Carter Bankshares, Inc. 10-K

ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA (continued) CONSOLIDATED STATEMENTS OF CASH FLOWS - (continued) Years Ended December 31, (Dollars in Thousands) 2020 2019 2018 SUPPLEMENTARY DATA Cash Interest Paid $ 36,696 $ 46,170 $ 37,918 Cash Paid for Income Taxes 416 220 175 Transfer from Loans to Other Real Estate Owned 755 302 28,212 Loans Provided for Sales of Other Real Estate Owned - - 893 Transfer from Fixed Assets to Other Real Estate Owned 2,221 1,694 2,177 Security (Purchases) Sales Settled in Subsequent Period (2,259 ) (3,270 ) - Right-of-use Asset Recorded in Exchange for Lease Liabilities 621 1,659 - Loans Held-for-Sale in Connection with Sale of Bank Branches 9,835 - - Bank Premises and Equipment Held-for-Sale 2,293 - - Deposits Held for Assumption in Connection with Sale of Bank Branches 84,717 - - See accompanying notes to audited consolidated financial statements. 90 CARTER BANKSHARES, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued) NOTE 1 – SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES Nature of Operations: Carter Bankshares, Inc. (the “Company”) is a holding company headquartered in Martinsville, Virginia. The Company is the parent company of its wholly owned subsidiary of Carter Bank & Trust (the “Bank”). The Bank is an insured, Virginia state-chartered commercial bank which operates branches in Virginia and North Carolina. The Bank is regulated by the FDIC, Federal Reserve Bank (“FRB”) and State Bureau of Financial Institutions. The Bank has one wholly owned subsidiary, CB&T Investment Company (the “Investment Company”), which was chartered effective April 1, 2019. Formerly, the Bank owned Mortgage Company of Virginia who owned 100% of Bank Services of Virginia and Bank Services Insurance, Inc. Mortgage Company of Virginia was terminated and dissolved on December 11, 2018. Bank Services of Virginia was terminated and dissolved on July 10, 2018. Bank Services Insurance, Inc. was sold in January of 2018. The Company was incorporated on October 7, 2020, by and at the direction of the board of directors of the Bank, for the sole purpose of acquiring the Bank and serving as the Bank’s parent bank holding company pursuant to a corporate reorganization transaction (the “Reorganization”) . On November 9, 2020, the Bank entered into an Agreement and Plan of Reorganization (the “Reorganization Agreement”) with the Company and CBT Merger Sub, Inc. (the “Merger Sub”), a wholly-owned subsidiary of the Company, pursuant to which the Reorganization would be effected. Effective at 7:00 p.m. on November 20, 2020 (the “Effective Time”), under the terms of the Reorganization Agreement and pursuant to Section 13.1-719.1 of the Virginia Stock Corporation Act (the “VSCA”), the Bank merged with the Merger Sub and survived such merger as a wholly-owned subsidiary of the Company. Prior to the Effective Time, the Company had no material assets and had not conducted any business or operations except for activities related to the Company’s organization and the Reorganization. At the Effective Time, under the terms of the Reorganization Agreement and pursuant to Section 13.1-719.1 of the VSCA, each of the outstanding shares of the Bank’s common stock, par value $1.00 per share, formerly held by its shareholders was converted into and exchanged for one newly issued share of the Company’s common stock, par value $1.00 per share, and the Bank became the Company’s wholly-owned subsidiary. The shares of the Company’s common stock issued to the Bank’s shareholders were issued without registration under the Securities Act of 1933, as amended (the “Act”), pursuant to the exemption from registration provided by Section 3(a)(12) of the Act. Pursuant to Section 13.1-719.1 of the VSCA, the Reorganization did not require approval of the Bank’s shareholders. In the Reorganization, each shareholder of the Bank received securities of the same class, having substantially the same designations, rights, powers, preferences, qualifications, limitations and restrictions, as those that the shareholder held in the Bank, and the Company’s current shareholders own the same percentages of its common stock as they previously owned of the Bank’s common stock. Prior to the Effective Time, the Bank’s common stock was registered under Section 12(b) of the Securities Exchange Act of 1934, as amended (the “Exchange Act”). The Bank was subject to the information requirements of the Exchange Act and, in accordance with Section 12(i) thereof, it filed annual and quarterly reports, proxy statements and other information with the Federal Deposit Insurance Corporation (“FDIC”). Upon consummation of the Reorganization, the Company’s common stock was deemed to be registered under Section 12(b) of the Exchange Act, pursuant to Rule 12g-3(a) promulgated thereunder, and the Company now files annual reports, proxy statements and other information with the Securities and Exchange Commission (the “SEC”). Accounting Policies: Our financial statements have been prepared in accordance with U.S. Generally Accepted Accounting Principles (“GAAP”). In preparing the financial statements, management is required to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosures of contingent assets and liabilities as of the dates of the balance sheets and revenues and expenses for the periods then ended. Actual results could differ from those estimates. Our significant accounting policies are described below. 91 CARTER BANKSHARES, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued) Principles of Consolidation : The Consolidated Financial Statements include the accounts of Carter Bankshares, Inc. and its wholly owned subsidiary. The Investment Company is a subsidiary of the Bank. All significant intercompany transactions have been eliminated in consolidation. Reclassification : Amounts in prior years' period financial statements and footnotes are reclassified whenever necessary to conform to the current year’s presentation. Reclassifications had no material effect on prior year net income or shareholders’ equity. Use of Estimates : To prepare financial statements in conformity with GAAP, management makes estimates and assumptions based on available information. These estimates and assumptions affect the amounts reported in the consolidated financial statements and the disclosures provided, and actual results could differ from those estimates. Information available which could affect these judgments include, but are not limited to, changes in interest rates, changes in the performance of the economy, including COVID-19-related changes, and changes in the financial condition of borrowers. The Company could experience a material adverse effect on its business as a result of the impact of the COVID-19 pandemic, and the resulting governmental actions to curtail its spread. It is at least reasonably possible that information which was available at the date of the financial statements will change in the near term due to the COVID-19 pandemic and that the effect of the change could be material to the financial statements. The extent to which the COVID-19 pandemic will impact our estimates and assumptions is highly uncertain and we are unable to make an estimate, at this time. Operating Segments: While the chief decision-makers monitor the revenue streams of the various products and services, operations are managed and financial performance is evaluated on a Company-wide basis, and operating segments are aggregated into one as operating results for all segments are similar. Accordingly, all of the financial service operations are considered by management to be aggregated in one reportable operating segment. Cash and Cash Equivalents : The Company considers all cash on hand, amounts due from banks, federal funds sold, and FRB excess reserves as cash equivalents for the purposes of the Consolidated Statements of Cash Flows with all items having original maturities fewer than 90 days. Federal funds are customarily sold for one-day periods. The FRB pays the target fed funds rate on the FRB excess reserves. Restrictions on Cash : Cash on hand or on deposit with the FRB is required to meet regulatory reserve and clearing requirements. Loan Commitments and Related Financial Instruments : Financial instruments include off-balance sheet credit instruments, such as commitments to make loans and commercial letters of credit, issued to meet customer financing needs. The face amount for these items represents the exposure to loss, before considering customer collateral or ability to repay. Such financial instruments are recorded when they are funded. Comprehensive Income (Loss) : Comprehensive income (loss) consists of net income (loss) and other comprehensive income (loss). Other comprehensive income (loss) includes unrealized gains and losses on securities available-for-sale, net of tax. 92 CARTER BANKSHARES, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued) Securities : The Company classifies securities into either the held-to-maturity or available-for-sale categories at the time of purchase. All securities were classified as available-for-sale at December 31, 2020 and December 31, 2019. Securities classified as available-for-sale include securities, which can be sold for liquidity, investment management, or similar reasons even if there is not a present intention of such a sale. Available-for-sale securities are reported at fair value, with unrealized gains or losses included in other comprehensive income (loss), net of tax. Premium amortization is deducted from, and discount accretion is added to, interest income on securities using the level yield method without anticipating prepayments, except for mortgage-backed securities where prepayments are anticipated. Gains and losses are recognized upon the sale of specific identified securities on the completed trade date. Other-Than-Temporary Impairments of Securities : Management evaluates debt securities for other-than-temporary impairment (“OTTI”) on at least a quarterly basis, and more frequently when economic or market conditions warrant such an evaluation. In determining OTTI, management considers many factors, including: (1) the length of time and the extent to which the fair value has been less than cost, (2) the financial condition and near-term prospects of the issuer, (3) whether the market decline was affected by macroeconomic conditions, and (4) whether the Company has the intent to sell the debt security or more likely than not will be required to sell the debt security before its anticipated recovery. The assessment of whether an OTTI decline exists involves a high degree of subjectivity and judgment and is based on the information available to management at a point in time. When an OTTI occurs, the amount of the OTTI recognized in earnings depends on whether an entity intends to sell the security or it is more likely than not it will be required to sell the security before recovery of its amortized cost basis, less any current-period credit loss. If an entity intends to sell or it is more likely than not it will be required to sell the security before recovery of its amortized cost basis, less any current-period credit loss, the OTTI shall be recognized in earnings equal to the entire difference between the investment’s amortized cost basis and its fair value at the balance sheet date. If an entity does not intend to sell the security and it is not more likely than not that the entity will be required to sell the security before recovery of its amortized cost basis less any current-period loss, the OTTI shall be separated into the amount representing the credit loss and the amount related to all other factors. The amount of the total OTTI related to the credit loss is determined based upon the difference of the present value of cash flows expected be collected and the amortized cost basis and is recognized in earnings. The amount of the total OTTI related to other factors is recognized in other comprehensive income, net of applicable taxes. The previous amortized cost basis less the OTTI recognized in earnings becomes the new amortized cost basis of the investment. Loans Held-for-Sale: Loans held-for-sale arise primarily 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. These loans are typically held about two weeks. Second, we originate certain mortgage loan types (30-year fixed rate and government) through our internal mortgage department that are targeted for sale into the secondary market. Gains and losses on sales of mortgage loans held-for-sale are determined using the specific identification method and are included in other noninterest income in the Consolidated Statements of Net (Loss) Income. From time to time, certain loans are transferred from the loan portfolio to loans held-for-sale, which are carried at the lower of cost or fair value. If a loan is transferred from the loan portfolio to the held-for-sale category, any write-down in the carrying amount of the loan at the date of transfer is recorded as a charge-off against the allowance for loan losses, or ALL. Subsequent declines in fair value are recognized as a charge to noninterest income. The remaining unamortized fees and costs are recognized as part of the cost basis of the loan at the time it is sold. Gains and losses on sales of loans held-for-sale are included in other noninterest income in the Consolidated Statements of Net (Loss) Income. 93 CARTER BANKSHARES, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued) Loans and Allowance for Loan Losses : Loans that management have the intent and ability to hold for the foreseeable future or until maturity or payoff are reported at the principal balance outstanding, net of deferred loan fees and costs, discounts, and an allowance for loan losses. Interest income is accrued on the unpaid principal balance. Loan origination fees, net of certain direct origination costs, are deferred and recognized in interest income using the level-yield method without anticipating prepayments. A loan is considered impaired when it is probable that the Company will be unable to collect all principal and interest amounts when due according to the contractual terms of the loan agreement. A performing loan may be considered impaired. The allowance for loan losses related to loans identified as impaired is primarily based on the excess of the loan's current outstanding principal balance compared to the estimated fair value of the related collateral, less cost to sell. For a loan that is not collateral-dependent, the allowance is recorded at the amount by which the outstanding principal balance exceeds the current estimate of the future cash flows on the loan discounted at the loan's original effective interest rate. Loans, including impaired loans, are generally classified as nonaccrual if they are past due as to maturity or payment of principal or interest for a period of more than 90 days based on contractual terms, unless such loans are well-secured and in the process of collection. If a loan or a portion of a loan is classified as doubtful or is partially charged off, the loan is generally classified as nonaccrual. Loans that are on a current payment status or past due less than 90 days may also be classified as nonaccrual, if repayment in full of principal and/or interest is unlikely. All interest accrued but not received for loans placed on non-accrual status is reversed against interest income. While a loan is classified as nonaccrual and the probability of collecting the recorded loan balance is doubtful, collections of interest and principal are generally applied as a reduction to principal outstanding. Payments collected on a nonaccrual loan are first applied to principal, secondly to any existing charge-offs, thirdly to interest, and lastly to any outstanding fees owed to the Company. Any interest that is accrued but not collected is reversed against interest income when a loan is placed on nonaccrual status, which typically occurs prior to charging off all, or a portion, of a loan. Loans may be returned to accrual status when all principal and interest amounts contractually due (including arrearages) are reasonably assured of repayment within an acceptable period of time, and there is a sustained period of repayment performance by the borrower in accordance with the contractual terms of interest and principal. The allowance for loan losses is a valuation allowance for probable incurred losses inherent in the loan portfolio as determined by management taking into consideration historical loan loss experience, diversification of the loan portfolio, amounts of secured and unsecured loans, banking industry standards and averages, and general economic conditions. Loan losses are charged against the allowance when management believes the un-collectability of a loan balance is confirmed. Subsequent recoveries, if any, are credited to the allowance. Ultimate losses may vary from current estimates. These estimates are reviewed periodically and as adjustments become necessary, they are reported in earnings in the periods in which they become reasonably estimable. During the quarterly evaluation of the allowance for loan losses, particular characteristics associated with a segment of the loan portfolio are also considered. These characteristics are detailed below: · Commercial loans not secured by real estate carry risks associated with the successful operation of a business, and the repayments of these loans depend on the profitability and cash flows of the business. Additional risk relates to the value of collateral upon which depreciation occurs and the valuation is less precise. 