Income Taxes

3 Months Ended

Mar. 31, 2012

Income Taxes

Income Taxes

Note 6.  Income Taxes

The income tax (benefit) / provision for the three months ended March 31, 2012 and 2011 resulted in an effective tax rate of (30.9)% and 31.7%, respectively.  The primary item causing the effective tax rate to be lower than the combined federal and state statutory rates for the first three months of 2012 and 2011 is the impact of non-taxable municipal interest.  In addition, the first three months of 2012 were impacted by the reversal of $0.8 million of deferred tax asset valuation allowance, resulting in a net tax benefit for the quarter, as discussed further below.

Deferred Tax Assets Valuation Allowance

U.S. GAAP requires that companies assess whether a valuation allowance should be established against deferred tax assets based on the consideration of all available evidence using a “more likely than not” standard.  In making such judgments, significant weight is given to evidence, both positive and negative, that can be objectively verified.  U.S. GAAP provides that a cumulative loss in recent years is significant negative evidence in considering whether deferred tax assets are realizable, and also limits projections of future taxable income to that which can be estimated over a reasonable amount of time.

The pre-tax losses the Company reported in 2010 and 2009 continue to result in a three year cumulative loss position, which provides significant negative evidence as to the realizability of a portion of the Company’s deferred tax assets as of December 31, 2010.  It should be noted however, that the three year cumulative loss position is down significantly from its peak at December 31, 2010.  As a result of this negative evidence, the Company recorded a partial valuation allowance of approximately $7.1 million for its deferred tax assets in 2010 through a charge to income tax expense. The Company’s determination of the valuation allowance for a portion of its deferred tax assets was based on: (1) an analysis of cumulative pre-tax losses over a three year horizon, through December 31, 2010; (2) a projection of future taxable income over a period of time the Company believed to be reasonably estimable (“the projection period”); and (3) a detailed analysis to determine the amount of the deferred tax asset expected to be realized over the projection period of five years.  The ultimate realization of the Company’s deferred tax assets is dependent on the generation of future taxable income during the periods in which those temporary differences reverse.  Given the Company was in a three year cumulative pre-tax loss position as of December 31, 2010, it became less likely the Company would generate enough future taxable income over the projection period in order for all of its deferred tax assets to be realized.

However, the Company’s return to profitability in 2011 and continued profits in 2012 are steadily reducing this three year cumulative loss position.  In addition, declines in the level of deferred tax assets and changes in its composition, along with projections of profitability for the foreseeable future and an improvement in the credit quality of the Company’s loan portfolio have combined to improve the outlook for the recovery of a portion of the valuation allowance provided for in 2010.  As a result of this improved outlook, the Company reduced the level of valuation allowance in the latter part of 2011 by $1.5 million and again in the first quarter of 2012 by an additional $0.8 million.

The deferred tax assets for which there is no valuation allowance relate to amounts that are expected to be realized through reversals of existing taxable temporary differences over the projection period.  The accounting for deferred taxes is based on an estimate of future results.  Differences between anticipated and actual outcomes of these future tax consequences could have an impact on the Company’s consolidated results of operations or financial position.  See Note 10. Income Taxes, of the Company’s Annual Report filed on Form 10-K for additional discussion of the accounting for deferred taxes.

The Company has and will continue to perform a quarterly analysis of its deferred tax assets and the valuation allowance established in 2010 for changes affecting realizability of the deferred tax assets and the level of valuation allowance needed.