Valley National Bancorp

INCOME TAXES (Note 13)

The U.S. Tax Cuts and Jobs Act (the "Tax Act") was enacted on December 22, 2017 and introduces significant changes to U.S. income tax law. Effective in 2018, the Tax Act reduces the U.S. statutory tax rate from 35 percent to 21 percent.

In response to the Tax Act, the SEC staff issued guidance on accounting for the tax effects of the Tax Act. The guidance provides a one-year measurement period for companies to complete the accounting. Valley reflected the income tax effects of those aspects of the Tax Act for which the accounting is complete. To the extent Valley’s accounting for certain income tax effects of the Tax Act is incomplete but it can determine a reasonable estimate, Valley recorded a provisional estimate in the financial statements. If a company cannot determine a provisional estimate to be included in the financial statements, it should continue to apply the provisions of the tax laws that were in effect immediately before the enactment of the Tax Act.

Due to the timing of the enactment and the complexity involved in applying the provisions of the Tax Act, Valley has made reasonable estimates of the effects and recorded provisional amounts in its financial statements as of December 31, 2017. As Valley collects and prepares necessary data, and interprets the Tax Act and any additional guidance issued by the U.S. Treasury Department, the IRS, and other standard-setting bodies, Valley may adjust the provisional amounts. Information needed to adjust provisional amounts are the completion of all 2017 tax returns. The potential adjustments may materially impact Valley’s provision for income taxes and effective tax rate in the period in which the adjustments are made. The accounting for the tax effects of the Tax Act will be completed in 2018.

Income tax expense for the years ended December 31, 2017, 2016 and 2015 consisted of the following:



	2017		2016		2015
	(in thousands)
Current expense (benefit):
Federal	$	8,483	$	25,176	$	7,978
State	5,500		12,904		(493		)
	13,983		38,080		7,485
Deferred expense (benefit):
Federal	49,169		10,658		(7,539		)
State	27,679		16,496		23,992
	76,848		27,154		16,453
Total income tax expense	$	90,831	$	65,234	$	23,938

The tax effects of temporary differences that gave rise to the significant portions of the deferred tax assets and liabilities as of December 31, 2017 and 2016 are as follows:



	2017		2016
	(in thousands)
Deferred tax assets:
Allowance for loan losses	$	34,885	$	47,485
Depreciation	8,336		12,432
Employee benefits	10,596		16,121
Investment securities, including other-than-temporary impairment losses	5,021		17,272
Net operating loss carryforwards	30,658		46,667
Purchase accounting	18,819		33,172
Other	21,930		22,183
Total deferred tax assets	130,245		195,332
Deferred tax liabilities:
Pension plans	18,912		24,575
Other investments	13,234		20,831
Deferred income	37,952		—
Other	12,651		20,418
Total deferred tax liabilities	82,749		65,824
Net deferred tax asset (included in other assets)	$	47,496	$	129,508

Valley's federal net operating loss carryforwards totaled approximately $71.6 million at December 31, 2017 and expire during the period from 2029 through 2034. State net operating loss carryforwards totaled approximately $405 million at December 31, 2017 and expire during the period from 2029 through 2037. Valley’s state alternative minimum tax credit carryforward was approximately $2.9 million at December 31, 2017 and can be carried forward indefinitely. Within the "Other" category of deferred tax assets in the table above, Valley has $6.1 million of tax credit carryforwards which expire in 2037.

Based upon taxes paid and projections of future taxable income over the periods in which the net deferred tax assets are deductible, management believes that it is more likely than not that Valley will realize the benefits of these deductible differences and loss carryforwards.

Reconciliation between the reported income tax expense and the amount computed by multiplying consolidated income before taxes by the statutory federal income tax rate of 35 percent for the years ended December 31, 2017, 2016 and 2015 were as follows:



	2017			2016			2015
	(in thousands)
Federal income tax at expected statutory rate	$	88,458		$	81,683		$	44,413
Increase (decrease) due to:
State income tax expense, net of federal tax effect	21,046			19,197			15,274
Tax-exempt interest, net of interest incurred to carry tax-exempt securities	(5,245		)	(5,308		)	(4,864		)
Bank owned life insurance	(2,568		)	(2,343		)	(2,385		)
Tax credits from securities and other investments	(27,037		)	(25,954		)	(28,988		)
Impact of the Tax Act	15,441			—			—
Other, net	736			(2,041		)	488
Income tax expense	$	90,831		$	65,234		$	23,938

