Carter Bankshares, Inc. 10-Q

ITEM 1 – FINANCIAL STATEMENTS (continued) CONSOLIDATED STATEMENTS OF CASH FLOWS Three Months Ended March 31, (Dollars in Thousands) 2022 2021 Net Income $ 9,323 $ 9,375 Adjustments to Reconcile Net Income to Net Cash Provided by Operating Activities Provision for Credit Losses, including Provision for Unfunded Commitments 394 1,575 Origination of Loans Held-for-Sale ( 3,554 ) ( 314,092 ) Proceeds From Loans Held-for-Sale 3,672 306,866 Depreciation/Amortization of Bank Premises and Equipment 1,478 1,559 Provision for Deferred Taxes 1,154 — Net Amortization of Securities 1,634 902 Tax Credit Amortization 615 427 Gains on Sales of Mortgage Loans Held-for-Sale ( 86 ) ( 74 ) Losses (Gains) on Sales of Securities, net 24 ( 3,610 ) Write-downs of Other Real Estate Owned 131 139 Losses on Sales of Other Real Estate Owned, Net 28 73 (Gains) Losses on Sales and Write-downs of Bank Premises ( 383 ) 43 Increase in the Value of Life Insurance Contracts ( 334 ) ( 340 ) Recognition of Restricted Stock Compensation Expense 395 208 Increase in Other Assets ( 9,563 ) ( 413 ) Increase (Decrease) in Other Liabilities 7,542 ( 2,279 ) Net Cash Provided By Operating Activities 12,470 359 INVESTING ACTIVITIES Securities Available-for-Sale: Proceeds from Sales 4,921 64,870 Proceeds from Maturities, Redemptions, and Pay-downs 26,406 25,365 Purchases ( 131,519 ) ( 92,014 ) Purchase of Bank Premises and Equipment, Net ( 809 ) ( 1,624 ) Proceeds from Sales of Bank Premises and Equipment, net 408 — Redemption of Federal Home Loan Bank Stock, net 285 1,878 Loan Originations and Payments, net ( 82,032 ) ( 24,994 ) Payments Received on Other Real Estate Owned 108 — Proceeds from Sales and Payments of Other Real Estate Owned 561 1,479 Net Cash Used In Investing Activities ( 181,671 ) ( 25,040 ) FINANCING ACTIVITIES Net Change in Demand, Money Markets and Savings Accounts 89,650 103,276 Decrease in Certificates of Deposits ( 59,848 ) ( 96,383 ) Payments on Federal Home Loan Bank Borrowings ( 7,000 ) ( 5,000 ) Repurchase of Common Stock ( 23,364 ) — Net Cash (Used In) Provided by Financing Activities ( 562 ) 1,893 Net Decrease in Cash and Cash Equivalents ( 169,763 ) ( 22,788 ) Cash and Cash Equivalents at Beginning of Period 277,799 241,942 Cash and Cash Equivalents at End of Period $ 108,036 $ 219,154 SUPPLEMENTARY DATA Cash Interest Paid $ 4,501 $ 6,666 Cash Paid for Income Taxes — 88 Transfer from Fixed Assets to Other Real Estate Owned 1,201 — Security (Purchases) Settled in Subsequent Period ( 4,115 ) ( 10,970 ) Right-of-use Asset Recorded in Exchange for Lease Liabilities 2,879 2,027 Stock Repurchase Settled in Subsequent Period ( 1,262 ) — 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 subsidiary, 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, 2021, filed with the Securities and Exchange Commission (“SEC”), on March 11, 2022. 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. 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 Company did not adopt any new accounting standards in the first quarter of 2022 that had a material impact to our financial statements. Accounting Statements Issued but Not Yet Adopted In March 2022, the FASB issued ASU No. 2022-02, which eliminates the troubled debt restructuring (TDR) accounting model for creditors that have adopted Topic 326, “Financial Instruments - Credit Losses.” Due to the removal of the TDR accounting model, all loan modifications now will be evaluated to determine if they result in a new loan or a continuation of the existing loan. The amendments in this ASU also requires that entities disclose current-period gross charge-offs by year of origination for loans and leases. We are currently evaluating the impact of the updated guidance on our Consolidated Financial Statements and write-offs. The amendments in this ASU are effective January 1, 2023, with early adoption permitted. The Company plans to early adopt this ASU in 2022. 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 U.S. 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 for all entities between March 12, 2020 and December 31, 2022. Furthermore, the United Kingdom’s Financial Conduct Authority (“FCA”), who is the regulator of LIBOR, announced on March 5, 2021 that they will no longer require any panel bank to continue to submit LIBOR after December 31, 2021. As it pertains to the U.S. dollar LIBOR, the FCA will consider the case to require continued publication of a number of LIBOR 8 Table of Contents CARTER BANKSHARES, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS NOTE 1 – BASIS OF PRESENTATION – (continued) settings through June 30, 2023. In a joint statement, Bank regulators urged banks to stop using LIBOR for any new transactions by the end of 2021 to avoid the possible creation of safety and soundness risk. The Federal Reserve System, (“FRB”), of New York has created a working group called the Alternative Reference Rate Committee (“ARRC”) to assist U.S. institutions in transitioning away from LIBOR as a benchmark interest rate. The ARRC has recommended the use of the Secured Overnight Financing Rate (“SOFR”) as a replacement index for LIBOR, and in March 2022 the U.S. Congress passed and the U.S. President signed legislation that provides a uniform approach for replacing LIBOR as a reference rate in legacy contracts that do not contain effective “fall back” provisions for when