Carter Bankshares, Inc. 10-K

ITEM 5. MARKET FOR REGISTRANT’S COMMON EQUITY, RELATED STOCKHOLDER MATTERS AND ISSUER PURCHASES OF EQUITY SECURITIES (continued) Five-Year Cumulative Total Return The following chart compares the cumulative total shareholder return on our common stock with the cumulative total return of the NASDAQ Composite Index and SNL Bank and Thrift Index, which includes the stocks of banks, thrifts and bank and financial holding companies listed on all major exchanges (NYSE, AMEX, NASDAQ) S&P Global Market Intelligence’s coverage universe. Period Ending Index 12/31/15 12/31/16 12/31/17 12/31/18 12/31/19 12/31/20 Carter Bankshares, Inc. (1) 100.00 100.73 133.02 113.69 179.78 81.83 NASDAQ Composite Index 100.00 108.87 141.13 137.12 187.44 271.64 SNL Bank and Thrift Index 100.00 126.25 148.45 123.32 166.67 144.61 (1) An investment in Carter Bankshares, Inc. prior to November 2020 represents an investment in Carter Bank & Trust. Repurchases of Shares of Common Stock Neither the Company nor the Bank repurchased any shares of its common stock during 2020. 37 CARTER BANKSHARES, INC. AND SUBSIDIARIES ITEM 6. SELECTED FINANCIAL DATA The tables below summarize selected consolidated financial data as of the dates or for the periods presented and should be read in conjunction with Management’s Discussion and Analysis of Financial Condition and Results of Operations in Part II, Item 7 and the Consolidated Financial Statements and Supplementary Data in Part II, Item 8 of this Report: (Dollars in Thousands except per Share Data) For the Year Ended December 31, Five-Year Selected Financial Data 2020 2019 2018 2017 2016 Balance Sheet Summary (At End of Period) Total Assets $ 4,179,179 $ 4,006,108 $ 4,039,599 $ 4,112,292 $ 4,505,529 Securities Available-for-Sale, at Fair Value 778,679 742,617 782,758 947,201 - Securities Held-to-Maturity, at Cost - - - - 879,694 Loans Held-for-Sale 25,437 19,714 2,559 517 - Loans Held-for-Sale in Connection with Sale of Bank Branches, at the lower of cost or fair value 9,835 - - - - Portfolio Loans 2,947,170 2,884,766 2,703,792 2,684,445 2,731,783 Allowance for Loan Losses (54,074 ) (38,762 ) (39,199 ) (35,318 ) (34,500 ) Goodwill and Other Intangibles - 62,192 62,192 63,350 63,261 Noninterest-Bearing Deposits 699,229 554,875 547,773 530,242 534,923 Interest-Bearing Deposits 2,900,682 2,949,370 3,043,408 3,139,373 3,528,916 Deposits Held for Assumption in connection with Sale of Bank Branches 84,717 - - - - Total Deposits 3,684,628 3,504,245 3,591,181 3,669,615 4,063,839 FHLB Borrowings 35,000 10,000 - - - Other Liabilities 19,377 18,752 12,204 10,551 7,040 Total Liabilities 3,739,005 3,532,997 3,603,385 3,680,166 4,070,879 Retained Earnings 254,611 304,158 277,835 265,930 266,214 Accumulated Other Comprehensive Income (Loss) 15,721 127 (10,066 ) (2,240 ) - Total Shareholders' Equity 440,174 473,111 436,214 432,126 434,650 Summary of Earnings Interest Income $ 140,941 $ 159,120 $ 152,019 $ 144,084 $ 147,648 Interest Expense 35,826 46,773 38,114 37,111 46,382 Provision for Loan Losses 18,006 3,404 16,870 43,197 17,717 Net Interest Income after Provision for Loan Losses 87,109 108,943 97,035 63,776 83,549 Noninterest Income 26,580 16,870 16,986 12,591 12,494 Noninterest Expense 158,775 98,029 99,713 94,579 78,419 Net (Loss) Income before Taxes (45,086 ) 27,784 14,308 (18,212 ) 17,624 Income Tax Provision (Benefit) 772 1,209 2,403 (17,531 ) 1,645 Net (Loss) Income $ (45,858 ) $ 26,575 $ 11,905 $ (681 ) $ 15,979 (Loss) Earnings per Share Basic and Diluted $ (1.74 ) $ 1.01 $ 0.45 $ (0.03 ) $ 0.61 Cash Dividends Declared per Share $ 0.14 $ - $ - $ - $ 0.30 Selected Ratios Return on average assets -1.12 % 0.65 % 0.29 % -0.02 % 0.33 % Return on average equity -9.78 % 5.76 % 2.75 % -0.15 % 3.63 % Equity to Assets 10.53 % 11.81 % 10.80 % 10.51 % 9.65 % Total Risk-based capital 14.33 % 14.83 % 15.11 % 14.05 % 13.25 % Leverage Ratio 10.26 % 10.33 % 9.61 % 9.25 % 8.03 % Dividend Payout NM 0.00 % 0.00 % 0.00 % 49.30 % NM – percentage not meaningful 38 CARTER BANKSHARES, INC. AND SUBSIDIARIES ITEM 7. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS This section reviews our financial condition for each of the past two years and results of operations for each of the past three years. Certain reclassifications have been made to prior periods to place them on a basis comparable with the current period presentation. Some tables may include additional time periods to illustrate trends within our Consolidated Financial Statements and notes thereto. The results of operations reported in the accompanying Consolidated Financial Statements are not necessarily indicative of results to be expected in future periods. Important Note Regarding Forward-Looking Statements This Annual Report on Form 10-K contains or incorporates statements that we believe are “forward-looking statements” within the meaning of the Private Securities Litigation Reform Act of 1995. Forward-looking statements generally relate to our financial condition, results of operations, plans, objectives, outlook for earnings, revenues, expenses, capital and liquidity levels and ratios, asset levels, asset quality, financial position, and other matters regarding or affecting the Company and its future business and operations. Forward looking statements are typically identified by words or phrases such as “will likely result,” “expect,” “anticipate,” “estimate,” “forecast,” “project,” “intend,” “ believe,” “assume,” “strategy,” “trend,” “plan,” “outlook,” “outcome,” “continue,” “remain,” “potential,” “opportunity,” “believe,” “comfortable,” “current,” “position,” “maintain,” “sustain,” “seek,” “achieve” and variations of such words and similar expressions, or future or conditional verbs such as will, would, should, could or may. Although we believe the assumptions upon which these forward-looking statements are based are reasonable, any of these assumptions could prove to be inaccurate and the forward-looking statements based on these assumptions could be incorrect. The matters discussed in these forward-looking statements are subject to various risks, uncertainties and other factors that could cause actual results and trends to differ materially from those made, projected, or implied in or by the forward-looking statements depending on a variety of uncertainties or other factors including, but not limited to: credit losses; technological risks and developments; cyber-security; threats, attacks or events; rapid technological developments and changes; the Company’s liquidity and capital positions; the potential adverse effects of unusual and infrequently occurring events, such as weather-related disasters, terrorist acts or public health events (such as the current COVID-19 pandemic), and of governmental and societal responses thereto; these potential adverse effects may include, without limitation, adverse effects on the ability of the Company's borrowers to satisfy their obligations to the Company, on the value of collateral securing loans, on the demand for the Company's loans or its other products and services, on incidents of cyberattack and fraud, on the Company’s liquidity or capital positions, on risks posed by reliance on third-party service providers, on other aspects of the Company's business operations and on financial markets and economic growth; the effect of steps the Company takes in response to the COVID-19 pandemic, the severity and duration of the pandemic, the uncertainty regarding new variants of COVID-19 that have emerged, the speed and efficacy of vaccine and treatment developments, the impact of loosening or tightening of government restrictions, the pace of recovery when the pandemic subsides and the heightened impact it has on many of the risks described herein; legislative or regulatory changes and requirements, including the impact of the CARES Act, as amended by the CAA, and other legislative and regulatory reactions to the COVID-19 pandemic; potential claims, damages, and fines related to litigation or government actions, including litigation or actions arising from the Company’s participation in and administration of programs related to the COVID-19 pandemic, including, among other things, under the CARES Act, as amended by the CAA; sensitivity to the interest rate environment including a prolonged period of low interest rates, a rapid increase in interest rates or a change in the shape of the yield curve; a change in spreads on interest-earning assets and interest-bearing liabilities; regulatory supervision and oversight; legislation affecting the financial services industry as a whole, and the Company, in particular; the outcome of pending and future litigation and governmental proceedings; increasing price and product/service competition; the ability to continue to introduce competitive new products and services on a timely, cost-effective basis; the Company’s strategic branch network optimization plan ; managing our internal growth and acquisitions; the possibility that the anticipated benefits from acquisitions cannot be fully realized in a timely manner or at all, or that integrating the acquired operations will be more difficult, disruptive or more costly than anticipated; containing costs and expenses; reliance on significant customer relationships; general economic or business conditions; deterioration of the housing market and reduced demand for mortgages; deterioration in the overall macroeconomic conditions or the state of the banking industry that could impact the re-emergence of turbulence in significant portions of the global financial and real estate markets that could impact our performance, both directly, by affecting our revenues and the value of our assets and liabilities, and indirectly, by affecting the economy generally and access to capital in the amounts, at the times and on the terms required to support our future businesses. Many of these factors, as well as other factors, are described throughout this Report, including Part I, Item 1A, Risk Factors and any of our subsequent filings with the SEC. Forward-looking statements are based on beliefs and assumptions using information available at the time the statements are made. We caution you not to unduly rely on forward-looking statements because the assumptions, beliefs, expectations and projections about future events may, and often do, differ materially from actual results. Any forward-looking statement speaks only as to the date on which it is made, and we undertake no obligation to update, revise or clarify any forward-looking statement to reflect developments occurring after the statement is made. 39 CARTER BANKSHARES, INC. AND SUBSIDIARIES ITEM 7. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS (continued) Explanation of Use of Non-GAAP Financial Measures In addition to the results of operations presented in accordance with generally accepted accounting principles (“GAAP”) in the United States, management uses, and this annual report references, adjusted net income and net interest income on a fully taxable equivalent, or (“FTE”), basis, each of which is a non-GAAP financial measure. Management believes these measures provide information useful to investors in understanding our underlying business, operational performance and performance trends as it facilitates comparisons with the performance of other companies in the financial services industry. Although management believes that this non-GAAP financial measure enhances an investor’s understanding of our business and performance, this non-GAAP financial measure should not be considered an alternative to GAAP or considered to be more important than financial results determined in accordance with GAAP, nor is it necessarily comparable with similar non-GAAP measures which may be presented by other companies. The Company believes the presentation of net interest income on an FTE basis ensures the comparability of net interest income arising from both taxable and tax-exempt sources and is consistent with industry practice. Net interest income per the Consolidated Statements of (Loss) Income is reconciled to net interest income adjusted to an FTE basis in the Net Interest Income section of the "Results of Operations – Year ended December 31, 2020." The Company believes the presentation of adjusted net income to exclude the impact of a one-time goodwill impairment charge during 2020 will help an investor compare the results of our core business operations with our operations for other fiscal years and with the results of operations of other companies in the financial services industry. The following table reconciles adjusted net income to GAAP net income for the periods presented: Years Ended December 31, (Dollars in Thousands) 2020 2019 2018 Net Income $ (45,858 ) $ 26,575 $ 11,905 Less: Goodwill Impairment Expense 62,192 - - Adjusted Net Income (non-GAAP) $ 16,334 $ 26,575 $ 11,905 40 CARTER BANKSHARES, INC. AND SUBSIDIARIES ITEM 7. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS (continued) Critical Accounting Policies and Significant Accounting Estimates The Company’s accounting and reporting policies conform to GAAP and predominant practice in the banking industry. The preparation of financial statements in accordance with GAAP requires management to make estimates, assumptions and judgments that affect the amounts reported in the financial statements and accompanying notes. Over time, these estimates, assumptions and judgments may prove to be inaccurate or vary from actual results and may significantly affect our reported results and financial position for the periods presented or in future periods. We currently view the determination of the allowance for loan losses, goodwill and income taxes to be critical, because they are highly dependent on subjective or complex judgments, assumptions and estimates made by management. Allowance for Loan Losses We account for the credit risk associated with our lending activities through the allowance and provision for loan losses. The allowance represents management’s best estimate of probable incurred losses that have been incurred in our existing loan portfolio as of the balance sheet date. The provision is a periodic charge to earnings in an amount necessary to maintain the allowance at a level that is appropriate based on management’s assessment of probable estimated losses. Management determines and reviews with the Board the adequacy of the allowance on a quarterly basis in accordance with the methodology described below: · Individual loans are selected for review in accordance with Financial Accounting Standards Board (the “FASB”) Accounting Standards Codification (“ASC”) Topic 310, “Receivables.” These are generally large balance commercial loans and commercial mortgages that are rated less than “satisfactory” based on our internal credit-rating process. · We assess whether the loans identified for review in step one are “impaired,” which means that it is probable that all amounts will not be collected according to the contractual terms of the loan agreement, which generally represents loans that management has placed on nonaccrual status. · For impaired loans we calculate the estimated fair value of the loans that are selected for review based on observable market prices, discounted cash flows or the value of the underlying collateral less costs to sell and record an allowance if needed. We individually evaluate all impaired loans greater than or equal to $1.0 million for additional impairment. In addition, we evaluate credits, which have complex loan structures, with balances less than $1.0 million for impairment. Impaired loans are reevaluated quarterly for additional impairment and adjustments to fair value less costs to sell are made, where appropriate. For collateral dependent loans, the first stage of our impairment analysis involves management’s inspection of the property in question to affirm the condition has not deteriorated since the previous impairment analysis date. The second stage involves an assessment of current trends in the regional market. After thorough consideration of these factors, management will either internally evaluate fair value or order a new appraisal. In circumstances where we feel confident in its ability to collect and analyze salient information on the subject collateral and its surrounding real estate market, an in-house valuation will be utilized. · We then select pools of homogeneous smaller balance loans, having similar risk characteristics, as well as unimpaired larger commercial loans, that have similar risk characteristics, for evaluation collectively under the provisions of the FASB ASC Topic 450, “Contingencies.” These smaller balance loans generally include residential mortgages, consumer loans, installment loans and some commercial loans. 41 CARTER BANKSHARES, INC. AND SUBSIDIARIES ITEM 7. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS (continued) · The FASB ASC Topic 450 loans are segmented into groups with similar characteristics and an allowance for loan losses is allocated to each segment based on recent loss history and other relevant information. · We then review the results to determine the appropriate balance of the allowance for loan losses. This review includes consideration of additional factors, such as the mix of loans in the portfolio, the balance of the allowance relative to total loans and nonperforming assets, trends in the overall risk profile in the portfolio, trends in delinquencies and nonaccrual loans, and local and national economic information and industry data, including trends in the industries we believe are higher risk. There are many factors affecting the allowance for loan losses; some are quantitative, while others require qualitative judgment. These factors require the use of estimates related to the amount and timing of expected future cash flows, appraised values on impaired loans, estimated losses for each loan category based on historical loss experience by category, and consideration of current economic trends and conditions, all of which may be susceptible to significant judgment and change. To the extent that actual outcomes differ from estimates, additional provisions for loan losses could be required that could adversely affect our earnings or financial position in future periods. The loan portfolio represents the largest asset category on our Consolidated Balance Sheets. The Company intends to adopt ASU 2016-13, Measurement of Credit Losses, or CECL, in the first quarter of 2021, which will impact the measurement of the Company’s allowance for credit losses (including the allowance for losses on lending-related commitments). CECL replaces the previous incurred loss methodology, discussed above, which delays recognition until such loss is probable, with a methodology that reflects an estimate of lifetime expected credit losses considering current economic condition and forecasts. Though other assets, including investment securities and other receivables, are considered in-scope of the standard and will require a measurement of the allowance for credit loss, the most significant impact of CECL remains within the Company’s loan portfolios and related lending commitments. Fair Value Measurements Fair value is the exchange price that would be received for an asset or paid to transfer a liability (exit price) in the principal or most advantageous market for the asset or liability in an orderly transaction between market participants on the measurement date. We use various valuation techniques to determine fair value, including market, income and cost approaches. There are three levels of inputs that may be used to measure fair values: Level 1: Quoted prices (unadjusted) for identical assets or liabilities in active markets that an entity has the ability to access as of the measurement date, or observable inputs. Level 2: Significant other observable inputs other than Level 1 prices, such as quoted prices for similar assets or liabilities, quoted prices in markets that are not active, and other inputs that are observable or can be corroborated by observable market data. Level 3: Significant unobservable inputs that reflect an entity’s own assumptions about the assumptions that market participants would use in pricing an asset or liability. 