Carter Bankshares, Inc. 10-Q

ITEM 1 – FINANCIAL STATEMENTS (continued) CONSOLIDATED STATEMENTS OF CASH FLOWS Six Months Ended June 30, (Dollars in Thousands) 2021 2020 Net Income $ 14,807 $ 8,878 Adjustments to Reconcile Net Income to Net Cash Provided by Operating Activities Provision for Credit Losses 1,939 10,271 Origination of Loans Held-for-Sale ( 414,780 ) ( 266,307 ) Proceeds From Loans Held-for-Sale 431,090 276,740 Depreciation/Amortization of Bank Premises and Equipment 3,113 3,016 Provision (Benefit) for Deferred Taxes 1,999 ( 1,159 ) Net Amortization of Securities 1,879 1,724 Tax Credit Amortization 854 544 Gains on Sales of Mortgage Loans Held-for-Sale ( 184 ) ( 64 ) Gains on Sales of Securities, net ( 5,109 ) ( 3,535 ) Write-downs of Other Real Estate Owned 3,211 70 Gains on Sales of Other Real Estate Owned, Net ( 396 ) ( 18 ) Losses on Sales and Write-downs of Bank Premises 107 71 Premiums on Branch Sales ( 506 ) — Increase in the Value of Life Insurance Contracts ( 682 ) ( 703 ) Recognition of Restricted Stock Compensation Expense 499 575 Increase in Other Assets ( 8,957 ) ( 20,138 ) Decrease in Other Liabilities ( 5,447 ) ( 1,010 ) Net Cash Provided By Operating Activities 23,437 8,955 INVESTING ACTIVITIES Securities Available-for-Sale: Proceeds from Sales 108,300 96,669 Proceeds from Maturities, Redemptions, and Pay-downs 52,183 43,534 Purchases ( 215,175 ) ( 128,688 ) Purchase of Bank Premises and Equipment, Net ( 3,248 ) ( 6,873 ) Net Cash Paid in Branch Sales ( 73,923 ) — Purchase of Federal Home Loan Bank Stock — ( 1,062 ) Redemption of Federal Home Loan Bank Stock 1,878 82 Loan Originations and Payments, net 28,891 ( 74,912 ) Payments Received on Other Real Estate Owned 230 245 Other Real Estate Owned Improvements — ( 19 ) Proceeds from Sales and Payments of Other Real Estate Owned 3,440 1,742 Net Cash Used In Investing Activities ( 97,424 ) ( 69,282 ) FINANCING ACTIVITIES Net Change in Demand, Money Markets and Savings Accounts 217,745 237,083 Decrease in Certificates of Deposits ( 164,049 ) ( 134,621 ) (Payments) Proceeds from Federal Home Loan Bank Borrowings ( 5,000 ) 25,000 Cash Dividends Paid — ( 3,689 ) Net Cash (Used In) Provided by Financing Activities 48,696 123,773 Net (Decrease) Increase in Cash and Cash Equivalents ( 25,291 ) 63,446 Cash and Cash Equivalents at Beginning of Period 241,942 125,812 Cash and Cash Equivalents at End of Period $ 216,651 $ 189,258 SUPPLEMENTARY DATA Cash Interest Paid $ 12,759 $ 20,272 Cash Paid for Income Taxes 820 240 Transfer from Loans to Other Real Estate Owned — 707 Transfer from Fixed Assets to Other Real Estate Owned 12,013 235 Security (Purchases) Settled in Subsequent Period ( 14,084 ) ( 3,225 ) Right-of-use Asset Recorded in Exchange for Lease Liabilities $ 2,027 $ — See accompanying notes to unaudited consolidated financial statements. 7 Table of Contents CARTER BANKSHARES, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS NOTE 1 – BASIS OF PRESENTATION Principles of Consolidation: The interim Consolidated Financial Statements include the accounts of Carter Bankshares, Inc. (the “Company”) and its wholly owned subsidiaries, including Carter Bank & Trust (the “Bank”). All significant intercompany transactions have been eliminated in consolidation. Basis of Presentation: The accompanying unaudited Consolidated Financial Statements have been prepared in accordance with generally accepted accounting principles (“GAAP”), in the United States for interim financial information and with the instructions to Form 10-Q and Article 10 of Regulation S-X. Accordingly, they do not include all of the information and footnotes required by GAAP for complete financial statements and should be read in conjunction with the audited Consolidated Financial Statements included in our Annual Report on Form 10-K for the year ended December 31, 2020, filed with the Securities and Exchange Commission (“SEC”), on March 12, 2021. In management’s opinion, the accompanying interim financial information reflects all adjustments, consisting of normal recurring adjustments, necessary to present fairly our financial position and the results of operations for each of the interim periods presented. Results of operations for interim periods are not necessarily indicative to the results of operations that may be expected for a full year or any future period. Reorganization: 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”). The Reorganization was completed on November 20, 2020 pursuant to an Agreement and Plan of Reorganization among the Bank, the Company and CBT Merger Sub, Inc., and the Bank survived the Reorganization as a wholly-owned subsidiary of the Company. In the Reorganization, each of the outstanding shares of the Bank’s common stock was converted into and exchanged for one newly issued share of the Company’s common stock. Reclassification: Certain reclassifications have been made to the prior period financial statements to conform to the current period presentation. Reclassifications had no material effect on prior year net income or shareholders’ equity. Use of Estimates: The preparation of financial statements in conformity with GAAP requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the consolidated financial statements and the reported amounts of revenues and expenses during the reporting period. Those estimates and assumptions affect the amounts reported in the consolidated financial statements and the disclosures provided. 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 CARES Act: In response to the COVID-19 pandemic, the Coronavirus Aid, Relief, and Economic Security Act (the “CARES Act”) was enacted on March 27, 2020. The CARES Act provided approximately $2.2 trillion in emergency economic relief measures including, among other things, loan programs for small and mid-sized businesses and other economic relief for impacted businesses and industries, including financial institutions. Many of the CARES Act’s programs depend upon the direct involvement of U.S. financial institutions and have been implemented through rules and guidance adopted by federal departments and agencies, including the U.S. Department of the Treasury, the Federal Deposit Insurance Corporation (the “FDIC”), the Board of Governors of the Federal Reserve System (“FRB”) and other federal bank regulatory authorities, including those with direct supervisory jurisdiction over the Company and the Bank. Set forth below is a brief overview of certain provisions of the CARES Act and certain other regulations and supervisory guidance related to the COVID-19 pandemic that are applicable to the operations and activities of the Company and the Bank. The following description is qualified in its entirety by reference to the full text of the CARES Act and the statutes, regulations, and policies described herein. Such statutes, regulations, and policies are subject to ongoing review by U.S. Congress and federal regulatory authorities. Future amendments to the provisions of the CARES Act or changes to any of the statutes, regulations, or regulatory policies applicable to the Company or the Bank could have a material effect on the Company and the Bank. Many of the requirements called for in the CARES Act and related regulations and supervisory guidance continue to be implemented and most are subject to implementing regulations, many of which continue to be refined by federal banking agencies. The Company and the Bank continue to assess the impact of the CARES Act and other statutes, regulations and supervisory guidance related to the COVID-19 pandemic. 8 Table of Contents CARTER BANKSHARES, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS NOTE 1 – BASIS OF PRESENTATION – (continued) Paycheck Protection Program (“PPP”) PPP is a program administered as part of the Small Business Administration’s (“SBA”) 7-A loan program. The PPP is a guaranteed, unsecured loan program created to fund certain payroll and operating costs of eligible businesses, organizations and self-employed persons during the COVID-19 pandemic. Initially, $349 billion was approved and designated for the PPP in order for the SBA to guarantee 100% of collective loans made under the program to eligible small businesses, nonprofits, veteran’s organizations, and tribal businesses. The Bank became an approved SBA 7-A lender in the second quarter of 2020. We participated in the initial round of funding through a referral relationship with a third-party, non-bank lender. When an additional $310 billion in funds were approved and designated for the PPP in April 2020, the Bank opted to set up an internal, automated loan process utilizing its core system provider. Congress enacted the Consolidated Appropriations Act, 2021 (the “CAA”) on December 27, 2020, which amended the CARES Act and included (i) the Economic Aid to Hard-Hit Small Businesses, Non-profits, and Venues Act, (ii) the COVID-Related Tax Relief Act of 2020, and (iii) the Taxpayer Certainty and Disability Relief Act of 2020. These laws include significant clarifications and modifications to the PPP, which had terminated on August 8, 2020. In particular, Congress revived PPP and allocated an additional $284 billion in the PPP funds for 2021. As a participating PPP lender, the Bank continues to monitor legislative, regulatory, and supervisory developments related thereto. Troubled Debt Restructurings (“TDRs”) and Loan Modifications for Affected Borrowers The CARES Act permits banks to suspend requirements under GAAP for certain loan modifications to borrowers affected by COVID-19 that would otherwise be characterized as TDRs and suspend any determination related thereto if (i) the loan modification is made between March 1, 2020 and the earlier of December 31, 2020 or 60 days after the end of the COVID-19 emergency declaration and (ii) the applicable loan was not more than 30 days past due as of December 31, 2019. The provisions of the CARES Act dealing with temporary relief related to TDRs were extended pursuant to the CAA which was signed into law on December 27, 2020. The CAA extended the “applicable” period to the earlier of January 1, 2022 or 60 days after the date on which the national emergency concerning the COVID-19 pandemic terminates. The federal banking agencies also issued guidance to encourage banks to make loan modifications for borrowers affected by the COVID-19 pandemic and to assure banks that they will not be criticized by examiners for making such modifications. The Bank is currently applying this guidance to qualifying loan modifications. FRB Programs and Initiatives Related to the COVID-19 Pandemic In response to COVID-19, the FRB’s Federal Open Market Committee (the “FOMC”) on March 16, 2020, set the federal funds target rate at 0-0.25%. Consistent with FRB policy, the FRB has committed to the use of overnight reverse repurchase agreements as a supplementary policy tool, as necessary, to help control the federal funds rate and keep it in the