INCOME TAXES:
On December 22, 2017, President Trump signed into law a major tax legislation commonly referred to as the Tax Cuts and Jobs Act ("Tax Reform Act"). The Tax Reform Act reduces the U.S. federal corporate income tax rate from 35 percent to 21 percent and makes many other changes to the U.S. tax code. Upon enactment, we were required to revalue our deferred tax assets and liabilities at the new statutory tax rate. As a result of this revaluation, we have recognized a one-time, non-cash, $23.3 million deferred income tax benefit in our 2017 year-end provision.
Income tax (benefit) expense consisted of following:
|
| | | | | | | | | | | |
| Years Ended December 31, |
(in thousands) | 2017 | | 2016 | | 2015 |
| | | | | |
Current (benefit) expense | | | | | |
Federal | $ | (649 | ) | | $ | (1,154 | ) | | $ | (1,469 | ) |
State and local | 62 |
| | 1,595 |
| | 668 |
|
Deferred expense (benefit) | | | | | |
Federal | 17,637 |
| | 27,538 |
| | 15,301 |
|
Revaluation of deferred items | (23,325 | ) | | — |
| | — |
|
State and local | 528 |
| | 3,058 |
| | 602 |
|
Tax credit investment amortization | 2,990 |
| | 1,589 |
| | 486 |
|
Total income tax (benefit) expense | $ | (2,757 | ) | | $ | 32,626 |
| | $ | 15,588 |
|
Income tax (benefit) expense differed from amounts computed at the federal income tax statutory rate as follows:
|
| | | | | | | | | | | |
| Years Ended December 31, |
(in thousands) | 2017 | | 2016 | | 2015 |
| | | | | |
Income taxes at statutory rate | $ | 23,166 |
| | $ | 31,772 |
| | $ | 19,917 |
|
State income tax expense net of federal tax benefit | 1,207 |
| | 2,073 |
| | 715 |
|
Tax-exempt interest | (2,855 | ) | | (2,177 | ) | | (1,307 | ) |
Tax credits | (2,041 | ) | | (1,389 | ) | | (903 | ) |
Amortization of and pass-through losses from low income housing investments | 1,716 |
| | 1,018 |
| | 658 |
|
Change in state rate | (714 | ) | | 811 |
| | 722 |
|
Bargain purchase gain | — |
| | — |
| | (2,704 | ) |
Reversal of deferred tax consequences on historical AFS | (2 | ) | | — |
| | (1,107 | ) |
Impact from Federal Rate Change | (23,325 | ) | | — |
| | — |
|
Uncertain tax positions | 76 |
| | — |
| | — |
|
Other, net | 15 |
| | 518 |
| | (403 | ) |
Total income tax (benefit) expense | $ | (2,757 | ) | | $ | 32,626 |
| | $ | 15,588 |
|
Deferred income taxes reflect the net tax effect of temporary differences between the carrying amounts of assets and liabilities for financial reporting purposes and those amounts used for tax return purposes. The following is a summary of the Company’s significant portions of deferred tax assets and liabilities:
|
| | | | | | | |
| At December 31, |
(in thousands) | 2017 | | 2016 |
| | | |
Deferred tax assets: | | | |
Provision for loan losses | $ | 11,844 |
| | $ | 18,123 |
|
Federal and state net operating loss carryforwards | 3,914 |
| | 7,073 |
|
Other real estate owned | — |
| | 1,196 |
|
Accrued liabilities | 4,747 |
| | 4,453 |
|
Other investments | 145 |
| | 283 |
|
Leases | 2,336 |
| | 3,121 |
|
Unrealized loss on investment available for sale securities | 2,286 |
| | 5,714 |
|
Tax credits | 1,695 |
| | 1,369 |
|
Stock-based compensation | 993 |
| | 1,164 |
|
Loan valuation | 1,857 |
| | 4,547 |
|
Other, net | 1,158 |
| | 2,163 |
|
| 30,975 |
| | 49,206 |
|
Deferred tax liabilities: | | | |
Mortgage servicing rights | (58,195 | ) | | (76,680 | ) |
FHLB dividends | (316 | ) | | (522 | ) |
Deferred loan fees and costs | (3,828 | ) | | (3,653 | ) |
Premises and equipment | (5,267 | ) | | (6,960 | ) |
Intangibles | (1,371 | ) | | (2,813 | ) |
Other, net | (141 | ) | | (107 | ) |
| (69,118 | ) | | (90,735 | ) |
Net deferred tax liability | $ | (38,143 | ) | | $ | (41,529 | ) |
The Company currently has a net deferred tax liability. This net deferred tax liability is included in accounts payable and other liabilities on the consolidated statements of financial condition. The Company’s net deferred tax liability is now significantly lower compared to the prior year, due primarily to the new lower federal income tax rate effective January 1, 2018.