42 CARTER BANKSHARES, INC. AND SUBSIDIARIES ITEM 7. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS (continued) In certain cases, the inputs used to measure fair value may fall into different levels of the fair value hierarchy. When that occurs, we classify the fair value hierarchy on the lowest level of input that is significant to the fair value measurement. We used the following methods and significant assumptions to estimate fair value: Securities: The fair values of securities available-for-sale are determined by obtaining quoted prices on nationally recognized securities exchanges, if available. This valuation method is classified as Level 1 in the fair value hierarchy. For securities where quoted prices are not available, fair values are calculated on market prices of similar securities, or matrix pricing, which is a mathematical technique, used widely in the industry to value debt securities without relying exclusively on quoted prices for the specific securities but rather by relying on the securities’ relationship to other benchmark quoted securities. Matrix pricing relies on the securities’ relationship to similarly traded securities, benchmark curves, and the benchmarking of like securities. Matrix pricing utilizes observable market inputs such as benchmark yields, reported trades, broker/dealer quotes, issuer spreads, two-sided markets, benchmark securities, bids, offers, reference data, and industry and economic events. In instances where broker quotes are used, these quotes are obtained from market makers or broker-dealers recognized to be market participants. This valuation method is classified as Level 2 in the fair value hierarchy. For securities where quoted prices or market prices of similar securities are not available, fair values are calculated using discounted cash flows or other market indicators. This valuation method is classified as Level 3 in the fair value hierarchy. Impaired Loans: Impaired loans with an outstanding balance equal to or greater than $1.0 million are evaluated for potential specific reserves and adjusted, if a shortfall exists, to fair value less costs to sell. Fair value is measured based on the value of the underlying collateral securing the loan if repayment is expected solely from the sale or operation of the collateral or present value of estimated future cash flows discounted at the loan’s contractual interest rate if the loan is not determined to be collateral dependent. All impaired loans with a specific reserve are classified as Level 3 in the fair value hierarchy. Fair value for collateral dependent loans is determined using several methods. Generally, the fair value of real estate is determined based on appraisals by qualified licensed appraisers. These appraisals may utilize a single valuation approach or a combination of approaches including comparable sales and the income approach. Adjustments are routinely made in the appraisal process by the appraisers to adjust for differences between the comparable sales and income data available. These routine adjustments are made to adjust the value of a specific property relative to comparable properties for variations in qualities such as location, size, and income production capacity relative to the subject property of the appraisal. Such adjustments are typically significant and result in a Level 3 classification of the inputs for determining fair value. Subsequent to the initial impairment date, existing impaired loans are reevaluated quarterly for additional impairment and adjustments to fair value less costs to sell are made, where appropriate. For collateral dependent loans, the first stage of our impairment analysis involves management’s inspection of the property in question to affirm the condition has not deteriorated since the previous impairment analysis date. Management also engages in conversations with local real estate professionals and market participants to determine the likely marketing time and value range for the property. The second stage involves an assessment of current trends in the regional market. After thorough consideration of these factors, management will either internally evaluate fair value or order a new appraisal. In circumstances where we feel confident in its ability to collect and analyze salient information on the subject collateral and its surrounding real estate market, an in house valuation shall be utilized. Factors which should be considered in an in house valuation are timing of sale, location and neighborhood, size of the structure and land component, age of any improvements, and other attributes as warranted by the Company. This determination is made on a property-by-property basis in light of circumstances in the broader economic climate and our assessment of deterioration of real estate values in the market in which the property is located. When we feel we cannot collect and analyze salient information on the subject collateral or the collateral’s real estate market, a full appraisal will be utilized. 43 CARTER BANKSHARES, INC. AND SUBSIDIARIE ITEM 7. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS (continued) For non-collateral dependent loans, the fair value is determined by updating the present value of estimated future cash flows using the loan’s existing rate to reflect the payment schedule for the remaining life of the loan. Other Real Estate Owned (“OREO”) : OREO is evaluated at the time of acquisition and is recorded at fair value as determined by an appraisal or evaluation, less costs to sell. After acquisition, most OREO assets are revalued every twelve months, or more frequently when deemed necessary by management based upon changes in market, or collateral conditions. For smaller OREO assets with existing carrying values less than $0.5 million, management may elect to revalue the assets, at minimum, once every twenty-four months based on the size of the exposure. Write-downs are recorded as a charge to operations, if necessary, to reduce the carrying value of a property to the lower of its carrying value or fair value less cost to sell. Such adjustments can be significant and result in a Level 3 classification of the inputs for determining fair value. At December 31, 2020 our OREO assets were in compliance with our OREO policy as set forth above, and substantially all of the assets were listed for sale with credible third-party real estate brokers. Goodwill Goodwill assets with indefinite useful lives are tested for impairment at least annually and written down and charged to results of operations only in periods in which the recorded value is more than the estimated fair value. Intangible assets that have finite useful lives will continue to be amortized over their useful lives and are periodically evaluated for impairment. The unprecedented decline in economic conditions triggered by the COVID-19 pandemic caused a significant decline in stock market valuations in March 2020, including our stock price. These triggering events indicated that goodwill related to our single reporting unit may be impaired and we expected to evaluate goodwill for impairment quarterly given the current environment. During the first quarter of 2020, with the recent volatility in the financial services industry and in our economic environment we determined it prudent to have a full goodwill impairment analysis performed as of March 31, 2020 updated as of June 30, 2020. We performed the goodwill impairment test by determining the fair value of the reporting unit. We engaged a third-party financial advisor to prepare the market and income approaches in order to determine fair value. Their analysis supported the conclusion that the fair value of our common stock at June 30, 2020 was greater than both stated and tangible common book value and therefore no impairment to the goodwill was recorded at June 30, 2020. As we monitored our performance due to the COVID-19 pandemic and continued to experience declines in our stock price in relation to other bank indices and the length of time that the market value of the reporting unit had been below its book value, we completed another interim quantitative goodwill impairment analysis as of September 30, 2020. Various valuation methodologies were considered when completing the quantitative impairment test to determine the estimated fair value of the reporting unit which is then compared to its carrying value, including goodwill. Upon completing the quantitative impairment analysis as of September 30, 2020, the analysis estimated fair value of the reporting unit to be less than the carrying value. Therefore, we recorded a goodwill impairment of $62.2 million, which represented the entire amount of goodwill allocated to the reporting unit. This was a non-cash charge to earnings and had no impact on our regulatory capital ratios, cash flows, liquidity position, or our overall financial strength. 44 CARTER BANKSHARES, INC. AND SUBSIDIARIES ITEM 7. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS (continued) Income Taxes We estimate income tax expense based on amounts expected to be owed to the tax jurisdictions where we conduct business. On a quarterly basis, management assesses the reasonableness of its effective tax rate based upon its current estimate of the amount and components of net income, tax credits and the applicable statutory tax rates expected for the full year. Deferred income tax assets and liabilities are determined using the asset and liability method and are reported in the Consolidated Balance Sheets. Under this method, deferred tax assets and liabilities are recognized for the future tax consequences attributable to differences between the financial statement carrying amounts of existing assets and liabilities and their respective tax bases. If current available information raises doubt as to the realization of the deferred tax assets, a valuation allowance is established. Deferred tax assets and liabilities are measured using enacted tax rates expected to be applied to taxable income in the years in which those temporary differences are expected to be recovered or settled. Management assesses all available positive and negative evidence on a quarterly basis to estimate if sufficient future taxable income will be generated to utilize the existing deferred tax assets. The amount of future taxable income used in management’s valuation is based upon management approved forecasts, evaluation of historical earnings levels, proven ability to raise capital to support growth or during times of economic stress and consideration of prudent and feasible potential tax strategies. If future events differ from our current forecasts, a valuation allowance may be required, which could have a material impact on our financial condition and results of operations. Accrued taxes payable or receivable represent the net estimated amount due to or due from taxing jurisdictions and are reported in other liabilities and other assets, respectively, in the Consolidated Balance Sheets. Management evaluates and assesses the relative risks and appropriate tax treatment of transactions and filing positions after considering statutes, regulations, judicial precedent and other information and maintains tax accruals consistent with its evaluation of these relative risks and merits. Changes to the estimate of accrued taxes occur periodically due to changes in tax rates, interpretations of tax laws, the status of examinations being conducted by taxing authorities and changes to statutory, judicial and regulatory guidance. These changes, when they occur, can affect deferred taxes and accrued taxes, as well as the current period’s income tax expense and can be significant to our operating results. Recent Accounting Pronouncements and Developments Note 1 Summary of Significant Accounting Policies in the Notes to Consolidated Financial Statements, which is included in Part II, Item 8 of this Report, discusses new accounting pronouncements that we have adopted during 2020. In December 2019, the FASB issued ASU No. 2019-12, “Income Taxes (Topic 740): Simplifying the Accounting for Income Taxes.” The amendments in this ASU simplifies the accounting for income taxes by removing certain exceptions and improves the consistent application of GAAP by clarifying and amending other existing guidance. The amendments in this ASU will be effective on January 1, 2021 and are not expected to have any impact on our consolidated financial statements. In March 2020, the FASB issued ASU No. 2020-04, “Reference Rate Reform (Topic 848): Facilitation of the Effects of Reference Rate Reform on Financial Reporting.” The amendments in this ASU provide optional guidance for a limited period of time to ease the potential burden in accounting for or recognizing the effects of reference rate reform on financial reporting. The amendments provide optional expedients and exceptions for applying GAAP to loan and lease agreements, derivative contracts, and other transactions affected by the anticipated transition away from LIBOR toward new interest rate benchmarks. Modified contracts that meet certain scope guidance are eligible for relief from the modification accounting requirements in US GAAP. The optional guidance generally allows for the modified contract to be accounted for as a continuation of the existing contract and does not require contract remeasurement at the modification date or reassessment of a previous accounting determination. The amendments in this ASU are effective as of March 12, 2020 through December 31, 2022. We are evaluating the impacts of this ASU and have not yet determined whether LIBOR transition and this ASU will have material effects on our business operations and consolidated financial statements. 45 CARTER BANKSHARES, INC. AND SUBSIDIARIES ITEM 7. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS (continued) In June 2016, the FASB issued ASU No. 2016-13, “Financial Instruments – Credit Losses (Topic 326): Measurement of Credit Losses on Financial Instruments”, universally referred to as Current Expected Credit Loss (“CECL”). The amendments in this ASU, among other things, require the measurement of all expected credit losses for financial assets held at the reporting date based on historical experience, current conditions, and reasonable and supportable forecasts. Financial institutions and other organizations will now use forward-looking information to better inform their credit loss estimates. Many of the loss estimation techniques applied today will still be permitted, although the inputs to those techniques will change to reflect the full amount of expected credit losses. In addition, the ASU amends the accounting for credit losses on available-for-sale debt securities and purchased financial assets with credit deterioration. For periodic report filers that are not smaller reporting companies, such as the Company, this standard (Topic 326) is effective as of January 1, 2020. The Company has elected to take advantage of Section 4014 of the Coronavirus Aid, Relief, and Economic Security Act (the “CARES Act”) provision to temporarily delay adoption of the CECL methodology. The Bank was subject to the adoption of the CECL accounting method under ASU 2016-03 and related amendments, Financial Instruments – Credit Losses (Topic 326). However, the Bank elected under the CARES Act to defer the implementation of CECL until the earlier of when the national emergency related to the outbreak of COVID-19 ends or December 31, 2020 which was later extended to January 1, 2022. The Company intends to adopt in the first quarter of 2021 as allowed under the provisions of the CARES Act. The Bank’s CECL Committee, which includes members from Credit Administration, Accounting/Finance, Risk Management and Internal Audit, has oversight by the Chief Executive Officer, Chief Financial Officer, and Chief Credit Officer. We engaged a third-party to assist us in developing our CECL model and to assist with evaluation of data and methodologies related to this standard. As part of its process of adopting CECL, management implemented a third-party software solution and determined appropriate loan segments, methodologies, model assumptions and qualitative components. Our CECL model includes portfolio loan segmentation based upon similar risk characteristics and both a quantitative and qualitative component of the calculation which incorporates a forecasting component of certain economic variables. Our implementation plan also includes the assessment and documentation of appropriate processes, policies and internal controls. Management had a third-party independent consultant review and validate our CECL model. Parallel runs utilizing data from the current and previous quarters in 2020 and 2019, incorporate elements of our operational procedures and internal controls. Our current parallel run includes the composition, characteristics and quality of our loan portfolio as well as current market economic conditions and forecasts as of the adoption date. In addition, ASU 2016-13 amends the accounting for credit losses on certain debt securities. Based upon the nature and characteristics of our securities portfolio at the adoption date, management does not expect to record any allowance for credit losses on its debt securities as a result of adopting ASU 2016-13. The ultimate impact of adopting ASU 2016-13, and at each subsequent reporting period, is highly dependent on credit quality, macroeconomic forecasts and conditions, composition of our loans and available-for-sale securities portfolio, along with other management judgments. The transition adjustment to record the allowance for loan losses (“ALL”) will be applied using a cumulative effect adjustment to retained earnings. 46 CARTER BANKSHARES, INC. AND SUBSIDIARIES ITEM 7. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS (continued) Executive Overview Carter Bankshares, Inc. (the “Company”) is bank holding company headquartered in Martinsville, Virginia with assets of $4.2 billion at December 31, 2020. The Company is the parent company of its wholly owned subsidiary, Carter Bank & Trust (the “Bank”). The Bank is an insured, Virginia state-chartered bank, which operates branches in Virginia and North Carolina. The Company provides a full range of financial services with retail, and commercial banking products and insurance. Per the 2019 Annual Report of the Virginia Bureau of Financial Institutions, our Company continues to be the fourth largest state-chartered bank by assets size at year end 2019 . Our common stock trades on the Nasdaq Global Select Market under the ticker symbol “CARE.” The Company earns revenue primarily from interest on loans and securities and fees charged for financial services provided to our customers. The Company incurs expenses for the cost of deposits, provision for loan losses and other operating costs such as salaries and employee benefits, data processing, occupancy and tax expense. Our mission is that the Company strives to be the preferred lifetime financial partner for our customers and shareholders, and the employer of choice in the communities the Company is privileged to serve. Our strategic plan focuses on restructuring the balance sheet to provide more diversification and higher yielding assets to increase the net interest margin. Another area of focus is the transformation of the infrastructure of the Company to provide a foundation for operational efficiency and provide new products and services for our customers that will ultimately increase noninterest income. Our focus continues to be on loan and deposit growth with a shift in the composition of deposits to more low cost core deposits with less dependence in higher cost certificates of deposits (“CDs”), as well as, implementing opportunities to increase fee income while closely monitoring our operating expenses. The Company is focused on executing our strategy to successfully build our brand and grow our business in our markets. FRB Reserve Programs and Initiatives The CARES Act encourages the FRB, in coordination with the Secretary of the Treasury, to establish or implement various programs to help midsize businesses, nonprofits, and municipalities, including (i) a Midsize Business/Nonprofit Organization Program to provide financing to banks and other lenders to make direct loans to eligible businesses and nonprofit organizations with between 500 and 10,000 employees and (ii) the Municipal Liquidity Facility, provide liquidity to the financial system that supports states and municipalities. On April 9, 2020, the FRB announced and solicited comments regarding the Main Street Lending Program, which would implement certain of these recommendations. Separately and in response to COVID-19, the FRB’s Federal Open Market Committee (the “FOMC”) has set the federal funds target rate – i.e., the interest rate at which depository institutions such as the Company lend reserve balances to other depository institutions overnight on an uncollateralized basis – to an historic low. On March 16, 2020, the FOMC set the federal funds target rate at 0-0.25%. Consistent with FRB policy, the FRB has committed to the use of overnight reverse repurchase agreements as a supplementary policy tool, as necessary, to help control the federal funds rate and keep it in the target range set by the FOMC. In addition, the FRB has expanded the size and scope of three existing programs to mitigate the economic impact of the COVID-19 pandemic: (i) the Primary Market Corporate Credit Facility; (ii) the Secondary Market Corporate Credit Facility; and (iii) the Term Asset-Backed Securities Loan Facility. The FRB has also established two new program facilities – the Money Market Mutual Fund Liquidity Facility and the Commercial Paper Funding Facility – to broaden its support for the flow of credit to households and businesses during COVID-19. 47 CARTER BANKSHARES, INC. AND SUBSIDIARIES ITEM 7. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS (continued) Temporary Regulatory Capital Relief related to Impact of CECL Concurrent with enactment of the CARES Act, the federal bank regulatory authorities issued an interim final rule to provide banking organizations that are required to implement CECL before the end of 2020 the option to delay the estimated impact on regulatory capital by up to two years, with a three-year transition period to phase out the cumulative benefit to regulatory capital provided during the two-year delay. Temporary Bank Secrecy Act (“BSA”) Reporting Relief The U.S. Department of the Treasury’s Financial Crimes Enforcement Network (“FinCEN”) has provided targeted relief from certain BSA reporting requirements and have provided updated guidance to financial institutions on complying with such requirements during COVID-19. Specifically, FinCEN has (i) granted targeted relief to financial institutions participating in the PPP, stating that PPP loans to existing customers will not require reverification under applicable BSA requirements, unless reverification is otherwise required under the financial institution’s risk-based BSA compliance program, (ii) acknowledged that there may be “reasonable delays in compliance” due to COVID-19, and (iii) temporarily suspended implementation of its February 2020 ruling, which would have entailed significant changes to currency transaction reporting filing requirements for transactions involving sole proprietorships and entities operating under a “doing business as” or other assumed name. The Company’s Response to COVID-19 Lending Operations The Company elected to take advantage of Section 4014 of the CARES Act provision to temporarily delay adoption of the CECL methodology. The Company is subject to the adoption of the CECL accounting method under the FASBASU 2016-03 and related amendments, Financial Instruments – Credit Losses (Topic 326). However, we elected under the CARES Act to defer the implementation of CECL until January 1, 2021. The Company quickly responded to the pandemic and the CARES Act, offering the option of payment deferrals, participation in the PPP, fee waivers and other relief actions to customers. Banks have been identified as essential services and have remained open during the order. On October 31, 2020, we opened 3 additional branch lobbies and as of December 31, 2020, the Company had opened the lobbies of 36 branches. However, the Company continues to serve its customers in the remaining branches through modified hours in both the drive-ins and branch services via appointment. Every opportunity is being taken to protect both customers and employees through enhanced cleaning services, social distancing and personal protective equipment requirements for both. Approximately 20% of the Company’s workforce is working remotely. Under the CARES Act, PPP is an amendment to the SBA 7-A loan program. The Bank became an approved SBA 7A lender in November of 2019. PPP is a guaranteed, unsecured loan program created to fund certain payroll and operating costs of eligible businesses, organizations and self-employed persons during COVID-19. Initially, $349 billion were approved and designated for PPP in order for the SBA to guarantee 100% of collective loans made under the program to eligible small businesses, nonprofits, veteran’s organizations, and tribal businesses. The Company participated in the initial round of funding though a referral relationship with a third-party, non-bank lender. When an additional $310 billion in funds were approved and designated for PPP, we opted to stand up an internal, automated loan process utilizing our core system provider. As of December 31, 2020 we processed either through a third-party or internally 966 PPP loans totaling $57.8 million, represented by $17.9 million and $39.9 million processed in round one and round two, respectively. During 2021 the Company has continued making PPP loans pursuant to the additional PPP authorization that was contained in the December 2020 COVID-19 relief law. 48 CARTER BANKSHARES, INC. AND SUBSIDIARIES ITEM 7. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS (continued) The FRB implemented a liquidity facility available to financial institutions participating in the PPP. However, the Company opted to fund all PPP loans through our internal liquidity sources. These loans are fully guaranteed by the SBA and do not represent a credit risk. We expect the vast majority of these PPP loans will be forgiven based upon a preliminary review of the loans. The Company provides deferrals to customers under Section 4013 of the CARES Act and regulatory interagency statements on loan modifications, which suspends the requirement to categorize these deferrals as TDRs. The Part I program was launched in March 2020 and expired at the end of August 2020. The deferrals in Part I typically provided deferral of both principal and interest through the expiry. The Part II program was launched in July 2020 and expired at the end of December 2020. The deferrals in this program were needs based and required the collection of updated financial information and in certain situations, the validation of liquidity to support the business. Prior to the extension of the CARES Act, the Company launched the Part III program that offered borrowers in the Part II program an extension of deferrals through June 2021. For those borrowers who opted into the Part III program, they are required to provide monthly financial statements and remit payments on a quarterly basis based on excess cash flows, if any, up to their otherwise contractual payment. Management expects the majority of deferrals in the Part III program to be principal only deferrals. At the end of the deferral period, for term loans, payments will be applied to accrued interest first and will resume principal payments once accrued interest is current. Deferred principal will be due at maturity. For interest only loans, such as lines of credit, deferred interest will be due at maturity. As of December 31, 2020, we had 83 total customers opt for deferrals under Part III of the program which continues through June 30, 2021, with an aggregate principal balance of $388.6 million with $11.1 million in deferred principal and interest payments. The weighted average deferment period for these loans is 5.9 months. Approximately $313.9 million, comprised of 56 loan modifications, were in the hospitality industry. The following table provides detail of the Bank’s deferred loans as of December 31, 2020: Weighted Average Deferment Total Deferment (Dollars in thousands) Number of Loans Loan Principal Percent of Outstanding Period (months) Principal Interest Commercial Commercial Real Estate 81 $ 382,437 12.98 % 6.0 $ 269,414 $ 113,023 Commercial and Industrial 1 6,000 0.20 % 6.0 - 6,000 Obligations of State and Political Subdivisions - - - - - - Commercial Construction 1 163 0.01 % 4.0 163 - Total Commercial Loans Consumer 83 388,600 13.18 % 5.9 269,577 119,023 Residential Mortgages - - - - - - Other Consumer - - - - - - Consumer Construction - - - - - - Total Consumer Loans - - - - - - Total Aggregate Deferred Payments 83 $ 388,600 13.18 % 5.9 $ 269,577 $ 119,023 49 CARTER BANKSHARES, INC. AND SUBSIDIARIES ITEM 7. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS (continued) Our interest income could be reduced due to COVID-19. In keeping with guidance from regulators, we are actively working with COVID-19 affected borrowers to defer their payments, interest, and fees. Interest and fees will still accrue to income through normal GAAP accounting. Should eventual credit losses on these deferred payments emerge, interest income and fees accrued would need to be reversed. In such a scenario, interest income in future periods could be negatively impacted. At this time, we are unable to project the significance of such an impact, if any but recognize the breadth of the economic impact may affect our borrowers’ ability to repay in future periods. The Company’s exposure to hospitality at December 31, 2020 equated to approximately $497.2 million, or 16.9% of total portfolio loans. These were mostly loans secured by upscale or top tier flagged hotels, which have historically exhibited low leverage and strong operating cash flows. However, we anticipate that a significant portion of our borrowers in the hotel industry will continue to operate at occupancy levels at or below breakeven which has caused, or will cause, them to draw on their existing lines of credit with other financial institutions or other sources of liquidity and may adversely affect their ability to repay existing indebtedness. These developments, together with the current economic conditions generally, may adversely impact the value of real estate collateral in hospitality and other commercial real estate exposure. As a result, we anticipate that our financial condition, capital levels and results of operations could be adversely affected. The total balance of allowance for loan losses increased $15.3 million during 2020 which was comprised of an increase in specific reserves of $9.1 million and an increase in general reserves of $6.2 million. The $6.2 million increase in general reserves included an increase of $16.1 million in qualitative reserves offset by a decrease of $9.9 million in quantitative reserves due to improvements in the Company’s loss history. The $16.1 million increase in qualitative reserves included $9.6 million due to general economic uncertainties and specific concerns regarding disruptions to the Company’s hospitality clients caused by the COVID-19 pandemic and an additional $6.5 million based on general economic, geo-political and other risk factors determined by management. These qualitative reserves are intended to reflect not only the risks of continued weak economic conditions on our loan portfolio, but also loss estimates identified in loan portfolios deemed to be at risk from the COVID-19 pandemic. The Company adjusted qualitative risk factors under its incurred loss model for economic conditions, changes in payment deferral procedures, expected changes in collateral values due to reduced cash flows and external factors such as government actions. Management believes the uncertainty regarding customers' ability to repay loans could be adversely impacted by the COVID-19 pandemic given higher unemployment rates, requests for payment deferrals, temporary business shutdowns and reduced consumer and business spending. Retail Operations The Company will continue to promote digital banking options through our website. Customers are encouraged to utilize online and mobile banking tools and our customer contact center for personal and automated telephone banking services. Retail branches are staffed and available to assist customers by offering lobby appointments, drive-up and virtual servicing. In March 2020, we closed all branch lobbies to customer activity, offering drive-up and appointment only services. On October 31, 2020, we opened 31 branch lobbies and as of December 31, 2020, we had 36 branch lobbies open. Retail leadership continues to monitor branch traffic and local conditions daily making adjustments as needed. All branches are equipped with video conferencing and online tools that enable virtual servicing. When we make the decision to open the remainder of our branch lobbies, plans are in place to resume full-service lobby operations augmented with the virtual and online servicing enhancements deployed over the past year. We continue to pay all employees according to their normal work schedule, even if their hours have been reduced. No employees have been furloughed. Employees whose job responsibilities can be effectively carried out remotely are working from home. Employees whose critical duties require their continued presence on-site are utilizing personal protection equipment and observing social distancing and cleaning protocols. 50 CARTER BANKSHARES, INC. AND SUBSIDIARIES ITEM 7. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS (continued) Our fee income for 2020 was negatively impacted due to COVID-19 by approximately $1.5 million. In keeping with guidance from regulators, we are actively working with COVID-19 affected customers to waive fees from a variety of sources, such as, but not limited to, insufficient funds and overdraft fees and account maintenance fees, etc. These reductions in fees are thought, at this time, to be temporary in conjunction with the length of the expected COVID-19 related economic crisis. Beginning on July 20, 2020, certain account fees were reinstated. The breadth of the economic impact is likely to continue to impact our fee income in future periods. Capital Resources and Liquidity As of December 31, 2020, all of the Company’s capital ratios were in excess of all regulatory requirements. An extended economic recession brought about by the COVID-19 pandemic could adversely impact our reported regulatory capital ratios. We maintain access to multiple sources of liquidity. Funding sources accessible to the Company include borrowing availability at the FHLB, equal to 25% of the Company’s assets approximating $1.0 billion, subject to the amount of eligible collateral pledged, federal funds unsecured lines with six other correspondent financial institutions in the amount of $145.0 million and access to the institutional CD market through brokered CDs. In addition to the above resources, the Company also has $632.7 million of unpledged available-for-sale securities as an additional source of liquidity at December 31, 2020. If an extended recession caused large numbers of our deposit customers to withdraw their funds, we might become more reliant on volatile or more expensive sources of funding. The Company is monitoring and will continue to monitor the impact of the COVID-19 pandemic and has taken and will continue to take steps to mitigate the potential risks and impact on our liquidity and capital resources. Due to the economic uncertainty, we are taking a prudent approach to capital management and have established access to the FRB’s PPP Lending Facility. Earnings Summary We recognized a net loss of $45.9 million, or ($1.74) per share in 2020, resulting in a decrease of $72.4 million, or 272.6% compared to net income of $26.6 million, or $1.01 per share for the same period in 2019. The decrease was primarily due to a one-time goodwill impairment charge of $62.2 million that was recorded in the third quarter of 2020. Excluding this one-time charge, adjusted net income was $16.3 million in 2020. Also contributing to the net loss and the decrease in net income and adjusted net income for the year was an increase in the provision for loan losses of $14.6 million. Net income is reconciled to adjusted net income, which is a non-GAAP financial measure, below in the “Explanation of Use of Non-GAAP Financial Measures” section of this MD&A. Net interest income decreased $7.2 million, or 6.4%, to $105.1 million in 2020 compared to $112.3 million for the same period in 2019. Net interest margin decreased 23 basis points to 2.74% in 2020 compared to 2.97% in 2019. The net interest margin, on a fully taxable equivalent basis, (or “FTE”), decreased 25 basis points to 2.80% in 2020 compared to 3.05% in 2019. The decreases in short-term interest rates had a negative impact on both net interest income and the net interest margin, but are offset by a lower cost of funds. The yield on interest-earning assets decreased 54 basis points in 2020, offset by a 34 basis point decline in funding costs as compared to 2019. Net interest margin is reconciled to net interest income adjusted to an FTE basis, which is a non-GAAP financial measure, below in the “Net Interest Income” section of this MD&A. 51 CARTER BANKSHARES, INC. AND SUBSIDIARIES ITEM 7. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS (continued) The provision for loan losses increased $14.6 million, or 429.0% to $18.0 million during 2020 compared to $3.4 million in 2019. The total balance of reserves increased $15.3 million during 2020 which was comprised of an increase in specific reserves of $9.1 million and an increase in general reserves of $6.2 million. The $6.2 million increase in general reserves included an increase of $16.1 million in qualitative reserves offset by a decrease of $9.9 million in quantitative reserves due to improvements in the Company’s loss history. The $16.1 million increase in qualitative reserves included $9.6 million due to general economic uncertainties and specific concerns regarding disruptions to the Company’s hospitality clients caused by the COVID-19 pandemic and an additional $6.5 million based on general economic, geo-political and other risk factors determined by management. At December 31, 2020, nonperforming loans and TDRs were $32.0 million compared to $42.1 million at December 31, 2019, a decrease of $10.1 million, or 24.0%. Net charge-offs were $2.7 million in 2020 compared to $3.8 million in 2019. As a percentage of total portfolio loans, net charge-offs were 0.09% at December 31, 2020 compared to 0.13% at December 31, 2019. Nonperforming loans as a percentage of total portfolio loans was 1.09% and 1.46% as of December 31, 2020 and December 31, 2019, respectively. Total noninterest income increased $9.7 million, or 57.6%, to $26.6 million for the full year 2020 compared to $16.9 million for the same period in 2019, primarily driven by the impact of a $6.9 million in net securities gains. Securities gains increased $4.7 million to $6.9 million during 2020 compared to $2.2 million during 2019 to take advantage of market opportunities and reposition and diversify holdings in the securities portfolio. Other key factors impacting total noninterest income during 2020 were $4.1 million of commercial loan swap fee income throughout 2020, due to the high demand for this product in the current low interest rate environment and $0.7 million of higher debit card interchange fees, $0.5 million of higher insurance commissions and $0.5 million in other noninterest income. These increases were offset by lower service charges, commissions and fees of $0.3 million due to COVID-19 waivers and OREO income of $0.3 million. OREO income declined due to the sale of several large commercial properties that generated income. Total noninterest expense increased $60.8 million, or 62.0%, to $158.8 million for the full year 2020 compared to $98.0 million for the same period in 2019, primarily driven by the impact of a $62.2 million one-time goodwill impairment charge during the third quarter of 2020. Other key factors impacting total noninterest expense during 2020 were a $1.6 million increase in occupancy expenses, a $1.0 million increase in FDIC expense due to the $1.1 million one-time credit for eligible institutions available in the third quarter of 2019, a $0.4 million increase in data processing licensing fee and a $0.5 million increase in professional and legal fees. Offsetting these increases were decreases of $3.3 million related to losses on sales and write-downs of OREO due to the write-down of $1.1 million on five closed retail branch offices moved to OREO in the third quarter of 2020, a $1.2 million decrease in tax credit amortization and a decrease of $0.5 million in salaries and employee benefits attributable to our branch network optimization project. The provision for income taxes decreased $0.4 million to $0.8 million in 2020 compared to $1.2 million in 2019. The decrease in pretax income of $72.9 million for the full year 2020 was primarily due to the full goodwill impairment charge of $62.2 million that was recorded in the third quarter of 2020. Our effective tax rate was (1.7%) for 2020 as compared to 4.4% in 2019. The $62.2 million goodwill impairment charge was the reason for the decreased effective tax rate in 2020. The goodwill impairment charge was not tax deductible. We ordinarily generate an annual effective tax rate that is less than the statutory rate of 21% due to benefits resulting from tax-exempt interest and tax credit projects, which are relatively consistent regardless of the level of pretax income. 52 CARTER BANKSHARES, INC. AND SUBSIDIARIES ITEM 7. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS (continued) RESULTS OF OPERATIONS Year Ended December 31, 2020 Net Interest Income Our principal source of revenue is net interest income. Net interest income represents the difference between the interest and fees earned on interest-earning assets and the interest paid on interest-bearing liabilities. Net interest income is affected by changes in the average balance of interest-earning assets and interest-bearing liabilities and changes in interest rates and spreads. The level and mix of interest-earning assets and interest-bearing liabilities is managed by our Asset and Liability Committee (“ALCO”), in order to mitigate interest rate and liquidity risks of the balance sheet. A variety of ALCO strategies were implemented, within prescribed ALCO risk parameters, to produce what the Company believes is an acceptable level of net interest income. The interest income on interest-earning assets and the net interest margin are presented on an FTE basis, which is a non-GAAP measure. The FTE basis adjusts for the tax benefit of income on certain tax-exempt loans and securities using the applicable federal statutory tax rate for each period (which was 21% for the years ended December 31, 2020, 2019 and 2018) and the dividend-received deduction for equity securities. The Company believes this FTE presentation provides a relevant comparison between taxable and non-taxable sources of interest income. The following table reconciles net interest income per the Consolidated Statements of (Loss) Income to net interest income on an FTE basis for the periods presented: Years Ended December 31, (Dollars in Thousands) 2020 2019 2018 Total Interest Income $ 140,941 $ 159,120 $ 152,019 Total Interest Expense 35,826 46,773 38,114 Net Interest Income per Consolidated Statements of Net (Loss) Income 105,115 112,347 113,905 Adjustment to FTE Basis 2,375 3,046 3,816 Net Interest Income (FTE) (non-GAAP) $ 107,490 $ 115,393 $ 117,721 Net Interest Margin 2.74 % 2.97 % 3.00 % Adjustment to FTE Basis 0.06 % 0.08 % 0.10 % Net Interest Income (FTE) (non-GAAP) 2.80 % 3.05 % 3.10 % Average Balance Sheet and Net Interest Income Analysis (FTE) Total net interest income decreased $7.2 million, or 6.4%, to $105.1 million in 2020, as compared to $112.3 million in 2019. Net interest income, on an FTE basis (non-GAAP), decreased $7.9 million, or 6.8%, to $107.5 million in 2020 as compared to $115.4 million in 2019. The decrease in net interest income, on an FTE basis, is driven by an $18.8 million decrease in interest income, offset by a $10.9 million decrease in interest expense during 2020 as compared to 2019. The decreases in short-term interest rates had a negative impact on both net interest income and the net interest margin, but are offset by a lower cost of funds. Net interest margin decreased 23 basis points to 2.74% in 2020 compared to 2.97% in 2019. The net interest margin, on an FTE basis (non-GAAP), decreased 25 basis points to 2.80% in 2020 compared to 3.05% in 2019, primarily due to the lower interest rate environment. The lower interest rate environment and the intentional runoff of higher cost CDs helped to lower the overall cost of funds. 53 CARTER BANKSHARES, INC. AND SUBSIDIARIES ITEM 7. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS (continued) The following table provides information regarding the average balances, interest and rates earned on interest-earning assets and the average balances, interest and rates paid on interest-bearing liabilities for the years ended December 31: (Dollars in Thousands) 2020 2019 2018 ASSETS Average Balance (3) Income/ Expense Rate Average Balance Income/ Expense Rate Average Balance Income/ Expense Rate Interest-Bearing Deposits with Banks $ 104,526 $ 302 0.29 % $ 123,946 $ 2,750 2.22 % $ 134,406 $ 2,682 2.00 % Tax-Free Investment Securities (2) 47,364 1,567 3.31 % 63,641 2,352 3.70 % 153,036 5,375 3.51 % Taxable Investment Securities 697,408 14,264 2.05 % 730,500 17,826 2.44 % 753,023 15,421 2.05 % Tax-Free Loans (1)(2) 307,023 9,739 3.17 % 379,090 12,154 3.21 % 419,981 12,794 3.05 % Taxable Loans (1) 2,672,435 117,226 4.39 % 2,489,105 126,940 5.10 % 2,331,165 119,563 5.13 % Federal Home Loan Bank Stock 4,925 218 4.43 % 2,352 144 6.12 % - - - Total Interest-Earning Assets $ 3,833,681 $ 143,316 3.74 % $ 3,788,634 $ 162,166 4.28 % $ 3,791,611 $ 155,835 4.11 % LIABILITIES Deposits: Interest-Bearing Demand $ 321,036 $ 1,140 0.36 % $ 249,086 $ 2,004 0.80 % $ 246,592 $ 1,959 0.79 % Money Market 197,225 924 0.47 % 134,676 1,671 1.24 % 96,068 694 0.72 % Savings 599,637 632 0.11 % 582,195 1,388 0.24 % 663,801 2,027 0.31 % Certificates of Deposit 1,818,837 32,695 1.80 % 2,054,077 41,593 2.02 % 2,090,103 33,414 1.60 % Total Interest-Bearing Deposits 2,936,735 35,391 1.21 % 3,020,034 46,656 1.54 % 3,096,564 38,094 1.23 % Borrowings: Federal Funds Purchased 55 1 1.82 % - - - 681 20 2.94 % FHLB Borrowings 30,628 361 1.18 % 2,329 38 1.63 % - - - Other Borrowings 1,408 73 5.18 % 1,042 79 7.58 % - - - Total Borrowings 32,091 435 1.36 % 3,371 117 3.47 % 681 20 2.94 % Total Interest-Bearing Liabilities $ 2,968,826 $ 35,826 1.21 % $ 3,023,405 $ 46,773 1.55 % $ 3,097,245 $ 38,114 1.23 % Net Interest Income (2) $ 107,490 $ 115,393 $ 117,721 Net Interest Margin (2) 2.80 % 3.05 % 3.10 % (1) Nonaccruing loans are included in the daily average loan amounts outstanding. (2) Tax-exempt income is on an FTE basis using the statutory federal corporate income tax rate of 21 percent. (3) Loan and deposit balances include held-for-sale transactions in connection with sale of Bank branches. Interest income, on an FTE basis (non-GAAP) decreased $18.8 million, or 11.6%, in 2020 compared to 2019. The decrease is primarily due to balance sheet repricing driven by the impact of the lower interest rate environment. We are currently maintaining higher liquidity levels as a result of COVID-19. The change was primarily due to an increase in average interest-earning assets of $45.0 million in 2020 offset by lower short-term interest rates compared to 2019. Average loan balances increased $111.3 million in 2020 compared to 2019 includes PPP loan production, which began in second quarter of 2020. Average PPP loans for the year ended December 31, 2020 totaled $24.7 million. The average rate earned on loans decreased 59 basis points in 2020 compared to 2019 primarily due to lower short-term interest rates. Average interest-bearing deposits with banks decreased $19.4 million and the average rate earned decreased 193 basis points compared to 2019. Average investment securities decreased $49.4 million and the average rate earned decreased 41 basis points in 2020 compared 2019. The change in investment securities is the result of active balance sheet management as our portfolio has been diversified as to bond types, maturities, and interest rate structures. Overall, the FTE rate on interest-earning assets (non-GAAP) decreased 54 basis points in 2020 compared to 2019. 54 CARTER BANKSHARES, INC. AND SUBSIDIARIES ITEM 7. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS (continued) Interest expense decreased $10.9 million in 2020 compared to the same periods in 2019. The decrease was primarily due to lower short-term interest rates compared to 2019. Average interest-bearing deposits decreased $83.3 million in 2020 compared to 2019 primarily due to the decline in the average balance of CDs offset by increases in all other deposit categories. The decrease in the average balance of CDs compared to 2019 was primarily due to the intentional runoff of these higher cost deposits. The growth we experienced in all of the other deposit categories was primarily due to our ongoing strategy to attract commercial deposits and customer PPP funds on deposit. The average rate paid on interest-bearing deposits decreased 33 basis points compared to 2019 primarily due to lower short-term interest rates. Average total borrowings increased $28.7 million and the average rate paid decreased 211 basis points in 2020 compared to 2019. Overall, the cost of interest-bearing liabilities decreased 34 basis points in 2020 compared to 2019. The following table sets forth for the periods presented a summary of the changes in interest earned and interest paid resulting from changes in volume and changes in rates: 2020 Compared to 2019 2019 Compared to 2018 (Dollars in Thousands) Increase/ (Decrease) Rate (3) Volume (3) Increase/ (Decrease) Rate (3) Volume (3) ASSETS Interest-Bearing Deposits with Banks $ (2,448 ) $ (2,074 ) $ (374 ) $ 68 $ 287 $ (219 ) Tax-Free Investment Securities (2) (785 ) (228 ) (557 ) (3,023 ) 268 (3,291 ) Taxable Investment Securities (3,562 ) (2,783 ) (779 ) 2,405 2,878 (473 ) Tax-Free Loans (1)(2) (2,415 ) (128 ) (2,287 ) (640 ) 648 (1,288 ) Taxable Loans (1) (9,714 ) (18,612 ) 8,898 7,377 (681 ) 8,058 Federal Home Loan Bank Stock 74 (49 ) 123 144 - 144 Total Interest-Earning Assets $ (18,850 ) $ (23,874 ) $ 5,024 $ 6,331 $ 3,400 $ 2,931 LIABILITIES Deposits: Interest-Bearing Demand $ (864 ) $ (1,333 ) $ 469 $ 45 $ 25 $ 20 Money Market (747 ) (1,317 ) 570 977 626 351 Savings (756 ) (796 ) 40 (639 ) (409 ) (230 ) Certificates of Deposit (8,898 ) (4,405 ) (4,493 ) 8,179 8,764 (585 ) Total Interest-Bearing Deposits (11,265 ) (7,851 ) (3,414 ) 8,562 9,006 (444 ) Borrowings: Federal Funds Purchased 1 - 1 (20 ) (10 ) (10 ) FHLB Borrowings 323 (13 ) 336 38 - 38 Other Borrowings (6 ) (29 ) 23 79 - 79 Total Borrowings 318 (42 ) 360 97 (10 ) 107 Total Interest-Bearing Liabilities $ (10,947 ) $ (7,893 ) $ (3,054 ) $ 8,659 $ 8,996 $ (337 ) Net Interest Income (FTE) $ (7,903 ) $ (15,981 ) $ 8,078 $ (2,328 ) $ (5,596 ) $ 3,268 (1) Nonaccruing loans are included in the daily average loan amounts outstanding. (2) Tax-exempt income is on an FTE basis using the statutory federal corporate income tax rate of 21 percent. (3) Changes to rate/volume are allocated to both rate and volume on a proportionate dollar basis. 55 CARTER BANKSHARES, INC. AND SUBSIDIARIES ITEM 7. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS (continued) Provision for Loan Losses The following table summarizes the activity in the ALL for the periods presented: (Dollars in Thousands) 2020 2019 2018 2017 2016 Balance Beginning of Year $ 38,762 $ 39,199 $ 35,318 $ 34,500 $ 26,990 Provision for Loan Losses 18,006 3,404 16,870 43,197 17,717 Charge-offs: Commercial Real Estate 40 69 11,740 26,074 1,232 Commercial and Industrial 66 22 20 32 257 Obligations of State and Political Subdivisions - - - - - Commercial Construction - 393 - 16,452 8,454 Residential Mortgages 258 197 184 286 1 Other Consumer 3,991 4,401 2,710 465 510 Consumer Construction - - - - - Total Charge-offs 4,355 5,082 14,654 43,309 10,454 Recoveries: Commercial Real Estate 707 - 654 10 - Commercial and Industrial 2 - - - 6 Obligations of State and Political Subdivisions - - - - - Commercial Construction 188 630 692 710 12 Residential Mortgages 27 9 69 - 119 Other Consumer 737 602 250 210 110 Consumer Construction - - - - - Total Recoveries 1,661 1,241 1,665 930 247 Total Net Charge-offs 2,694 3,841 12,989 42,379 10,207 Balance End of Year $ 54,074 $ 38,762 $ 39,199 $ 35,318 $ 34,500 Net Charge-offs to Average Loans 0.09 % 0.13 % 0.47 % 1.56 % 0.38 % Allowance for Loan Losses to Total Portfolio Loans 1.83 % 1.34 % 1.45 % 1.32 % 1.26 % The provision for loan losses is the amount to be added to the ALL, after considering loan charge-offs and recoveries, to bring the ALL to a level determined to be appropriate in management's judgment to absorb probable incurred losses inherent in the loan portfolio. We are subject to the adoption of the CECL accounting method under ASU 2016-03 and related amendments, Financial Instruments – Credit Losses (Topic 326). However, we elected under the CARES Act to defer the implementation of CECL until the earlier of when the national emergency related to the outbreak of COVID-19 ends or December 31, 2020, which was later extended to January 1, 2022. We intend to adopt in the first quarter of 2021 as allowed under the provisions of the CARES Act. The provision for loan losses increased $14.6 million to $18.0 million in 2020 compared to $3.4 million in 2019. Included in the provision expense during 2020 was an increase in qualitative loss factors as a result of the estimated economic impact of COVID-19 of $9.6 million. This represents a 429.0% increase in the provision expense as compared to the same period of 2019. The Bank adjusted qualitative risk factors under its incurred loss model for economic conditions, changes in payment deferral procedures, expected changes in collateral values due to reduced cash flows and external factors such as government actions. Management believes the uncertainty regarding customers’ ability to repay loans could be adversely impacted by the COVID-19 pandemic given higher unemployment rates, requests for payment deferrals, temporary business shutdowns and reduced consumer and business spending. Also contributing to the increase in provision for loan loss expense was higher specific reserves in 2020 of $15.3 million compared to $6.2 million in 2019. 56 CARTER BANKSHARES, INC. AND SUBSIDIARIES ITEM 7. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS (continued) The increase was comprised of both higher specific reserves of $9.1 million and general reserves of $6.2 million. The $6.2 million increase in general reserves included an increase of $16.1 million in qualitative reserves offset by a decrease of $9.9 million in quantitative reserves due to improvements in the Company’s loss history. The $16.1 million increase in qualitative reserves included $9.6 million due to general economic uncertainties and specific concerns regarding disruptions to the Company’s hospitality clients caused by the COVID-19 pandemic and an additional $6.5 million based on general economic, geo-political and other risk factors determined by management. These qualitative reserves are intended to reflect not only the risks of continued weak economic conditions on our loan portfolio, but also loss estimates identified in loan portfolios deemed to be at risk from the COVID-19 pandemic. The Company adjusted qualitative risk factors under its incurred loss model for economic conditions, changes in payment deferral procedures, expected changes in collateral values due to reduced cash flows and external factors such as government actions. Management believes the uncertainty regarding customers' ability to repay loans could be adversely impacted by the COVID-19 pandemic given higher unemployment rates, requests for payment deferrals, temporary business shutdowns and reduced consumer and business spending. Net charge-offs decreased $1.1 million to $2.7 million in 2020 compared to $3.8 million for 2019. Net loan charge-offs to average loans were 0.09% and 0.13% in 2020 and 2019, respectively. Specific reserves were $15.3 million at December 31, 2020 and $6.2 million at December 31, 2019. Nonperforming loans and TDRs decreased at December 31, 2020 by $10.1 million, to $32.0 million as compared to $42.1 million at December 31, 2019, due to sale proceeds from two credit relationships. The allowance for loan losses was 169.1% of nonperforming loans as of December 31, 2020 as compared to 92.0% of nonperforming loans as of December 31, 2019. Management is aggressively taking steps to address problem loan relationships. The ALL at December 31, 2020 was $54.1 million compared to $38.8 million at December 31, 2019. The ALL as a percentage of total portfolio loans was 1.83% at December 31, 2020 and 1.34% at December 31, 2019. Discussion of net interest income for the year ended December 31, 2018 has been omitted as such discussion was provided in Part II, Item 7. “Management’s Discussion and Analysis,” under the heading “Net Interest Income” in the Bank’s Annual Report on Form 10-K for the year ended December 31, 2019, which was filed as Exhibit 99.1 with the SEC on November 23, 2020 (and originally filed with the FDIC). Noninterest Income Years Ended December 31, (Dollars in Thousands) 2020 2019 $ Change % Change Gains on Sales of Securities, net $ 6,882 $ 2,205 $ 4,677 212.1 % Service Charges, Commissions and Fees 4,668 4,962 (294 ) (5.9 )% Debit Card Interchange Fees 5,857 5,160 697 13.5 % Insurance Commissions 1,728 1,225 503 41.1 % Bank Owned Life Insurance Income 1,400 1,436 (36 ) (2.5 )% Other Real Estate Owned Income 340 689 (349 ) (50.7 )% Commercial Loan Swap Fee Income 4,051 - 4,051 NM Other 1,654 1,193 461 38.6 % Total Noninterest Income $ 26,580 $ 16,870 $ 9,710 57.6 % NM - percentage not meaningful 57 CARTER BANKSHARES, INC. AND SUBSIDIARIES ITEM 7. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS (continued) Total noninterest income increased $9.7 million, or 57.6%, to $26.9 million for the full year 2020 compared to the same period of 2019, primarily driven by the impact of $6.9 million in net securities gains. Securities gains increased $4.7 million to $6.9 million during 2020 compared to $2.2 million during 2019 to take advantage of market opportunities and reposition and diversify holdings in the securities portfolio. Other key factors impacting total noninterest income during 2020 were $4.1 million commercial loan swap fee income for 2020 compared to 2019, due to the high demand for this product in the current low interest rate environment and $0.7 million increase in debit card interchange fees due to higher volumes in demand deposits, $0.5 million in insurance income and $0.5 million in other noninterest income. The increase of $0.5 million in other income primarily relates to higher gains on sales of mortgage loans and tax credit exits. These increases were partially offset by lower service charges, commissions and fees of $0.3 million due to COVID-19 waivers and OREO income of $0.3 million. OREO income declined due to the sale of several large commercial properties that generated income in 2019. Discussion of noninterest income for the year ended December 31, 2018 has been omitted as such discussion was provided in Part II, Item 7. “Management’s Discussion and Analysis,” under the heading “Noninterest Income” in the Bank’s Annual Report on Form 10-K for the year ended December 31, 2019, which was filed as Exhibit 99.1 with the SEC on November 23, 2020 (and originally filed with the FDIC). Noninterest Expense Years Ended December 31, (Dollars in Thousands) 2020 2019 $ Change % Change Salaries and Employee Benefits $ 52,390 $ 52,879 $ (489 ) (0.9 )% Occupancy Expense, net 13,369 11,785 1,584 13.4 % FDIC Insurance Expense 2,313 1,270 1,043 82.1 % Other Taxes 3,151 2,847 304 10.7 % Advertising Expense 1,633 1,445 188 13.0 % Telephone Expense 2,303 2,202 101 4.6 % Professional and Legal Fees 5,006 4,507 499 11.1 % Data Processing 2,648 2,267 381 16.8 % Losses on Sales and Write-downs of Other Real Estate Owned, net 1,435 4,732 (3,297 ) (69.7 )% Losses on Sales and Write-downs of Bank Premises, net 99 188 (89 ) (47.3 )% Debit Card Expense 2,565 2,753 (188 ) (6.8 )% Tax Credit Amortization 1,088 2,265 (1,177 ) (52.0 )% Unfunded Loan Commitment Expense (252 ) 121 (373 ) (308.3 )% Other Real Estate Owned Expense 657 525 132 25.1 % Goodwill Impairment Expense 62,192 - 62,192 NM Other 8,178 8,243 (65 ) (0.8 )% Total Noninterest Expense $ 158,775 $ 98,029 $ 60,746 62.0 % NM - percentage not meaningful Total noninterest expense increased $60.8 million, or 62.0% to $158.8 million for the full year 2020 compared to $98.0 million in the same period of 2019, primarily driven by the impact of a $62.2 million one-time goodwill impairment charge during the third quarter of 2020. Other key factors impacting total noninterest expense during 2020 were a $1.6 million increase in occupancy expense resulting from higher depreciation expense on software and equipment for ancillary products and services, an increase of $1.0 million for FDIC expense which related to a one-time credit of $1.1 million received in the third quarter of 2019 for eligible institutions, a $0.4 million increase in data processing licensing fee and a $0.5 million increase in professional and legal fees. The decreases offsetting these increases included losses and write-downs of OREO of $3.3 million, $1.2 million decline in the amortization of tax credits and a $0.5 million decrease in salaries and employee benefits. The losses and write-downs of OREO relate to eight retail offices that were closed as part of our branch optimization project. Five of these branches were moved to OREO and marketed for sale resulting in a $1.1 million write-down. The decline of $1.2 million for the amortization of tax credits relates to tax credits being fully amortized. The net decrease of $0.5 million in salaries and employee benefits was comprised of a $0.9 million increase in salaries offset by a $1.4 million decrease in benefits. Salaries increased primarily due to $0.2 million in merit increases, a $0.6 million decrease in salary deferral on new loan origination in 2020, and $0.2 million in hazard bonus payments offset by a reduction of overtime expense of $0.1 million. Benefits decreased primarily due to a $0.5 million reduction in profit sharing and a $0.9 million reduction in medical expense. There have not been any permanent or temporary reductions in employees as a result of COVID-19. Discussion of noninterest expense for the year ended December 31, 2018 has been omitted as such discussion was provided in Part II, Item 7. “Management’s Discussion and Analysis,” under the heading “Noninterest Expense” in the Bank’s Annual Report on Form 10-K for the year ended December 31, 2019, which was filed as Exhibit 99.1 with the SEC on November 23, 2020 (originally filed with the FDIC). 58 CARTER BANKSHARES, INC. AND SUBSIDIARIES ITEM 7. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS (continued) Provision for Income Taxes The provision for income taxes decreased $0.4 million to $0.8 million in 2020 compared to $1.2 million in 2019. The decrease in pretax income of $72.9 million for the full year 2020 was primarily due to the full goodwill impairment charge of $62.2 million that was recorded in the third quarter of 2020 . Our effective tax rate was (1.7%) for 2020 as compared to 4.4% in 2019. The $62.2 million goodwill impairment charge is the reason for the decreased effective tax rate in 2020. The goodwill impairment charge was not tax deductible. The Company ordinarily generates an annual effective tax rate that is less than the statutory rate of 21% due to benefits resulting from tax-exempt interest and tax credit projects, which are relatively consistent regardless of the level of pretax income. Discussion of provision for income taxes for the year ended December 31, 2018 has been omitted as such discussion was provided in Part II, Item 7. “Management’s Discussion and Analysis,” under the heading “Provision for Income Taxes” in the Bank’s Annual Report on Form 10-K for the year ended December 31, 2019, which was filed as Exhibit 99.1 with the SEC on November 23, 2020 (and originally filed with the FDIC). Financial Condition December 31, 2020 Total assets increased $173.1 million to $4.2 billion at December 31, 2020 compared to $4.0 billion at December 31, 2019. Federal Reserve Bank excess reserves increased $124.2 million to $163.5 million at December 31, 2020 compared to $39.3 million at December 31, 2019 due to maintaining higher liquidity levels as a result of COVID-19. Total portfolio loans increased $62.4 million, or 2.2%, to $2.9 billion at December 31, 2020 compared to December 31, 2019. The increase in portfolio loans primarily related to growth in the commercial loan portfolio of $118.6 million with increases of $94.6 million in commercial construction, $88.5 million in Commercial Real Estate (“CRE”) and $50.0 million in Commercial and Industrial (“C&I”), which includes $35.0 million of PPP loans , offset by a decrease of $114.5 million in the obligations of state and political subdivisions portfolio compared to December 31, 2019. The decline in state and political subdivisions are due to municipalities finding cheaper refinancing alternatives. Consumer loans decreased $56.2 million compared to December 31, 2019 with decreases in all portfolios except consumer construction. The decrease in consumer loans is primarily a result of de-risking the portfolio during the economic downturn. At December 31, 2020 we had $9.8 million l oans held-for-sale in connection with the sale of Bank branches that is expected to close in the second quarter of 2021. Nonperforming loans and TDRs decreased $10.1 million to $32.0 million, or 24.0%, at December 31, 2020 compared to $42.1 million at December 31, 2019. OREO decreased $2.6 million at December 31, 2020 compared to December 31, 2019. Closed retail bank offices declined $0.5 million with a remaining book value of $2.5 million at December 31, 2020 compared to $3.0 million at December 31, 2019. 59 CARTER BANKSHARES, INC. AND SUBSIDIARIES ITEM 7. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS (continued) The securities portfolio increased $36.1 million at December 31, 2020 from December 31, 2019 and comprised 18.6% of total assets at December 31, 2020 compared to 18.5% of total assets at December 31, 2019. The increase was a result of active balance sheet management. We have further diversified the securities portfolio as to bond types, maturities and interest rate structures. Total deposits increased $180.4 million to $3.7 billion at December 31, 2020 compared to $3.5 billion at December 31, 2019. The increase in deposits primarily related to the growth in all our core deposit categories, which includes noninterest-bearing and interest-bearing demand deposits, money market and savings accounts. Core deposits increased $441.3 million, or 28.6%, compared to December 31, 2019. Offsetting the increase in core deposits was a decline of $345.6 million in our CDs. This decrease relates to the intentional runoff of $289.1 million of higher cost CDs. Noninterest-bearing deposits comprised 19.0% and 15.8% of total deposits at December 31, 2020 and December 31, 2019, respectively. At December 31, 2020, $84.7 million of deposits were held for assumption in connection with the sale of Bank branches that is expected to close in the second quarter of 2021. Total shareholders’ equity decreased by $32.9 million to $440.2 million at December 31, 2020 compared to $473.1 million at December 31, 2019. The decrease was primarily due to a net loss of $45.9 million and a special dividend of $3.7 million paid in March of 2020, both offset by a $15.6 million, net of tax, increase in other comprehensive income due to changes in the fair value of available-for-sale securities. The remaining difference is related to stock-based compensation during the year ended December 31, 2020. The ALL was 1.83% of total portfolio loans at December 31, 2020 compared to 1.34% as of December 31, 2019. General reserves as a percentage of total portfolio loans were 1.32% at December 31, 2020 compared to 1.13% at December 31, 2019. The ALL was 169.1% of nonperforming loans at December 31, 2020 compared to 92.0% of nonperforming loans at December 31, 2019. Management believes, the allowance for loan losses is adequate to absorb probable losses inherent in the loan portfolio. The Company remains well capitalized. Our Tier 1 capital ratio decreased to 13.08% at December 31, 2020 compared to 13.58% at December 31, 2019. Our leverage ratio was 10.26% at December 31, 2020, compared to 10.33% at December 31, 2019 and total risk-based capital ratio was 14.33% at December 31, 2020 compared to 14.83% at December 31, 2019. Securities The following table presents the composition of available-for-sale securities for the periods presented: (Dollars in Thousands) December 31, 2020 December 31, 2019 $ Change Residential Mortgage-Backed Securities $ 44,724 $ 52,644 $ (7,920 ) Commercial Mortgage-Backed Securities 5,447 19,006 (13,559 ) Asset Backed Securities 133,557 109,639 23,918 Collateralized Mortgage Obligations 218,359 292,224 (73,865 ) Small Business Administration 99,145 105,736 (6,591 ) States and Political Subdivisions 252,622 148,480 104,142 Corporate Notes 24,825 14,888 9,937 Total Debt Securities $ 778,679 $ 742,617 $ 36,062 60 CARTER BANKSHARES, INC. AND SUBSIDIARIES ITEM 7. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS (continued) The balances and average rates of our securities portfolio are presented below as of December 31: 2020 2019 2018 (Dollars in Thousands) Balance Weighted- Average Yield Balance Weighted- Average Yield Balance Weighted- Average Yield U.S. Government Agency Securities $ - 0.00 % $ - 0.00 % $ 270,388 1.44 % Residential Mortgage-Backed Securities 44,724 1.86 % 52,644 2.72 % 70,871 2.37 % Commercial Mortgage-Backed Securities 5,447 2.77 % 19,006 2.53 % 21,792 2.59 % Asset Backed Securities 133,557 1.47 % 109,639 3.05 % 58,861 3.46 % Collateralized Mortgage Obligations 218,359 1.38 % 292,224 2.49 % 76,819 2.84 % Small Business Administration 99,145 1.69 % 105,736 3.23 % 89,238 3.59 % States and Political Subdivisions 252,622 2.69 % 148,480 2.94 % 167,474 3.45 % Corporate Notes 24,825 5.42 % 14,888 4.08 % 27,315 3.62 % Total Securities Available-for-Sale $ 778,679 2.02 % $ 742,617 2.82 % $ 782,758 2.49 % The Company invests in various securities in order to maintain a source of liquidity, to satisfy various pledging requirements, to increase net interest income and as a tool of the ALCO to diversify and reposition the balance sheet for interest rate risk purposes. Securities are subject to market risks that could negatively affect the level of liquidity available to us. Security purchases are subject to our Investment Policy approved annually by our Board and administered through ALCO and our treasury function. The securities portfolio increased by $36.1 million at December 31, 2020 as compared to December 31, 2019. Securities comprise 18.6% of total assets at December 31, 2020 as compared to 18.5% at December 31, 2019. The increase is a result of active balance sheet management. We have further diversified the securities portfolio as to bond types, maturities and interest rate structures. At December 31, 2020, total gross unrealized gains in the available-for-sale portfolio were $22.6 million offset by $2.7 million of gross unrealized losses. At December 31, 2019, total gross unrealized gains in the available-for-sale portfolio were $6.2 million offset by $6.0 million of gross unrealized losses. Management evaluates the securities portfolio for OTTI on a quarterly basis. During the years ended December 31, 2020 and 2019 the Company did not record any OTTI. The performance of the debt and equity securities markets could generate impairments in future periods requiring realized losses to be reported. 61 CARTER BANKSHARES, INC. AND SUBSIDIARIES ITEM 7. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS (continued) The following table sets forth the maturities of securities at December 31, 2020 and the weighted average yields of such securities. Taxable-equivalent adjustments (using a 21% federal income tax rate) for 2020 have been made in calculating yields on obligations of state and political subdivisions. Available-for-Sale Securities Maturing After One But Within After Five But Within Within One Year Five Years Ten Years After Ten Years (Dollars in Thousands) Amount Yield Amount Yield Amount Yield Amount Yield Residential Mortgage-Backed Securities - 0.00 % 40 2.58 % - 0.00 % 44,684 1.85 % Commercial Mortgage-Backed Securities - 0.00 % - 0.00 % 3,146 2.97 % 2,301 2.47 % Asset Backed Securities - 0.00 % - 0.00 % 21,442 2.01 % 112,115 1.37 % Collateralized Mortgage Obligations - 0.00 % - 0.00 % 25,626 2.71 % 192,733 1.22 % Small Business Administration - 0.00 % 2,686 1.27 % 59,506 1.73 % 36,953 1.66 % States and Political Subdivisions 394 2.78 % 1,650 3.97 % 33,871 2.53 % 216,707 2.71 % Corporate Notes - 0.00 % - 0.00 % 24,825 5.42 % - 0.00 % Total $ 394 $ 4,376 168,416 $ 605,493 Weighted Average Yield 2.78 % 2.30 % 2.64 % 1.86 % Weighted -average yields are calculated on a taxable-equivalent basis using the federal statutory tax rate of 21 percent. Loan Composition T he following table summarizes our loan portfolio as of the periods presented: December 31, (Dollars in Thousands) 2020 2019 2018 2017 2016 Commercial Commercial Real Estate $ 1,453,799 $ 1,365,310 $ 1,359,036 $ 1,479,765 $ 1,527,552 Commercial and Industrial 306,828 256,798 229,468 334,023 372,775 Obligations of State and Political Subdivisions 250,336 364,869 432,402 470,569 462,356 Commercial Construction 387,407 292,827 201,240 118,786 199,551 Total Commercial Loans 2,398,370 2,279,804 2,222,146 2,403,143 2,562,234 Consumer Residential Mortgages 472,170 514,538 397,280 193,328 138,657 Other Consumer 57,647 73,688 73,058 79,980 20,724 Consumer Construction 18,983 16,736 11,308 7,994 10,168 Total Consumer Loans 548,800 604,962 481,646 281,302 169,549 Total Portfolio Loans 2,947,170 2,884,766 2,703,792 2,684,445 2,731,783 Loans Held-for-Sale 25,437 19,714 2,559 517 - Loans Held-for-Sale in Connection with Sale of Bank Branches, at the lower of cost or fair value 9,835 - - - - Total Loans $ 2,982,442 $ 2,904,480 $ 2,706,351 $ 2,684,962 $ 2,731,783 62 CARTER BANKSHARES, INC. AND SUBSIDIARIES ITEM 7. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS (continued) Our loan portfolio represents our most significant source of interest income. The risk that borrowers will be unable to pay such obligations is inherent in the loan portfolio. Other conditions such as downturns in the borrower's industry or the overall economic climate can significantly impact the borrower’s ability to pay. Total portfolio loans increased $62.4 million, or 2.2%, at December 31, 2020 compared to December 31, 2019. Commercial loans increased $118.6 million, or 5.2%, including $35.0 million of PPP loans, offset by a decrease of $114.5 million in the obligations of state and political subdivisions portfolio compared to December 31, 2019. The decline in state and political subdivisions are due to municipalities finding cheaper refinancing alternatives. Consumer loans decreased $56.2 million, or 9.3% in all categories, except consumer construction. The decrease in consumer loans if primarily a result of de-risking the portfolio during the economic downturn. Total commercial loans represented 81.4% of total portfolio loans at December 31, 2020 and 79.0% of total portfolio loans at December 31, 2019. Within our commercial portfolio, the CRE and Commercial Construction portfolios combined comprised $1.8 billion or 76.8% of total commercial loans and 62.5% of total portfolio loans at December 31, 2020 and comprised $1.7 billion or 72.7% of total commercial loans and 57.5% of total portfolio loans at December 31, 2019. Net deferred costs included in the portfolio balances above were $3.0 million and $5.1 million at December 31, 2020 and 2019, respectively. Discounts on purchased 1-4 family loans included in the portfolio balances above were $219 thousand and $250 thousand at December 31, 2020 and 2019, respectively. The commercial portfolio is monitored for potential concentrations of credit risk by market, type of lending, CRE property type, C&I and owner-occupied CRE by industry, investment CRE dependent on common tenants and industries or property types that are similarly impacted by external factors. Our exposure to hospitality at December 31, 2020 equated to approximately $497.2 million, or 16.9% of total portfolio loans. These were mostly loans secured by upscale or top tier flagged hotels, which have historically exhibited low leverage and strong operating cash flows. However, we anticipate that a significant portion of our borrowers in the hotel industry will continue to operate at occupancy levels at or below breakeven which has caused, or will cause, them to draw on their existing lines of credit with other financial institutions or other sources of liquidity and may adversely affect their ability to repay existing indebtedness. These developments, together with the current economic conditions generally, may adversely impact the value of real estate collateral in hospitality and other commercial real estate exposure. As a result, we anticipate that our financial condition, capital levels and results of operations could be adversely affected. Portfolio loan balances of our top 10 credit relationships were $675.9 million at December 31, 2020, with a total commitment exposure of $727.7 million. These loans are in the hospitality, golf course, agricultural, land holdings, commercial real estate (multi-family and office/retail), energy, land development, and lumber industries. Line utilization, unused commitments, excluding consumer overdraft lines, were $410.7 million at December 31, 2020 as compared to $355.5 million at December 31, 2019. The majority of unused commitments are for construction projects that will be drawn as the construction completes. Total utilization, excluding consumer overdraft lines, was 47.8% at December 31, 2020, as compared to 51.1% at December 31, 2019. Commercial line utilization was 48.3% at December 31, 2020, as compared to 50.8% at December 31, 2019. From time to time, we have mortgage loans held-for-sale derived from two sources. First, we purchase mortgage loans on a short-term basis from a partner financial institution that have fully executed sales contracts to end investors. Secondly, we originate and close mortgages with fully executed contracts with investors to purchase shortly after closing. We then hold these mortgage loans from both sources until funded by the investor, typically a two-week period. Mortgage loans held-for-sale were $25.4 million and $19.7 million at December 31, 2020 and December 31, 2019, respectively. 63 CARTER BANKSHARES, INC. AND SUBSIDIARIES ITEM 7. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS (continued) In addition to mortgage loans held-for-sale, the Company had $9.8 million in loans held-for-sale in connection with sale of Bank branches at December 31, 2020 that are expected to close in the second quarter of 2021. The following tables present the maturity schedule of selected loan types at December 31, 2020: Maturity After One Within But Within After (Dollars in Thousands) One Year Five Years Five Years Total Fixed interest rates $ 187,635 $ 52,829 $ 5,870 $ 246,334 Variable interest rates 48,707 98,207 13,142 160,056 Total Construction Loans (1) $ 236,342 $ 151,036 $ 19,012 $ 406,390 (1) Totals to Commercial Construction and Consumer Construction in the loan composition table above. Maturity After One Within But Within After (Dollars in Thousands) One Year Five Years Five Years Total Fixed interest rates $ 6,050 $ 80,059 $ 53,410 $ 139,519 Variable interest rates 13,983 99,691 53,635 167,309 Total Commercial, Industrial & Agricultural (2) $ 20,033 $ 179,750 $ 107,045 $ 306,828 (2) Totals to Commercial & Industrial in the loan composition table above. Credit Quality On a monthly basis, a criticized asset committee meets to review all special mention and substandard loans within prescribed policy thresholds. These loans typically represent the highest risk of loss to the Company. Action plans are established and these loans are monitored through regular contact with the borrower and loan officer, review of current financial information and other documentation, review of all loan or potential loan restructures or modifications and the regular re-evaluation of assets held as collateral. We attempt to limit our exposure to credit risk by diversifying our loan portfolio by segment, geography, collateral and industry and actively managing concentrations. When concentrations exist in certain segments, we mitigate this risk by reviewing the relevant economic indicators and interest risk rating trends and through stress testing of the loans in these segments. The Company has specific loan segment limits in its loan policy. Total commercial real estate balances should not exceed the combination of 300% of total risk based capital and growth in excess of 50% over the previous thirty-six months and construction loan balances should not exceed 100% of total risk based capital. Investment real estate property types and purchased loan programs have individual dollar limits that should not be exceeded in the portfolio. In addition, there are specific limits in place for various categories of real estate loans with regards to loan-to-value ratios, loan terms, and amortization periods. Unsecured loans pose a higher risk for the Company due to the lack of a well-defined secondary source of repayment. Unsecured loans are reserved for the best quality customers with well-established businesses, operate with low financial and operating leverage and demonstrate an ability to clear the outstanding balance on lines of credit for at least thirty consecutive days annually. The repayment capacity of the borrower should exceed all policy and guidelines for secured loans. If the borrower is unable to comply with this requirement and the Company is willing to renew the credit facility, the line should be secured and/or begin amortization. 64 CARTER BANKSHARES, INC. AND SUBSIDIARIES ITEM 7. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS (continued) On a quarterly basis, the Credit Risk Committee of the Board meets to review our loan portfolio metrics, segmentation guidelines, and loan review findings from the previous quarter. Annually, this same committee reviews credit related policies and policy enhancements as they become available. Additional credit risk management practices include periodic review and update of our lending policies and procedures to support sound underwriting practices and portfolio management through portfolio stress testing. Our loan review serves as a mechanism to independently monitor credit quality and assess the effectiveness of credit risk management practices to provide oversight of all corporate lending activities. The loan review function has the primary responsibility for assessing commercial credit administration and credit decision functions of consumer and mortgage underwriting, as well as providing input to the loan risk rating process. Our policy is to place loans in all categories in nonaccrual status when collection of interest or principal is doubtful, or generally when interest or principal payments are 90 days or more past due based on contractual terms. The Company has a loan review policy and annual scope report that details the level of loan review for commercial loans in a given year. Primary objectives of loan reviews include the identification of unknown risks and patterns that might influence potential future losses. In concert with significant enhancements to the underwriting process, the scope of loan review has been broadened since 2019 to include assurance testing with respect to the accuracy of the underwriting function. During 2020, we used a four-step approach for loan review in the following segments: · A review of the largest twenty pass-rated loan relationships, which represents approximately a quarter of total loans; · A sampling of new loans originated to include an examination of the evidence of appropriate approval, adherence to loan policy and the completeness and accuracy of the analysis contained in the approval document; · A sampling of Large Loan Relationships (“LLRs”) which are defined as loan relationships with aggregate exposure of at least $2 million that are not part of the top 20 review; and · Concentration focus reviews of identified segments that represent concentration risk, represented by collateral types including but not limited to hospitality, multifamily and retail with the goal of examining patterns of loss history, document exceptions, policy exceptions and emerging trends in risk characteristics. The Company does not typically structure these with a 30-day cleanout feature since that is difficult to measure and enforce. Instead we usually set higher debt service standards and underwrite to the ability to amortize the loan on unsecured terms. 65 CARTER BANKSHARES, INC. AND SUBSIDIARIES ITEM 7. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS (continued) Nonperforming assets (“NPAs”) consist of nonaccrual loans, nonaccrual TDRs and OREO. The following table summarizes nonperforming assets for the dates presented: (Dollars in Thousands) December 31, Nonaccrual Loans 2020 2019 2018 2017 2016 Commercial Real Estate $ 224 $ 1,017 $ 684 $ 39,421 $ 45,181 Commercial and Industrial 456 77 606 - 1 Obligations of State and Political Subdivisions - - - - - Commercial Construction 2,012 3,210 826 11,342 50,604 Residential Mortgages 4,135 2,857 1,779 284 358 Other Consumer 191 267 65 47 1 Consumer Construction - - - - - Total Nonaccrual Loans 7,018 7,428 3,960 51,094 96,145 Nonaccrual Troubled Debt Restructurings Commercial Real Estate 21,667 30,073 36,369 39,138 11,969 Commercial and Industrial - 390 - - - Obligations of State and Political Subdivisions - - - - - Commercial Construction 3,319 4,242 10,130 2,241 11,238 Residential Mortgages - - 272 425 112 Other Consumer - - - - - Consumer Construction - - - - - Total Nonaccrual Troubled Debt Restructurings 24,986 34,705 46,771 41,804 23,319 Total Nonaccrual Loans and Troubled Debt Restructurings 32,004 42,133 50,731 92,898 119,464 Other Real Estate Owned 15,722 18,324 33,681 39,793 23,558 Total Nonperforming Assets $ 47,726 $ 60,457 $ 84,412 $ 132,691 $ 143,022 Nonaccrual Loans and Troubled Debt Restructurings to Total Portfolio Loans 1.09 % 1.46 % 1.88 % 3.46 % 4.37 % Nonperforming Assets to Total Portfolio Loans plus Other Real Estate Owned 1.61 % 2.08 % 3.08 % 4.87 % 5.19 % Nonperforming assets decreased to $12.7 million to $47.7 million at December 31, 2020 compared to $60.4 million at December 31, 2019. The decrease was due to a $10.1 million decline in nonaccrual loans and a $2.6 million net decrease in OREO. The decrease in nonaccrual loans was primarily due to pay-downs during the 2020, offset by draws on minimal commitments. The gross amount of interest that would have been recorded under original terms, had these loans not been placed on nonaccrual status was $4.7 million during 2020. The decrease in OREO was primarily due to sales of properties during 2020, offset by transfers into OREO. Eight retail branch banking offices were closed during 2020 as part of our branch optimization project. Five of these branches were moved to OREO in 2020 and marketed for sale resulting in a $1.1 million write-down. Closed retail bank offices have a remaining book value of $2.5 million at December 31, 2020 and $3.0 million at December 31, 2019. As of December 31, 2020 total nonaccrual loans include $7 thousand in loans held-for-sale in connection with sale of Bank branches. There were no nonaccrual loans related to loans held-for-sale in 2019. The CARES Act permits banks to suspend requirements under GAAP for loan modifications to borrowers affected by COVID-19 that would otherwise be characterized as TDRs and suspend any determination related thereto if (i) the loan modification is made between March 1, 2020 and the earlier of December 31, 2020 or 60 days after the end of the COVID-19 emergency declaration and (ii) the applicable loan was not more than 30 days past due as of December 31, 2019. The provisions of the CARES Act dealing with temporary relief related to TDRs was extended pursuant to the CAA, which was signed into law on December 27, 2020. This amendment extended the “applicable” period to the earlier of January 1, 2022 or 60 days after the date on which the national emergency concerning the COVID-19 pandemic terminates. The federal banking agencies also issued guidance to encourage banks to make loan modifications for borrowers affected by COVID-19 and to assure banks that they will not be criticized by examiners for doing so. We are currently applying this guidance to qualifying loan modifications. At this time, it is uncertain what future impact loan and lease modifications related to COVID-19 will have on our financial condition, results of operations and allowance for loan losses. 66 CARTER BANKSHARES, INC. AND SUBSIDIARIES ITEM 7. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS (continued) The following table summarizes past due loans for the dates presented: December 31, (Dollars in Thousands) 2020 2019 2018 2017 2016 Loans 90 Days or More Past Due and Still Accruing Commercial Commercial Real Estate $ - $ - $ - $ - $ 208 Commercial and Industrial - - - 4 - Obligations of State and Political Subdivisions - - - - - Commercial Construction - - - - 73 Total Commercial Loans - - - 4 281 Consumer Residential Mortgages - - - 493 311 Other Consumer - - - 59 26 Consumer Construction - - - - - Total Consumer Loans - - - 552 337 Total Loans 90 Days or More Past Due $ - $ - $ - $ 556 $ 618 December 31, (Dollars in Thousands) 2020 2019 2018 2017 2016 Loans 30 to 89 Days Past Due Commercial Commercial Real Estate $ 3,816 $ 1,220 $ 1,103 $ 3,682 $ 7,692 Commercial and Industrial 384 161 62 161 23 Obligations of State and Political Subdivisions - 236 - - - Commercial Construction 284 228 2,501 109 91 Total Commercial Loans 4,484 1,845 3,666 3,952 7,806 Consumer Residential Mortgages 1,347 942 2,442 1,652 1,375 Other Consumer 580 1,283 1,510 392 197 Consumer Construction - - - - - Total Consumer Loans 1,927 2,225 3,952 2,044 1,572 Total Loans 30 to 89 Days Past Due $ 6,411 $ 4,070 $ 7,618 $ 5,996 $ 9,378 Loans past due 90 days or more and still accruing were zero at December 31, 2020 and 2019. With the implementation of the Company’s new core system, loans past due 90 days are automatically transferred to nonaccrual status. Loans past due 30 to 89 days or more and still accruing increased $2.3 million to $6.4 million at December 31, 2020 compared to $4.1 million at December 31, 2019. As of December 31, 2020 total loans past due 30 to 89 days include $7 thousand in loans held-for-sale in connection with sale of Bank branches. There were no past due loans related to loans held-for-sale in 2019. 67 CARTER BANKSHARES, INC. AND SUBSIDIARIES ITEM 7. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS (continued) Closed-end installment loans, amortizing loans secured by real estate and any other loans with payments scheduled monthly are reported past due when the borrower is in arrears two or more monthly payments. Other multi-payment obligations with payments scheduled other than monthly are reported past due when one scheduled payment is due and unpaid for 30 days or more. We monitor delinquency on a monthly basis, including early stage delinquencies of 30 to 89 days past due for early identification of potential problem loans. TDRs are loans that we, for economic or legal reasons related to a borrower’s financial difficulties, grant a concession to the borrower that we would not otherwise grant. The Company strives to identify borrowers in financial difficulty early and work with them to modify the terms before their loan reaches nonaccrual status. These modified terms generally include extension of maturity dates at a stated interest rate lower than the current market rate for a new loan with similar characteristics, reductions in contractual interest rates or principal deferment. While unusual, there may be instances of principal forgiveness. These modifications are generally for longer term periods that would not be considered insignificant. An accruing loan that is modified into a TDR can remain in accrual status if, based on a current credit analysis, collection of principal and interest in accordance with the modified terms is reasonably assured, and the borrower has demonstrated sustained historical performance for a reasonable period before the modification. All TDRs are considered to be impaired loans and will be reported as impaired loans for their remaining lives, unless the restructuring agreement specifies an interest rate equal to or greater than the rate that would be accepted at the time of the restructuring for a new loan with comparable risk and we fully expect that the remaining principal and interest will be collected according to the restructured agreement. The Company individually evaluates all impaired loans, which includes TDRs, greater than or equal to $1.0 million for additional impairment. In addition, the Company evaluates credits that have complex loan structures for impairment, even if the balance is less than $1.0 million. Nonaccrual TDRs can be returned to accruing status if the ultimate collectability of all contractual amounts due, according to the restructured agreement, is not in doubt and there is a period of a minimum of six months of satisfactory payment performance by the borrower either immediately before or after the restructuring. As an example, consider a substandard commercial construction loan that is currently 90 days past due where the loan is restructured to extend the maturity date for a period longer than would be considered an insignificant period of time. The post-modification interest rate given to the borrower is considered to be lower than the current market rate for new debt with similar risk and all other terms remain the same according to the original loan agreement. This loan will be considered a TDR as the borrower is experiencing financial difficulty and a concession has been granted due to the long extension, resulting in payment delay as well as the rate being lower than current market rate for new debt with similar risk. The loan will be reported as a nonaccrual TDR and an impaired loan. In addition, the loan could be charged down to the fair value of the collateral if a confirmed loss exists. If the loan subsequently performs, by means of making on-time principal and interest payments according to the newly restructured terms for a period of six months, and it is expected that all remaining principal and interest will be collected according to the terms of the restructured agreement, the loan will be returned to accrual status and reported as an accruing TDR. The loan will remain an impaired loan for the remaining life of the loan because the interest rate was not adjusted to be equal to or greater than the rate that would be accepted at the time of the restructuring for a new loan with comparable risk. 68 CARTER BANKSHARES, INC. AND SUBSIDIARIES ITEM 7. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS (continued) The following table summarizes the restructured loans as of the dates presented: December 31, 2020 December 31, 2019 Performing Nonperforming Total Performing Nonperforming Total (Dollars in Thousands) TDRs TDRs TDRs TDRs TDRs TDRs Commercial Commercial Real Estate $ 6,151 $ 21,667 $ 27,818 $ 3,183 $ 30,073 $ 33,256 Commercial and Industrial - - - - 390 390 Obligations of State and Political Subdivisions - - - - - - Commercial Construction 52,481 3,319 55,800 53,116 4,242 57,358 Total Commercial TDRs 58,632 24,986 83,618 56,299 34,705 91,004 Consumer Residential Mortgages 50,618 - 50,618 52,966 - 52,966 Other Consumer - - - - - - Consumer Construction - - - - - - Total Consumer TDRs 50,618 - 50,618 52,966 - 52,966 Total TDRs $ 109,250 $ 24,986 $ 134,236 $ 109,265 $ 34,705 $ 143,970 TDRs decreased $9.7 million, or 6.8%, to $134.2 million at December 31, 2020 compared to December 31, 2019. The Bank received $12.8 million of pay-downs, offset by an addition of $3.1 million. TDRs of $25.0 million and $34.7 million were nonaccrual as of December 31, 2020 and December 31, 2019, respectively. At December 31, 2020 we had one relationship identified as a TDR that had minimal commitments to lend additional funds. During the twelve months ended December 31, 2020, the Bank modified one loan totaling $3.1 million that constituted a TDR. The loan is part of a $15.7 million relationship. The relationship is collateralized by income producing property and unimproved land that was acquired for future development. The cash flows of the income producing property are insufficient to amortize the $3.1 million loan which matured during the year. The underlying conditions in the immediate submarket make development in the near term unlikely. The Bank renewed the $3.1 million loan and extended interest only terms which management considered a concession. The balance of the relationship continues to amortize as agreed and the cash flows of the income producing property are sufficient to amortize the larger loan and fund interest payments on the $3.1 million loan. The Bank had o ne loan modified as a TDR during the twelve months ending December 31, 2019 totaling $0.6 million in post-modified recorded balances. The TDR modification was a result of several key factors. The borrower is experiencing financial difficulties due to negative cash flows and being dependent upon collateral to repay the loan. The most recent appraisal suggests that the borrower would have to sell the lots in this lot development project at a price higher than the appraisal for this project to be profitable. In addition, when comparing the complete value versus the cost to complete, the loan would not currently fit our standards for underwriting a lot development loan. The current rate on the loan is below market rate and there are other terms and conditions that would not be offered to a comparable borrower. There were no TDR payment defaults during the year ended December 31, 2019 for TDRs with outstanding principal balances at year end 2019. For purposes of this disclosure, a TDR payment default occurs when, within 12 months of the original TDR modification, either a full or partial charge-off occurs or a TDR becomes 90 days or more past due. 69 CARTER BANKSHARES, INC. AND SUBSIDIARIES ITEM 7. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS (continued) The following tables represent credit exposures by internally assigned grades as of December 31, 2020 and 2019: Obligations (Dollars in Thousands) Commercial Commercial Of States and Commercial Residential Other Consumer December 31, 2020 Real Estate & Industrial Political Sub. Construction Mortgages Consumer Construction Total Pass $ 1,281,106 $ 228,200 $ 250,336 $ 270,798 $ 415,773 $ 57,418 $ 18,983 $ 2,522,614 Special Mention 126,535 48 - 58,899 723 6 - 186,211 Substandard 46,158 78,580 - 57,710 55,674 223 - 238,345 Doubtful - - - - - - - - Loss - - - - - - - - Total Portfolio Loans $ 1,453,799 $ 306,828 $ 250,336 $ 387,407 $ 472,170 $ 57,647 $ 18,983 $ 2,947,170 Performing Loans $ 1,431,908 $ 306,372 $ 250,336 $ 382,076 $ 468,035 $ 57,463 $ 18,983 $ 2,915,173 Non-Accrual Loans 21,891 456 - 5,331 4,135 184 - 31,997 Total Portfolio Loans $ 1,453,799 $ 306,828 $ 250,336 $ 387,407 $ 472,170 $ 57,647 $ 18,983 $ 2,947,170 Obligations (Dollars in Thousands) Commercial Commercial Of States and Commercial Residential Other Consumer December 31, 2019 Real Estate & Industrial Political Sub. Construction Mortgages Consumer Construction Total Pass $ 1,198,269 $ 167,326 $ 364,869 $ 173,176 $ 456,859 $ 73,345 $ 16,736 $ 2,450,580 Special Mention 1,368 203 - 1,476 1,178 9 - 4,234 Substandard 165,673 89,269 - 118,175 56,501 334 - 429,952 Doubtful - - - - - - - - Loss - - - - - - - - Total Portfolio Loans $ 1,365,310 $ 256,798 $ 364,869 $ 292,827 $ 514,538 $ 73,688 $ 16,736 $ 2,884,766 Performing Loans $ 1,334,220 $ 256,331 $ 364,869 $ 285,375 $ 511,681 $ 73,421 $ 16,736 $ 2,842,633 Non-Accrual Loans 31,090 467 - 7,452 2,857 267 - 42,133 Total Portfolio Loans $ 1,365,310 $ 256,798 $ 364,869 $ 292,827 $ 514,538 $ 73,688 $ 16,736 $ 2,884,766 Loans held-for-sale in connection with sale of Bank branches at December 31, 2020 include $7 thousand in the substandard category. There were no substandard loans in loans held-for-sale at December 31, 2019. 70 CARTER BANKSHARES, INC. AND SUBSIDIARIES ITEM 7. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS (continued) Special mention, substandard and doubtful loans at December 31, 2020 decreased by $9.6 million to $424.6 million compared to $434.2 million at December 31, 2019, with an increase of $182.0 million in special mention and a decrease of $191.6 million in substandard. During 2020 there was a significant risk rating upgrade due to improvements in underlying operating cash flows of certain credits. At this time, it is uncertain what impact COVID-19 will have on our current impaired loans or the susceptibility of the loan portfolio to future loan impairment. Allowance for Loan Losses The Company maintains an ALL at a level determined to be adequate to absorb estimated probable credit losses inherent within the loan portfolio as of the balance sheet date and it is presented as a reserve against loans in the Consolidated Balance Sheets. Determination of an adequate ALL is inherently subjective and may be subject to significant changes from period to period. The methodology for determining the ALL has two main components: evaluation and impairment tests of individual loans and evaluation and impairment tests of certain groups of homogeneous loans with similar risk characteristics. Our charge-off policy for commercial loans requires that loans and other obligations that are not collectible be promptly charged-off when the loss becomes probable, regardless of the delinquency status of the loan. We may elect to recognize a partial charge-off when management has determined that the value of collateral is less than the remaining investment in the loan. A loan or obligation does not need to be charged-off, regardless of delinquency status, if (i) management has determined there exists sufficient collateral to protect the remaining loan balance and (ii) there exists a strategy to liquidate the collateral. Management may also consider a number of other factors to determine when a charge-off is appropriate. These factors may include, but are not limited to: • The status of a bankruptcy proceeding • The value of collateral and probability of successful liquidation; and/or • The status of adverse proceedings or litigation that may result in collection Consumer unsecured loans and secured loans are evaluated for charge-off after the loan becomes 90 days past due. Unsecured loans are fully charged-off and secured loans are charged-off to the estimated fair value of the collateral less the cost to sell. 71 CARTER BANKSHARES, INC. AND SUBSIDIARIES ITEM 7. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS (continued) The following summarizes our allowance for loan loss experience at December 31 for each of the years presented: (Dollars in Thousands) 2020 2019 2018 2017 2016 Balance Beginning of Year $ 38,762 $ 39,199 $ 35,318 $ 34,500 $ 26,990 Provision for Loan Losses 18,006 3,404 16,870 43,197 17,717 Charge-offs: Commercial Real Estate 40 69 11,740 26,074 1,232 Commercial and Industrial 66 22 20 32 257 Obligations of State and Political Subdivisions - - - - - Commercial Construction - 393 - 16,452 8,454 Residential Mortgages 258 197 184 286 1 Other Consumer 3,991 4,401 2,710 465 510 Consumer Construction - - - - - Total Charge-offs 4,355 5,082 14,654 43,309 10,454 Recoveries: Commercial Real Estate 707 - 654 10 - Commercial and Industrial 2 - - - 6 Obligations of State and Political Subdivisions - - - - - Commercial Construction 188 630 692 710 12 Residential Mortgages 27 9 69 - 119 Other Consumer 737 602 250 210 110 Consumer Construction - - - - - Total Recoveries 1,661 1,241 1,665 930 247 Total Net Charge-offs 2,694 3,841 12,989 42,379 10,207 Balance End of Year $ 54,074 $ 38,762 $ 39,199 $ 35,318 $ 34,500 Net Charge-offs to Average Loans 0.09 % 0.13 % 0.47 % 1.56 % 0.38 % Allowance for Loan Losses to Total Portfolio Loans 1.83 % 1.34 % 1.45 % 1.32 % 1.26 % The increase in the ALL of $15.3 million was primarily due an increase in specific reserves of $9.1 million and an increase in general reserves of $6.2 million. The $6.2 million increase in general reserves included an increase of $16.1 million in qualitative reserves offset by a decrease of $9.9 million in quantitative reserves due to improvements in our loss history. The $16.1 million increase in qualitative reserves included $9.6 million due to general economic uncertainties and specific concerns regarding disruptions to our hospitality clients caused by the COVID-19 pandemic and an additional $6.5 million based on general economic, geo-political and other risk factors determined by management. These qualitative reserves are intended to reflect not only the risks of continued weak economic conditions on our loan portfolio, but also loss estimates identified in loan portfolios deemed to be at risk from the COVID-19 pandemic. We adjusted qualitative risk factors under our incurred loss model for economic conditions, changes in payment deferral procedures, expected changes in collateral values due to reduced cash flows and external factors such as government actions. Management believes the uncertainty regarding customers' ability to repay loans could be adversely impacted by the COVID-19 pandemic given higher unemployment rates, requests for payment deferrals, temporary business shutdowns and reduced consumer and business spending. Net charge-offs were $2.7 million in 2020 as compared to $3.8 million in 2019. As a percentage of total portfolio loans net charge-offs were 0.09% and 0.13% for the periods ending December 31, 2020 and 2019, respectively. Nonperforming loans as a percentage of total portfolio loans were 1.09% and 1.46% as of December 31, 2020 and December 31, 2019, respectively. 72 CARTER BANKSHARES, INC. AND SUBSIDIARIES ITEM 7. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS (continued) An inherent risk to the loan portfolio as a whole is the condition of the economy in our markets. In addition, each loan segment carries with it risks specific to the segment. The Company develops and documents a systematic ALL methodology based on the following portfolio segments: 1) CRE, 2) C&I, 3) Obligations of States and Political Subdivisions, 4) Commercial Construction, 5) Residential Mortgages, 6) Other Consumer, and 7) Consumer Construction. The following is a discussion of the key risks by portfolio segment that management assesses in preparing the ALL. CRE loans are secured by commercial purpose real estate, including both owner occupied properties and investment properties, for various purposes such as hotels, strip malls and apartments. Operations of the individual projects as well as global cash flows of the debtors are the primary sources of repayment for these loans. The condition of the local economy is an important indicator of risk, but there are also more specific risks depending on the collateral type as well as the business. C&I loans are made to operating companies or manufacturers for the purpose of production, operating capacity, accounts receivable, inventory or equipment financing. Cash flow from the operations of the borrower is the primary source of repayment for these loans. The condition of the local economy is an important indicator of risk, but there are also more specific risks depending on the industry of the borrower. Collateral for these types of loans often do not have sufficient value in a distressed or liquidation scenario to satisfy the outstanding debt. Obligations of States and Political Subdivision loans are made to local and state municipalities for various purposes including refinancing existing obligations, infrastructure up-fit and expansion, or to purchase new equipment. This segment of loans may be secured by general obligations from the municipal authority or revenues generated by infrastructure and equipment financed by the Company. The primary repayment source for these loans include the tax basis of the municipality, specific revenue streams related to the infrastructure financed, and other business operations of the municipal authority. The health and stability of state and local economies directly impacts each municipality’s tax basis and are important indicators of risk for this segment. The ability of each municipality to increase taxes and fees to offset debt service requirements give this type of loan a very low risk profile in the continuum of the Company’s loan portfolio. Commercial Construction loans are made to finance construction of buildings or other structures, as well as to finance the acquisition and development of raw land for various purposes. While the risk of these loans is generally confined to the construction period, if there are problems, the project may not be completed, and as such, may not provide sufficient cash flow on its own to service the debt or have sufficient value in a liquidation to cover the outstanding principal. The condition of the local economy is an important indicator of risk, but there are also more specific risks depending on the type of project and the experience and resources of the developer. Residential Mortgages are loans secured by first and second liens such as home equity loans, home equity lines of credit and 1-4 family residential mortgages, including purchase money mortgages. The primary source of repayment for these loans is the income and assets of the borrower. The condition of the local economy, in particular the unemployment rate, is an important indicator of risk for this segment. The state of the local housing market can also have a significant impact on this segment because low demand and/or declining home values can limit the ability of borrowers to sell a property and satisfy the debt. Consumer loans are made to individuals and may be secured by assets other than 1-4 family residences, as well as unsecured loans. This segment includes auto loans and unsecured loans and lines. The primary source of repayment for these loans is the income and assets of the borrower. The condition of the local economy, in particular the unemployment rate, is an important indicator of risk for this segment. The value of the collateral, if there is any, is less likely to be a source of repayment due to less certain collateral values. 73 CARTER BANKSHARES, INC. AND SUBSIDIARIES ITEM 7. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS (continued) Consumer Construction loans are made for the construction of residential homes for which a binding sales contract exists and generally are for a period of time sufficient to complete construction. Residential construction loans to individuals generally provide for the payment of interest only during the construction phase. Credit risk for residential real estate construction loans can arise from construction delays, cost overruns, failure of the contractor to complete the project to specifications and economic conditions that could impact demand for or supply of the property being constructed. 74 CARTER BANKSHARES, INC. AND SUBSIDIARIES ITEM 7. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS (continued) The following is the ALL balance by segment as of December 31 for the years presented below: 2020 2019 2018 2017 2016 % of % of % of % of % of Loans Loans Loans Loans Loans in each in each in each in each in each Category Category Category Category Category to Total to Total to Total to Total to Total (Dollars in Thousands) Amount Loans Amount Loans Amount Loans Amount Loans Amount Loans Commercial Real Estate $ 36,428 49.3 % $ 24,706 47.3 % $ 23,897 50.3 % $ 28,471 55.1 % $ 26,445 55.9 % Commercial & Industrial 4,113 10.4 % 3,236 8.9 % 626 8.5 % 1,210 12.4 % 1,480 13.6 % Obligations of States and Political Sub. 951 8.5 % 365 12.6 % 432 16.0 % 460 17.5 % 462 16.9 % Commercial Construction 7,929 13.1 % 5,377 10.2 % 5,214 7.4 % 2,198 4.4 % 3,455 7.3 % Residential Mortgages 2,099 16.0 % 1,736 17.8 % 6,129 14.7 % 2,543 7.2 % 2,400 5.1 % Other Consumer 2,479 2.0 % 3,299 2.6 % 2,728 2.7 % 288 3.0 % 82 0.8 % Consumer Construction 75 0.6 % 43 0.6 % 173 0.4 % 148 0.3 % 176 0.4 % Balance End of Year $ 54,074 100 % $ 38,762 100 % $ 39,199 100.0 % $ 35,318 100.0 % $ 34,500 100.0 % Significant to our ALL is a higher concentration of commercial loans. The ability of borrowers to repay commercial loans is dependent upon the success of their business and general economic conditions. Due to the greater potential for loss within our commercial portfolio, we monitor the commercial loan portfolio through an internal risk rating system. Loan risk ratings are assigned based upon the creditworthiness of the borrower and are reviewed on an ongoing basis according to our internal policies. Loans rated special mention or substandard have potential or well-defined weaknesses not generally found in high quality, performing loans, and require attention from management to limit loss. The following table summarizes the ALL balance as of December 31 for the years presented below: (Dollars in Thousands) 2020 2019 2018 2017 2016 Collectively Evaluated for Impairment $ 38,824 $ 32,593 $ 34,000 $ 35,286 $ 34,256 Individually Evaluated for Impairment 15,250 6,169 5,199 32 244 Total Allowance for Loan Losses $ 54,074 $ 38,762 $ 39,199 $ 35,318 $ 34,500 The ALL was $54.1 million, or 1.83% of total portfolio loans at December 31, 2020 compared to $38.8 million, or 1.34% of total portfolio loans at December 31, 2019. 