target range set by the FOMC. Newly Adopted Pronouncements in 2021: In December 2019, the Financial Accounting Standards Board (the “FASB”) issued Accounting Standards Update (“ASU”) No. 2019-12, Income Taxes (Topic 740): Simplifying the Accounting for Income Taxes. The amendments in this ASU simplifies the accounting for income taxes by removing certain exceptions and improves the consistent application of GAAP by clarifying and amending other existing guidance. The amendments in this ASU became effective on January 1, 2021 and did not have any material impact on our consolidated financial statements. In June 2016, the FASB issued ASU No. 2016-13, “Financial Instruments – Credit Losses (Topic 326): Measurement of Credit Losses on Financial Instruments”, universally referred to as Current Expected Credit Loss (“CECL”). The amendments in this ASU, among other things, require the measurement of all expected credit losses for financial assets held at the reporting date based on historical experience, current conditions, and reasonable and supportable forecasts. Financial institutions and other organizations will now use forward-looking information to better inform their credit loss estimates. Many of the loss estimation techniques applied today are still permitted, although the inputs to those techniques will change to reflect the full amount of expected credit losses. In addition, the ASU amends the accounting for credit losses on available-for-sale debt securities and purchased financial assets with credit deterioration. For periodic report filers that are not smaller reporting companies, such as the Company, this standard (Topic 326) was effective as of January 1, 2020. The Company elected to take advantage of Section 4014 of the CARES Act provision to temporarily delay adoption of the CECL methodology. The Company was subject to the adoption of the CECL accounting method under FASB ASU 2016-03 9 Table of Contents CARTER BANKSHARES, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS NOTE 1 – BASIS OF PRESENTATION – (continued) and related amendments, Financial Instruments – Credit Losses (Topic 326). The CARES Act allowed companies to defer the implementation of CECL until the earlier of when the national emergency related to the outbreak of COVID-19 ends or December 31, 2020 which was later extended to January 1, 2022. The Company adopted the CECL accounting method as of January 1, 2021 as allowed under the provisions of the CARES Act. The Bank’s CECL Committee, which includes members from Credit Administration, Accounting/Finance, Risk Management and Internal Audit, has oversight by the Chief Executive Officer, Chief Financial Officer, and Chief Credit Officer. We engaged a third-party to assist us in developing our CECL model and to assist with evaluation of data and methodologies related to this standard. As part of its process of adopting CECL, management implemented a third party software solution and determined appropriate loan segments, methodologies, model assumptions and qualitative components. Our CECL model includes portfolio loan segmentation based upon similar risk characteristics and both a quantitative and qualitative component of the calculation which incorporates a forecasting component of certain economic variables. Our implementation plan also includes the assessment and documentation of appropriate processes, policies and internal controls. Management had a third party independent consultant review and validate our CECL model. In addition, Topic 326 amends the accounting for credit losses on certain debt securities. The Company did not record any allowance for credit losses (“ACL”) on its debt securities as a result of adopting Topic 326. The ultimate impact of adopting Topic 326, and at each subsequent reporting period, is highly dependent on credit quality, macroeconomic forecasts and conditions, composition of our loans and available-for-sale securities portfolio, along with other management judgments. The Company adopted Topic 326 using the modified retrospective method. Results for reporting periods beginning after January 1, 2021 are presented under Topic 326 while prior period amounts continue to be reported in accordance with previously applicable GAAP. In connection with our adoption of Topic 326, we made changes to our loan portfolio segments to align with the methodology applied in determining the allowance under CECL. Refer to Note 5 – Allowance for Credit Losses for further discussion of these portfolio segments. Our new segmentation breaks out Other loans from our original loan segments: Commercial Real Estate (“CRE”), Commercial and Industrial (“C&I”), Residential Mortgages and Construction. Other loans include unique risk attributes considered inconsistent with current underwriting standards. The Company recorded a net decrease to retained earnings of $ 50.7 million as of January 1, 2021 for the cumulative effect of adopting Topic 326. The following table illustrates the impact of Topic 326: January 1, 2021 (Dollars in Thousands) As Reported Under Topic 326 Pre Topic 326 Impact of Topic 326 Adoption Assets Allowance for Credit Losses on Loans Commercial Real Estate $ 41,458 $ 34,871 $ 6,587 Commercial and Industrial 4,071 2,692 1,379 Obligations of States and Political Subdivisions 951 951 — Residential Mortgages 5,356 2,000 3,356 Other Consumer 1,602 2,479 ( 877 ) Construction 6,277 6,357 ( 80 ) Other 56,001 4,724 51,277 Allowance for Credit Losses on Loans $ 115,716 $ 54,074 $ 61,642 Assets: Total Loans Held for Investments, net $ 2,831,454 $ 2,893,096 $ 61,642 Net deferred tax asset 21,413 7,589 13,824 Liabilities: Life-of-loss Reserve on Unfunded Loan Commitments 3,052 144 2,908 Equity: Retained Earnings $ 203,885 $ 254,611 $ ( 50,726 ) The adoption of Topic 326 resulted in a Day 1 adjustment of $ 64.5 million, including an increase to our ACL of $ 61.6 million and a $ 2.9 million life-of-loss reserve on our unfunded loan commitments recorded in other liabilities on our 10 Table of Contents CARTER BANKSHARES, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS NOTE 1 – BASIS OF PRESENTATION – (continued) Consolidated Balance Sheets on January 1, 2021. As of January 1, 2021, the Company recorded a cumulative-effect adjustment of $ 50.7 million to decrease retained earnings related to the adoption of Topic 326. Allowance for Credit Losses Policy The ACL represents an amount which, in management's judgment, is adequate to absorb expected losses on outstanding loans at the balance sheet date based on the evaluation of the size and current risk characteristics of the loan portfolio, past events, current conditions, reasonable and supportable forecasts of future economic conditions and prepayment experience. The ACL is measured and recorded upon the initial recognition of a financial asset. The ACL is reduced by charge-offs, net of recoveries of previous losses, and is increased or decreased by a provision for credit losses, which is recorded as a current period operating expense. Determination of an appropriate ACL is inherently complex and requires the use of significant and highly subjective estimates. The reasonableness of the ACL is reviewed quarterly by management. Management believes it uses relevant information available to make determinations about the ACL and that it has established the existing allowance in accordance with GAAP. However, the determination of the ACL requires significant judgment, and estimates of expected losses in the loan portfolio can vary significantly from the amounts actually observed. While management uses available information to recognize expected losses, future additions to the ACL may be necessary based on changes in the loans comprising the portfolio, changes in the current and forecasted economic conditions, changes to the interest rate environment which may directly impact prepayment and curtailment rate assumptions, and changes in the financial condition of borrowers. The adoption of CECL accounting did not result in a significant change to any other credit risk management and monitoring processes, including identification of past due or delinquent borrowers, nonaccrual practices, assessment of troubled debt restructurings or charge-off policy. The Company’s methodology for estimating the ACL includes: Segmentation. The Company’s loan portfolio is segmented by homogeneous loan types that behave similarly to economic cycles. Specific Analysis. A specific reserve analysis is applied to certain individually evaluated loans. These loans are evaluated quarterly generally based on collateral value, observable market value or the present value of expected future cash flows. A specific reserve is established if the fair value is less than the loan balance. A charge-off is recognized when the loss is quantifiable. Individually evaluated loans, not specifically analyzed, reside in the Quantitative Analysis. Quantitative Analysis. The Company elected to use Discounted Cash Flow (“DCF”). Economic forecasts include but are not limited to unemployment, the Consumer Price Index, the Housing Price Index and Gross Domestic Product. These forecasts are assumed to revert to the long-term average and utilized in the model to estimate the probability of default and loss given default through regression. Model assumptions include, but are not limited to, the discount rate, prepayments and curtailments. The product of the probability of default and the loss given default is the estimated loss rate, which varies over time. The estimated loss rate is applied within the appropriate periods in the cash flow model to determine the net present value. Net present value is also impacted by assumptions related to the duration between default and recovery. The reserve is based on the difference between the summation of the principal balances taking amortized costs into consideration and the summation of the net present values. Qualitative Analysis. Based on management’s review and analysis of internal, external and model risks, management may adjust the model output. Management reviews the peaks and troughs of the model’s calibration, taking into account economic forecasts to develop guardrails that serve as the basis for determining the reasonableness of the model’s output and makes adjustments as necessary. This process challenges unexpected variability resulting from outputs beyond the model’s calibration that appear to be unreasonable. Additionally, management may adjust the economic forecast if it is incompatible with known market conditions based on management’s experience and perspective. At Day 1 adoption of CECL, current expected losses of $ 10.2 million were recorded due to economic uncertainties related to the Company's hospitality portfolio. Between the Day 1 CECL model and the model ended June 30, 2021, additional current expected losses of $ 1.5 million were recognized, which 11 Table of Contents CARTER BANKSHARES, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS NOTE 1 – BASIS OF PRESENTATION – (continued) resulted in a total current expected loss balance of $ 11.7 million as of June 30, 2021. Certain hospitality loans exhibit more than expected deterioration and the risk rating has been downgraded to non-pass to reflect the increased risk. “Other” Segmented Pool CECL provides for the flexibility to model loans differently compared to the Incurred Loss model. With the adoption of CECL, management elected to evaluate certain loans based on shared but unique risk attributes. The loans included in the Other segment of the model were underwritten and approved based on standards that are inconsistent with our current underwriting standards. The model for the Other segment was developed with subjective assumptions that may cause volatility driven by the following key factors: prepayment speeds, timing of contractual payments, discount rate, as well as other factors. The discount rate is reflective of the inherit risk in the Other segment. A significant change in these assumptions could cause a significant impact to the model causing volatility. Management reviews the model output for appropriateness and subjectively makes adjustments as needed. The analysis applied to this pool resulted in an increase in reserves of $ 51.3 million and is disclosed in the Other segment in the table above. Accounting Statements Issued but Not Yet Adopted: In March 2020, the FASB issued ASU No. 2020-04, Reference Rate Reform (Topic 848): Facilitation of the Effects of Reference Rate Reform on Financial Reporting. The amendments in this ASU provide optional guidance for a limited period of time to ease the potential burden in accounting for or recognizing the effects of reference rate reform on financial reporting. The amendments provide optional expedients and exceptions for applying GAAP to loan and lease agreements, derivative contracts, and other transactions affected by the anticipated transition away from the London Interbank Offered Rate (“LIBOR”) toward new interest rate benchmarks. Modified contracts that meet certain scope guidance are eligible for relief from the modification accounting requirements in US GAAP. The optional guidance generally allows for the modified contract to be accounted for as a continuation of the existing contract and does not require contract remeasurement at the modification date or reassessment of a previous accounting determination. The amendments in this ASU are effective through December 31, 2022. We are evaluating the impacts of this ASU and have not yet determined whether LIBOR transition and this ASU will have material effects on our business operations or consolidated financial statements. 12 Table of Contents CARTER BANKSHARES, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS NOTE 2 – EARNINGS PER SHARE Basic earnings per share is calculated by dividing net income available to common shareholders by the weighted average number of common shares outstanding during the period. Diluted earnings per share is calculated using the two-class method. Diluted earnings 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 per share calculations for the periods presented: Three Months Ended June 30, Six Months Ended June 30, (Dollars in Thousands, except share and per share data) 2021 2020 2021 2020 Numerator for Earnings per Share – Basic and Diluted Net Income $ 5,432 $ 4,455 $ 14,807 $ 8,878 Less: Income allocated to participating shares 25 15 69 30 Net Income Allocated to Common Shareholders $ 5,407 $ 4,440 $ 14,738 $ 8,848 Denominator: Weighted Average Shares Outstanding, including Shares Considered Participating Securities 26,466,922 26,384,957 26,437,761 26,373,803 Less: Average Participating Securities 122,818 88,528 122,818 88,528 Weighted Average Common Shares Outstanding 26,344,104 26,296,429 26,314,943 26,285,275 Earnings per Common Share – Basic $ 0.21 $ 0.17 $ 0.56 $ 0.34 Earnings per Common Share – Diluted $ 0.21 $ 0.17 $ 0.56 $ 0.34 All outstanding unvested restricted stock awards are considered participating securities for the earnings per share calculation. As such, these shares have been allocated to a portion of net income and are excluded from the diluted earnings per share calculation. NOTE 3 - INVESTMENT SECURITIES The following tables present the amortized cost and fair value of available-for-sale securities as of the dates presented: June 30, 2021 (Dollars in Thousands) Amortized Cost Gross Unrealized Gains Gross Unrealized Losses Fair Value U.S. Treasury Securities $ 4,438 $ 27 $ ( 25 ) $ 4,440 U.S. Government Agency Securities 3,445 32 — 3,477 Residential Mortgage-Backed Securities 62,074 276 ( 456 ) 61,894 Commercial Mortgage-Backed Securities 2,134 111 — 2,245 Asset Backed Securities 137,926 816 ( 536 ) 138,206 Collateralized Mortgage Obligations 255,808 4,407 ( 405 ) 259,810 Small Business Administration 102,392 941 ( 659 ) 102,674 States and Political Subdivisions 221,818 8,544 ( 628 ) 229,734 Corporate Notes 40,750 382 ( 74 ) 41,058 Total Debt Securities $ 830,785 $ 15,536 $ ( 2,783 ) $ 843,538 13 Table of Contents CARTER BANKSHARES, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS NOTE 3 – INVESTMENT SECURITIES (continued) 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 The Company did no t have securities classified as held-to-maturity at June 30, 2021 or December 31, 2020. The following table shows the composition of gross and net realized gains and losses for the periods presented: Three Months Ended June 30, Six Months Ended June 30, (Dollars in Thousands) 2021 2020 2021 2020 Proceeds from Sales of Securities Available-for-Sale $ 43,430 $ 42,167 $ 108,300 $ 96,669 Gross Realized Gains $ 1,565 $ 2,354 $ 5,194 $ 3,571 Gross Realized Losses ( 66 ) ( 33 ) ( 85 ) ( 36 ) Net Realized Gains 1,499 2,321 5,109 3,535 Tax Impact $ 318 $ 487 $ 1,076 $ 742 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. The net realized gains are included in noninterest income as gains on sales of securities, net in the Consolidated Statements of Income. The tax impact is included in income tax provision in the Consolidated Statements of Income. The amortized cost and fair value of available-for-sale debt securities are shown below by contractual maturity as of the date presented. 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. June 30, 2021 (Dollars in Thousands) Amortized Cost Fair Value Due in One Year or Less $ 1,157 $ 1,164 Due after One Year through Five Years 3,492 3,519 Due after Five Years through Ten Years 166,435 168,538 Due after Ten Years 201,759 208,162 Residential Mortgage-Backed Securities 62,074 61,894 Commercial Mortgage-Backed Securities 2,134 2,245 Collateralized Mortgage Obligations 255,808 259,810 Asset Backed Securities 137,926 138,206 Total Debt Securities $ 830,785 $ 843,538 At June 30, 2021 and December 31, 2020, 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 $ 145.9 million at June 30, 2021 and $ 146.0 million at December 31, 2020. 14 Table of Contents CARTER BANKSHARES, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS NOTE 3 – INVESTMENT SECURITIES (continued) Available-for-sale securities with unrealized losses at June 30, 2021 and December 31, 2020, aggregated by investment category and length of time the individual securities have been in a continuous unrealized loss position, were as follows: June 30, 2021 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 U.S. Treasury Securities 1 $ 2,430 $ ( 25 ) — $ — $ — 1 $ 2,430 $ ( 25 ) Residential Mortgage-Backed Securities 13 39,144 ( 454 ) 3 27 ( 2 ) 16 39,171 ( 456 ) Asset Backed Securities 9 21,883 ( 100 ) 20 41,153 ( 436 ) 29 63,036 ( 536 ) Collateralized Mortgage Obligations 12 37,980 ( 257 ) 8 18,538 ( 148 ) 20 56,518 ( 405 ) Small Business Administration 5 7,885 ( 196 ) 58 26,895 ( 463 ) 63 34,780 ( 659 ) States and Political Subdivisions 27 34,467 ( 602 ) 2 696 ( 26 ) 29 35,163 ( 628 ) Corporate Notes 5 12,426 ( 74 ) — — — 5 12,426 ( 74 ) Total Debt Securities 72 $ 156,215 $ ( 1,708 ) 91 $ 87,309 $ ( 1,075 ) 163 $ 243,524 $ ( 2,783 ) 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 ) The Company adopted Topic 326, Financial Instruments—Credit Losses (Topic 326) on January 1, 2021 and did no t record an ACL on its investment securities during the quarter ended June 30, 2021 as the Company did no t have securities classified as held-to-maturity at June 30, 2021. The Company regularly reviews debt securities for expected credit loss using both qualitative and quantitative criteria, as necessary, based on the composition of the portfolio at period end. Securities are evaluated for other-than-temporary impairment (“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 June 30, 2021 and December 31, 2020, no OTTI has been identified for any investment securities in our portfolio. We do not believe any individual unrealized loss as of June 30, 2021 represents an OTTI. At June 30, 2021, there were 163 securities in an unrealized loss position and at December 31, 2020, there were 168 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. We generally do not intend to sell and it is not more likely than not that we will be required to sell any of the securities in an unrealized loss position before recovery of their amortized cost. 15 Table of Contents CARTER BANKSHARES, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS NOTE 4 – LOANS AND LOANS HELD-FOR-SALE The composition of the loan portfolio by dollar amount is shown in the table below: (Dollars in Thousands) June 30, 2021 December 31, 2020 Commercial Commercial Real Estate $ 1,337,792 $ 1,453,799 Commercial and Industrial 413,842 557,164 Total Commercial Loans 1,751,634 2,010,963 Consumer Residential Mortgages 425,642 472,170 Other Consumer 43,336 57,647 Total Consumer Loans 468,978 529,817 Construction 320,885 406,390 Other (1) 375,157 — Total Portfolio Loans $ 2,916,654 $ 2,947,170 Loans Held-for-Sale $ 9,311 $ 25,437 Loans Held-for-Sale in Connection with Sale of Bank Branches, at the lower of cost or fair value $ — $ 9,835 Total Loans $ 2,925,965 $ 2,982,442 (1) Refer to Note 1, Basis of Presentation for details of reclassification of our portfolio segments related to the adoption of ASU 2016-13 Financial Instruments - Credit Losses (Topic 326): Measurement of Credit Losses on Financial Instruments. We attempt to limit our exposure to credit risk by diversifying our loan portfolio by segment, geography, collateral and industry and actively managing concentrations. When concentrations exist in certain segments, this risk is mitigated by reviewing the relevant economic indicators and internal risk rating trends 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. We also have policy limits on loan-to-cost for construction projects. Unsecured loans pose higher risk for the Company due to the lack of a well-defined secondary source of repayment. Commercial unsecured loans are reserved for the best quality customers with well-established businesses, operate with low financial and operating leverage. 