A reconciliation of Valley’s gross unrecognized tax benefits for 2017, 2016 and 2015 are presented in the table below:



	2017			2016			2015
	(in thousands)
Beginning balance	$	16,144		$	19,892		$	18,647
Additions based on tax positions related to prior years	1,121			3,958			1,245
Settlements with taxing authorities	(13,027		)	(4,820		)	—
Reductions due to expiration of statute of limitations	—			(2,886		)	—
Ending balance	$	4,238		$	16,144		$	19,892

The entire balance of unrecognized tax benefits, if recognized, would favorably affect our effective income tax rate. It is reasonably possible that the liability for unrecognized tax benefits could increase or decrease in the next twelve months due to completion of tax authorities’ exams or the expiration of statutes of limitations. Management estimates that the liability for unrecognized tax benefits could decrease by $4.2 million within the next 12 months.

Valley’s policy is to report interest and penalties, if any, related to unrecognized tax benefits in income tax expense. Valley has accrued approximately $1.8 million and $4.6 million of interest associated with Valley’s uncertain tax positions at December 31, 2017 and 2016, respectively.

Valley files income tax returns in the U.S. federal and various state jurisdictions. With few exceptions, Valley is no longer subject to U.S. federal and state income tax examinations by tax authorities for years before 2013. Valley is under examination by the IRS and also currently under routine examination by various state jurisdictions, and we expect the examinations to be completed within the next 12 months. Valley has considered, for all open audits, any potential adjustments in establishing our reserve for unrecognized tax benefits as of December 31, 2017.

TAX CREDIT INVESTMENTS (Note 14)

Valley’s tax credit investments are primarily related to investments promoting qualified affordable housing projects, and other investments related to community development and renewable energy sources. Some of these tax-advantaged investments support Valley’s regulatory compliance with the Community Reinvestment Act. Valley’s investments in these entities generate a return primarily through the realization of federal income tax credits, and other tax benefits, such as tax deductions from operating losses of the investments, over specified time periods. These tax credits and deductions are recognized as a reduction of income tax expense.

Valley’s tax credit investments are carried in other assets on the consolidated statements of financial condition. Valley’s unfunded capital and other commitments related to the tax credit investments are carried in accrued expenses and other liabilities on the consolidated statements of financial condition. Valley recognizes amortization of tax credit investments, including impairment losses, within non-interest expense of the consolidated statements of income using the equity method of accounting. An impairment loss is recognized when the fair value of the tax credit investment is less than its carrying value.

The following table presents the balances of Valley’s affordable housing tax credit investments, other tax credit investments, and related unfunded commitments at December 31, 2017 and 2016:



	December 31,
	2017		2016
	(in thousands)
Other Assets:
Affordable housing tax credit investments, net	$	22,135	$	29,567
Other tax credit investments, net	42,015		44,763
Total tax credit investments, net	$	64,150	$	74,330
Other Liabilities:
Unfunded affordable housing tax credit commitments	$	3,690	$	4,850
Unfunded other tax credit commitments	15,020		7,276
Total unfunded tax credit commitments	$	18,710	$	12,126

The following table presents other information relating to Valley’s affordable housing tax credit investments and other tax credit investments for the years ended December 31, 2017, 2016 and 2015:



	2017		2016		2014
	(in thousands)
Components of Income Tax Expense:
Affordable housing tax credits and other tax benefits	$	7,383	$	5,013	$	4,709
Other tax credit investment credits and tax benefits	35,530		33,294		23,877
Total reduction in income tax expense	$	42,913	$	38,307	$	28,586
Amortization of Tax Credit Investments:
Affordable housing tax credit investment losses	$	2,748	$	2,077	$	2,594
Affordable housing tax credit investment impairment losses*	4,684		450		1,321
Other tax credit investment losses	2,866		790		1,079
Other tax credit investment impairment losses*	31,449		31,427		22,318
Total amortization of tax credit investments recorded in non-interest expense	$	41,747	$	34,744	$	27,312


*	As a result of the Tax Act, Valley incurred additional impairment of $2.2 million and $2.1 million related to affordable housing tax credit investments and other tax credit investments, respectively, during the fourth quarter of 2017.