75 CARTER BANKSHARES, INC. AND SUBSIDIARIES ITEM 7. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS (continued) Deposits The following tables present the composition of deposits at December 31: (Dollars in Thousands) 2020 2019 $ Change % Change Noninterest-Bearing Demand $ 699,229 $ 554,875 $ 144,354 26.0 % Interest-Bearing Demand 366,201 286,561 79,640 27.8 % Money Market 294,229 140,589 153,640 109.3 % Savings 625,482 561,814 63,668 11.3 % Certificates of Deposits 1,614,770 1,960,406 (345,636 ) (17.6 )% Deposits Held for Assumption in Connection with Sale of Bank Branches 84,717 - 84,717 NM Total $ 3,684,628 $ 3,504,245 $ 180,383 5.1 % NM - percentage not meaningful The daily average balance of deposits and rates paid on deposits are summarized in the following table for the years ended December 31: 2020 2019 2018 (Dollars in Thousands) Average Balance Rate Average Balance Rate Average Balance Rate Noninterest-Bearing Demand Deposits $ 634,864 - $ 557,505 - $ 551,124 - Noninterest-Bearing Demand Deposits Held for Assumption in Connection with Sale of Bank Branches 6,776 - - - - - Interest-Bearing Transaction Accounts 317,664 0.36 % 249,086 0.80 % 246,592 0.79 % Money Market 194,129 0.47 % 134,676 1.24 % 96,068 0.72 % Savings 591,967 0.11 % 582,195 0.24 % 663,801 0.31 % Certificates of Deposit 1,765,310 1.79 % 2,054,077 2.02 % 2,090,103 1.60 % Interest-Bearing Deposits Held for Assumption in Connection with Sale of Bank Branches 67,665 1.52 % - - - - Total Interest-Bearing Deposits 2,936,735 1.21 % 3,020,034 1.54 % 3,096,564 1.23 % Total Deposits $ 3,578,375 0.99 % $ 3,577,539 1.30 % $ 3,647,688 1.04 % 76 CARTER BANKSHARES, INC. AND SUBSIDIARIES ITEM 7. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS (continued) Deposits are our primary source of funds. We believe that our deposit base is stable and that we have the ability to attract new depositors while diversifying the deposit composition. Total deposits at December 31, 2020 increased $180.4 million, or 5.1%, from December 31, 2019. Noninterest-bearing deposits increased by $144.3 million, or 26.0%, to $699.2 million as of December 31, 2020 as compared to $554.9 million at December 31, 2019. Money market accounts increased $153.6 million, or 109.3%, during 2020 compared to 2019, due to recent special rate promotions. Interest-bearing demand deposits increased $79.6 million, or 27.8% to $366.2 million at December 31, 2020 compared to December 31, 2019. Savings accounts increased $63.7 million, or 11.3%, at December 31, 2020 compared to December 31, 2019. Offsetting these increases was a decrease of $345.6 million, or 17.6%, in CDs at December 31, 2020 compared to December 31, 2019 due to intentional runoff of these higher cost deposits. Noninterest-bearing deposits comprised 19.0% and 15.8% of total deposits at December 31, 2020 and December 31, 2019, respectively. At December 31, 2020, $84.7 million of deposits were held for assumption in connection with the sale of Bank branches that is expected to close in the second quarter of 2021. The following table summarizes the maturities of CDs, excluding CDs held-for-assumption: (Dollars in Thousands) 2020 2021 $ 746,635 2022 249,239 2023 293,434 2024 135,306 2025 187,931 Thereafter 2,225 Total $ 1,614,770 Maturities of CDs of $250,000 or more outstanding, excluding CDs held-for-assumption at December 31, 2020 are summarized as follows: (Dollars in Thousands) Amount Percent Three Months or Less $ 24,449 13.28 % Over Three Months Through Twelve Months 70,974 38.54 % Over Twelve Months Through Three Years 54,721 29.71 % Over Three Years 34,018 18.47 % Total $ 184,162 100 % Federal Home Loan Bank (“FHLB”) Borrowings Borrowings are an additional source of liquidity for the Company. FHLB borrowings were $35.0 million and $10.0 million at December 31, 2020 and December 31, 2019, respectively. FHLB borrowings are fixed rate advances for various terms and are secured by a blanket lien on select residential mortgages, select multifamily loans, and select commercial real estate loans at December 31, 2020. Total loans pledged as collateral were $804.2 million and $284.6 million at December 31, 2020 and December 31, 2019, respectively. There were no securities available-for-sale pledged as collateral at December 31, 2020. The bank continues to methodically pledge additional eligible loans, with the ultimate expectation to have full pledging by year end 2021. Total securities available-for-sale pledged as collateral were $28.6 million at December 31, 2019. The Company is eligible to borrow up to an additional $510.5 million based upon current qualifying collateral and has a maximum borrowing capacity of approximately $1.0 billion, or 25% of the Company’s assets, as of December 31, 2020. The Company had the capacity to borrow up to an additional $242.2 million from the FHLB at December 31, 2019. 77 CARTER BANKSHARES, INC. AND SUBSIDIARIES ITEM 7. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS (continued) Information pertaining to FHLB advances at December 31 is summarized in the table below: (Dollars in Thousands) 2020 2019 2018 Balance at Period End $ 35,000 $ 10,000 $ - Average Balance during Period 30,628 2,329 - Average Interest Rate during the Period 1.18 % 1.63 % 0.00 % Maximum Month-end Balance during the Period 35,000 10,000 - Average Interest Rate at Period End 1.13 % 1.63 % 0.00 % The Company held FHLB Atlanta stock of $5.1 million and $4.1 million at December 31, 2020 and December 31, 2019, respectively. Dividends recorded on this restricted stock were $218 thousand, $144 thousand, and zero for the years ended December 31, 2020, 2019, and 2018, respectively. The investment is carried at cost and evaluated for impairment based on the ultimate recoverability of the par value. We hold FHLB stock because we are a member of the FHLB of Atlanta. The FHLB requires members to purchase and hold a specified level of FHLB stock based upon the members’ asset values, level of borrowings and participation in other programs offered. Stock in the FHLB is non-marketable and is redeemable at the discretion of the FHLB. Members do not purchase stock in the FHLB for the same reasons that traditional equity investors acquire stock in an investor-owned enterprise. Rather, members purchase stock to obtain access to the products and services offered by the FHLB. Unlike equity securities of traditional for-profit enterprises, the stock of the FHLB does not provide its holders with an opportunity for capital appreciation because, by regulation, FHLB stock can only be purchased, redeemed and transferred at par value. Capital Resources The following table summarizes ratios for the Company for December 31: 2020 2019 2018 2017 2016 Common Equity Tier 1 13.08 % 13.58 % 13.86 % 12.82 % 12.12 % Tier 1 Ratio 13.08 % 13.58 % 13.86 % 12.82 % 12.12 % Total Risk-Based Capital Ratio 14.33 % 14.83 % 15.11 % 14.05 % 13.25 % Leverage Ratio 10.26 % 10.33 % 9.61 % 9.25 % 8.03 % Shareholders’ equity decreased $32.9 million, or 7.0%, to $440.2 million at December 31, 2020 as compared to $473.1 million at December 31, 2019. The decrease in shareholders’ equity is primarily due to a net loss of $45.9 million in 2020, a special dividend of $3.7 million paid in March of 2020, both offset by an increase in other comprehensive income in the amount of $15.6 million. The change in other comprehensive income of $15.6 million was primarily due to the increase in net unrealized gains on securities available-for-sale driven by a change in interest rates during the period. The remaining difference is related to stock-based compensation during the year ended December 31, 2020. The Company continues to maintain its capital position with a leverage ratio of 10.26% as compared to the regulatory guideline of 5.0% to be well-capitalized and a risk-based Common Equity Tier 1 ratio of 13.08% compared to the regulatory guideline of 6.5% to be well-capitalized. Our risk-based Tier 1 and Total Capital ratios were 13.08% and 14.33%, respectively, which places the Company about the federal bank regulatory agencies’ well-capitalized guidelines of 8.0% and 10.0%, respectively. We believe that we have the ability to raise additional capital, if necessary. In July 2013 the federal banking agencies issued a final rule to implement the Basel III Final Rules and the minimum leverage and risk-based capital requirements of the Dodd-Frank Act. The final rule established a comprehensive capital framework and went into effect on January 1, 2015 for smaller banking organizations such as the Company. The rule also requires the Company and the Bank to maintain a capital conservation buffer composed of Common Equity Tier 1 capital in an amount greater than 2.50% of total risk-weighted assets beginning in 2019. The capital conservation buffer was phased-in, in equal increments from 2016 through 2019. As a result, starting in 2019, the Company and the Bank were required to maintain a Common Equity Tier I risk-based capital ratio greater than 7.0%, a Tier 1 risk-based capital ratio greater than 8.5%, and a Total risk-based capital ratio greater than 10.5%; otherwise, they will be subject to restrictions on capital distributions and discretionary bonus payments. 78 CARTER BANKSHARES, INC. AND SUBSIDIARIES ITEM 7. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS (continued) Federal regulators periodically propose amendments to the regulatory capital rules and the related regulatory framework and consider changes to the capital standards that could significantly increase the amount of capital needed to meet applicable standards. The timing of adoption, ultimate form and effect of any such proposed amendments cannot be predicted. The community bank leverage ratio final rule was effective on January 1, 2020 and allows qualifying community banking organizations to calculate a leverage ratio to measure capital adequacy. Qualifying banking organizations that have less than $10 billion total assets, a leverage ratio of greater than 9%, and meet other criteria such as off-balance sheet exposures and trading assets limits. Banks opting into this framework are not required to calculate or report risk-based capital. We did not adopt this framework; therefore, capital ratios are calculated and reported as detailed above. Contractual Obligations Contractual obligations represent future cash commitments and liabilities under agreements with third parties and exclude contingent contractual liabilities for which we cannot reasonably predict future payments. The Company has various financial obligations, including contractual obligations and commitments that may require future cash payments. The following table presents as of December 31, 2020, significant fixed and determinable contractual obligations to third parties by payment date: Payments Due In (Dollars in Thousands) Less Than One Year One to Three Years Three to Five Years More Than five Years Total Deposits without a Stated Maturity (1) $ 1,985,141 $ - $ - $ - $ 1,985,141 Certificates of Deposits (1) 746,635 542,673 323,237 2,225 1,614,770 Deposits Held for Assumption in Connection with sale of Bank Branches (1) 84,717 - - - 84,717 FHLB Advances 3,000 14,000 18,000 - 35,000 Operating and Capital Leases 241 496 360 725 1,822 Purchase Obligations 4,990 7,987 5,899 7,894 26,770 Total $ 2,824,724 $ 565,156 $ 347,496 $ 10,844 $ 3,748,220 (1) Excludes Interest Lease contracts are described in Note 8, Premises and Equipment, to the Consolidated Financial Statements included in Part II, Item 8 of this Report. Purchase obligations primarily represent obligations under agreement with a third-party data processing vendor and communications charges. 79 CARTER BANKSHARES, INC. AND SUBSIDIARIES ITEM 7. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS (continued) Off-Balance Sheet Arrangements In the normal course of business, the Company offers our customers lines of credit and letters of credit to meet their financing objectives. The undrawn or unfunded portion of these facilities do not represent outstanding balances and therefore are not reflected in our financial statements as loans receivable. The Company provides lines of credit to our clients to memorialize the commitment to finance the completion of construction projects and revolving lines of credit to operating companies to finance their working capital needs. Lines of credit for construction projects represent $391.4 or 66.2% and $298.8 or 61.1% of the Commitments to Extend Credit identified in the table below at December 31, 2020 and 2019, respectively. The Company provides letters of credit, generally for the benefit or our customers to provide assurance to various municipalities that construction projects will be completed according to approved plans and specifications. These instruments involve elements of credit and interest rate risk and our exposure to credit loss, in the event the customer does not satisfy the terms of the agreement, could be equal to the contractual amount of the obligation less the value of any collateral. The Company analyzes this risk and calculates a reserve for unfunded commitments. The same credit policies are applied in granting these facilities as those used for underwriting loans. Lines of credit to finance construction projects include a construction end date, at which time the loan is expected to convert to a mini-perm loan. A department independent of our lending group monitors construction commitments of $1 million or more. Lines of credit to operating companies to finance working capital include a maturity date and may include various financial covenants. Letters of credit include an expiration date unless it is a standby letter of credit which automatically renews but generally provide for a termination clause on an annual basis given sufficient notice to the beneficiary. The Company typically charges an annual fee for the issuance of letters of credit. Because letters of credit are expected to expire without being drawn upon, these commitments do not necessary represent future cash requirements of the Company. The following table sets forth the commitments and letters of credit as of December 31: (Dollars in Thousands) 2020 2019 Commitments to Extend Credit $ 591,175 $ 488,864 Standby Letters of Credit 29,293 39,575 Total $ 620,468 $ 528,439 Estimates of the fair value of these off-balance sheet items were not made because of the short-term nature of these arrangements and the credit standing of the counterparties. Our allowance for unfunded commitments is determined using a methodology similar to that used to determine the ALL. Amounts are added to the allowance for unfunded commitments through a charge to current earnings in noninterest expense. The balance in the allowance for unfunded commitments was $0.1 million and $0.4 million at December 31, 2020 and December 31, 2019, respectively. Liquidity Liquidity is defined as a financial institution’s ability to meet its cash and collateral obligations at a reasonable cost. This includes the ability to satisfy the financial needs of depositors who want to withdraw funds or of borrowers needing to access funds to meet their credit needs. In order to manage liquidity risk the Company’s Board has delegated authority to the ALCO for formulation, implementation and oversight of liquidity risk management for the Company. The ALCO’s goal is to maintain adequate levels of liquidity at a reasonable cost to meet funding needs in both a normal operating environment and for potential liquidity stress events. The ALCO monitors and manages liquidity through various ratios, reviewing cash flow projections, performing stress tests and by having a detailed contingency funding plan. The ALCO policy guidelines define graduated risk tolerance levels. If our liquidity position moves to a level that has been defined as high risk, specific actions are required, such as increased monitoring or the development of an action plan to reduce the risk position. 80 CARTER BANKSHARES, INC. AND SUBSIDIARIES ITEM 7. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS (continued) Our primary funding and liquidity source is a stable customer deposit base. Management believes that we have the ability to retain existing deposits and attract new deposits, mitigating any funding dependency on other more volatile sources. Although deposits are the primary source of funds, the Company has identified various other funding sources that can be used as part of our normal funding program when either a structure or cost efficiency has been identified. Additional funding sources accessible to the Company include borrowing availability at the FHLB, equal to 25% of the Company’s assets approximating $1.0 billion, subject to the amount of eligible collateral pledged, federal funds lines with six other correspondent financial institutions in the amount of $145.0 million, and the brokered deposit market. In addition to the lines referenced above, the Company also has its available-for-sale investment securities portfolio as an additional source of liquidity. An important component of our ability to effectively respond to potential liquidity stress events is maintaining a cushion of highly liquid assets. Highly liquid assets are those that can be converted to cash quickly, with little or no loss in value, to meet financial obligations. ALCO policy guidelines define a ratio of highly liquid assets to total assets by graduated risk tolerance levels of minimal, moderate and high. At December 31, 2020, the Bank had $871.4 million in highly liquid assets, which consisted of $40.0 million in interest-bearing deposits in other financial institutions, $163.5 million in FRB Excess Reserves, $632.7 million in unpledged securities, $25.4 million in mortgage loans held-for-sale and $9.8 million in loans held-for-sale in connection with sale of Bank branches. This resulted in highly liquid assets to total assets ratio of 20.9% at December 31, 2020. If an extended recession caused large numbers of our deposit customers to withdraw their funds, we might become more reliant on volatile or more expensive sources of funding. The following table provides detail of liquidity sources as of the periods presented: (Dollars in Thousands) December 31, 2020 December 31, 2019 Cash and Due From Banks $ 38,535 $ 41,386 Interest Bearing Deposits in Other Financial Institutions 39,954 45,156 Federal Reserve Bank Excess Reserves 163,453 39,270 Unpledged Investment Securities 632,724 592,065 Excess Pledged Securities 7,857 16,030 FHLB Borrowing Availability 510,533 242,188 Unsecured Lines of Credit 145,000 115,000 Total Liquidity Sources $ 1,538,056 $ 1,091,095 Inflation Management is aware of the significant effect inflation has on interest rates and can have on financial performance. The Company’s ability to cope with this is best determined by analyzing its capability to respond to changing interest rates and its ability to manage noninterest income and expense. The mix of interest-rate sensitive assets and liabilities is monitored through ALCO in order to reduce the impact of inflation on net interest income. The effects of inflation are controlled by reviewing the prices of our products and services, by introducing new products and services and by controlling overhead expenses. 81 CARTER BANKSHARES, INC. AND SUBSIDIARIES