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. The Company provided deferrals to customers under Section 4013 of the CARES Act and regulatory interagency statements on loan modifications, which suspends the requirement to categorize these deferrals as TDRs. The Part I program was launched in March 2020 and expired at the end of August 2020. The deferrals in Part I typically provided deferral of both principal and interest through the expiry. The Part II program was launched in July 2020 and expired at the end of December 2020. The deferrals in this program were needs based and required the collection of updated financial information and in certain situations, the validation of liquidity to support the business. Prior to the extension of the CARES Act, the Company launched the Part III program that offered borrowers in the Part II program an extension of deferrals through June 2021. Those borrowers who opted into the Part III program were required to provide monthly financial statements and remit payments on a quarterly basis based on excess cash flows, if any, up to their otherwise contractual payment. The majority of deferrals in the Part III program were principal only deferrals. At the end of the deferral period in Part III, which expired at June 30, 2021, for term loans, payments were applied to accrued interest first and resumed principal payments once accrued interest was current. Deferred principal is due at maturity. For interest only loans, such as lines of credit, deferred interest was due at maturity. The expiration of the Part III program as of June 30, 2021 marked the end of any payment deferral programs for the Company. 16 Table of Contents CARTER BANKSHARES, INC. NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS NOTE 4 – LOANS AND LOANS HELD-FOR-SALE (continued) In connection with our adoption of Topic 326, we made changes to our loan portfolio segments to align with the methodology applied in determining the allowance under CECL. Our new segmentation breaks out Other loans from our original loan segments: CRE, C&I, Construction and Residential Mortgages. At March 31, 2021 related to the adoption of Topic 326, the initial break-out of other loans totaled $ 373.4 million consisting of loans that would otherwise have been included in the following loan segments: $ 136.3 million of CRE, $ 77.8 million of C&I, $ 49.6 million of Residential Mortgages and $ 109.7 million of Construction. This segment of loans includes unique risk attributes considered inconsistent with current underwriting standards. The analysis applied to the Other loans segment, at adoption, resulted in an increase in current expected credit losses of $ 51.3 million. Deferred costs and fees included in the portfolio balances above were $ 2.9 million and $ 3.0 million at June 30, 2021 and December 31, 2020, respectively. Discounts on purchased 1-4 family loans included in the portfolio balances above were $ 205 thousand and $ 219 thousand at June 30, 2021 and December 31, 2020, respectively. Mortgage loans held-for-sale were $ 9.3 million and $ 25.4 million as of June 30, 2021 and December 31, 2020, respectively. In addition to mortgage loans held-for-sale, the Company had $ 9.8 million in loans held-for-sale in connection with the sale of bank branches at December 31, 2020, that closed in the second quarter of 2021. Troubled Debt Restructurings (“TDR”) The following table summarizes the Company’s TDRs as of the dates presented: June 30, 2021 December 31, 2020 (Dollars in Thousands) Performing TDRs Nonperforming TDRs Total TDRs Performing TDRs Nonperforming TDRs Total TDRs Commercial Commercial Real Estate $ 6,107 $ 146 $ 6,253 $ 6,151 $ 21,667 $ 27,818 Commercial and Industrial — — — — — — Total Commercial TDRs 6,107 146 6,253 6,151 21,667 27,818 Consumer Residential Mortgages — — — 50,618 — 50,618 Other Consumer — — — — — — Total Consumer TDRs — — — 50,618 — 50,618 Construction 541 3,071 3,612 52,481 3,319 55,800 Other 99,566 — 99,566 — — — Total TDRs (1) $ 106,214 $ 3,217 $ 109,431 $ 109,250 $ 24,986 $ 134,236 (1) Refer to Note 1, Basis of Presentation for details of reclassification of our portfolio segments related to the adoption of ASU 2016-13 Financial Instruments - Credit Losses (Topic 326): Measurement of Credit Losses on Financial Instruments. 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. As of June 30, 2021, there were minimal commitments to lend additional funds for loans identified as TDRs. TDRs decreased $ 24.8 million, or 18.5 % to $ 109.4 million at June 30, 2021 compared to December 31, 2020. The Company received $ 13.6 million and $ 16.6 million of pay-downs and had no new additions for the three and six months ended June 30, 2021, respectively. The $ 24.8 million of pay-downs included $ 8.2 million in charge-offs for the resolution of our two largest nonperforming credits. There were no new TDRs for the three and six months ended June 30, 2021. TDRs of $ 3.2 million and $ 25.0 million were nonaccrual as of June 30, 2021 and December 31, 2020, respectively. During the six months ended June 30, 2021, the Company modified no loans that constituted a TDR that had minimal commitments to lend additional funds. The Company had one consumer automobile loan modified as a TDR during the three and six months ended June 30, 2020. The customer was experiencing financial difficulties, but sold the vehicle and the proceeds from that sale were applied to the loan balance. The remaining balance was charged-off, but the loan has been re-amortized for the customer to repay the balance by the end of 2021. 17 Table of Contents CARTER BANKSHARES, INC. NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS NOTE 4 – LOANS AND LOANS HELD-FOR-SALE (continued) There were no TDR payment defaults during the three and six months ended June 30, 2021. 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 June 30, 2021 and December 31, 2020, we had $ 3.2 million and $ 25.0 million, respectively, in loans modified as TDRs that had experienced a payment default subsequent to the rework date and were classified as nonperforming. The specific reserve portion of the ACL 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 ACL or charges off the individually evaluated loan balance if it determines that such amount is a confirmed loss. This method is used consistently for all segments of the portfolio. The following table presents nonperforming assets as of June 30, 2021 and December 31, 2020. Nonperforming Assets (Dollars in Thousands) June 30, 2021 December 31, 2020 Nonperforming Assets Nonaccrual loans $ 6,351 $ 7,018 Nonaccrual TDRs 3,217 24,986 Total Nonaccrual Loans 9,568 32,004 Other Real Estate Owned, or (“OREO”) 21,250 15,722 Total Nonperforming Assets $ 30,818 $ 47,726 As of June 30, 2021 and December 31, 2020, we had $ 15 thousand and $ 67 thousand, respectively, of residential real estate in the process of foreclosure. We also had $ 57 thousand at June 30, 2021 and $ 109 thousand at December 31, 2020 in residential real estate included in OREO. NOTE 5 – ALLOWANCE FOR CREDIT LOSSES The Company maintains an ACL at a level determined to be adequate to absorb current expected credit losses over the life of loans inherent in the loan portfolio as of the balance sheet date. Refer to Note 1, Basis of Presentation for details of reclassification of our portfolio segments related to the adoption of ASU 2016-13 Financial Instruments - Credit Losses (Topic 326): Measurement of Credit Losses on Financial Instrument. The Company develops and documents a systematic ACL methodology based on the following portfolio segments: 1) CRE, 2) C&I, 3) Residential Mortgages, 4) Other Consumer, 5) Construction and 6) Other. The Company’s loan portfolio is segmented by homogeneous loan types that behave similarly to economic cycles. The segmentation in the CECL model is different from the segmentation in the Incurred Loss model. The following is a discussion of the key risks by portfolio segment that management assesses in preparing the ACL. CRE loans are secured by commercial purpose real estate, including both owner occupied properties and investment properties, for various purposes such as hotels, strip malls and apartments. Operations of the individual projects as well as global cash flows of the debtors are the primary sources of repayment for these loans. The condition of the local economy is an important indicator of risk, but there are also more specific risks depending on the collateral type as well as the business. C&I loans are made to operating companies or manufacturers for the purpose of production, operating capacity, accounts receivable, inventory or equipment financing. Cash flow from the operations of the borrower is the primary source of repayment for these loans. The condition of the local economy is an important indicator of risk, but there are also more specific risks depending on the industry of the borrower. Collateral for these types of loans often do not have sufficient value in a distressed or liquidation scenario to satisfy the outstanding debt. These loans are also made to local and state municipalities for various purposes including refinancing existing obligations, infrastructure up-fit and expansion, or to purchase new equipment. These 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. 18 Table of Contents CARTER BANKSHARES, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS NOTE 5 – ALLOWANCE FOR CREDIT LOSSES (continued) 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 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. Other 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. Construction loans include both commercial and consumer. Commercial 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. Consumer 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. Other loans include unique risk attributes considered inconsistent with our current underwriting standards. The ACL reserve for the Other segment is based on a discounted cash flow methodology and reserves will fluctuate based on expected cash flow changes in the future. These inconsistencies may include, but are not limited to i) transaction and/or relationship sizes that exceed limits established in 2018, ii) overreliance on secondary, tertiary or guarantor cash flow, iii) land acquisition loans without a defined source of amortization, and iv) loan structures on operating lines of credit dependent on the value of real estate rather than trading assets. Management continuously assesses underwriting standards, but significantly enhanced these standards in 2018. Our model is based on our best estimate of facts known with the most current information. Certain portions of the CECL model are inherently subjective and include, but are not limited to estimates with respect to: prepayment speeds, the timing of prepayments, potential losses given default, discount rates and the timing of future cash flows. Management utilizes widely published economic forecasts as the basis for the regression analysis used to estimate the probability of default in the baseline model. The peaks and troughs of these forecasts serve as guardrails for potential subjective adjustments. In addition to considering the outcomes based on the range of forecasts, management recognizes that the assumptions used in economic forecasts may not perfectly align with our market area, risk profile or unique attributes of our portfolio along with other important considerations. Severe changes in forecasts can also create significant variability and management must assess not only the absolute balance of reserves but also consider the appropriateness of the velocity of change. Therefore, management developed a framework to assess the tolerance and reasonableness of the CECL modeling process by challenging certain elements of the forecasts, when appropriate. These outcomes, known as “challenger models” provide opportunities to examine and subjectively adjust the CECL model output and are designed to be counter cyclical, thereby reducing variability. 