Deferred Tax Asset Valuation Allowance
During the third quarter and first nine months of 2010, the Company established valuation allowances of $3.7 million and $12.2 million, respectively, against its existing net deferred tax assets. The Company’s primary deferred tax assets relate to its allowance for loan losses, interest on non-accruing loans and net tax operating loss carryforwards. Under generally accepted accounting principles, a valuation allowance must be recognized if it is “more likely than not” that such deferred tax assets will not be realized. In making that determination, management is required to evaluate both positive and negative evidence including recent historical financial performance, forecasts of future income, tax planning strategies and assessments of the current and future economic and business conditions. The Company performs and updates this evaluation on a quarterly basis.
In conducting its regular quarterly evaluation, the Company made a determination at September 30, 2010 to continue to record a deferred tax valuation allowance based primarily upon the existence of a three year cumulative loss. This three year cumulative loss position is primarily attributable to significant provisions for loan losses incurred during the three years prior to September 30, 2010. Although the Company’s current financial forecasts indicate that taxable income will be generated in the future, those forecasts were not considered sufficient positive evidence to overcome the observable negative evidence associated with the three year cumulative loss position determined. The creation of the valuation allowance, although it increased tax expense and similarly reduced tangible book value, does not have an effect on the Company’s cash flows, and may be recoverable in subsequent periods if the Company realizes certain sustained future taxable income. Since the amount of the net deferred tax assets available as regulatory capital is already restricted by regulation, the deferred tax valuation allowance has no effect on the Bank’s regulatory capital.