	(34,578		)
Bank-owned life insurance	(408		)	(403		)	(375		)
Reduction of deferred tax assets at Granite	—			—			28,293
Nondeductible merger costs	351			—			—
Other	710			1,571			(1,379		)
Total income tax (benefit) expense	$	7,124		$	(142,492	)	$	1,326

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



(dollars in thousands)	December 31, 2015		December 31, 2014
Deferred tax assets:
Allowance for loan losses	$	5,957	$	8,037
Net operating loss	133,524		137,412
Compensation and benefit plans	544		1,277
Fair value basis on securities	363		656
Pension and other post-retirement benefits	1,857		1,470
Other real estate owned	2,176		2,256
Gross unrealized securities losses	3,787		2,560
Other	474		851
Subtotal deferred tax assets	148,682		154,519
Less: Valuation allowance	—		(1,300		)
Total deferred tax assets	148,682		153,219
Deferred tax liabilities:
Core deposit intangible	953		1,513
Depreciable basis of premises and equipment	301		563
Net deferred loan fees and costs	1,726		1,306
Gross unrealized securities gains	352		490
Fair value basis of loans	3,186		2,473
Other	448		441
Total deferred tax liabilities	6,966		6,786
Net deferred tax assets	$	141,716	$	146,433

As of December 31, 2015 and December 31, 2014, net deferred income tax assets totaling $141.7 million and $146.4 million, respectively, are recorded on COB’s balance sheet. At December 31, 2014, the Company’s gross deferred tax assets were offset by a valuation allowance of $1.3 million. During 2015 management reevaluated the continuing need for this valuation allowance in accordance with the procedures described in the “Income Taxes” section of Note 1 and as more fully described below, applied its judgment to determine that it is more likely than not that all of the Company’s deferred tax assets will be realized.

The Company’s deferred tax assets consist primarily of consolidated federal and Bank-originated North Carolina loss carryforwards from prior periods. The consolidated federal net operating loss carryforwards are $352.0 million and $355.9 million and the North Carolina net economic loss carryforwards are $368.7 million and $371.8 million at December 31, 2015 and 2014, respectively. The remaining federal and North Carolina carryforward periods range between fourteen and eighteen years and nine and thirteen years, respectively, at December 31, 2015.

Management regularly evaluates the likelihood that the Company will be able to realize its deferred tax assets and the continuing need for a valuation allowance. In 2013 and prior years management determined that sufficient evidence was not available to conclude that it was more likely than not that all of its deferred tax assets could be realized, requiring a valuation allowance for certain of its deferred tax assets. At December 31, 2014 management determined, based on all available positive and negative evidence, that it is more likely than not that future taxable income will be available during the carryforward periods to absorb all of the consolidated federal net operating loss carryforward and all but a small portion of the Bank’s North Carolina net economic loss carryforward. As a result of this determination, $142.5 million of valuation allowance against the Company's deferred tax assets was reversed. A number of factors played a critical role in this determination, including:


•	Improvements in the asset quality of the loan portfolio and diminishment of credit-related losses that were the source of the Company's losses;


•	Implementation of strong internal controls making it unlikely that the large volume of troubled loans leading to the Company’s losses between 2008 and 2012 will reoccur;


•	The increased remoteness and diminished relevance of such losses;


•	Continued improvement of the Company’s financial metrics and six consecutive quarters of earnings;


•	A credible forecast of future taxable income based on management’s demonstrated forecasting accuracy;


•	Various cost-reduction initiatives that will have a continuing positive effect on earnings in future periods;


•	Availability of tax planning strategies, and


•	Long-dated carryforward periods.

Accordingly, upon consideration of all available objectively verifiable positive and negative evidence, management has applied its judgment to conclude that the Company’s valuation allowance should be reduced from $1.3 million at December 31, 2014 to $0 million at December 31, 2015.

Management will continue to regularly assess the Company’s ability to realize its deferred tax assets. Changes in earnings performance and future earnings projections may, among other factors, require the Company to adjust its valuation allowance, which would impact the Company's income tax expense in the period of adjustment.

Under GAAP, COB is not required to provide a deferred tax liability for the tax effect of additions to the tax bad debt reserve accumulating through 1987. Retained earnings at December 31, 2015 include approximately $5.0 million for which no provision for federal income tax has been made. In the remote possibility that circumstances occur requiring a reduction of the reserve, such reduction could be taxable and subject to the then-current corporate income tax rate.

Federal and North Carolina income tax returns for 2012 and tax years thereafter remain subject to examination by the relevant taxing authorities as of December 31, 2015. As of December 31, 2015 and December 31, 2014, COB had no material unrecognized tax benefits or accrued interest and penalties.

The merger of COB and Granite in 2011 resulted in an ownership change for Granite under Internal Revenue Code Section 382 and the Regulations thereunder. Accordingly, the Company is required to apply a limitation against Granite Corp.’s pre-acquisition net operating loss carryforwards and net unrealized built-in losses. During 2013, COB determined that it would be able to use only $2.9 million of the Granite Corp. net operating loss carryforwards and built-in losses and reduced both its deferred tax asset and related valuation allowance by $28.3 million.

On July 23, 2013, the State of North Carolina lowered the North Carolina corporate income tax rate from 6.9% to 6% effective 2014

and to 5% effective 2015. On July 28, 2015, North Carolina announced that, based on the state achieving its 2015 tax year revenue

target, the rate would be reduced to 4% during the 2016 tax year. The rate will be further reduced to 3% for post-2016 tax years

provided that additional revenue growth targets are reached. The rate reduction trigger resulted in a $2.3 million reduction in deferred

income tax asset. The Company recorded the impact of this legislation as a reduction in deferred income tax asset as of

September 30, 2015 and a charge to income tax expense in the third quarter of 2015.