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 has a loan review policy and annual scope report that details the level of loan review for commercial loans in a given year. Primary objectives of loan reviews include the identification of emerging risks and patterns that might influence potential future losses. In concert with significant enhancements to the underwriting process, the scope of loan review has been broadened since 2019 to include assurance testing with respect to the accuracy of the underwriting function. Since 2020 and continuing into 2021, the Company used a four step approach for loan review in the following categories: 19 Table of Contents CARTER BANKSHARES, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS NOTE 5 – ALLOWANCE FOR CREDIT LOSSES (continued) • A review of the largest twenty pass-rated loan relationships, which represents approximately a quarter of total loans; • A sampling of new loans originated to include an examination of the evidence of appropriate approval, adherence to loan policy and the completeness and accuracy of the analysis contained in the approval document; • A sampling of Large Loan Relationships (“LLRs”) which are defined as loan relationships with aggregate exposure of at least $ 2.0 million that are not part of the top twenty review; and • Concentration focus reviews of identified segments that represent concentration risk, represented by collateral types including but not limited to hospitality, multifamily and retail with the goal of examining patterns of loss history, document exceptions, policy exceptions and emerging trends in risk characteristics. The Company’s internally assigned grades are as follows: Pass – The Company uses six grades of pass. Generally, a pass rating indicates that 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 classified 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. 20 Table of Contents CARTER BANKSHARES, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS NOTE 5 – ALLOWANCE FOR CREDIT LOSSES (continued) The following table presents loan balances by year of origination and internally assigned risk rating for our portfolio segments as of June 30, 2021: Risk Rating (Dollars in Thousands) 2021 2020 2019 2018 2017 2016 and Prior Revolving Total Commercial Real Estate Pass $ 58,201 $ 161,432 $ 196,469 $ 330,423 $ 118,980 $ 354,304 $ 52,651 $ 1,272,460 Special Mention — — 5,852 8,143 3,046 931 — 17,972 Substandard 230 — 471 4,553 34,889 7,217 — 47,360 Total Commercial Real Estate $ 58,431 $ 161,432 $ 202,792 $ 343,119 $ 156,915 $ 362,452 $ 52,651 $ 1,337,792 Commercial and Industrial Pass $ 25,615 $ 58,536 $ 14,819 $ 37,315 $ 23,016 $ 241,028 $ 12,815 $ 413,144 Special Mention — 10 — 13 — — — 23 Substandard — — 455 220 — — — 675 Total Commercial and Industrial $ 25,615 $ 58,546 $ 15,274 $ 37,548 $ 23,016 $ 241,028 $ 12,815 $ 413,842 Residential Mortgages Pass $ 74,684 $ 98,690 $ 79,166 $ 95,260 $ 8,937 $ 53,540 $ 10,896 $ 421,173 Special Mention — — — — — 570 — 570 Substandard — — 1,193 822 225 1,659 — 3,899 Total Residential Mortgages $ 74,684 $ 98,690 $ 80,359 $ 96,082 $ 9,162 $ 55,769 $ 10,896 $ 425,642 Other Consumer Pass $ 4,314 $ 13,420 $ 1,803 $ 794 $ 272 $ 22,268 $ 341 $ 43,212 Special Mention — — — — — — — — Substandard — 19 1 68 36 — — 124 Total Other Consumer $ 4,314 $ 13,439 $ 1,804 $ 862 $ 308 $ 22,268 $ 341 $ 43,336 Construction Pass $ 75,794 $ 104,595 $ 85,487 $ 10,913 $ 16,658 $ 4,337 $ 17,172 $ 314,956 Special Mention — — 179 — — 442 — 621 Substandard — 107 3,223 97 1,741 140 — 5,308 Total Construction $ 75,794 $ 104,702 $ 88,889 $ 11,010 $ 18,399 $ 4,919 $ 17,172 $ 320,885 Other Pass $ — $ — $ — $ — $ — $ 4,659 $ 219 $ 4,878 Special Mention — — — — 122,895 61,651 — 184,546 Substandard — — — 88,345 48,524 48,864 — 185,733 Total Other Loans $ — $ — $ — $ 88,345 $ 171,419 $ 115,174 $ 219 $ 375,157 Total Portfolio Loans Pass $ 238,608 $ 436,673 $ 377,744 $ 474,705 $ 167,863 $ 680,136 $ 94,094 $ 2,469,823 Special Mention — 10 6,031 8,156 125,941 63,594 — 203,732 Substandard 230 126 5,343 94,105 85,415 57,880 — 243,099 Total Portfolio Loans $ 238,838 $ 436,809 $ 389,118 $ 576,966 $ 379,219 $ 801,610 $ 94,094 $ 2,916,654 21 Table of Contents CARTER BANKSHARES, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS NOTE 5 – ALLOWANCE FOR CREDIT LOSSES (continued) The following table presents loan balances by year of origination and performing and nonperforming status for our portfolio segments as of June 30, 2021. (Dollars in Thousands) 2021 2020 2019 2018 2017 2016 and Prior Revolving Total Commercial Real Estate Performing $ 58,201 $ 161,432 $ 202,321 $ 343,119 $ 156,915 $ 362,375 $ 52,651 $ 1,337,014 Nonperforming 230 — 471 — — 77 — 778 Total Commercial Real Estate $ 58,431 $ 161,432 $ 202,792 $ 343,119 $ 156,915 $ 362,452 $ 52,651 $ 1,337,792 Commercial and Industrial Performing $ 25,615 $ 58,546 $ 14,820 $ 37,328 $ 23,016 $ 241,028 $ 12,815 $ 413,168 Nonperforming — — 454 220 — — — 674 Total Commercial and Industrial $ 25,615 $ 58,546 $ 15,274 $ 37,548 $ 23,016 $ 241,028 $ 12,815 $ 413,842 Residential Mortgages Performing $ 74,684 $ 98,690 $ 79,165 $ 95,727 $ 8,937 $ 54,702 $ 10,896 $ 422,801 Nonperforming — — 1,194 355 225 1,067 — 2,841 Total Residential Mortgages $ 74,684 $ 98,690 $ 80,359 $ 96,082 $ 9,162 $ 55,769 $ 10,896 $ 425,642 Other Consumer Performing $ 4,314 $ 13,427 $ 1,804 $ 794 $ 298 $ 22,268 $ 341 $ 43,246 Nonperforming — 12 — 68 10 — — 90 Total Other Consumer $ 4,314 $ 13,439 $ 1,804 $ 862 $ 308 $ 22,268 $ 341 $ 43,336 Construction Performing $ 75,794 $ 104,595 $ 85,666 $ 11,010 $ 16,658 $ 4,805 $ 17,172 $ 315,700 Nonperforming — 107 3,223 — 1,741 114 — 5,185 Total Construction $ 75,794 $ 104,702 $ 88,889 $ 11,010 $ 18,399 $ 4,919 $ 17,172 $ 320,885 Other Performing $ — $ — $ — $ 88,345 $ 171,419 $ 115,174 $ 219 $ 375,157 Nonperforming — — — — — — — — Total Other Loans $ — $ — $ — $ 88,345 $ 171,419 $ 115,174 $ 219 $ 375,157 Total Portfolio Loans Performing $ 238,608 $ 436,690 $ 383,776 $ 576,323 $ 377,243 $ 800,352 $ 94,094 $ 2,907,086 Nonperforming 230 119 5,342 643 1,976 1,258 — 9,568 Total Portfolio Loans $ 238,838 $ 436,809 $ 389,118 $ 576,966 $ 379,219 $ 801,610 $ 94,094 $ 2,916,654 22 Table of Contents CARTER BANKSHARES, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS NOTE 5 – ALLOWANCE FOR CREDIT LOSSES (continued) The following table presents the aging of the amortized cost basis in past due loans for our portfolio segments as of June 30, 2021 and December 31, 2020: June 30, 2021 (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 $ 1,331,082 $ 80 $ 5,852 $ 5,932 $ 778 $ 1,337,792 Commercial and Industrial 413,044 31 93 124 674 413,842 Residential Mortgages 422,296 505 — 505 2,841 425,642 Other Consumer 42,919 207 120 327 90 43,336 Construction 315,684 16 — 16 5,185 320,885 Other 375,157 — — — — 375,157 Total (1) $ 2,900,182 $ 839 $ 6,065 $ 6,904 $ 9,568 $ 2,916,654 (1) Refer to Note 1, Basis of Presentation for details of reclassification of our portfolio segments related to the adoption of ASU 2016-13 Financial Instruments - Credit Losses (Topic 326): Measurement of Credit Losses on Financial Instruments. 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 and Industrial 556,324 194 190 384 456 557,164 Construction 400,775 193 91 284 5,331 406,390 Residential Mortgages 466,688 1,347 — 1,347 4,135 472,170 Other Consumer 56,890 278 295 573 184 57,647 Total $ 2,908,769 $ 5,499 $ 905 $ 6,404 $ 31,997 $ 2,947,170 The following table presents loans on nonaccrual status and loans past due 90 days or more and still accruing by class of loan as of June 30, 2021. For the three and six months ended June 30, 2021, the amount of interest income on nonaccrual loans was immaterial. There were no loans at June 30, 2021 that were past due more than 90 days and still accruing. June 30, 2021 (Dollars in Thousands) Beginning of Period Nonaccrual End of Period Nonaccrual Nonaccrual With No Related Allowance Past Due 90+ Days Still Accruing Commercial Real Estate $ 21,891 $ 778 $ 146 $ — Commercial and Industrial 456 674 — — Residential Mortgages 4,135 2,841 — — Other Consumer 184 90 — — Construction 5,331 5,185 3,073 — Other — — — — Total Portfolio Loans $ 31,997 $ 9,568 $ 3,219 $ — A loan is considered impaired when it is transferred to nonaccrual status, or remains on accrual status but is considered a TDR. Impaired loans with a commitment of $ 1.0 million or more are individually evaluated. During the three and six months ended June 30, 2021, no material amount of interest income was recognized on individually evaluated loans subsequent to their classification as individually evaluated loans. 