94 CARTER BANKSHARES, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued) · Loans secured by commercial real estate also carry risks associated with the success of the business and the ability to generate a positive cash flow sufficient to service debts. Real estate security diminishes risks only to the extent that a market exists for the subject collateral. · Residential real estate loans carry risks associated with the continued credit-worthiness of the borrower and changes in the value of the collateral. In instances where construction is in process, these loans carry risks that a project will not be completed as scheduled and budgeted and that the value of the collateral may, at any point be less than the principal amount of the loan. Additional risks may occur if the general contractor, who may not be a loan customer, is unable to finish the project as planned due to financial pressures unrelated to the project. · Consumer loans carry risks associated with the continued credit-worthiness of the borrower and the value of the collateral, such as automobiles, which may depreciate more rapidly than other assets. In addition, these loans may be unsecured. Consumer loans are more likely than real estate loans to be immediately affected in an adverse manner by job loss, divorce, illness, or personal bankruptcy. Consumer loans are further segmented into automobile and recreational vehicle loans and other consumer loans. · Loans to tax-exempt state and political subdivisions carry risks associated with changes in budget constraints or revenue bases of the particular municipality or entity. These loans are dependent on the cash flow from the tax-exempt entity and often times have collateral upon which depreciation occurs and valuation is less than precise. The allowance consists of specific and general components. The specific component relates to loans that are individually classified as impaired. Factors considered by management in determining impairment include payment status, collateral value, and the probability of collecting scheduled principal and interest payments when due. Loans equal to or greater than $1.0 million are individually evaluated for impairment. If a loan is impaired, a portion of the allowance is allocated so that the loan is reported, net, at the present value of estimated future cash flows using the loan’s existing rate or at the fair value of collateral if repayment is expected solely from the collateral. The general component covers loans that are collectively evaluated for impairment. Large groups of homogeneous loans are collectively evaluated for impairment, and accordingly, they are not included in the separately identified impairment disclosures. The general allowance component also includes loans that are not individually identified for impairment evaluation, such as those loans that fall below the individual evaluation threshold. The general component is based on historical loss experience adjusted for current factors. These factors may include consideration for the following: levels of delinquency and delinquency trends; migration of loans to the classification of special mention, substandard or doubtful; trends in volume and terms of loans; effects of changes in underwriting standards; changes in lending policies, procedures, and practices; national and local economic trends and conditions; industry conditions, and effects of credit concentrations. Our charge-off policy for 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. The Company 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 95 CARTER BANKSHARES, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued) • 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. 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. Troubled Debt Restructurings : In situations where, for economic or legal reasons related to a borrower's financial condition, management may grant a concession to the borrower that it would not otherwise consider, the related loan is classified as a troubled debt restructuring (“TDR”). Management strives to identify borrowers in financial difficulty early and work with them to modify their loan to more affordable terms before their loan reaches nonaccrual status. These modified terms have historically included interest only periods, extended amortization periods beyond what management would typically offer for a similar loan or a below market interest rate when compared to management's underwriting standards for a similar loan type. These concessions are intended to minimize the economic loss and to avoid foreclosure or repossession of the collateral. In cases where borrowers are granted new terms that provide for a reduction of interest, management measures any impairment on the restructuring as noted above for impaired loans. On March 22, 2020, a regulatory interagency statement was issued by our banking regulators that encouraged financial institutions to work with borrowers who are or may be unable to meet their contractual payment obligations due to the effects of COVID-19. The Coronavirus Aid, Relief, and Economic Security Act (the “CARES Act”) further provided that a qualified loan modification is exempt by law from classification as a TDR as defined by GAAP, from the period beginning March 1, 2020 until the earlier of December 31, 2020 or the date that is 60 days after the date on which the national emergency concerning the COVID-19 outbreak declared by the President of the United States under the National Emergencies Act terminates. The provisions of the CARES act dealing with temporary relief from TDR was extended pursuant to the Consolidated Appropriations Act, of 2021 (the “CAA”), which was signed into law on December 27, 2020. The 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. Concentration of Credit Risk: The majority of the Company's loans, commitments and lines of credit have been granted to customers in the Company's market area. The concentrations of credit by loan classification are set forth in Note 5. Advertising Costs : We expense all marketing-related costs, including advertising costs, as incurred. Advertising expense was $1.6 million, $1.4 million, and $884 thousand for the years ended 2020, 2019, and 2018, respectively. Bank Owned Life Insurance: The Company has purchased life insurance policies on certain executive officers and employees. We receive the cash surrender value of each policy upon its termination or benefits are payable to us upon the death of the insured. Changes in net cash surrender value are recognized in noninterest income in the Consolidated Statements of (Loss) Income. 96 CARTER BANKSHARES, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued) Bank Premises and Equipment : Bank premises and equipment acquired are stated at cost, less accumulated depreciation. Depreciation is charged to operating expenses over the estimated useful life of the assets by the straight-line method. Land is carried at cost. Costs of maintenance or repairs are charged to expense as incurred and improvements are capitalized. Upon retirement or disposal of an asset, the asset and related allowance account are eliminated. Any gain or loss on such transactions is included in current operations. Depreciation has been included under occupancy expense in the Consolidated Statements of (Loss) Income totaling $6.1 million in 2020, $5.3 million in 2019, and $3.7 million in 2018. The estimated useful life for bank premises ranges from 5 to 40 years and equipment depreciates over a 3 to 10-year period. Land and Land Improvements Non-depreciating assets Buildings 25 years Furniture and Fixtures 5 years Computer Equipment and Software 5 years or term of license Other Equipment 5 years Vehicles 5 years Leasehold Improvements Lesser of estimated useful life of the asset (generally 15 years unless established otherwise) or the remaining term of the lease, including renewal options in the lease that are reasonably assured of exercise Federal Home Loan Bank Stock (“FHLB”) : The Company is a member of the FHLB system. Members are required to own a certain amount of stock based on the level of borrowings and other factors such as asset base. FHLB stock is carried at cost, classified as a restricted security, and periodically evaluated for impairment based on ultimate recovery of par value. Cash dividends are reported as dividend income on the Consolidated Statements of (Loss) Income. Earnings (Loss) per Share: Basic earnings (loss) per share represent income (loss) available to common shareholders divided by the weighted-average number of common shares outstanding during the period. Diluted earnings per share reflect additional common shares that would have been outstanding if dilutive common shares had been issued, as well as any adjustment to income resulting from the assumed issuance. Non-vested shares of restricted stock are included in the computation of basic and diluted earnings (loss) per share because the holder has voting rights and shares in non-forfeitable dividends during the vesting period. Other Real Estate Owned (“OREO”) : Real estate properties acquired through or in lieu of loan foreclosure is initially recorded at fair value less estimated selling cost at the date of foreclosure, which establishes a new cost basis. Any write-downs based on the asset's fair value at the date of acquisition are charged to the allowance for loan losses. After foreclosure, these assets are carried at the lower of their new cost basis or fair value less cost to sell. In addition, any retail branch locations closed for branch operations and marketed for sale are also moved to OREO from bank premises and equipment. This real estate is initially valued based on recent comparative market values received from a real estate broker and any necessary write-downs are charged to operations. Costs of significant property improvements are capitalized, whereas costs relating to holding property are expensed. Valuations are periodically performed by management, and any 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. 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 re-value the assets, at minimum, once every twenty-four months based on the size of the exposure. Operating costs after acquisition are expensed. Income Taxes: Income tax expense is the total of the current year income tax due or refundable and the change in deferred tax assets and liabilities. Deferred taxes are provided on a liability method whereby deferred tax assets are recognized for deductible temporary differences, operating losses, and tax credit carryforwards. Deferred tax liabilities are recognized for taxable temporary differences. Temporary differences are the differences between the reported amounts of assets and liabilities and their tax bases. Deferred tax assets are reduced by a valuation allowance when, in the opinion of management, it is more likely than not that some portion or all of the deferred tax assets will not be realized. Deferred tax assets and liabilities are adjusted for the effects of changes in tax laws and rates on the date of enactment. 97 CARTER BANKSHARES, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued) When tax returns are filed, it is highly certain that some positions taken would be sustained upon examination by the taxing authorities, while others are subject to uncertainty about the merits of the position taken or the amount of the position that would be ultimately sustained. The benefit of a tax position is recognized in the financial statements in the period during which, based on all available evidence, management believes it is more likely than not that the position will be sustained upon examination, including the resolution of appeals or litigation processes, if any. Tax positions taken are not offset or aggregated with other positions. Tax positions that meet the more-likely-than-not recognition threshold are measured as the largest amount of tax benefit that is more than 50 percent likely of being realized upon settlement with the applicable taxing authority. The portion of the benefits associated with tax positions taken that exceeds the amount measured as described above is reflected as a liability for unrecognized tax benefits in the accompanying consolidated balance sheets along with any associated interest and penalties that would be payable to the taxing authorities upon examination. Interest and penalties associated with unrecognized tax benefits are classified as additional income taxes in the Consolidated Statements of (Loss) Income. The Company is a limited partner in several tax-advantaged limited partnerships whose purpose is to invest in approved new market and historic rehabilitation projects. These investments are included in other assets on the Consolidated Balance Sheets. These partnership investments generate a return through the realization of federal income tax credits, as well as other tax benefits, such as tax deductions from net operating losses of the investments over a period of time. The investments are accounted for under the equity method, with the expense included within noninterest expense on the Consolidated Statements of (Loss) Income. All of the Company's tax credit investments are evaluated for impairment at the end of each reporting period. Transfer of Financial Assets : Transfers of financial assets are accounted for as sales, when control over the assets has been surrendered. Control over transferred assets is deemed to be surrendered when (1) the assets have been isolated from the Company, (2) the transferee obtains the right (free of conditions that constrain it from taking advantage of that right) to pledge or exchange the transferred assets, and (3) the Company does not maintain effective control over the transferred assets through an agreement to repurchase them before their maturity, or the ability to unilaterally cause the transferee to return specific assets. Retirement Benefits : The Company has established an employee benefit plan as described in Note 14. The Company does not provide any other post-retirement benefits. Goodwill: Goodwill represents the excess of the purchase price over the sum of the estimated fair values of tangible and identifiable intangible assets acquired less the estimated fair value of the liabilities assumed. Goodwill has an indefinite useful life and is evaluated for impairment annually or more frequently if events and circumstances indicate that the asset might be impaired. Long-lived assets are those that provide the Bank with a future economic benefit beyond the current year or operating period. Long-lived assets are reviewed for impairment whenever events or circumstances indicate that the carrying amount of an asset is greater than the fair value of the asset. Assets to be disposed of are reported at the lower of the cost or the fair value, less costs to sell. Effective January 1, 2020, the Company adopted Accounting Standards Update (“ASU”) No. 2017-04, “Intangibles – Goodwill and Other (Topic 350): Simplifying the Test for Goodwill Impairment”, which simplifies the subsequent measurement of goodwill by eliminating Step 2 from the goodwill impairment test. The goodwill impairment test is performed by comparing the fair value of a reporting unit with its carrying amount. An impairment charge would be recognized for the amount by which the carrying amount exceeds the reporting unit’s fair value, to the extent that the loss recognized does not exceed the amount of goodwill allocated to that reporting unit. 98 CARTER BANKSHARES, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued) 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. Allowance for Unfunded Commitments: In the normal course of business, we offer off-balance sheet credit arrangements to enable our customers to meet their financing objectives. These instruments involve, to varying degrees, elements of credit and interest rate risk in excess of the amount recognized in the financial statements. Our exposure to credit loss, in the event the customer does not satisfy the terms of the agreement, equals the contractual amount of the obligation less the value of any collateral. We apply the same credit policies in making commitments and standby letters of credit that are used for the underwriting of loans to customers. Commitments generally have fixed expiration dates, annual renewals or other termination clauses and may require payment of a fee. Because many of the commitments are expected to expire without being drawn upon, the total commitment amounts do not necessarily represent future cash requirements. The allowance for unfunded commitments is included in other liabilities in the Consolidated Balance Sheets 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. Stock-Based Compensation : Compensation cost is recognized for restricted stock awards issued to employees and non-employee directors, based on the fair value of these awards at the date of the grant. The market price of the Company’s common stock at the date of the grant is the fair value of the award. Compensation cost is recognized over the required service period, generally defined as the vesting period. For awards with graded vesting, compensation cost is recognized on a straight-line basis over the requisite service period for the entire award. The Company recognizes forfeitures as they occur. 