Management assesses the available positive and negative evidence to estimate if sufficient future taxable income will be generated to utilize the existing deferred tax assets. As of December 31, 2017 management determined that sufficient evidence exists to support the future utilization of all of the Company’s deferred tax assets.
Utilization of the federal and state net operating loss and tax credit carryforwards may be subject to an annual limitation due to the “change in ownership” provisions of the Internal Revenue Code of 1986, as amended. Specifically, the Company is subject to annual limitations on the amounts of net operating loss and credit carryover that the Company can use from its pre-IPO period, or from the pre-acquisition periods of the companies that it has acquired in prior years. At December 31, 2017 and 2016, the Company has federal net operating loss carryforwards totaling $10.8 million and $16.1 million, respectively, which expire between 2029 and 2036. In addition, as of December 31, 2017, the Company has minimum tax credits of $1.6 million which never expire. The Tax Reform Act repeals the corporate alternative minimum tax rules and makes any unused minimum tax credit partially refundable in the tax years 2018 - 2020, and fully refundable in the tax year 2021. Accordingly, we expect to utilize all of the remaining minimum tax credit before 2022. We also have state net operating loss carryforwards as of December 31, 2017 and 2016 of $17.4 million and $14.0 million, respectively, that expire between 2018 and 2036.
Retained earnings at December 31, 2017 and 2016 include approximately $12.7 million in tax basis bad debt reserves for which no income tax liability has been recorded. This represents the balance of bad debt reserves created for tax purposes as of December 31, 1987. These amounts are subject to recapture (i.e., included in taxable income) in certain events, such as in the event HomeStreet Bank ceases to be a bank. In the event of recapture, the Company will incur both federal and state tax liabilities on this pre-1988 bad debt reserve balance at the then prevailing corporate tax rates.
The Company has recorded unrecognized tax positions of $514 thousand and $438 thousand as of December 31, 2017 and 2016, respectively, both periods including potential interest of $19 thousand. Any resolution of our unrecognized tax positions would impact our effective tax rate. We periodically evaluate our exposures associated with our filing positions. During 2017, we updated the amount of recorded potential liability based on actual proposed adjustments received from the relevant tax authority. We expect our uncertain tax positions will be settled within the next 12 months.
A reconciliation of our unrecognized tax positions, excluding accrued interest and penalties, for the years ended December 31, 2017, 2016 and 2015 is as follows:
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| | | | | | | | | | | |
| Years Ended December 31, |
(in thousands) | 2017 | | 2016 | | 2015 |
| | | | | |
Balance, beginning of year | $ | 419 |
| | $ | 419 |
| | $ | — |
|
Increases related to prior year tax positions | 76 |
| | — |
| | 419 |
|
Balance, end of year | $ | 495 |
| | $ | 419 |
| | $ | 419 |
|
The Company files federal income tax returns with the Internal Revenue Service and state income tax returns with various state tax authorities. The Company is no longer subject to federal income tax examinations for tax years prior to 2014 or state income tax examination for tax years prior to 2012.