23 Table of Contents CARTER BANKSHARES, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS NOTE 5 – ALLOWANCE FOR CREDIT LOSSES (continued) The following table presents the amortized cost basis of individually evaluated loans as of June 30, 2021. Changes in the fair value of the collateral for individually evaluated loans are reported as credit loss expense or a reversal of credit loss expense in the period of change. June 30, 2021 Type of Collateral (Dollars in Thousands) Real Estate Commercial Real Estate $ 3,208 Commercial and Industrial — Residential Mortgages — Other Consumer — Construction 4,811 Other — Total $ 8,019 The following table presents activity in the ACL and ALL for the three and six months ended June 30, 2021 and June 30, 2020, respectively: Three Months Ended June 30, 2021 (Dollars in Thousands) Commercial Real Estate Commercial and Industrial Residential Mortgage Other Consumer Construction Other (1) Total Allowance for Credit Losses on Loans: Balance at Beginning of Period $ 42,342 $ 4,905 $ 5,171 $ 1,347 $ 7,106 $ 56,001 $ 116,872 Provision for Credit Losses on Loans ( 6,103 ) ( 185 ) 217 269 1,039 5,730 967 Charge-offs ( 8,238 ) ( 7 ) ( 22 ) ( 539 ) — — ( 8,806 ) Recoveries 140 1 1 144 — — 286 Net (Charge-offs) / Recoveries ( 8,098 ) ( 6 ) ( 21 ) ( 395 ) — — ( 8,520 ) Balance at End of Period $ 28,141 $ 4,714 $ 5,367 $ 1,221 $ 8,145 $ 61,731 $ 109,319 (1) In connection with our adoption of Topic 326, we made changes to our loan portfolio segments to align with the methodology applied in determining the allowance under CECL. Our new segmentation breaks out Other loans from our original loan segments: CRE, C&I , residential mortgages and construction. The allowance balance at the beginning of period was reclassified to Other from their original loan segments: CRE, C&I, residential mortgages and construction to conform to current presentation. Six Months Ended June 30, 2021 (Dollars in Thousands) Commercial Real Estate Commercial and Industrial Residential Mortgage Other Consumer Construction Other (1) Total Allowance for Credit Losses on Loans: Balance at Beginning of Period $ 34,871 $ 3,643 $ 2,000 $ 2,479 $ 6,357 $ 4,724 $ 54,074 Impact of CECL Adoption 6,587 1,379 3,356 ( 877 ) ( 80 ) 51,277 61,642 Provision for Credit Losses on Loans ( 5,219 ) ( 302 ) 61 747 1,807 5,730 2,824 Charge-offs ( 8,238 ) ( 8 ) ( 217 ) ( 1,409 ) — — ( 9,872 ) Recoveries 140 2 167 281 61 — 651 Net (Charge-offs) / Recoveries ( 8,098 ) ( 6 ) ( 50 ) ( 1,128 ) 61 — ( 9,221 ) Balance at End of Period $ 28,141 $ 4,714 $ 5,367 $ 1,221 $ 8,145 $ 61,731 $ 109,319 (1) In connection with our adoption of Topic 326, we made changes to our loan portfolio segments to align with the methodology applied in determining the allowance under CECL. Our new segmentation breaks out Other loans from our original loan segments: CRE, C&I , residential mortgages and construction. The allowance balance at the beginning of period was reclassified to Other from their original loan segments: CRE, C&I, residential mortgages and construction to conform to current presentation. 24 Table of Contents CARTER BANKSHARES, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS NOTE 5 – ALLOWANCE FOR CREDIT LOSSES (continued) Three Months Ended June 30, 2020 (Dollars in Thousands) Commercial Real Estate Commercial and Industrial Construction Residential Mortgage Other Consumer Total Allowance for Loan Losses on Loans: Balance at Beginning of Period $ 26,073 $ 3,990 $ 7,334 $ 1,811 $ 3,734 $ 42,942 Provision for Loan Losses on Loans 2,513 848 1,043 390 679 5,473 Charge-offs ( 40 ) ( 8 ) — ( 15 ) ( 1,094 ) ( 1,157 ) Recoveries — 1 — — 146 147 Net (Charge-offs) / Recoveries ( 40 ) ( 7 ) — ( 15 ) ( 948 ) ( 1,010 ) Balance at End of Period $ 28,546 $ 4,831 $ 8,377 $ 2,186 $ 3,465 $ 47,405 Six Months Ended June 30, 2020 (Dollars in Thousands) Commercial Real Estate Commercial and Industrial Construction Residential Mortgage Other Consumer Total Allowance for Loan Losses on Loans: Balance at Beginning of Period $ 24,706 $ 3,601 $ 5,420 $ 1,736 $ 3,299 $ 38,762 Provision for Loan Losses on Loans 3,173 1,274 2,957 470 2,397 10,271 Charge-offs ( 40 ) ( 46 ) — ( 20 ) ( 2,621 ) ( 2,727 ) Recoveries 707 2 — — 390 1,099 Net Recoveries / (Charge-offs) 667 ( 44 ) — ( 20 ) ( 2,231 ) ( 1,628 ) Balance at End of Period $ 28,546 $ 4,831 $ 8,377 $ 2,186 $ 3,465 $ 47,405 The adoption of Topic 326 resulted in an increase to our ACL of $ 61.6 million on January 1, 2021. The Day 1 model introduced a segmented pool of loans for discrete analysis. This segmented pool had an aggregate principal balance of $ 373.4 million at March 31, 2021, the initial break-out, and included unique risk attributes considered inconsistent with current underwriting standards. The analysis applied to this pool resulted in an increase in expected credit losses of $ 51.3 million, at adoption, and is disclosed in the Other segment in the 2021 tables below. At December 31, 2020, the aforementioned Other segment within the probable incurred loss model included $ 102.5 million of impaired loans and the remaining $ 270.9 million were not impaired and remained in their respective segments. Based on the fair value of collateral, the specific reserves on the impaired loans totaled zero and the general reserves for the remainder of these loans totaled $ 4.7 million at December 31, 2020. Our CECL methodology introduced a modified discounted cash flow methodology based on expected cash flow changes in the future for the Other segment. A significant population of the Other segment was not impaired under the probable incurred loss model and therefore not subject to a collateral dependent specific reserve analysis. For the population of the Other segment that was impaired under the incurred loss model, based on collateral values, the specific reserves totaled zero. Certain portions of the CECL model are inherently subjective and include, but are not limited to, estimates with respect to: prepayment speeds, the timing of prepayments, potential losses given default, discount rates and the timing of future cash flows. Management utilizes widely published economic forecasts as the basis for the regression analysis used to estimate the probability of default in the baseline model. The peaks and troughs of these forecasts serve as guardrails for potential subjective adjustments. In addition to considering the outcomes based on the range of forecasts, management recognizes that the assumptions used in economic forecasts may not perfectly align with our market area, risk profile or unique attributes of our portfolio along with other important considerations. Severe changes in forecasts can also create significant variability and management must assess not only the absolute balance of reserves but also consider the appropriateness of the velocity of change. Therefore, management developed a framework to assess the tolerance and reasonableness of the CECL modeling process by challenging certain elements of the forecasts, when appropriate. These outcomes, known as “challenger models,” provide opportunities to examine and subjectively adjust the CECL model output and are designed to be counter cyclical, thereby reducing variability. An expected credit loss of $ 56.0 million upon adoption, which is an increase from the $ 4.7 million under the probable incurred loss model, was established based on the discounted cash flow method with a discount rate, which was quantitatively adjusted. The ACL increased $ 55.2 million to $ 109.3 million at June 30, 2021 compared to $ 54.1 million at December 31, 2020 primarily due to the Day 1 adoption of CECL of $ 61.6 million. In the first six months of 2021, adjustments to the CECL model were made to account for additional potential deterioration in credit quality with respect to certain hospitality loans on deferral. 25 Table of Contents CARTER BANKSHARES, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS NOTE 5 – ALLOWANCE FOR CREDIT LOSSES (continued) Management reviews and analyzes the monthly operating statements of commercial clients in the deferral program. The recovery has not been as sharp as management had anticipated as observed in other hospitality credits. Hospitality loans on deferral at the end of Phase III of the deferral program, which expired on June 30, 2021, had an aggregate principal balances of $ 50.9 million, which resulted in a current expected credit loss of $ 11.7 million. The Day 1 model recognized the deterioration of loans with an aggregate principal balance of $ 42.8 million which resulted in current expected losses of $ 10.2 million as of January 1, 2021. Between the Day 1 model and the model ended June 30, 2021 a loan with a principal balance of $ 8.1 million experienced additional deterioration resulting in additional current expected losses of $ 1.5 million in the first quarter of 2021. Included in the provision for unfunded commitments for the three and six months ended June 30, 2021 was a release of $ 0.6 million and $ 0.9 million for the life-of-loss reserve for unfunded commitments. The following table presents the recorded investment in commercial loan classes by internally assigned risk ratings and loan classes by performing and nonperforming status as of June 30, 2021: June 30, 2021 (Dollars in Thousands) Commercial Real Estate Commercial and Industrial Residential Mortgage Other Consumer Construction Other Total Portfolio Loans Pass $ 1,272,460 $ 413,144 $ 421,173 $ 43,212 $ 314,956 $ 4,878 $ 2,469,823 Special Mention 17,972 23 570 — 621 184,546 203,732 Substandard 47,360 675 3,899 124 5,308 185,733 243,099 Doubtful — — — — — — — Loss — — — — — — — Total Portfolio Loans $ 1,337,792 $ 413,842 $ 425,642 $ 43,336 $ 320,885 $ 375,157 $ 2,916,654 Performing $ 1,337,014 $ 413,168 $ 422,801 $ 43,246 $ 315,700 $ 375,157 $ 2,907,086 Nonperforming 778 674 2,841 90 5,185 — 9,568 Total Portfolio Loans $ 1,337,792 $ 413,842 $ 425,642 $ 43,336 $ 320,885 $ 375,157 $ 2,916,654 Prior to the adoption of Topic 326 on January 1, 2021, we calculated our allowance for loan losses using an incurred loan loss methodology. The following tables are disclosures related to the allowance for loan losses in prior periods. The following table presents the recorded investment in commercial loan classes by internally assigned risk ratings and loan classes by performing and nonperforming status as of December 31, 2020: December 31, 2020 (Dollars in Thousands) Commercial Real Estate Commercial and Industrial Construction Residential Mortgage Other Consumer Total Portfolio Loans Pass $ 1,281,106 $ 478,536 $ 289,781 $ 415,773 $ 57,418 $ 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 $ 557,164 $ 406,390 $ 472,170 $ 57,647 $ 2,947,170 Performing $ 1,431,908 $ 556,708 $ 401,059 $ 468,035 $ 57,463 $ 2,915,173 Nonperforming 21,891 456 5,331 4,135 184 31,997 Total Portfolio Loans $ 1,453,799 $ 557,164 $ 406,390 $ 472,170 $ 57,647 $ 2,947,170 26 Table of Contents CARTER BANKSHARES, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS NOTE 5 – ALLOWANCE FOR CREDIT LOSSES (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: December 31, 2020 (Dollars in Thousands) Commercial Real Estate Commercial and Industrial Construction Residential Mortgage Other Consumer Total Allowance for Loan Losses: Individually Evaluated for Impairment $ 13,773 $ — $ 1,477 $ — $ — $ 15,250 Collectively Evaluated for Impairment 22,655 5,064 6,527 2,099 2,479 38,824 Total Allowance for Loan Losses $ 36,428 $ 5,064 $ 8,004 $ 2,099 $ 2,479 $ 54,074 Total Portfolio Loans: Individually Evaluated for Impairment $ 27,666 $ — $ 56,987 $ 50,618 $ — $ 135,271 Collectively Evaluated for Impairment 1,426,133 557,164 349,403 421,552 57,647 2,811,899 Total Portfolio Loans $ 1,453,799 $ 557,164 $ 406,390 $ 472,170 $ 57,647 $ 2,947,170 The recorded investment in loans excludes accrued interest receivable. Individually evaluated loans do not include certain TDR loans which are less than $ 1.0 million. The following table includes the recorded investment and unpaid principal balance for impaired loans with the associated allowance, if applicable, at December 31, 2020. (Dollars in