99 CARTER BANKSHARES, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued) Loss Contingencies : Loss contingencies, including claims and legal actions arising in the ordinary course of business, are recorded as liabilities when the likelihood of loss is probable and an amount or range of loss can be reasonably estimated. Management does not believe there are any such matters that will have a material effect on the financial statements. Legal costs related to loss contingencies are expensed as incurred. Fair Value Measurements We use fair value measurements when recording and disclosing certain financial assets and liabilities. Securities available-for-sale, derivative financial instruments are recorded at fair value on a recurring basis. Additionally, from time to time, we may be required to record other assets at fair value on a nonrecurring basis, such as loans held-for-sale, impaired loans, other real estate owned, (“OREO”), and certain other assets. Fair value is the price that would be received to sell an asset or paid to transfer a liability in the principal or most advantageous market in an orderly transaction between market participants at the measurement date. An orderly transaction is a transaction that assumes exposure to the market for a period prior to the measurement date to allow for marketing activities that are usual and customary for transactions involving such assets or liabilities; it is not a forced transaction. In determining fair value, we use various valuation approaches, including market, income and cost approaches. The fair value standard establishes a hierarchy for inputs used in measuring fair value that maximizes the use of observable inputs and minimizes the use of unobservable inputs by requiring that observable inputs be used when available. Observable inputs are inputs that market participants would use in pricing an asset or liability, which are developed based on market data we have obtained from independent sources. Unobservable inputs reflect our estimates of assumptions that market participants would use in pricing an asset or liability, which are developed based on the best information available in the circumstances. The fair value hierarchy gives the highest priority to unadjusted quoted market prices in active markets for identical assets or liabilities (Level 1 measurement) and the lowest priority to unobservable inputs (Level 3 measurement). 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. A financial instrument’s level within the fair value hierarchy is based on the lowest level of input that is significant to the fair value measurement. We recognize transfers between any of the fair value hierarchy levels at the end of the reporting period in which the transfer occurred. 100 CARTER BANKSHARES, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued) The following are descriptions of the valuation methodologies that we use for financial instruments recorded at fair value on either a recurring or nonrecurring basis. Recurring Basis Securities Available-for-Sale: 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. Derivative Financial Instruments and Hedging Activities: The Company uses derivative instruments such as interest rate swaps for commercial loans with our customers. Upon entering into swaps with the borrower, the Company entered into offsetting positions with counterparties to minimize risk to the Company. The back-to-back swaps qualify as derivatives, but are not designated as hedging instruments. Interest rate swap contracts involve the risk of dealing with borrower and counterparties and their ability to meet contractual terms. When the fair value of a derivative instrument contract is positive, this generally indicates that the counterparty or customer owes the Company, and results in credit risk to the Company. When the fair value of a derivative instrument contract is negative, the Company owes the customer or counterparty, and, therefore, has no risk. The Company also enters into commitments to originate mortgage loans whereby the interest rate on the loan is determined prior to funding (rate lock commitments). Rate lock commitments on mortgage loans to be held-for-sale are considered to be derivatives. The period of time between issuance of a loan commitment and closing and sale of the loan generally ranges from 15 to 90 days. The Company protects itself from changes in interest rates through the use of best efforts forward delivery commitments, whereby the Company commits to sell a loan at the time the borrower commits to an interest rate with the intent that the buyer has assumed interest rate risk on rate lock commitments dues to changes in interest rates. Nonrecurring Basis Impaired Loans: Impaired loans with an outstanding balance greater than or equal to $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. 101 CARTER BANKSHARES, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued) 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 the Company feels 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 the Company feels it cannot collect and analyze salient information on the subject collateral or the collateral’s real estate market, a full appraisal will be utilized. 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. 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 re-value the assets, at minimum, once every twenty-four months based on the size of the exposure. At December 31, 2020 our OREO assets were in compliance with the OREO policy as set forth above, and substantially all of the assets were listed for sale with credible third-party real estate brokers. Financial Instruments In addition to financial instruments recorded at fair value in our financial statements, fair value accounting guidance requires disclosure of the fair value of all of an entity’s assets and liabilities that are considered financial instruments. The majority of our assets and liabilities are considered financial instruments. Many of these instruments lack an available trading market as characterized by a willing buyer and willing seller engaged in an exchange transaction. Also, it is our general practice and intent to hold our financial instruments to maturity and to not engage in trading or sales activities with respect to such financial instruments. For fair value disclosure purposes, we substantially utilize the fair value measurement criteria as required and explained above. In cases where quoted fair values are not available, we use present value methods to determine the fair value of our financial instruments. Cash and Cash Equivalents The carrying amounts reported in the Consolidated Balance Sheets for cash and due from banks, including interest-bearing deposits, approximate fair value. Loans The fair value of variable rate performing loans that may reprice frequently at short-term market rates is based on carrying values adjusted for credit risk. The fair value of variable rate performing loans that reprice at intervals of one year or longer, such as adjustable rate mortgage products, is estimated using discounted cash flow analyses that utilize interest rates currently being offered for similar loans and adjusted for credit risk. The fair value of fixed rate performing loans is estimated using a discounted cash flow analysis that utilizes interest rates currently being offered for similar loans and adjusted for credit risk. The fair value of nonperforming loans is the carrying value less any specific reserve on the loan if it is impaired. The carrying amount of accrued interest approximates fair value. 102 CARTER BANKSHARES, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued) Bank Owned Life Insurance Fair value approximates net cash surrender value of bank owned life insurance, or BOLI. Federal Home Loan Bank Stock It is not practical to determine the fair value of our FHLB and other restricted stock due to the restrictions placed on the transferability of these stocks; it is presented at carrying value. Deposits The fair values disclosed for deposits without defined maturities (e.g., noninterest and interest-bearing demand, money market and savings accounts) are by definition equal to the amounts payable on demand. The carrying amounts for variable rate, fixed-term time deposits approximate their fair values. Estimated fair values for fixed rate and other time deposits are based on discounted cash flow analysis using interest rates currently offered for time deposits with similar terms. The carrying amount of accrued interest approximates fair value. Borrowings The fair values disclosed for fixed rate long-term borrowings are determined by discounting their contractual cash flows using current interest rates for long-term borrowings of similar remaining maturities. The carrying amounts of variable rate long-term borrowings approximate their fair values. Loan Commitments and Standby Letters of Credit Off-balance sheet financial instruments consist of commitments to extend credit and letters of credit. Except for interest rate lock commitments, estimates of the fair value of these off-balance sheet items are not made because of the short-term nature of these arrangements and the credit standing of the counterparties. Newly Adopted Pronouncements in 2020: In August 2016, the Financial Accounting Standards Board (the “FASB”) issued ASU No. 2016-15, “Statement of Cash Flows (Topic 230): Classification of Certain Cash Receipts and Cash Payments”. The update addresses eight specific cash flow issues with the objective of reducing the existing diversity in practice. This accounting guidance became effective on January 1, 2020. The amendments in this ASU did not materially impact our Consolidated Balance Sheets or Consolidated Statements of Comprehensive (Loss) Income. In August 2018, the FASB issued ASU 2018-13, “Fair Value Measurement (Topic 820): Disclosure Framework— Changes to the Disclosure Requirements for Fair Value Measurement”. The amendments modify the disclosure requirements in Topic 820 to add disclosures regarding changes in unrealized gains and losses, the range and weighted average of significant unobservable inputs used to develop Level 3 fair value measurements and the narrative description of measurement uncertainty. Certain disclosure requirements in Topic 820 are also removed or modified. We adopted this ASU on January 1, 2020. The amendments in this ASU did not materially impact our Consolidated Balance Sheets or Consolidated Statements of Comprehensive (Loss) Income. In January 2017, the FASB issued ASU No. 2017-04, “Intangibles – Goodwill and Other (Topic 350): Simplifying the Test for Goodwill Impairment”. The main objective of ASU is to simplify the current requirements for testing goodwill for impairment by eliminating step two from the goodwill impairment test. The amendments are expected to reduce the complexity and costs associated with performing the goodwill impairment test, which could result in recording impairment charges sooner. We adopted the amendments of this ASU on January 1, 2020. During the third quarter of 2020, we recorded an impairment charge of $62.2 million as the estimated fair value of the reporting unit was less than the carrying value. 103 CARTER BANKSHARES, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued) NOTE 2 – EARNINGS (LOSS) PER SHARE Basic earnings (loss) per share is calculated by dividing net income (loss) available to common shareholders by the weighted average number of common shares outstanding during the period. Diluted earnings (loss) per share is calculated using the two-class method. Diluted earnings (loss) per share reflects the potential dilution that could occur if securities or other contracts to issue common stock were exercised or converted into common stock or resulted in the issuance of common stock that then shared in the earnings of the entity. For all periods presented, the dilutive effect on average shares outstanding is the result of unvested restricted stock grants. The following table reconciles the numerators and denominators of basic and diluted earnings (loss) per share calculations for the periods presented: Years ended December 31, (Dollars in Thousands, except share and per share data) 2020 2019 2018 Numerator for Earnings (Loss) per Share- Basic: Net (Loss) Income Allocated to Common Shareholders $ (45,858 ) $ 26,575 $ 11,905 Numerator for Earnings (Loss) per Share- Diluted: Net (Loss) Income Allocated to Common Shareholders $ (45,858 ) $ 26,575 $ 11,905 Denominators: Weighted Average Shares Outstanding- Basic 26,379,774 26,323,899 26,259,223 Add: Average Participating Shares Outstanding - 15,186 11 Denominator for Two-Class Method-Diluted 26,379,774 26,339,085 26,259,234 (Loss) Earnings per Common Share-Basic $ (1.74 ) $ 1.01 $ 0.45 (Loss) Earnings per Common Share-Diluted $ (1.74 ) $ 1.01 $ 0.45 As a result of the net loss for the full year 2020, all average participating shares outstanding are considered anti-dilutive to loss per share. There were two shares not included in the average participating shares outstanding because they would be considered to be anti-dilutive for the year ended December 31, 2019. There were no weighted average shares considered anti-dilutive in the calculations for the year ended December 31, 2018. NOTE 3 - RESTRICTIONS ON CASH AND DUE FROM BANK ACCOUNTS The Board of Governors of the Federal Reserve System (the “FRB”) imposes certain reserve requirements on all depository institutions. These reserves are maintained in the form of vault cash or as an interest-bearing balance with the FRB. The required reserves averaged $3.7 million for 2020, $44.3 million for 2019, and $42.4 million for 2018. The average of required reserves declined during 2020 as a result of the implementation of a new deposit management tool. 104 CARTER BANKSHARES, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued) NOTE 4 - INVESTMENT SECURITIES The following tables present the amortized cost and fair value of available-for-sale securities as of the dates presented: December 31, 2020 (Dollars in Thousands) Amortized Cost Gross Unrealized Gains Gross Unrealized Losses Fair Value Residential Mortgage-Backed Securities $ 44,057 $ 1,008 $ (341 ) $ 44,724 Commercial Mortgage-Backed Securities 5,194 253 - 5,447 Asset Backed Securities 133,672 884 (999 ) 133,557 Collateralized Mortgage Obligations 212,751 6,007 (399 ) 218,359 Small Business Administration 99,604 346 (805 ) 99,145 States and Political Subdivisions 239,251 13,490 (119 ) 252,622 Corporate Notes 24,250 582 (7 ) 24,825 Total Debt Securities $ 758,779 $ 22,570 $ (2,670 ) $ 778,679 December 31, 2019 (Dollars in Thousands) Amortized Cost Gross Unrealized Gains Gross Unrealized Losses Fair Value Residential Mortgage-Backed Securities $ 51,600 $ 1,136 $ (92 ) $ 52,644 Commercial Mortgage-Backed Securities 18,972 147 (113 ) 19,006 Asset Backed Securities 110,943 285 (1,589 ) 109,639 Collateralized Mortgage Obligations 291,139 2,425 (1,340 ) 292,224 Small Business Administration 106,485 347 (1,096 ) 105,736 States and Political Subdivisions 148,596 1,669 (1,785 ) 148,480 Corporate Notes 14,721 167 - 14,888 Total Debt Securities $ 742,456 $ 6,176 $ (6,015 ) $ 742,617 The Company did not have securities classified as held-to-maturity at December 31, 2020 or December 31, 2019. The following table shows the composition of gross and net realized gains and losses for the periods presented: Years ended December 31, (Dollars in Thousands) 2020 2019 2018 Proceeds from Sales of Securities Available-for-Sale $ 188,169 $ 390,548 $ 133,120 Gross Realized Gains $ 6,957 $ 4,172 $ 1,899 Gross Realized Losses (75 ) (1,967 ) (628 ) Net Realized Gains $ 6,882 $ 2,205 $ 1,271 Tax Impact $ 1,445 $ 463 $ 267 Gains or losses are recognized in earnings on the trade date using the amortized cost of the specific security sold. The net realized gains above reflect reclassification adjustments in the calculation of other comprehensive income (loss). The net realized gains are included in noninterest income as gains on sales of securities, net in the Consolidated Statements of (Loss) Income. The tax impact is included in income tax provision in the Consolidated Statements of (Loss) Income. 105 CARTER BANKSHARES, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued) The amortized cost and fair value of available-for-sale debt securities are shown below by contractual maturity. Expected maturities may differ from contractual maturities if borrowers have the right to call or prepay obligations with or without call or prepayment penalties. Securities not due at a single maturity date are shown separately. (Dollars in Thousands) Amortized Fair December 31, 2020 Cost Value Due in One Year or Less $ 391 $ 394 Due after One Year through Five Years 10,967 11,053 Due after Five Years through Ten Years 131,639 134,475 Due after Ten Years 220,108 230,670 Residential Mortgage-Backed Securities 44,057 44,724 Commercial Mortgage-Backed Securities 5,194 5,447 Collateralized Mortgage Obligations 212,751 218,359 Asset Backed Securities 133,672 133,557 Total Securities $ 758,779 $ 778,679 At December 31, 2020 and December 31, 2019, there were no holdings of securities of any one issuer, other than those securities issued by or collateralized by the U.S. Government and its Agencies, in an amount greater than 10% of shareholders’ equity. The carrying value of securities pledged for various regulatory and legal requirements was $146.0 million at December 31, 2020 and $150.6 million at December 31, 2019. 