Thousands) Unpaid Principal Balance Recorded Balance Specific Reserve Loans without a Specific Valuation Allowance Commercial Real Estate $ 3,236 $ 3,236 $ — Construction 55,248 55,248 — Residential Mortgages 50,618 50,618 — Loans with a Specific Valuation Allowance Commercial Real Estate 24,430 24,430 13,773 Commercial & Industrial — — — Construction 1,739 1,739 1,477 Total by Category Commercial Real Estate 27,666 27,666 13,773 Commercial & Industrial — — — Construction 56,987 56,987 1,477 Residential Mortgages 50,618 50,618 — Total Impaired Loans $ 135,271 $ 135,271 $ 15,250 27 Table of Contents CARTER BANKSHARES, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS NOTE 5 – ALLOWANCE FOR CREDIT LOSSES (continued) The following table presents the year-to-date average recorded investment and interest income recognized on individually evaluated loans for the three and six months ended June 30, 2020: June 30, 2020 Three Months Ended June 30, 2020 Six Months Ended June 30, 2020 (Dollars in Thousands) Average Investment on Impaired Loans Interest Income Recognized Interest Income Recognized Loans without a Specific Valuation Allowance Commercial Real Estate $ 3,816 $ 32 $ 64 Construction 5,247 — — Residential Mortgages — — — Loans with a Specific Valuation Allowance Commercial Real Estate 28,727 — — Commercial & Industrial 307 — — Construction 53,752 595 1,008 Residential Mortgages 52,099 428 1,048 Total by Category Commercial Real Estate 32,543 32 64 Commercial & Industrial 307 — — Construction 58,999 595 1,008 Residential Mortgages 52,099 428 1,048 Total Impaired Loans $ 143,948 $ 1,055 $ 2,120 NOTE 6 – FAIR VALUE MEASUREMENTS 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. 28 Table of Contents CARTER BANKSHARES, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS NOTE 6 – FAIR VALUE MEASUREMENTS (continued) The following are descriptions of the valuation methodologies used 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 Individually Evaluated Loans: Individually evaluated 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 loans with a specific reserve are classified as Level 3 in the fair value hierarchy. Fair value for individually evaluated loans is determined using several methods. Generally, the fair value of real estate is determined based on appraisals by qualified licensed appraisers. These appraisals may utilize a single valuation approach or a combination of approaches including comparable sales and the income approach. Adjustments are routinely made in the appraisal process by the appraisers to adjust for differences between the comparable sales and income data available. These routine adjustments are made to adjust the value of a specific property relative to comparable properties for variations in qualities such as location, size, and income production capacity relative to the subject property of the appraisal. Such adjustments are typically significant and result in a Level 3 classification of the inputs for determining fair value. Subsequent to the initial impairment date, existing individually evaluated loans are reevaluated quarterly for additional impairment and adjustments to fair value less costs to sell are made, where appropriate. For individually evaluated loans, the first stage of our impairment analysis involves 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 29 Table of Contents CARTER BANKSHARES, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS NOTE 6 – FAIR VALUE MEASUREMENTS (continued) assessment of current trends in the regional market. After thorough consideration of these factors, management will order a new appraisal. For non-individually evaluated 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 June 30, 2021 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 assets measured at fair value on a recurring basis are summarized below for the periods presented: June 30, 2021 (Dollars in Thousands) Carrying Value Quoted Prices in Active Markets for Identical Assets (Level 1) Significant Other Observable Inputs (Level 2) Significant Unobservable Inputs (Level 3) Assets Securities Available-for-Sale $ 843,538 $ 4,440 $ 825,418 $ 13,680 Derivatives 2,774 — 2,774 — Total $ 846,312 $ 4,440 $ 828,192 $ 13,680 Liabilities Derivatives $ 2,884 $ — $ 2,884 $ — Total $ 2,884 $ — $ 2,884 $ — December 31, 2020 (Dollars in Thousands) Carrying Value Quoted Prices in Active Markets for Identical Assets (Level 1) Significant Other Observable Inputs (Level 2) Significant Unobservable Inputs (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 $ — There were no transfers between Level 1 and Level 2 during the six months ended June 30, 2021 or the year ended December 31, 2020. We have invested in subordinated debt of other financial institutions. We have three securities totaling $ 13.7 million that are considered to be Level 3 securities at June 30, 2021 and two totaling $ 10.4 million at December 31, 2020. The change in the fair value of Level 3 securities available-for-sale from $ 10.4 million at December 31, 2020 to $ 13.7 million at June 30, 2021 is attributable to the calculated change in fair value as further detailed below as well as a new security in the second quarter of 2021 for $ 3.5 million. 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 30 Table of Contents CARTER BANKSHARES, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS NOTE 6 – FAIR VALUE MEASUREMENTS (continued) operations, and the institution’s core earnings ability, liquidity management platform and current on and off balance sheet interest rate risk exposures. Financial assets measured at fair value on a nonrecurring basis are summarized below for the periods presented: June 30, 2021 (Dollars in Thousands) Level 1 Level 2 Level 3 Fair Value OREO $ — $ — $ 21,250 $ 21,250 Individually Evaluated Loans $ — $ — $ 2,928 $ 2,928 December 31, 2020 (Dollars in Thousands) Level 1 Level 2 Level 3 Fair Value OREO $ — $ — $ 15,722 $ 15,722 Impaired Loans $ — $ — $ 10,919 $ 10,919 Individually evaluated loans had a net carrying amount of $ 2.9 million at June 30, 2021 with a valuation allowance of $ 1.9 million. Impaired loans had a net carrying amount of $ 10.9 million at December 31, 2020 with a valuation allowance of $ 15.3 million. OREO, which is measured at the lower of carrying or fair value less costs to sell, had a net carrying amount of $ 21.3 million as of June 30, 2021, compared with $ 15.7 million at December 31, 2020. Write-downs of $ 3.2 million were recorded on OREO for the six months ended June 30, 2021 compared to $ 0.1 million for the same period in 2020. The following table summarizes the Company’s assets that were measured at fair value on a nonrecurring basis for the periods presented: June 30, 2021 (Dollars in Thousands) Fair Value Valuation Technique Unobservable Inputs Weighted Range Average Assets Individually Evaluated Loans $ 2,698 Discounted Appraisals Estimated Selling Costs & Qualitative Adjustments 12.0 – 50.0 % 20.8 % Individually Evaluated Loans 230 Discounted Appraisals Estimated Selling Costs 20.9 % 20.9 % Total Individually Evaluated Loans $ 2,928 Other Real Estate Owned $ 9,511 Appraisals Estimated Selling Costs 6.0 – 10.0 % 6.5 % Other Real Estate Owned 1,033 Discounted Cash Flow Discount Rate 6.3 % 6.3 % Other Real Estate Owned 1,469 Internal Valuations Estimated Selling Costs 5.0 % 5.0 % Other Real Estate Owned 9,237 Discounted Internal Valuations Management’s Discount & Estimated Selling Costs 0.0 % – 50.7 % 2.4 % Total Other Real Estate Owned $ 21,250 31 Table of Contents CARTER BANKSHARES, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS NOTE 6 – FAIR VALUE MEASUREMENTS (continued) December 31, 2020 (Dollars in Thousands) Fair Value Valuation Technique Unobservable Inputs Weighted Range Average Assets 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 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 our financial instruments at June 30, 2021 and December 31, 2020 are presented in the following tables. Fair values for June 30, 2021 and December 31, 2020 are estimated under the exit price notion in accordance with ASU 2016-01, “Recognition and Measurement of Financial Assets and Financial Liabilities.” GAAP requires disclosure of fair value information about financial instruments carried at book value on the consolidated balance sheet. in cases where quoted market prices are not available, fair values are based on estimates using present value or other valuation techniques. Those techniques are significantly affected by the assumptions used, including the discount rate and estimates of future cash flows. In that regard, the derived fair value estimates cannot be substantiated by comparison to independent markets and, in many cases, could not be realized in immediate settlement of the instruments. Accordingly, the aggregate fair value amounts presented do not represent the underlying value of the Company. 32 Table of Contents CARTER BANKSHARES, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS NOTE 6 – FAIR VALUE MEASUREMENTS (continued) Fair Value Measurements at June 30, 2021 (Dollars in Thousands) Carrying Value Level 1 Level 2 Level 3 Total Financial Assets: Cash and Cash Equivalents $ 216,651 $ 41,850 $ 174,801 $ — $ 216,651 Securities Available-for-Sale 843,538 4,440 825,418 13,680 843,538 Loans Held-for-Sale 9,311 — — 9,311 9,311 Portfolio Loans, net 2,807,335 — — 2,768,885 2,768,885 Federal Home Loan Bank Stock, at Cost 3,215 — — NA NA Other Assets- Interest Rate Derivatives 2,774 — 2,774 — 2,774 Accrued Interest Receivable 31,619 17 2,998 28,604 31,619 Financial Liabilities: Deposits $ 3,659,341 $ 720,231 $ 1,481,942 $ 1,480,465 $ 3,682,638 Other Liabilities- Interest Rate Derivatives 2,884 — 2,884 — 2,884 FHLB Borrowings 30,000 — — 30,198 30,198 Accrued Interest Payable 1,691 — — 1,691 1,691 Fair Value Measurements at December 31, 2020 (Dollars in Thousands) Carrying Value Level 1 Level 2 Level 3 Total Financial Assets: 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 — — 2,854,244 2,854,244 Loans Held-for-Sale in Connection with Sale of Bank Branches, at the lower of 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 Bank 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 NOTE 7 – 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. 