106 CARTER BANKSHARES, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued) Available-for-sale securities with unrealized losses at December 31, 2020 and 2019, aggregated by investment category and length of time that individual securities have been in a continuous unrealized loss position, were as follows: December 31, 2020 Less Than 12 Months 12 Months or More Total (Dollars in Thousands) Number of Securities Fair Value Unrealized Losses Number of Securities Fair Value Unrealized Losses Number of Securities Fair Value Unrealized Losses Residential Mortgage-Backed Securities 7 $ 21,109 $ 339 3 $ 40 $ 2 10 $ 21,149 $ 341 Asset Backed Securities 11 23,653 219 27 61,599 780 38 85,252 999 Collateralized Mortgage Obligations 13 48,318 212 14 38,615 187 27 86,933 399 Small Business Administration 7 10,444 53 73 47,371 752 80 57,815 805 States and Political Subdivisions 12 12,558 119 - - - 12 12,558 119 Corporate Notes 1 2,493 7 - - - 1 2,493 7 Total Debt Securities 51 $ 118,575 $ 949 117 $ 147,625 $ 1,721 168 $ 266,200 $ 2,670 December 31, 2019 Less Than 12 Months 12 Months or More Total (Dollars in Thousands) Number of Securities Fair Value Unrealized Losses Number of Securities Fair Value Unrealized Losses Number of Securities Fair Value Unrealized Losses Residential Mortgage-Backed Securities 5 $ 9,972 $ 92 1 $ 2 $ - 6 $ 9,974 $ 92 Commercial Mortgage-Backed Securities 3 7,713 113 - - - 3 7,713 113 Asset Backed Securities 22 50,530 549 16 39,153 1,040 38 89,683 1,589 Collateralized Mortgage Obligations 37 144,543 1,051 6 18,107 289 43 162,650 1,340 Small Business Administration 13 25,380 91 69 47,616 1,005 82 72,996 1,096 States and Political Subdivisions 37 70,678 1,785 - - - 37 70,678 1,785 Total Debt Securities 117 $ 308,816 $ 3,681 92 $ 104,878 $ 2,334 209 $ 413,694 $ 6,015 107 CARTER BANKSHARES, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued) Securities are evaluated for OTTI quarterly and more frequently if economic or market concerns warrant. Consideration is given to the length of time and the extent to which the fair value has been less than cost, the financial condition and near-term prospects of the issuer, the credit quality of the issuer, and whether the Company intends to sell the security or may be required to sell the security prior to maturity. The Company has reviewed all securities for OTTI. As of December 31, 2020, no OTTI has been identified for any investment securities in the Company’s portfolio. The Company does not believe any individual unrealized loss as of December 31, 2020 represents an OTTI. At December 31, 2020 there were 168 debt securities in an unrealized loss position and at December 31, 2019 there were 209 debt securities in an unrealized loss position. The unrealized losses on debt securities were primarily attributable to changes in interest rates and not related to the credit quality of these securities. All debt securities are determined to be investment grade and are paying principal and interest according to the contractual terms of the security. The Company generally does not intend to sell and it is not more likely than not that the Company will be required to sell any of the securities in an unrealized loss position before recovery of their amortized cost. NOTE 5 – LOANS AND LOANS HELD-FOR-SALE The composition of the loan portfolio by dollar amount is shown in the table below: December 31, (Dollars in Thousands) 2020 2019 Commercial Commercial Real Estate $ 1,453,799 $ 1,365,310 Commercial and Industrial 306,828 256,798 Obligations of State and Political Subdivisions 250,336 364,869 Commercial Construction 387,407 292,827 Total Commercial Loans 2,398,370 2,279,804 Consumer Residential Mortgages 472,170 514,538 Other Consumer 57,647 73,688 Consumer Construction 18,983 16,736 Total Consumer Loans 548,800 604,962 Total Portfolio Loans $ 2,947,170 $ 2,884,766 The Company attempts to limit its 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, this risk is mitigated by reviewing the relevant economic indicators and internal 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. 108 CARTER BANKSHARES, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued) Unsecured loans pose 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 the 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. 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. Mortgage loans held-for-sale were $25.4 million and $19.7 million as of December 31, 2020 and December 31, 2019, respectively. 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. Troubled Debt Restructurings The following table summarizes the TDRs 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 In order to maximize the collection of loan balances, the Company evaluates troubled loan accounts on a case-by-case basis to determine if a loan modification would be appropriate. Loan modifications may be utilized when there is a reasonable chance that an appropriate modification would allow our client to continue servicing the debt. A loan is a TDR if both of the following exist: 1) the debtor is experiencing financial difficulties, and 2) a creditor has granted a concession to the debtor that it would not normally grant. Nonaccrual loans that are modified can be placed back on accrual status when both principal and interest are current and it is probable that the Company will be able to collect all amounts due (both principal and interest) according to the terms of the loan agreement. There were minimal commitments to lend additional funds for loans identified as TDRs. 109 CARTER BANKSHARES, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued) TDRs decreased from $143.9 million at December 31, 2019 to $134.2 million at December 31, 2020. This represents a $9.7 million decrease, or 6.8%. 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. During the twelve months ended December 31, 2020, the Bank modified one loan totaling $3.1 million that constituted a TDR that had minimal commitments to lend additional funds. The Company had one loan modified as a TDR during the twelve months ending December 31, 2019 totaling $0.6 million in post-modified recorded balances. The loan was classified as a TDR because there are concessions present that would not be offered to a comparable borrower. There were no TDR payment defaults during the years ended December 31, 2020, 2019 and 2018. 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 . At December 31, 2020 and 2019 the Company had $25.0 million and $34.7 million, respectively in loans modified as TDR’s in previous years which had experienced a payment default subsequent to the rework date and were classified as nonperforming. The specific reserve portion of the allowance for loan losses on TDRs, if required, is determined by discounting the restructured cash flow at the original effective rate of the loan before modification or is based on the fair value of the collateral less cost to sell, if repayment of the loan is collateral dependent. If the resulting amount is less than the recorded book value, the Company either establishes a valuation allowance as a component of the allowance for loan losses or charges off the impaired balance if it determines that such amount is a confirmed loss. This method is used consistently for all segments of the portfolio. Loans to principal officers, directors and their affiliates during 2020 were as follows: (Dollars in Thousands) 2020 Beginning Balance $ 39,680 New Loans 11,162 Repayments (11,637 ) Balance at End of Year (1) $ 39,205 (1) Balance at end of year includes $37.0 million in loans to a retired director and affiliates during 2020. NOTE 6 - ALLOWANCE FOR LOAN LOSSES The Company maintains an ALL at a level determined to be adequate to absorb estimated probable incurred losses inherent in the loan portfolio as of the balance sheet date. 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. 110 CARTER BANKSHARES, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued) 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 base 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 either secured by assets other than 1-4 family residences or unsecured. 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. 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. 111 CARTER BANKSHARES, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued) The following tables present, by portfolio segment, the changes in the allowance for loan losses and the allocation of the allowance for loan losses for the years ended December 31, 2020, 2019, and 2018: Commercial Obligations (Dollars in Thousands) Real Commercial Of States and Commercial Residential Other Consumer December 31, 2020 Estate & Industrial Political Sub. Construction Mortgages Consumer Construction Total Allowance for Loan Losses: Balance: Beginning of Year $ 24,706 $ 3,236 $ 365 $ 5,377 $ 1,736 $ 3,299 $ 43 $ 38,762 Provision Charged to Expense 11,055 941 586 2,364 594 2,434 32 18,006 Losses Charged Off (40 ) (66 ) – – (258 ) (3,991 ) – (4,355 ) Recoveries 707 2 – 188 27 737 – 1,661 Balance, End of Year $ 36,428 $ 4,113 $ 951 $ 7,929 $ 2,099 $ 2,479 $ 75 $ 54,074 Commercial Obligations (Dollars in Thousands) Real Commercial Of States and Commercial Residential Other Consumer December 31, 2019 Estate & Industrial Political Sub. Construction Mortgages Consumer Construction Total Allowance for Loan Losses: Balance: Beginning of Year $ 23,897 $ 626 $ 432 $ 5,214 $ 6,129 $ 2,728 $ 173 $ 39,199 Provision Charged to Expense 878 2,632 (67 ) (74 ) (4,205 ) 4,370 (130 ) 3,404 Losses Charged Off (69 ) (22 ) – (393 ) (197 ) (4,401 ) – (5,082 ) Recoveries – – – 630 9 602 – 1,241 Balance, End of Year $ 24,706 $ 3,236 $ 365 $ 5,377 $ 1,736 $ 3,299 $ 43 $ 38,762 Commercial Obligations (Dollars in Thousands) Real Commercial Of States and Commercial Residential Other Consumer December 31, 2018 Estate & Industrial Political Sub. Construction Mortgages Consumer Construction Total Allowance for Loan Losses: Balance: Beginning of Year $ 28,471 $ 1,210 $ 460 $ 2,198 $ 2,543 $ 288 $ 148 $ 35,318 Provision Charged to Expense 6,512 (564 ) (28 ) 2,324 3,701 4,900 25 16,870 Losses Charged Off (11,740 ) (20 ) – – (184 ) (2,710 ) – (14,654 ) Recoveries 654 – – 692 69 250 – 1,665 Balance, End of Year $ 23,897 $ 626 $ 432 $ 5,214 $ 6,129 $ 2,728 $ 173 $ 39,199 112 CARTER BANKSHARES, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued) Credit Quality Indicators: The Company’s portfolio grading analysis estimates the capability of the borrower to repay the contractual obligations of the loan agreements as scheduled or at all. The Company’s internal credit risk grading system is based on debt service coverage, collateral values and other subjective factors. Mortgage and consumer loans are defaulted to a pass grade until a loan migrates to past due status. The Company’s internally assigned grades are as follows: Pass – The loan is currently performing and is of high quality. Special Mention – Assets with potential weaknesses that warrant management’s close attention and if left uncorrected, these potential weaknesses may result in deterioration of the repayment prospects for the asset or in the institutions credit position at some future date. Special mention assets are not adversely classified and do not expose an institution to sufficient risk to warrant adverse classification. Substandard – Assets that are inadequately protected by the current sound worth and paying capacity of the obligor or by the collateral pledged, if any. Assets so classified have a well-defined weakness, or weaknesses that jeopardize the liquidation of the debt. Such assets are characterized by the distinct possibility that the institution will sustain some loss if the deficiencies are not corrected. Doubtful – Assets with all the weaknesses inherent in one classified substandard with the added characteristic that the weaknesses make collection or liquidation in full, on the basis of currently known facts, conditions, and values, highly questionable and improbable. Loss – Assets considered of such little value that its continuance on the books is not warranted. This classification does not mean that the asset has absolutely no recovery or salvage value, but rather it is not practical or desirable to defer writing off this basically worthless asset even though partial recovery may be affected in the future. 113 CARTER BANKSHARES, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (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. 114 CARTER BANKSHARES, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued) The Company individually evaluates all substandard and nonaccrual loans greater than or equal to $1.0 million for impairment. A loan is impaired when, based on current information and events, it is probable that the Company will be unable to collect all amounts due according to the contractual terms of the loan agreement. Our methodology for evaluating whether a loan is impaired includes risk-rating credits on an individual basis and consideration of the borrower’s overall financial condition, payment history and available cash resources. In measuring impairment, the Company primarily utilizes fair market value of the collateral; however, the Company also uses the discounted cash flow method for loans that are not deemed to be collateral dependent at the time of impairment. TDRs whether on accrual or nonaccrual status, are also classified as impaired loans. TDRs are loans where the Company, for economic or legal reasons related to a borrower’s financial difficulties, grant a concession to the borrower that the Company 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 extensions of maturity dates at a stated interest rate lower than the current market rate for a new loan with similar risk 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. 115 CARTER BANKSHARES, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued) The following tables present the balances in the ALL and the recorded investment in the loan balances based on impairment method as of December 31, 2020 and 2019. Commercial Obligations (Dollars in Thousands) Real Commercial Of States and Commercial Residential Other Consumer December 31, 2020 Estate & Industrial Political Sub. Construction Mortgages Consumer Construction Total Allowance for Loan Losses: Individually Evaluated for Impairment $ 13,773 $ - $ - $ 1,477 $ – $ – $ – $ 15,250 Collectively Evaluated for Impairment 22,655 4,113 951 6,452 2,099 2,479 75 38,824 Total Allowance for Loan Losses $ 36,428 $ 4,113 $ 951 $ 7,929 $ 2,099 $ 2,479 $ 75 $ 54,074 Total Loans: Individually Evaluated for Impairment $ 27,666 $ - $ - $ 56,987 $ 50,618 $ - $ - $ 135,271 Collectively Evaluated for Impairment 1,426,133 306,828 250,336 330,420 421,552 57,647 18,983 2,811,899 Total Portfolio Loans $ 1,453,799 $ 306,828 $ 250,336 $ 387,407 $ 472,170 $ 57,647 $ 18,983 $ 2,947,170 Commercial Obligations (Dollars in Thousands) Real Commercial Of States and Commercial Residential Other Consumer December 31, 2019 Estate & Industrial Political Sub. Construction Mortgages Consumer Construction Total Allowance for Loan Losses: Individually Evaluated for Impairment $ 5,779 $ 390 $ - $ – $ – $ – $ – $ 6,169 Collectively Evaluated for Impairment 18,927 2,846 365 5,377 1,736 3,299 43 32,593 Total Allowance for Loan Losses $ 24,706 $ 3,236 $ 365 $ 5,377 $ 1,736 $ 3,299 $ 43 $ 38,762 Total Loans: Individually Evaluated for Impairment $ 33,256 $ 390 $ - $ 59,053 $ 52,966 $ - $ - $ 145,665 Collectively Evaluated for Impairment 1,332,054 256,408 364,869 233,774 461,572 73,688 16,736 2,739,101 Total Portfolio Loans $ 1,365,310 $ 256,798 $ 364,869 $ 292,827 $ 514,538 $ 73,688 $ 16,736 $ 2,884,766 The recorded investment in loans excludes accrued interest receivable. Individually evaluated impaired loans do not include certain troubled debt restructured loans which are less than $1.0 million. 116 CARTER BANKSHARES, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued) The following table includes the recorded investment and unpaid principal balance for impaired loans with the associated allowance, if applicable, at December 31, 2020, 2019 and 2018: (Dollars in Thousands) Unpaid Principal Recorded Specific Average Investment Interest Income December 31, 2020 Balance Balance Allowance in Impaired Loans Recognized Loans without a Specific Valuation Allowance: Commercial Real Estate $ 3,236 $ 3,236 $ - $ 4,201 $ 128 Commercial Construction 55,248 55,248 - 56,941 1,871 Residential Mortgages 50,618 50,618 - 51,716 1,906 Loans with a Specific Valuation Allowance: Commercial Real Estate 24,430 24,430 13,773 27,780 163 Commercial and Industrial - - - 184 - Commercial Construction 1,739 1,739 1,477 1,739 - Total by Category: Commercial Real Estate 27,666 27,666 13,773 31,981 291 Commercial and Industrial - - - 184 - Commercial Construction 56,987 56,987 1,477 58,680 1,871 Residential Mortgages 50,618 50,618 - 51,716 1,906 Total Impaired Loans $ 135,271 $ 135,271 $ 15,250 $ 142,561 $ 4,068 (Dollars in Thousands) Unpaid Principal Recorded Specific Average Investment Interest Income December 31, 2019 Balance Balance Allowance in Impaired Loans Recognized Loans without a Specific Valuation Allowance: Commercial Real Estate $ 4,487 $ 4,487 $ - $ 5,885 $ 131 Commercial Construction 59,053 59,053 - 59,558 3,056 Residential Mortgages 52,966 52,966 - 57,079 5,862 Loans with a Specific Valuation Allowance: Commercial Real Estate 28,769 28,769 5,779 31,201 - Commercial and Industrial 390 390 390 434 - Commercial Construction - - - 1,716 - Total by Category: Commercial Real Estate 33,256 33,256 5,779 37,086 131 Commercial and Industrial 390 390 390 434 - Commercial Construction 59,053 59,053 - 61,274 3,056 Residential Mortgages 52,966 52,966 - 57,079 5,862 Total Impaired Loans $ 145,665 $ 145,665 $ 6,169 $ 155,873 $ 9,049 117 CARTER BANKSHARES, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued) (Dollars in Thousands) Unpaid Principal Recorded Specific Average Investment Estimated Interest December 31, 2018 Balance Balance Allowance in Impaired Loans Income Recognized Loans without a Specific Valuation Allowance: Commercial Real Estate $ 69,739 $ 69,739 $ - $ 69,677 $ 2,392 Commercial and Industrial - - - 187,978 - Commercial Construction 61,187 61,187 - 58,623 1,554 Residential Mortgages 272 272 - 394 - Loans with a Specific Valuation Allowance: Commercial Construction 30,379 30,379 5,199 23,126 20 Total by Category: Commercial Real Estate 69,739 69,739 - 69,677 2,392 Commercial and Industrial - - - 187,978 - Commercial Construction 91,566 91,566 5,199 81,749 1,574 Residential Mortgages 272 272 - 394 - Total Impaired Loans $ 161,577 $ 161,577 $ 5,199 $ 339,798 $ 3,966 For the years ended December 31, 2020, 2019 and 2018, interest income recognized on impaired loans was $4.1 million, $9.0 million, and $4.0 million, respectively. 