33 Table of Contents CARTER BANKSHARES, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS NOTE 7 – DERIVATIVE INSTRUMENTS AND HEDGING ACTIVITIES – (continued) 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 Income. The following table indicates the amounts representing the fair value of derivative assets and derivative liabilities for the periods presented: Fair Values of Derivative Instruments Asset Derivatives (Included in Other Assets) June 30, 2021 December 31, 2020 (Dollars in Thousands) 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 2 $ 327 $ 2 1 $ 151 $ — Interest Rate Swap Contracts – Commercial Loans 52 330,726 2,772 38 255,572 4,493 Total Derivatives not Designated as Hedging Instruments 54 $ 331,053 $ 2,774 39 $ 255,723 $ 4,493 Fair Values of Derivative Instruments Liability Derivatives (Included in Other Liabilities) June 30, 2021 December 31, 2020 (Dollars in Thousands) 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 2 $ 327 $ 2 1 $ 151 $ — Interest Rate Swap Contracts – Commercial Loans 52 330,726 2,882 38 255,572 4,756 Total Derivatives not Designated as Hedging Instruments 54 $ 331,053 $ 2,884 39 $ 255,723 $ 4,756 The following table indicates the income (loss) recognized in income on derivatives for the periods presented: For the Three Months Ended June 30, For the Six Months Ended June 30, (Dollars in Thousands) 2021 2020 2021 2020 Derivatives not Designated as Hedging Instruments Interest Rate Lock Commitments – Mortgage Loans $ 2 $ ( 5 ) $ 2 $ 6 Forward Sale Contracts – Mortgage Loans ( 2 ) 5 ( 2 ) ( 6 ) Interest Rate Swap Contracts – Commercial Loans ( 276 ) ( 108 ) 153 ( 199 ) Total Derivative (Loss) Income $ ( 276 ) $ ( 108 ) $ 153 $ ( 199 ) 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. 34 Table of Contents CARTER BANKSHARES, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS NOTE 7 – DERIVATIVE INSTRUMENTS AND HEDGING ACTIVITIES – (continued) 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 the dates presented: Asset Derivatives (Included in Other Assets) Liability Derivatives (Included in Other Liabilities) (Dollars in Thousands) June 30, 2021 December 31, 2020 June 30, 2021 December 31, 2020 Derivatives not Designated as Hedging Instruments Gross Amounts Recognized $ 2,772 $ 4,493 $ 2,882 $ 4,756 Gross Amounts Offset — — — — Net Amounts Presented in the Consolidated Balance Sheets 2,772 4,493 2,882 4,756 Gross Amounts Not Offset (1) — — ( 1,310 ) ( 5,220 ) Net Amount $ 2,772 $ 4,493 $ 1,572 $ ( 464 ) (1) Amounts represent collateral posted for the periods presented. 35 Table of Contents CARTER BANKSHARES, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS NOTE 8 – FEDERAL HOME LOAN BANK BORROWINGS Borrowings are an additional source of liquidity the Company. Federal Home Loan Bank, or (“FHLB”) borrowings were $ 30.0 million and $ 35.0 million at June 30, 2021 and December 31, 2020, 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 June 30, 2021 and December 31, 2020. Total loans pledged as collateral were $ 846.4 million and $ 804.2 million at June 30, 2021 and December 31, 2020, respectively. There were no securities available-for-sale pledged as collateral at both June 30, 2021 and December 31, 2020. The Company continues to methodically pledge additional eligible loans and expect continued progress in additional pledging throughout the year. The Company is eligible to borrow up to an additional $ 547.9 million based upon current qualifying collateral and has a maximum borrowing capacity of approximately $ 1.0 billion, or 25.0 % of the Company’s assets, as of June 30, 2021. The Company had the capacity to borrow up to an additional $ 510.5 million from the FHLB at December 31, 2020. The following table represents the balance of long-term borrowings and the weighted average interest rate as of the periods presented: (Dollars in Thousands) June 30, 2021 December 31, 2020 Long-term Borrowings $ 30,000 $ 35,000 Weighted Average Interest Rate 1.15 % 1.13 % Scheduled annual maturities and weighted average interest rates for FHLB borrowings for each of the five years subsequent to June 30, 2021 and thereafter are as follows: (Dollars in Thousands) Balance Weighted Average Rate 1 year $ 3,000 1.68 % 2 years 14,000 1.09 % 3 years 10,000 0.94 % 4 years 3,000 1.63 % 5 years — — % Thereafter — — % Total FHLB Borrowings $ 30,000 1.15 % NOTE 9 – COMMITMENTS AND CONTINGENCIES Commitments to extend credit, which amounted to $ 460.2 million at June 30, 2021 and $ 591.2 million at December 31, 2020, 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 $ 284.6 million, or 61.8 %, and $ 391.4 million, or 66.2 %, of the commitments to extend credit at June 30, 2021 and December 31, 2020, 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 $ 31.4 million at June 30, 2021 and $ 29.3 million at December 31, 2020. 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. Life-of-Loss Reserve on Unfunded Loan Commitments We maintain a life-of-loss reserve on unfunded commercial lending commitments and letters of credit to provide for the risk of loss inherent in these arrangements. The life-of-loss reserve is computed using a methodology similar to that used to determine the ACL for loans, modified to take into account the probability of a draw-down on the commitment. Results for reporting periods beginning after January 1, 2021 are presented under Topic 326, while prior period amounts continue to be reported in 36 Table of Contents CARTER BANKSHARES, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS other expense on our Consolidated Statements of Income. The life-of-loss reserve for unfunded commitments is included in other liabilities on our Consolidated Balance Sheets. The activity in the life-of-loss reserve on unfunded loan commitments for the three and six months ended June 30, 2021 were as follows: (Dollars in Thousands) Three Months Ended June 30, 2021 Life-of-Loss Reserve on Unfunded Loan Commitments March 31, 2021 $ 2,770 Provision for unfunded commitments ( 603 ) June 30, 2021 $ 2,167 (Dollars in Thousands) Six Months Ended June 30, 2021 Life-of-Loss Reserve on Unfunded Loan Commitments Balance at beginning of period $ 144 Impact of Adopting ASU 2016-13 2,908 January 1, 2021 $ 3,052 Provision for unfunded commitments ( 885 ) June 30, 2021 $ 2,167 Our life-of-loss reserve for unfunded commitments is determined using a methodology similar to that used to determine the ACL. Amounts are added to the provision for unfunded commitments through a charge to current earnings in the provision for unfunded commitments. The provision for unfunded commitments was a release of $ 0.9 million for the six months ended June 30, 2021. Litigation In the normal course of business, the Company is subject to various legal and administrative proceedings and claims. Legal and administrative proceedings are subject to inherent uncertainties and unfavorable rulings could occur, and the timing and outcome of any legal or administrative proceeding cannot be predicted with certainty. Other than as set forth below, as of June 30, 2021, the Company is not involved in any other material pending legal proceedings other than proceedings occurring in the ordinary course of business. On May 31, 2021, the Bank and its directors were named as defendants in a lawsuit filed in the United States District Court for the Southern District of West Virginia by James C. Justice, II, Cathy L. Justice, James C. Justice, III and various related entities that he and/or they own and control (such entities, the “Justice Entities” and collectively, the “Plaintiffs”). The allegations contained in the lawsuit relate to a series of loans (the “Loans”) made by the Bank to certain Justice Entities that are secured by collateral pledged by certain Justice Entities and are backed by personal guarantees from James C. Justice, II and Cathy L. Justice and, in certain cases, by personal guarantees from James C. Justice, III. In the lawsuit the Plaintiffs allege that the Bank (i) breached an implied covenant of good faith and fair dealing, (ii) breached fiduciary duties of care and loyalty, and (iii) violated anti-tying restrictions of the Bank Holding Company Act of 1956, as amended, and allege that the Bank’s directors aided and abetted breaches of fiduciary duties of care and loyalty by the Bank. The Plaintiffs seek monetary damages of $ 421 million, additional punitive damages and interest on damages as allowed by law, payment of costs, expenses and attorneys’ fees, and a declaratory judgment from the court that certain confessions of judgment, release and affirmation agreements, and forbearance agreements executed by the Plaintiffs in favor of the Bank and relating to the Loans and/or their origination, extension, restructuring or forbearance, are unenforceable. On July 14, 2021, the Bank filed a motion to dismiss the lawsuit for improper venue or, in the alternative, to transfer the lawsuit from the United States District Court for the Southern District of West Virginia, to the United States District Court for the Western District of Virginia (the “WDVA”), including on the grounds that Plaintiffs executed approximately 90 documents between 2017 and 2020 that contain forum selection clauses that mandate either the WDVA or the Circuit Court in the City of Martinsville, Virginia as the exclusive forum to adjudicate disputes arising from the lending relationship between the Bank and the Plaintiffs. Also, on July 14, 2021, the Bank’s directors filed a motion to dismiss the lawsuit for lack of personal jurisdiction, including because the complaint contains no allegations that tie any of the Bank’s directors to West Virginia. Both motions are pending. 37 Table of Contents CARTER BANKSHARES, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS The Company and the Bank deny the allegations contained in the lawsuit and intend to vigorously defend the matter and the validity of the confessions of judgment, release and affirmation agreements and forbearance agreements. Based on information presently available to the Company and the Bank and based on consultation with legal counsel, the Company believes that the Bank has meritorious defenses to all allegations contained in the lawsuit. At this early stage of the lawsuit, the Company is not yet able to make a determination as to the likelihood of an unfavorable outcome in this matter or to estimate the range of any possible loss. NOTE 10 – TAX EFFECTS ON OTHER COMPREHENSIVE INCOME (LOSS) The following table presents the change in components of other comprehensive income (loss) for the periods presented, net of tax effects: Three Months Ended June 30, 2021 Three Months Ended June 30, 2020 (Dollars in Thousands) Pre-Tax Amount Tax (Expense) Benefit Net of Tax Amount Pre-Tax Amount Tax (Expense) Benefit Net of Tax Amount Net Unrealized Gains Arising during the period $ 8,456 $ ( 1,776 ) $ 6,680 $ 14,422 $ ( 3,029 ) $ 11,393 Reclassification Adjustment for Gains included in Net Income ( 1,499 ) 315 ( 1,184 ) ( 2,321 ) 488 ( 1,833 ) Other Comprehensive Income $ 6,957 $ ( 1,461 ) $ 5,496 $ 12,101 $ ( 2,541 ) $ 9,560 Six Months Ended June 30, 2021 Six Months Ended June 30, 2020 (Dollars in Thousands) Pre-Tax Amount Tax Benefit Net of Tax Amount Pre-Tax Amount Tax (Expense) Benefit Net of Tax Amount Net Unrealized (Losses) Gains Arising during the period $ ( 2,038 ) $ 428 $ ( 1,610 ) $ 16,426 $ ( 3,449 ) $ 12,977 Reclassification Adjustment for Gains included in Net Income ( 5,109 ) 1,073 ( 4,036 ) ( 3,535 ) 742 ( 2,793 ) Other Comprehensive (Loss) Income $ ( 7,147 ) $ 1,501 $ ( 5,646 ) $ 12,891 $ ( 2,707 ) $ 10,184 38 Table of Contents CARTER BANKSHARES, INC.