118 CARTER BANKSHARES, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued) Age Analysis of Past-Due Loans by Class The following table includes an aging analysis of the recorded investment of past-due portfolio loans as of December 31, 2020 and 2019: December 31, 2020 (Dollars in Thousands) Current Loans Loans 30-59 Days Past Due Loans 60-89 Days Past Due Total 30-89 Days Past Due Nonaccrual Loans Total Portfolio Loans Commercial Real Estate $ 1,428,092 $ 3,487 $ 329 $ 3,816 $ 21,891 $ 1,453,799 Commercial & Industrial 305,988 194 190 384 456 306,828 Obligations of States and Political Sub. 250,336 - - - - 250,336 Commercial Construction 381,792 193 91 284 5,331 387,407 Residential Mortgages 466,688 1,347 - 1,347 4,135 472,170 Other Consumer 56,890 278 295 573 184 57,647 Consumer Construction 18,983 - - - - 18,983 Total $ 2,908,769 $ 5,499 $ 905 $ 6,404 $ 31,997 $ 2,947,170 December 31, 2019 (Dollars in Thousands) Current Loans Loans 30-59 Days Past Due Loans 60-89 Days Past Due Total 30-89 Days Past Due Nonaccrual Loans Total Portfolio Loans Commercial Real Estate $ 1,333,000 $ 307 $ 913 $ 1,220 $ 31,090 $ 1,365,310 Commercial & Industrial 256,170 146 15 161 467 256,798 Obligations of States and Political Sub. 364,633 236 - 236 - 364,869 Commercial Construction 285,147 58 170 228 7,452 292,827 Residential Mortgages 510,739 937 5 942 2,857 514,538 Other Consumer 72,138 894 389 1,283 267 73,688 Consumer Construction 16,736 - - - - 16,736 Total $ 2,838,563 $ 2,578 $ 1,492 $ 4,070 $ 42,133 $ 2,884,766 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 loans held-for-sale in connection with sale of Bank branches included $7 thousand in nonaccrual status and $7 thousand that were past due. There were no nonaccrual or past due loans related to loans held-for-sale in 2019. 119 CARTER BANKSHARES, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued) NOTE 7 - FAIR VALUE MEASUREMENTS Financial assets measured at fair value on a recurring basis at December 31, 2020 are summarized below: Quoted Prices In Significant Active Markets for Significant Other Unobservable Carrying Identical Assets Observable Inputs Inputs (Dollars in Thousands) Value (Level 1) (Level 2) (Level 3) Assets Securities Available-for-Sale $ 778,679 $ - $ 768,316 $ 10,363 Derivatives 4,493 - 4,493 - Total $ 783,172 $ - $ 772,809 $ 10,363 Liabilities Derivatives $ 4,756 $ - $ 4,756 $ - Total $ 4,756 $ - $ 4,756 $ - Financial assets measured at fair value on a recurring basis at December 31, 2019 are summarized below: Quoted Prices In Significant Active Markets for Significant Other Unobservable Carrying Identical Assets Observable Inputs Inputs (Dollars in Thousands) Value (Level 1) (Level 2) (Level 3) Assets Securities Available-for-Sale $ 742,617 $ - $ 737,617 $ 5,000 Derivatives 626 - 626 - Total $ 743,243 $ - $ 738,243 $ 5,000 Liabilities Derivatives $ 675 $ - $ 675 $ - Total $ 675 $ - $ 675 $ - There were no transfers between Level 1 and Level 2 during 2020 or 2019. We have invested in subordinated debt of other financial institutions. We have two securities of $5.0 million each that are considered to be Level 3 securities at December 31, 2020, an increase of $5.0 million in one security from December 31, 2019. The Level 3 fair value is benchmarked to other securities that have observable market values in Level 2 using comparable financial ratio analysis specific to the industry in which the underlying company operates. The underwriting includes considerations of capital adequacy, asset quality trends, management’s ability to continue efficient and profitable operations, and the institution’s core earnings ability, liquidity management platform and current on and off balance sheet interest rate risk exposures. 120 CARTER BANKSHARES, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued) Financial assets measured at fair value on a nonrecurring basis at December 31, 2020 and 2019 are summarized below: (Dollars in Thousands) December 31, 2020 Level 1 Level 2 Level 3 Fair Value OREO $ – $ – $ 15,722 $ 15,722 Impaired Loans $ – $ – $ 10,919 $ 10,919 December 31, 2019 Level 1 Level 2 Level 3 Fair Value OREO $ – $ – $ 18,324 $ 18,324 Impaired Loans $ – $ – $ 22,989 $ 22,989 Impaired loans had a net carrying amount of $10.9 million at December 31, 2020 with a valuation allowance of $15.3 million, resulting in a $9.1 million increase in provision for loan losses for the year ended December 31, 2020. Impaired loans had a net carrying amount of $23.0 million at December 31, 2019 with a valuation allowance of $6.2 million, resulting in a $1.0 million increase in provision for loan losses for the year ended December 31, 2019. OREO had a net carrying amount of $15.7 million as of December 31, 2020, compared with $18.3 million at December 31, 2019, respectively. Write-downs of $1.5 million were recorded on OREO for the year ended December 31, 2020 compared to $4.5 million for the year ended December 31, 2019, respectively. The following tables summarize the Company’s assets that were measured at fair value on a nonrecurring basis as of December 31, 2020 and 2019: (Dollars in Thousands) December 31, 2020 Fair Valuation Unobservable Weighted Assets Value Technique Inputs Range Average Impaired Loans $ 1,163 Discounted Appraisals Estimated Selling Costs 43.0 % 43.0 % Impaired Loans 9,494 Discounted Appraisals Estimated Selling Costs & Qualitative Adjustments 12.0 – 50.0 % 33.2 % Impaired Loans 262 Discounted Appraisals Estimated Selling Costs 20.9 % 20.9 % Total Impaired Loans $ 10,919 Other Real Estate Owned $ 11,972 Appraisals Estimated Selling Costs 6.0 – 10.0 % 6.5 % Other Real Estate Owned 1,260 Discounted Cash Flow Discount Rate 6.3 % 6.3 % Other Real Estate Owned 1,583 Internal Valuations Estimated Selling Costs 5.0 % 5.0 % Other Real Estate Owned 907 Discounted Internal Valuations Management’s Discount & Estimated Selling Costs 33.7 – 73.5 % 55.5 % Total Other Real Estate Owned $ 15,722 (Dollars in Thousands) December 31, 2019 Fair Valuation Unobservable Weighted Assets Value Technique Inputs Range Average Impaired Loans $ 2,700 Purchase Contract Pending Close of Contract, Net of Closing Costs 25.0 % 25.0 % Impaired Loans 20,289 Discounted Appraisals Management’s Disc. & Selling Costs 2.6 – 84.6 % 24.1 % Total Impaired Loans $ 22,989 Other Real Estate Owned $ 13,596 Appraisals Selling Costs 6.0 – 10.0 % 6.4 % Other Real Estate Owned 1,735 Discounted Cash Flow Discount Rate 6.3 % 6.3 % Other Real Estate Owned 2,993 Internal Valuations Selling Costs 5.0 % 5.0 % Total Other Real Estate Owned $ 18,324 121 CARTER BANKSHARES, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued) A baseline discount rate has been established for impairment measurement. This baseline discount rate was back tested against historical OREO sales and therefore represents an average recovery rate based on the transaction sizes and asset types in the population examined. Management considers the unique attributes and characteristics of each specific impaired loan and may use judgement to adjust the baseline discount rate when appropriate. The carrying values and estimated fair values of the Company’s financial instruments at December 31, 2020 and December 31, 2019 are presented in the following tables. Fair values for December 31, 2020 and December 31, 2019 are estimated under the exit price notion in accordance with ASU 2016-01, “Recognition and Measurement of Financial Assets and Financial Liabilities.” (Dollars in Thousands) Fair Value Measurements at December 31, 2020 Financial Assets: Carrying Value Level 1 Level 2 Level 3 Total Cash and Cash Equivalents $ 241,942 $ 38,535 $ 203,407 $ - $ 241,942 Securities Available-for-Sale 778,679 - 768,316 10,363 778,679 Loans Held-for-Sale 25,437 - - 25,437 25,437 Portfolio Loans, net 2,893,096 - - 2,854,958 2,854,958 Loans Held-for-Sale in Connection with Sale of Bank Branches, at the lower cost or fair value 9,835 - - 9,835 9,835 Federal Home Loan Bank Stock, at Cost 5,093 - - NA NA Other Assets- Interest Rate Derivatives 4,493 - 4,493 - 4,493 Accrued Interest Receivable 32,157 - 2,887 29,270 32,157 Financial Liabilities: Deposits $ 3,599,911 $ 699,229 $ 1,285,912 $ 1,640,587 $ 3,625,728 Deposits Held for Assumption in Connection with Sale of Banking Branches 84,717 9,506 18,699 56,512 84,717 Other Liabilities- Interest Rate Derivatives 4,756 - 4,756 - 4,756 FHLB Borrowings 35,000 - - 35,461 35,461 Accrued Interest Payable 2,131 - - 2,131 2,131 (Dollars in Thousands) Fair Value Measurements at December 31, 2019 Financial Assets: Carrying Value Level 1 Level 2 Level 3 Total Cash and Cash Equivalents $ 125,812 $ 41,386 $ 84,426 $ - $ 125,812 Securities Available-for-Sale 742,617 - 737,617 5,000 742,617 Loans Held-for-Sale 19,714 - - 19,714 19,714 Portfolio Loans, net 2,846,004 - - 2,819,585 2,819,585 Federal Home Loan Bank Stock, at Cost 4,113 - - NA NA Other Assets- Interest Rate Derivatives 626 - 626 - 626 Accrued Interest Receivable 13,751 - 3,018 10,733 13,751 Financial Liabilities: Deposits $ 3,504,245 $ 554,875 $ 988,964 $ 1,967,563 $ 3,511,402 Other Liabilities- Interest Rate Derivatives 675 - 675 - 675 FHLB Borrowings 10,000 - - 9,886 9,886 Accrued Interest Payable 3,001 - - 3,001 3,001 122 CARTER BANKSHARES, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued) NOTE 8 - PREMISES AND EQUIPMENT Premises and equipment are stated at cost less accumulated depreciation as follows: December 31, (Dollars in Thousands) 2020 2019 Land $ 27,673 $ 28,526 Bank Premises 60,571 59,161 Furniture and Equipment 31,339 28,783 Leasehold Improvements 613 702 120,196 117,172 Accumulated Depreciation (34,889 ) (31,230 ) Total $ 85,307 $ 85,942 At December 31, 2020, we had $2.3 million bank premises and equipment held-for-sale. Depreciation has been included under occupancy expense in the Consolidated Statements of (Loss) Income totaling $6.1 million in 2020, $5.3 million in 2019, and $3.7 million in 2018. Real estate on closed branches was valued based on recent comparative market values received from a real estate broker. Write-downs in the amount of $1.1 million, $0.8 million and $3.5 million were recognized during 2020, 2019 and 2018, respectively. The net remaining carrying value of $2.5 million and $3.0 million is classified as held-for-sale in OREO in the Consolidated Balance Sheets as of December 31, 2020 and 2019, respectively. The Company leases offices from non-related parties under various terms, some of which contain contingent rentals tied to a price index. Rental expense for these leases was $99 thousand in 2020, $37 thousand in 2019, and $211 thousand for 2018. The Company currently has two depository locations, a loan production office, and a commercial banking office under lease contracts. We have included $1.5 million and $1.2 million in right-of-use assets in other assets on its Consolidated Balance Sheets at December 31, 2020 and 2019, respectively. The Company has included $1.6 million and $1.5 million in lease liabilities in other liabilities on its Consolidated Balance Sheets at December 31, 2020 and 2019, respectively. NOTE 9 - OTHER REAL ESTATE OWNED The following table presents OREO owned activity as of the dates presented: Year Ended December 31, (Dollars in Thousands) 2020 2019 2018 Beginning Balance $ 18,324 $ 33,681 $ 39,793 Loans Transferred to Other Real Estate Owned 755 302 28,212 Loans to Finance the Sale of Other Real Estate Owned - - (893 ) Transfer of Closed Retail Offices to Other Real Estate Owned 2,221 1,694 2,177 Capitalized Expenditures 19 - 1,272 Direct Write-Downs (1,483 ) (4,457 ) (8,714 ) Cash Proceeds from Pay-downs (483 ) (580 ) - Sales of Other Real Estate Owned (3,631 ) (12,316 ) (28,166 ) End of Year $ 15,722 $ 18,324 $ 33,681 123 CARTER BANKSHARES, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued) At December 31, 2020, 2019, and 2018, the balance of OREO includes $13.2 million, $15.3 million, and $26.9 million, respectively, of foreclosed properties recorded as a result of obtaining physical possession of the asset. At December 31, 2020 and 2019, the recorded investment of foreclosed residential real estate was $109 thousand and $69 thousand, respectively. At December 31, 2020 and 2019, the recorded investment of consumer mortgage loans secured by residential real estate properties for which formal foreclosure proceeds are in process is $67 thousand and $290 thousand, respectively. Income and expenses applicable to foreclosed assets include the following: Year Ended December 31, (Dollars in Thousands) 2020 2019 2018 Provision for Losses $ 1,483 $ 4,457 $ 8,714 Operating Expenses, net of rental income 317 (164 ) (476 ) Net (Gain) Loss on Sales (48 ) 275 (513 ) Other Real Estate Owned Expense $ 1,752 $ 4,568 $ 7,725 NOTE 10 – GOODWILL Accounting guidance requires the Company to test its goodwill impairment at least annually, or more frequently, if an event occurs or circumstances change which are considered to be triggering events that would more likely than not reduce the fair value of its goodwill below the carrying value of the reporting unit. 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 continued to monitor 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. 124 CARTER BANKSHARES, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued) The following table presents goodwill as of December 31: (Dollars in Thousands) 2020 2019 Balance as of January 1 $ 62,192 $ 62,192 Impairment Losses (62,192 ) - Balance as of December 31 $ - $ 62,192 NOTE 11 – DERIVATIVE INSTRUMENTS AND HEDGING ACTIVITIES In accordance with applicable accounting guidance for derivatives and hedging, all derivatives are recognized as either assets or liabilities on the Consolidated Balance Sheet at fair value. Interest rate swaps are contracts in which a series of interest rate flows (fixed and variable) are exchanged over a prescribed period. The notional amounts on which the interest payments are based are not exchanged. These derivative positions relate to transactions in which the Company enters into an interest rate swap with a commercial customer while at the same time entering into an offsetting interest rate swap with another financial institution, or counterparty. In connection with each transaction, the Company originates a floating rate loan to the customer at a notional amount. In turn, the customer contracts with the counterparty to swap the stream of cash flows associated with the floating interest rate loan with the Company for a stream of fixed interest rate cash flows based on the same notional amount as the Company’s loan. The transaction allows the customer to effectively convert a variable rate loan to a fixed rate loan with the Company receiving a variable rate. These agreements could have floors or caps on the contracted interest rates. Pursuant to agreements with various financial institutions, the Company may receive collateral or may be required to post collateral based upon mark-to-market positions. Beyond unsecured threshold levels, collateral in the form of cash or securities may be made available to counterparties of interest rate swap transactions. Based upon current positions and related future collateral requirements relating to them, management believes any effect on our cash flow or liquidity position to be immaterial. Derivatives contain an element of credit risk, the possibility that the Company will incur a loss because a counterparty, which may be a financial institution or a customer, fails to meet its contractual obligations. All derivative contracts with financial institutions may be executed only with counterparties approved by the Asset and Liability Committee (“ALCO”) and all derivatives with customers are approved by a team of qualified members from senior management who have been trained to understand the risk associated with interest rate swaps and have past industry experience. Interest rate swaps are considered derivatives but are not accounted for using hedge accounting. As such, changes in the estimated fair value of the derivatives are recorded in current earnings in the Consolidated Statements of (Loss) Income. 125 CARTER BANKSHARES, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued) The following table indicates the amounts representing the value of derivative assets and derivative liabilities at December 31: Fair Values of Derivative Instruments Asset Derivatives (Included in Other Assets) (Dollars in Thousands) 2020 2019 Number of Transactions Notional Amount Fair Value Number of Transactions Notional Amount Fair Value Derivatives not Designated as Hedging Instruments Interest Rate Lock Commitments – Mortgage Loans 1 $ 151 $ - 5 $ 937 $ 1 Interest Rate Swap Contracts – Commercial Loans 38 255,572 4,493 2 18,773 625 Total Derivatives not Designated as Hedging Instruments 39 $ 255,723 $ 4,493 7 $ 19,710 $ 626 Fair Values of Derivative Instruments Liability Derivatives (Included in Other Liabilities) (Dollars in Thousands) 2020 2019 Number of Transactions Notional Amount Fair Value Number of Transactions Notional Amount Fair Value Derivatives not Designated as Hedging Instruments Forward Sale Contracts – Mortgage Loans 1 $ 151 $ - 5 $ 937 $ 1 Interest Rate Swap Contracts – Commercial Loans 38 255,572 4,756 2 18,773 674 Total Derivatives not Designated as Hedging Instruments 39 $ 255,723 $ 4,756 7 $ 19,710 $ 675 The following table indicates the loss recognized in income on derivatives for the years ended December 31: (Dollars in Thousands) 2020 2019 2018 Derivatives not Designated as Hedging Instruments Interest Rate Lock Commitments – Mortgage Loans $ (1 ) $ - $ 1 Forward Sale Contracts – Mortgage Loans 1 - (1 ) Interest Rate Swap Contracts – Commercial Loans (214 ) (22 ) (27 ) Total Derivative Loss $ (214 ) $ (22 ) $ (27 ) Presenting offsetting derivatives that are subject to legally enforceable netting arrangements with the same party is permitted. For example, we may have a derivative asset and a derivative liability with the same counterparty to a swap transaction and are permitted to offset the asset position and the liability position resulting in a net presentation. The following table indicates the gross amounts of commercial loan swap derivative assets and derivative liabilities, the amounts offset and the carrying values in the Consolidated Balance Sheets at December 31: Asset Derivatives (Included in Other Assets) Liability Derivatives (Included in Other Liabilities) (Dollars in Thousands) 2020 2019 2020 2019 Derivatives not Designated as Hedging Instruments Gross Amounts Recognized $ 4,493 $ 625 $ 4,756 $ 674 Gross Amounts Offset - - - - Net Amounts Presented in the Consolidated Balance Sheets 4,493 625 4,756 674 Gross Amounts Not Offset (1) - - (5,220 ) (860 ) Net Amount $ 4,493 $ 625 $ (464 ) $ (186 ) (1) Amounts represent collateral posted for the periods presented. 126 CARTER BANKSHARES, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued) NOTE 12 – DEPOSITS The following table presents 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 All depos i t accounts are i nsured by the FDIC u p to the maximum amount allowed by l aw. The Dodd-Frank Act , signed into law on July 2 1 , 2010, makes permanent the $250 , 000 limit for federal deposit insurance and the coverage limit applies per depositor, per insured depository institution for each account ownership. Time deposits that meet or exceed the FDIC Insurance limit of $250,000, excluding deposits held-for-assumption, at year-end 2020 and 2019 were $184.2 million and $195.3 million, respectively. Certificates of Deposit, excluding deposits held for assumption for pending branch sale transactions, maturing as of December 31: (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 Overdrafts reclassified to loans at December 31, 2020 and 2019 were $0.5 million and $0.7 million, respectively. Total deposit dollars from executive officers, directors, and their related interests at December 31, 2020 and 2019, respectively, were $6.7 million and $7.5 million. NOTE 13 – FEDERAL HOME LOAN BANK 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. 127 CARTER BANKSHARES, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued) The following table represents the balance of long-term borrowings, the weighted average interest rate, and interest expense for the years ended December 31: (Dollars in Thousands) 2020 2019 2018 Long-term Borrowings $ 35,000 $ 10,000 $ - Weighted Average Interest Rate 1.13 % 1.63 % 0.00 % Interest Expense $ 361 $ 38 $ - Scheduled annual maturities and average interest rates for FHLB advances for each of the five years subsequent to December 31, 2020 and thereafter are as follows: Weighted (Dollars in Thousands) Balance Average Rate 2021 $ 3,000 1.68 % 2022 4,000 1.60 % 2023 10,000 0.88 % 2024 13,000 1.10 % 2025 5,000 1.02 % Thereafter - 0.00 % Total FHLB Advances $ 35,000 1.13 % NOTE 14 - EMPLOYEE BENEFIT PLANS The Company has adopted an integrated profit sharing plan, which allows for elective deferrals and non-elective contributions. Employees participate in the profit sharing plan following completion of six (6) months of service and upon reaching the age of twenty years and six months as of January 1. Vesting is based on years of service to the Company, with a year being any year an employee works a minimum of 1,000 hours. The following table details the vesting schedule based on years of service for participants: 1 Year of Service 0 % Vested 2 Years of Service 20 % Vested 3 Years of Service 40 % Vested 4 Years of Service 60 % Vested 5 Years of Service 100 % Vested Any participant who has reached the age of 62 is fully vested regardless of length of service. Each participant in the plan (who has not reached age 62) becomes 100% vested after five (5) years of service. The non-elective contribution to the plan is determined each year by the Company’s Board of Directors (the “Board”) and thus may fluctuate in amount from year to year. The contribution by the Company, which includes contributions to the non-qualified plan discussed below, was $1.0 million in 2020, $1.4 million in 2019 and $1.7 million in 2018. These amounts are included in salaries and employee benefits in the Consolidated Statements of (Loss) Income. Beginning in 2019, our integrated profit sharing plan includes a Company match based upon an employee’s elective deferral. This elective deferral is subject to dollar limits announced annually by the Internal Revenue Service (“IRS”). Elective deferrals are matched equal to 100% of the first 3% deferred and 50% of the next 2%, producing a maximum 4% match. Expense for this deferral match was $1.2 million and $1.1 million for the years ended December 31, 2020 and 2019, respectively. There was no expense for the calendar year ended 2018. 128 CARTER BANKSHARES, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued) The Bank entered into a Nonqualified Profit Sharing Plan originally on December 30, 1996, which was subsequently amended and restated effective December 20, 2007. The purpose of the Nonqualified Profit Sharing Plan was to provide additional benefits to be paid to the executive upon the occurrence of a “Distributable Event,” which is either termination or death. The board of directors of the Bank (the “Bank Board”) approved the amended plan on December 20, 2007. Since its inception, the Bank’s former Chairman and Chief Executive Officer was the only executive who participated in the Nonqualified Profit Sharing Plan. In April 2017, a Distributable Event occurred, in which distributions will occur over 45 quarterly payments. The value of the plan was $1.0 million as of December 31, 2020, and was solely comprised of cash. The quarterly distributions began on January 1, 2018 and will continue to be paid out in equal quarterly installments approximating $30 thousand. On December 15, 2020, the Bank adopted an unfunded, nonqualified deferred compensation plan, called the Nonqualified Deferred Compensation Plan, to provide to provide (i) certain key executives of the Bank (beginning after the date of adoption) the opportunity to defer to a later year on a pre-tax basis certain compensation without being subject to the dollar limits that apply to these employees under the Bank’s tax-qualified integrated profit-sharing plan and (ii) the Bank’s non-employee directors (beginning in January 2022) the opportunity to defer to a later year on a pre-tax basis certain director fees. The compensation and fees (and related earnings) deferred under this plan are held in a grantor trust until paid to the participants and remain subject to the claims of the creditors of the Bank and Company until paid to the participants . NOTE 15 – INCENTIVE AND RESTRICTED STOCK PLAN The Bank Board adopted the Carter Bank & Trust 2018 Omnibus Equity Incentive Plan on March 29, 2018 based on the recommendation of the Bank’s Nominating and Compensation Committee (now, a committee of the Company, the “Committee”), which became effective on June 27, 2018. In connection with the Reorganization, the Company adopted and assumed Carter Bank & Trust 2018 Omnibus Equity Incentive Plan as its own (now the Carter Bankshares, Inc. Amended and Restated 2018 Omnibus Equity Incentive Plan, or, for purposes of this discussion, the “Plan”). The Plan reserves a total 2,000,000 shares of common stock for issuance and provides for the grant to key employees and non-employee directors of the Company and its subsidiaries of awards that may include one or more of the following: stock options, restricted stock, restricted stock units, stock appreciation rights, stock awards, performance units and performance cash awards (collectively, the “awards”). Subject to accelerated vesting under certain circumstances, the Plan requires a minimum vesting period of one year for awards subject to time-based conditions and a minimum performance period of one year for awards subject to achievement or satisfaction of performance goals. These minimums are applicable to awards other than those granted as part of a retainer for the service of non-employee directors. The Committee will determine the vesting period on the awards. No awards may be granted under the Plan more than ten years from the effective date of the Plan. For purposes of this Note 15, references to the “Company” mean the “Bank’ with respect to actions prior to the Reorganization. Restricted Stock The Company periodically issues restricted stock to non-employee directors, executive officers and employees pursuant to the Plan. As of December 31, 2020, 132,027 restricted shares had been granted under the Plan and 4,747 restricted shares had been forfeited. The Company granted 39,019 and 47,309 restricted shares of common stock to key personnel under the Plan during 2020 and 2019, respectively. These grants were approved by the Committee as compensation for substantial contributions to the Company’s performance, including contribution during our recent core systems conversion. These key personnel time-based restricted shares vest in one-third annual installments over three years after the grant date. The closing price of our stock was used to determine the fair value on the date of the grant. 129 CARTER BANKSHARES, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued) There were 16,137 and 17,149 restricted shares of common stock issued to non-employee directors under the Plan during 2020 and 2019, respectively. These grants were approved by the Committee as compensation for the Company’s performance. These restricted shares granted in 2019 were originally approved to fully vest three years after the grant date. However, the Committee approved accelerated vesting of these non-employee director restricted shares in January 2020 to fully vest one year after the grant date. The restricted shares granted in 2020 fully vest one year after the grant date. The closing price of our stock was used to determine the fair value on the date of the grant. If any award granted under the Plan terminates, expires, or lapses for any reason other than by virtue of exercise or settlement of the award, or if shares issued pursuant to awards are forfeited, any stock subject to such award again shall be available for future awards under the Plan. Compensation expense for restricted shares of stock is recognized ratably over the period of service, generally the entire vesting period, based on fair value on the grant date. The Company recognized compensation expense of $1.0 million and $381 thousand for 2020 and 2019, respectively. As of December 31, 2020 and 2019, there was $907 thousand and $946 thousand, respectively, of total unrecognized compensation cost related to restricted stock that will be recognized as compensation expense over a weighted average period of 1.68 years and 2.13 years, respectively. The following table provides information about restricted stock granted under the Plan for the years ended December 31: Weighted Average Grant Date Restricted Shares Fair Value Non-vested at December 31, 2018 12,413 $ 17.86 Granted 64,458 17.39 Vested (3,995 ) 17.86 Forfeited (403 ) 17.86 Non-vested at December 31, 2019 72,473 17.44 Granted 55,156 19.23 Vested (37,908 ) 16.94 Forfeited (4,344 ) 19.06 Non-vested at December 31, 2020 85,377 $ 18.73 130 CARTER BANKSHARES, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued) NOTE 16 - FED E RAL AND ST AT E INCO M E T AX ES The components of the provision (benefit) for income tax expense were as follows: (Dollars in Thousands) 2020 2019 2018 Current $ 2,399 $ 1,285 $ (2,447 ) Deferred (1,627 ) (76 ) 4,850 Income Tax Provision $ 772 $ 1,209 $ 2,403 The following is a reconciliation of the differences between the provision (benefit) for income taxes and the amount computed by applying the statutory federal income tax rate (21% at December 31, 2020, 2019 and 2018) to income before taxes: 2020 2019 2018 (Dollars in Thousands) Amount Percent Amount Percent Amount Percent Federal Income Tax at Statutory Rate $ (9,468 ) 21.0 $ 5,835 21.0 $ 3,006 21.0 State Income Tax, net of Federal Benefit 455 (1.0 ) 220 0.8 190 1.3 Tax-exempt Interest, net of Disallowance (1,757 ) 3.9 (2,128 ) (7.7 ) (2,629 ) (18.4 ) Federal Tax Credits, net of Basis Reduction (948 ) 2.2 (2,032 ) (7.3 ) (1,375 ) (9.6 ) Change in Valuation Allowance (excluding the effect of the Act) (374 ) 0.8 (424 ) (1.5 ) (384 ) (2.7 ) Income from Bank Owned Life Insurance (294 ) 0.7 (302 ) (1.1 ) (244 ) (1.7 ) True-up of Book and Tax Basis Differences 81 (0.2 ) 8 - 3,742 26.1 Goodwill Impairment 13,060 (29.1 ) Other 17 - 32 0.2 97 0.8 Income Tax Provision and Effective Income Tax Rate $ 772 (1.7 ) $ 1,209 4.4 $ 2,403 16.8 Realization of deferred tax assets is dependent upon the generation of future taxable income. A valuation allowance is provided when it is more likely than not that some portion of the deferred tax assets will not be realized. In assessing the need for a valuation allowance, management considers the scheduled reversal of the deferred tax liabilities and the projected future taxable income over the periods in which the temporary differences comprising the deferred tax assets will be deductible. Based on its assessment, management recorded a valuation allowance on deferred tax assets related to its equity investments in partnerships that will generate capital losses upon exiting the investments. The Company has not identified prudent and feasible strategies to generate future capital gains to offset the capital losses. Management has determined that it is more likely than not that all other deferred tax assets will be realized in future periods so no additional valuation allowance is necessary at December 31, 2020 and 2019. 131 CARTER BANKSHARES, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued) Deferred income taxes reflect the net tax effects of temporary differences between the carrying amounts of assets and liabilities for financial reporting purposes and the amount used for income tax purposes. Significant components of the Company’s deferred tax assets and liabilities are as follows: (Dollars in Thousands) Deferred Tax Assets 2020 2019 Allowance for Loan Losses $ 11,580 $ 8,301 Valuation Adjustments on Other Real Estate Owned 1,537 1,556 Tax Credit Carryforwards 1,771 5,120 Equity Investment in Partnerships 837 1,212 Accrued Interest on Nonaccrual Loans 1,900 889 Operating Lease Liabilities 349 323 Other 1,057 1,280 Gross Deferred Tax Assets 19,031 18,681 Less: Valuation Allowance (838 ) (1,212 ) Total Deferred Tax Assets $ 18,193 $ 17,469 Deferred Tax Liabilities 2020 2019 Fixed Asset Depreciation $ (5,512 ) $ (5,715 ) Acquisition-Related Fair Value Adjustments (4,063 ) (4,386 ) Deferred Loan Income (649 ) (1,088 ) Operating Lease Right-of-Use Assets (321 ) (263 ) Net Unrealized Gain on Available-for-Sale Securities (4,179 ) (34 ) Other (59 ) (55 ) Total Deferred Tax Liabilities (14,783 ) (11,541 ) Net Deferred Tax Assets $ 3,410 $ 5,928 The Company had federal tax credit carryforward of $1.8 million at December 31, 2020 and $5.1 million at December 31, 2019. The federal tax credits consist primarily of new markets credits and historic rehabilitation credits that, if not used, will expire from 2038 to 2040. At December 31, 2020 and 2019, the Company had no ASC 740-10 unrecognized tax benefits or accrued interest and penalties recorded. The Company does not expect the total amount of unrecognized tax benefits to significantly increase within the next twelve months. The Company recognizes interest and penalties on unrecognized tax benefits in income tax expense. The Company is subject to U.S. federal income tax as well as various other state and local jurisdictions. The Company is generally no longer subject to examination by federal, state and local taxing authorities for years prior to December 31, 2017. 132 CARTER BANKSHARES, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued) NOTE 17 – TAX EFFECTS ON OTHER COMPREHENSIVE INCOME (LOSS) The following tables present the tax effects of the components of other comprehensive income (loss) for the years ended December 31: Pre-Tax Tax (Expense) Net of Tax (Dollars in Thousands) Amount Benefit Amount 2020 Net Unrealized Gains Arising during the Period $ 26,621 $ (5,590 ) $ 21,031 Reclassification Adjustment for Gains included in Net Loss (6,882 ) 1,445 (5,437 ) Other Comprehensive Income $ 19,739 $ (4,145 ) $ 15,594 2019 Net Unrealized Gains Arising during the Period $ 15,108 $ (3,173 ) $ 11,935 Reclassification Adjustment for Gains included in Net Income (2,205 ) 463 (1,742 ) Other Comprehensive Income $ 12,903 $ (2,710 ) $ 10,193 2018 Net Unrealized Losses Arising during the Period $ (8,636 ) $ 1,814 $ (6,822 ) Reclassification Adjustment for Gains included in Net Income (1,271 ) 267 (1,004 ) Other Comprehensive Loss $ (9,907 ) $ 2,081 $ (7,826 ) NOTE 18 – COMMITMENTS AND CONTINGENCIES Commitments to extend credit, which amounted to $591.2 million at December 31, 2020 and $488.9 million at December 31, 2019, represent agreements to lend to customers with fixed expiration dates or other termination clauses. The Company provides lines of credit to our clients 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 at December 31, 2020 and 2019, respectively. Standby letters of credit are conditional commitments issued by the Company guaranteeing the performance of a customer to a third-party. Those guarantees are primarily issued to support public and private borrowing arrangements. The Company had outstanding letters of credit totaling $29.3 million in 2020 and $39.5 million in 2019. Our exposure to credit loss in the event of nonperformance by the other party to the financial instrument for commitments to extend credit and standby letters of credit is represented by the contractual amount of those instruments. The Company uses the same credit policies in making commitments and unconditional obligations as it does for on balance sheet instruments. Unless noted otherwise, collateral or other security is required to support financial instruments with credit risk. 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 2019, respectively. The allowance for unfunded commitments is included in other liabilities in the Consolidated Balance Sheets. The reserve is calculated by applying historical loss rates to our unfunded commitments. 133 CARTER BANKSHARES, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued) Litigation In the normal course of business, the Company is subject to various legal and administrative proceedings and claims. While any type of litigation contains a level of uncertainty, management believes that the outcome of such proceedings or claims pending will not have a material adverse effect on our consolidated financial position or results of operations. NOTE 19 – REVENUE FROM CONTRACTS WITH CUSTOMERS Topic 606 does not apply to revenue associated with financial instruments, including revenue from loans and securities. In addition, certain noninterest income streams such as fees associated with mortgage servicing rights, financial guarantees, derivatives, and certain credit card fees are also not in scope of the new guidance. Topic 606 is applicable to noninterest revenue streams such as trust and asset management income, deposit related fees, interchange fees, merchant income, and annuity and insurance commissions and return on investment. However, the recognition of these revenue streams did not change significantly upon adoption of Topic 606. Substantially all of the Company’s revenue is generated from contracts with customers. Noninterest revenue streams in-scope of Topic 606 are discussed below. Service Charges on Deposit Accounts: Service charges on deposit accounts consist of overdraft fees, service charges on returned checks, stop payment fees, check chargeback fees, minimum balance fees, and other deposit account related fees. Overdraft fees are recognized at the point in time that the overdraft occurs. Service charges on returned checks are recognized at the point in time that a check is returned. Transaction-based fees, which include services such as stop payment fees, check chargeback fees, and other deposit account related fees are recognized at the point in time the Company fulfills the customer’s request. Minimum balance fees are system-assessed at the point in time that a customer’s balance is below the required minimum for the product. Service charges on deposits are withdrawn from the customer’s account balance. Other Fees and Other Income: Other fees and other income consists of safe deposit rents, money order fees, check cashing and cashiers’ check fees, wire transfer fees, letter of credit fees, check order income, and other miscellaneous fees. These fees are largely transaction-based; therefore, the Company’s performance obligation is satisfied and the resultant revenue is recognized at the point in time the service is rendered. Payments for transaction-based fees are generally received immediately or in the following month by a direct charge to a customer’s account. Debit Card Interchange Fees: The Company earns interchange fees from debit cardholder transactions conducted through a card payment network. Interchange fees from cardholder transactions represent a percentage of the underlying transaction value and are recognized daily, concurrently with the transaction processing services provided to the cardholder. Insurance: Commission income is earned based on customer transactions. The commission income is recognized when the transaction is complete. The Company also receives a return on its investment in Bankers Insurance, LLC on an annual basis based on the income of the insurance company and percentage of ownership. OREO Income: The Company owns properties acquired through foreclosure that are included in other real estate owned, net on the Consolidated Balance Sheet. If the Company rents any of those properties, the resultant income is recognized at the point of receipt since the performance obligation has been satisfied. The rents are generally received monthly. Gains/Losses on Sales of OREO: The Company records a gain or loss from the sale of OREO when control of the property transfers to the buyer, which generally occurs at the time of an executed deed. When the Company finances the sale of OREO to the buyer, the Company assesses whether the buyer is committed to perform their obligations under the contract and whether collectability of the transaction price is probable. Once these criteria are met, the OREO asset is derecognized and the gain or loss on sale is recorded upon the transfer of control of the property to the buyer. In determining the gain or loss on the sale, the Company adjusts the transaction price and related gain (loss) on sale if a significant financing component is present. 134 CARTER BANKSHARES, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued) The following table summarizes the point of revenue recognition and the income recognized for each of the revenue streams for the years ended December 31: Point of Revenue (Dollars in Thousands) Recognition 2020 2019 2018 In-Scope Revenue Streams Service Charges on Deposit Accounts At a point in time $ 3,518 $ 3,919 $ 3,127 Other Fees and Other Income At a point in time 2,497 1,789 1,756 Debit Card Interchange Fees At a point in time 5,857 5,160 4,750 Commercial Loan Swap Fee Income At a point in time 4,051 - - Insurance Customer Commissions At a point in time 73 120 625 Annual Commission on Investment Over time 1,366 1,105 1,230 Special Production Payout Over time 289 - - Other Real Estate Owned Income At a point in time 340 689 2,692 Gains (Losses) on Sale of Other Real Estate Owned At a point in time *** *** *** Total In-Scope Revenue Streams 13,940 12,782 14,180 Out of Scope Revenue Streams Gain on Sales of Securities, net 6,882 2,205 1,271 Bank Owned Life Insurance Income 1,400 1,436 1,161 Other 307 447 374 Total Noninterest Income $ 26,580 $ 16,870 $ 16,986 ***Reported net with Losses on Sales and Write-downs of Other Real Owned in Noninterest Expense NOTE 20 – PARENT COMPANY CONDENSED FINANCIAL INFORMATION Balance Sheets December 31, (Dollars in Thousands) 2020 2019 ASSETS Cash $ 639 $ - Investment in Bank Subsidiary 439,553 - Other Assets - - Total Assets $ 440,192 $ - LIABILITIES Other Liabilities $ 18 $ - Total Shareholders’ Equity 440,174 - Total Liabilities and Shareholders’ Equity $ 440,192 $ - 135 CARTER BANKSHARES, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued) Statements of Net Income December 31, (Dollars in Thousands) 2020 2019 2018 Dividends from Subsidiaries $ 1,000 $ - $ - Total Expenses (594 ) - - Income before income tax and undistributed net loss of bank subsidiary 406 - - Income tax benefit - - - Income before undistributed net loss of bank subsidiary 406 - - Equity in undistributed net loss of bank subsidiary (46,264 ) - - Net Loss $ (45,858 ) $ - $ - Statements of Cash Flows December 31, (Dollars in Thousands) 2020 2019 2018 OPERATING ACTIVITIES Net Loss $ (45,858 ) $ - $ - Equity in undistributed net loss of bank subsidiary 46,264 - - Adjustments to Reconcile Net Loss to Net Cash Provided by Operating Activities Stock Compensation Expense 215 - - Increase in Intercompany Liability 18 - - Net Cash Provided by Operating Activities 639 - - INVESTING ACTIVITIES Investments in subsidiaries - - - Net Cash Used in Investing Activities - - - FINANCING ACTIVITIES Cash dividends paid to common shareholders - - - Net Cash Provided by Financing Activities - - - Net increase in cash 639 - - Cash at beginning of year - - - Cash at end of year $ 639 $ - $ - NOTE 21 - CAPITAL ADEQUACY The Company and the Bank are subject to various capital requirements administered by the federal banking regulators. Failure to meet the minimum capital requirements can initiate certain mandatory and possibly additional discretionary actions by regulators that, if undertaken, could have a direct material effect on our financial statements. Under capital adequacy guidelines and the regulatory framework for prompt corrective action, we must meet specific capital guidelines that involve quantitative measures of assets, liabilities and certain off-balance sheet items as calculated under regulatory accounting practices. The capital amounts and classifications are also subject to qualitative judgments by the regulators about components, risk weightings and other factors. Prompt corrective action provisions are not applicable to bank holding companies. Quantitative measures established by regulations to ensure capital adequacy require us to maintain minimum amounts and ratios as shown in the following table. The final rules implementing Basel Committee on Banking Supervision’s capital guidelines for U.S. Banks (“Basel III rules”) became effective for the Company on January 1, 2015 with full compliance with all of the requirements being phased in over a multi-year schedule, and fully phased in by January 1, 2019. Under the Basel III rules, we must hold a capital conservation buffer above the adequately capitalized risk-based capital ratios. The capital conservation buffer was phased in at the rate of 0.625% per year and was 2.5% on January 1, 2019. Management believes as of December 31, 2020, we met all capital adequacy requirements to which we are subject. 136 CARTER BANKSHARES, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued) Prompt corrective action regulations provide five classifications: well capitalized, adequately capitalized, undercapitalized, significantly undercapitalized, and critically undercapitalized, although these terms are not used to represent overall financial condition. If adequately capitalized, regulatory approval is required to accept brokered deposits. If undercapitalized, capital distributions are limited, as is asset growth and expansion, and capital restoration plans are required. At year-end 2020 and 2019, the most recent regulatory notifications categorized the Bank as well-capitalized under the regulatory framework for prompt corrective action. There are no conditions or events since that notification that management believes have changed the institutions category. The following table summarizes risk-based capital amounts and ratios for the Company and the Bank: Actual Minimum Regulatory Capital Requirements To be Well Capitalized Under Prompt Corrective Action Provisions (dollars in thousands) Amount Ratio Amount Ratio Amount Ratio As of December 31, 2020 Leverage Ratio Carter Bankshares, Inc. $ 424,453 10.26 % $ 165,514 4.00 % NA NA Carter Bank & Trust 423,832 10.24 % 165,514 4.00 % $ 206,892 5.00 % Common Equity Tier 1 (to Risk-Weighted Assets) Carter Bankshares, Inc. $ 424,453 13.08 % $ 146,077 4.50 % NA NA Carter Bank & Trust 423,832 13.06 % 146,078 4.50 % $ 211,001 6.50 % Tier 1 Capital (to Risk-Weighted Assets) Carter Bankshares, Inc. $ 424,453 13.08 % $ 194,769 6.00 % NA NA Carter Bank & Trust 423,832 13.06 % 194,770 6.00 % $ 259,694 8.00 % Total Capital (to Risk-Weighted Assets) Carter Bankshares, Inc. $ 465,198 14.33 % $ 259,692 8.00 % NA NA Carter Bank & Trust 464,578 14.31 % 259,694 8.00 % $ 324,617 10.00 % As of December 31, 2019 Leverage Ratio Carter Bank & Trust $ 410,793 10.33 % $ 158,993 4.00 % $ 198,741 5.00 % Common Equity Tier 1 (to Risk-Weighted Assets) Carter Bank & Trust $ 410,793 13.58 % $ 136,126 4.50 % $ 196,626 6.50 % Tier 1 Capital (to Risk-Weighted Assets) Carter Bank & Trust $ 410,793 13.58 % $ 181,501 6.00 % $ 242,002 8.00 % Total Capital (to Risk-Weighted Assets) Carter Bank & Trust $ 448,622 14.83 % $ 242,002 8.00 % $ 302,502 10.00 % On November 20, 2020, the Company acquired the Bank in a merger and reorganization pursuant to Section 13.1-719.1 of the Virginia Stock Corporation Act, and in accordance with the terms of a Plan of Merger and Reorganization dated November 9, 2020. Pursuant to the Agreement, on November 20, 2020 at 7:00 p.m. all of the outstanding shares of the Bank’s $1.00 par value common stock formerly held by its shareholders was converted into and exchanged for one newly issued share of the Company’s par value common stock, and the Bank became a subsidiary of the Company. In December 2018, the Office of the Comptroller of the Currency, (the “OCC”), the FRB, and the FDIC approved a final rule to address changes to credit loss accounting under GAAP, including banking organizations’ implementation of CECL. The final rule provides banking organizations the option to phase in over a three-year period the day-one adverse effects on regulatory capital that may result from the adoption of the new accounting standard. In March 2020, the OCC, the FRB, and the FDIC published an interim final rule to delay the estimated impact on regulatory capital stemming from the implementation of CECL. The interim final rule maintains the three-year transition option in the previous rule and provides banks the option to delay for two years an estimate of CECL’s effect on regulatory capital, relative to the incurred loss methodology’s effect on regulatory capital, followed by a three-year transition period (five-year transition option). We plan to adopt the capital transition relief over the permissible three-year period due to our intended adoption of CECL in the first quarter of 2021. 137 CARTER BANKSHARES, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued) NOTE 22 - QUARTERLY FINANCIAL DATA (Unaudited) The following summarizes the quarterly results of operations for the years ended December 31: (Dollars in Thousands) First Second Third Fourth 2020 Quarter Quarter Quarter Quarter Total Interest Income $ 37,836 $ 35,617 $ 33,986 $ 33,502 Total Interest Expense 10,572 9,355 8,550 7,349 Net Interest Income 27,264 26,262 25,436 26,153 Provision for Loan Losses 4,798 5,473 2,914 4,821 Net Interest Income after Provision for Loan Losses 22,466 20,789 22,522 21,332 Total Noninterest Income 6,952 6,201 7,975 5,589 Total Noninterest Expense 24,748 23,023 87,300 23,841 Income (Loss) Before Income Taxes 4,670 3,967 (56,803 ) 3,080 Income Tax Expense (Benefit) 247 (488 ) 875 138 Net Income (Loss) $ 4,423 $ 4,455 $ (57,678 ) $ 2,942 Earnings (Loss) Per Share $ 0.17 $ 0.17 $ (2.19 ) $ 0.11 (Dollars in Thousands) First Second Third Fourth 2019 Quarter Quarter Quarter Quarter Total Interest Income $ 39,139 $ 40,068 $ 40,154 $ 39,759 Total Interest Expense 11,243 12,113 12,084 11,333 Net Interest Income 27,896 27,955 28,070 28,426 Provision for Loan Losses 1,627 1,369 1,390 (982 ) Net Interest Income after Provision for Loan Losses 26,269 26,586 26,680 29,408 Total Noninterest Income 3,804 4,579 4,156 4,509 Total Noninterest Expense 22,110 22,834 22,777 30,486 Income Before Income Taxes 7,963 8,331 8,059 3,431 Income Tax Expense (Benefit) 422 504 458 (175 ) Net Income $ 7,541 $ 7,827 $ 7,601 $ 3,606 Earnings Per Share $ 0.29 $ 0.30 $ 0.29 $ 0.14 (Dollars in Thousands) First Second Third Fourth 2018 Quarter Quarter Quarter Quarter Total Interest Income $ 35,588 $ 38,362 $ 38,207 $ 39,862 Total Interest Expense 8,151 9,111 10,079 10,773 Net Interest Income 27,437 29,251 28,128 29,089 Provision for Loan Losses 1,515 1,730 13,743 (118 ) Net Interest Income after Provision for Loan Losses 25,922 27,521 14,385 29,207 Total Noninterest Income 4,731 4,741 4,610 3,832 Total Noninterest Expense 22,559 23,022 25,360 29,700 Income (Loss) Before Income Taxes 8,094 9,240 (6,365 ) 3,339 Income Tax (Benefit) Expense (735 ) 2,041 1,164 (67 ) Net Income (Loss) $ 8,829 $ 7,199 $ (7,529 ) $ 3,406 Earnings (Loss) Per Share $ 0.34 $ 0.27 $ (0.29 ) $ 0.13 138 CARTER BANKSHARES, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued) NOTE 23 – SUBSEQUENT EVENT On January 6, 2021, the Company announced that it will be closing 24 Bank branches, throughout its footprint, through the closure or sale of those branches. The branch closures are expected to occur on or about April 16, 2021, as part of a strategic network optimization plan that is being implemented to support the long-term, sustainable growth of the Company. On January 14, 2021, the Company announced that the Bank had agreed to sell three branches in Staunton, Harrisonburg, and Bridgewater, Virginia to Pendleton Community Bank, a subsidiary of Allegheny Bancshares, Inc. On January 27, 2021, the Company announced that the Bank had agreed to sell one branch in Waynesboro, Virginia to F&M Bank, a subsidiary of F&M Bank Corp. As part of the execution of these agreements, the purchasers will acquire loans, assume deposits and acquire bank premises and equipment. The balances as of December 31, 2020 were $9.8 million of combined loans, $84.7 million of combined deposits and book value of $2.3 million of bank premises and equipment. These transactions are subject to customary closing conditions, including regulatory approvals. 139 Crowe LLP Independent Member Crowe Global Report of Independent Registered Public Accounting Firm Shareholders and the Board of Directors of Carter Bankshares, Inc. and Subsidiaries Martinsville, Virginia Opinions on the Financial Statements and Internal Control over Financial Reporting We have audited the accompanying consolidated balance sheets of Carter Bankshares, Inc. and Subsidiaries (formerly Carter Bank & Trust) (the "Company") as of December 31, 2020 and 2019, the related consolidated statements of (loss) income, comprehensive (loss) income, changes in shareholders’ equity, and cash flows for each of the years in the two-year period ended December 31, 2020, and the related notes (collectively referred to as the "financial statements"). We also have audited the Company’s internal control over financial reporting as of December 31, 2020, based on criteria established in Internal Control – Integrated Framework: (2013) issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO). In our opinion, the financial statements referred to above present fairly, in all material respects, the financial position of the Company as of December 31, 2020 and 2019, and the results of its operations and its cash flows for each of the years in the two-year period ended December 31, 2020 in conformity with accounting principles generally accepted in the United States of America. Also in our opinion, the Company maintained, in all material respects, effective internal control over financial reporting as of December 31, 2020, based on criteria established in Internal Control – Integrated Framework: (2013) issued by COSO. Basis for Opinions The Company’s management is responsible for these financial statements, for maintaining effective internal control over financial reporting, and for its assessment of the effectiveness of internal control over financial reporting, included in the accompanying Management’s Report on Internal Control Over Financial Reporting. Our responsibility is to express an opinion on the Company’s financial statements and an opinion on the Company’s internal control over financial reporting based on our audits. We are a public accounting firm registered with the Public Company Accounting Oversight Board (United States) ("PCAOB") and are required to be independent with respect to the Company in accordance with the U.S. federal securities laws and the applicable rules and regulations of the Securities and Exchange Commission and the PCAOB. We conducted our audits in accordance with the standards of the PCAOB. Those standards require that we plan and perform the audits to obtain reasonable assurance about whether the financial statements are free of material misstatement, whether due to error or fraud, and whether effective internal control over financial reporting was maintained in all material respects. Our audit of the financial statements included performing procedures to assess the risks of material misstatement of the financial statements, whether due to error or fraud, and performing procedures that respond to those risks. Such procedures included examining, on a test basis, evidence regarding the amounts and disclosures in the financial statements. Our audits also included evaluating the accounting principles used and significant estimates made by management, as well as evaluating the overall presentation of the financial statements. Our audit of internal control over financial reporting included obtaining an understanding of internal control over financial reporting, assessing the risk that a material weakness exists, and testing and evaluating the design and operating effectiveness of internal control based on the assessed risk. Our audits also included performing such other procedures as we considered necessary in the circumstances. We believe that our audits provide a reasonable basis for our opinions. 140 Definition and Limitations of Internal Control Over Financial Reporting A company’s internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. A company’s internal control over financial reporting includes those policies and procedures that (1) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the company; (2) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the company are being made only in accordance with authorizations of management and directors of the company; and (3) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the company’s assets that could have a material effect on the financial statements. Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate. Critical Audit Matters The critical audit matters communicated below are matters arising from the current period audit of the financial statements that were communicated or required to be communicated to the audit committee and that: (i) relate to accounts or disclosures that are material to the financial statements and (ii) involved our especially challenging, subjective, or complex judgments. The communication of critical audit matters does not alter in any way our opinion on the financial statements, taken as a whole, and we are not, by communicating the critical audit matters below, providing a separate opinions on the critical audit matters or on the accounts or disclosures to which they relate. Allowance for Loan Losses – Qualitative Factors As more fully described in Note 1 and Note 6 to the financial statements, the Company’s allowance for loan losses is a valuation allowance for probable incurred losses inherent in the loan portfolio. The allowance for loan losses consists of a specific component which relates to individually impaired loans and a general component. The general component covers loans that are collectively evaluated for impairment. The general component is based on historical loss experience adjusted for current conditions and qualitative factors. These qualitative factors may include consideration for the following: levels of delinquency and delinquency trends; migration of loans to the classification of special mention, substandard or doubtful; trends in volume and terms of loans; effects of changes in underwriting standards; changes in lending policies, procedures, and practices; national and local economic trends and conditions; industry conditions, and effects of credit concentrations. We determined that auditing the qualitative factors applied to adjust the historical loss experience within the general component of the allowance for loan losses is a critical audit matter. The principal considerations for our determination are the high degree of subjectivity involved in management’s assessment of the risk of loss associated with each risk factor and the weightings applied to them, and the significant degree of auditor judgment and audit effort. Our audit procedures to address the critical audit matter included: · Testing the effectiveness of controls over management’s review of the reasonableness of the qualitative factors, the amounts and weightings applied to each factor, the underlying documentation used in the calculation, and the accuracy of the mathematical application of the qualitative factors used to adjust the historical loss experience and determine the general component of the allowance for losses calculation. · Substantively testing management’s estimate, including evaluating their judgments and assumptions, which included: o Evaluating the reliability of the underlying objective data used to derive the qualitative factors. Based on the underlying data, we evaluated the reasonableness of management’s designation of the resulting adjustment to the historical loss experience. We also evaluated the reasonableness of weightings applied to each risk factor and the impact of changes in the factors from prior periods. 141 o Tested the accuracy of the mathematical application of the qualitative factors used to adjust the historical loss experience within the allowance for loan loss calculation and respective loan segmentation balances the qualitative factors are applied too. o Performing analytical review procedures to determine if the general component of the allowance for loan losses balance was consistent with trends in the loan portfolio and economic conditions and methodology was consistently applied. Allowance for Loan Losses - Fair Value of Collateral Associated with Impaired Loans As more fully described in Note 1 and Note 6 to the financial statements, the allowance for loan losses consists of specific and general components. The specific component relates to loans that are individually classified as impaired. Factors considered by management in determining impairment include payment status, collateral value, and the probability of collecting scheduled principal and interest payments when due. If a loan is impaired, and the loan is collateral dependent, the fair value of collateral is used to measure impairment. Management obtained a third-party appraisal to estimate the fair value of collateral associated with two collateral-dependent impaired loans. The collateral’s fair value is considered material to the impairment analyses and underlying assumptions used to estimate fair value have a high degree of subjectivity. We determined that auditing the fair value of the collateral associated with the two collateral-dependent impaired loans is a critical audit matter. The principal considerations for our determination are the high degree of subjectivity associated with the underlying assumptions used by a third-party appraiser in determining the fair value of the collateral and the significant degree of auditor judgment and audit effort. Our audit procedures to address the critical audit matter included: · Testing the effectiveness of management review controls including: o Management’s evaluation of the valuation methodologies and critical assumptions used by the Company engaged third-party appraiser and their sensitivity analysis. o Management’s review of the accuracy of information utilized within the impairment analysis. · Substantively testing management’s estimate of fair value of the collateral which included: o Utilization of auditor engaged valuation specialist to evaluate the appropriateness of valuation methodologies and critical assumptions of the Company’s engaged third-party appraiser. o Evaluate the relevance and reliability of data used by the auditor engaged specialist. o Performed a sensitivity analysis of the significant assumptions. o Evaluation of the impairment analysis of the two-collateral dependent impaired loans to determine the application of the fair value was appropriately stated. Goodwill Impairment Evaluation As described in Notes 1 and 10 to the financial statements, goodwill is tested for impairment at the reporting unit level at least annually, or more frequently whenever events or circumstances occur that indicate that it is more-likely-than-not that the fair value of a reporting unit is less than its carrying amount. During 2020, the Company performed impairment testing on a quarterly basis due to the continued decline in the Company stock price primarily related to the economic fallout of COVID-19. A goodwill impairment charge of $62,192,000 was taken in the third quarter based on the Company’s impairment test. The quantitative assessment of goodwill for the Company’s single reporting unit was performed utilizing a discounted cash flow analysis (“income approach”) and estimates of selected market information (“market approach”) performed by a third-party. The calculation of the goodwill impairment involves significant estimates and subjective assumptions which require a high degree of management judgment. This judgment includes, but is not limited to, the selection of appropriate discount rates, the identification of relevant market comparables and the development of cash flow projections. The selection and weighting of the various fair value techniques may result in a higher or lower fair value. Judgment is applied in determining the weightings that are most representative of fair value. 142 We identified the goodwill impairment assessment of the Company as a critical audit matter. The principal considerations for this determination was the degree of auditor judgment in performing procedures over the fair value methodologies and key assumptions used to determine fair value, which included, discount rate, prospective financial information, and weighting allocation to valuation methodologies and the timing of the goodwill impairment charge during 2020. Our audit procedures to address the critical audit matter included: · Testing the effectiveness of controls over management’s goodwill impairment test including: o Management’s review of the reasonableness and accuracy of the Company’s prospective financial information used in the discounted cash flow methodology associated with each quarterly impairment analysis. o Management’s evaluation of key assumptions used by a third-party valuation specialist, including discount rate, terminal growth rate, control premium and allocated weightings incorporated into the methodologies used to determine fair value associated with each quarterly impairment analysis. · Substantively testing management’s process, including evaluating their judgements and assumptions, for estimating fair value which included: o Evaluation of key financial data for accuracy, including comparison of prospective financial information to the Company’s strategic plan for the second and third quarter analysis. o Evaluation of management’s ability to reasonably forecast cash flows by comparing actual results to management’s historical forecasts for the second and third quarter analysis. o Utilization of auditor employed valuation specialist to evaluate appropriateness of valuation methodologies, discount rate, control premium, overall reasonableness of the fair value for the second and third quarter’s analysis. o Evaluation of management’s weighting allocation to each valuation methodology tested. /s/ Crowe LLP We have served as the Company's auditor since 2019. Washington, D.C. March 12, 2021 143 REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM To the Board of Directors and Shareholders Carter Bankshares, Inc. (as successor to Carter Bank & Trust) Martinsville, Virginia Opinion on the Financial Statements We have audited the accompanying consolidated statements of income, comprehensive income (loss), changes in shareholders' equity and cash flows for the year ended December 31, 2018, (collectively, the financial statements) of Carter Bankshares, Inc. and subsidiaries (as successor to Carter Bank & Trust and subsidiaries), the Company. In our opinion, the financial statements present fairly, in all material respects the results of its operations and its cash flows for the year ended December 31, 2018, in conformity with accounting principles generally accepted in the United States of America. Basis for Opinion These financial statements are the responsibility of the Company’s management. Our responsibility is to express an opinion on the Company’s financial statements based on our audit. We are a public accounting firm registered with the PCAOB and are required to be independent with respect to the Company in accordance with U.S. federal securities laws and the applicable rules and regulations of the Securities and Exchange Commission and the PCAOB. We conducted our audit in accordance with the standards of the PCAOB. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement, whether due to error or fraud. Our audit included performing procedures to assess the risks of material misstatement of the financial statements, whether due to error or fraud, and performing procedures that respond to those risks. Such procedures included examining, on a test basis, evidence regarding the amounts and disclosures in the financial statements. Our audit also included evaluating the accounting principles used and significant estimates made by management, as well as evaluating the overall presentation of the financial statements. We believe that our audit provides a reasonable basis for our opinion. /s/ Yount, Hyde & Barbour , P.C. We served as the Company’s auditor from 2012 to 2018. Roanoke, Virginia March 14, 2019 144 CARTER BANKSHARES, INC. AND SUBSIDIARIES ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURES None. ITEM 9A. CONTROLS AND PROCEDURES Disclosure Controls and Procedures Under the supervision and with the participation of the Company’s Chief Executive Officer (“CEO”) and Chief Financial Officer (“CFO”) (its principal executive officer and principal financial officer, respectively), management has evaluated the effectiveness of the design and operation of the Company’s disclosure controls and procedures as of December 31, 2020. In designing and evaluating the disclosure controls and procedures, management recognizes that any controls and procedures, no matter how well designed and operated, can provide only reasonable assurance of achieving the desired control objectives. We maintain disclosure controls and procedures that are designed to ensure that information required to be disclosed by us in the reports that we file or submit under the Securities Exchange Act of 1934, as amended, is recorded, processed, summarized and reported within the time periods required by the Securities and Exchange Commission, or the SEC, and that such information is accumulated and communicated to the Company’s management, including our CEO and CFO as appropriate, to allow timely decisions regarding required disclosure. Based on and as of the date of such evaluation, our CEO and CFO concluded that the design and operation of our disclosure controls and procedures were effective in all material respects, as of the end of the period covered by this Report. Management’s Report on Internal Control over Financial Reporting Our management is responsible for establishing and maintaining adequate internal control over financial reporting, (as defined in Exchange Act Rule 13a-15(f)). Our internal control over financial reporting is a process designed by or under the supervision of, our CEO and CFO to provide reasonable assurance to our management and Board of Directors regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with U.S. generally accepted accounting principles. A Company’s internal control over financial reporting includes those policies and procedures that (i) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the Company; (ii) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the Company are being made only in accordance with authorizations of management and directors of the Company; and (iii) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the Company’s assets that could have a material effect on the financial statements. Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of the effectiveness of specific controls or internal control over financial reporting overall to future periods are subject to the risk that controls may become inadequate because of changes in conditions or that the degree of compliance with the policies or procedures may deteriorate. Based on this assessment, management concludes that, as of December 31, 2020, the Company’s system of internal control over financial reporting is effective and meets the criteria of the “Internal Control Integrated Framework (2013). ”Crowe LLP, our independent registered public accounting firm, has issued a report on the effectiveness of Company’s internal control over financial reporting as of December 31, 2020, which is included herein. 145 CARTER BANKSHARES, INC. AND SUBSIDIARIES