LIBOR is no longer published or no longer representative, and that instructs the Federal Reserve to identify a replacement benchmark based on SOFR. In response, we have created an internal team that is managing our transition away from LIBOR. This transition team is a cross-functional group comprised of representatives from the lending lines of business, as well as representatives from loan operations, information technology, finance and other support functions. To date, the transition team has completed an assessment of tasks needed for a successful transition, identified contracts that contain LIBOR language, and documented the risks associated with the transition. The team is currently in the process of: i) reviewing existing contract language for the presence of appropriate fallback rate language, ii) developing loan fallback rate language for when LIBOR is retired if needed, and iii) studying industry best practices. We are considering SOFR and other credit-sensitive alternative indices that may gain market acceptance as potential replacements to LIBOR. The financial impact regarding pricing, valuation and operations of the transition is not expected to be material in nature. Our transition team is fully committed to working within the guidelines established by the FCA and ARRC to provide a smooth transition away from LIBOR. As of March 31, 2022, approximately 16.0 % of our loan portfolio consists of loans whose variable rate index is LIBOR. We ceased originating new LIBOR based variable rate loans by December 31, 2021 per the ARRC’s guidance. 9 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 allocated to common shareholders by the weighted average number shares of common stock outstanding during the period. 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. The following table reconciles the numerators and denominators of basic and diluted earnings per share calculations for the periods presented: Three Months Ended March 31, (Dollars in Thousands, except share and per share data) 2022 2021 Numerator for Earnings per Share – Basic and Diluted Net Income $ 9,323 $ 9,375 Less: Income allocated to participating shares 43 46 Net Income Allocated to Common Shareholders - Basic & Diluted $ 9,280 $ 9,329 Denominator: Weighted Average Shares Outstanding, including Shares Considered Participating Securities 25,859,982 26,408,319 Less: Average Participating Securities 119,346 131,429 Weighted Average Common Shares Outstanding - Basic & Diluted 25,740,636 26,276,890 Earnings per Common Share – Basic $ 0.36 $ 0.36 Earnings per Common Share – Diluted $ 0.36 $ 0.36 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: March 31, 2022 (Dollars in Thousands) Amortized Cost Gross Unrealized Gains Gross Unrealized Losses Fair Value U.S. Treasury Securities $ 19,263 $ — $ ( 654 ) $ 18,609 U.S. Government Agency Securities 3,490 — ( 253 ) 3,237 Residential Mortgage-Backed Securities 122,266 5 ( 6,549 ) 115,722 Commercial Mortgage-Backed Securities 44,302 153 ( 810 ) 43,645 Asset Backed Securities 86,545 7 ( 1,112 ) 85,440 Collateralized Mortgage Obligations 316,798 52 ( 11,841 ) 305,009 Small Business Administration 68,233 591 ( 118 ) 68,706 States and Political Subdivisions 288,247 477 ( 17,981 ) 270,743 Corporate Notes 73,750 51 ( 2,871 ) 70,930 Total Debt Securities $ 1,022,894 $ 1,336 $ ( 42,189 ) $ 982,041 10 Table of Contents CARTER BANKSHARES, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS NOTE 3 – INVESTMENT SECURITIES (continued) December 31, 2021 (Dollars in Thousands) Amortized Cost Gross Unrealized Gains Gross Unrealized Losses Fair Value U.S. Treasury Securities $ 4,442 $ — $ ( 29 ) $ 4,413 U.S. Government Agency Securities 3,475 3 — 3,478 Residential Mortgage-Backed Securities 112,118 76 ( 2,181 ) 110,013 Commercial Mortgage-Backed Securities 4,155 53 ( 40 ) 4,168 Asset Backed Securities 82,119 49 ( 305 ) 81,863 Collateralized Mortgage Obligations 287,734 2,190 ( 2,310 ) 287,614 Small Business Administration 108,643 879 ( 608 ) 108,914 States and Political Subdivisions 257,810 6,344 ( 1,952 ) 262,202 Corporate Notes 59,750 375 ( 390 ) 59,735 Total Debt Securities $ 920,246 $ 9,969 $ ( 7,815 ) $ 922,400 The Company did no t have securities classified as held-to-maturity at March 31, 2022 or December 31, 2021. The following table shows the composition of gross and net realized gains and losses for the periods presented: Three Months Ended March 31, (Dollars in Thousands) 2022 2021 Proceeds from Sales of Securities Available-for-Sale $ 4,921 $ 64,870 Gross Realized Gains $ — $ 3,629 Gross Realized Losses ( 24 ) ( 19 ) Net Realized (Losses) Gains ( 24 ) 3,610 Tax Impact $ ( 5 ) $ 758 Gains or losses are recognized in earnings on the trade date using the amortized cost of the specific security sold. The net realized (losses) gains above reflect reclassification adjustments in the calculation of Other Comprehensive Loss. The net realized (losses) gains are included in noninterest income as (losses) 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. March 31, 2022 (Dollars in Thousands) Amortized Cost Fair Value Due in One Year or Less $ 400 $ 401 Due after One Year through Five Years 17,407 17,053 Due after Five Years through Ten Years 221,217 213,602 Due after Ten Years 213,959 201,169 Residential Mortgage-Backed Securities 122,266 115,722 Commercial Mortgage-Backed Securities 44,302 43,645 Collateralized Mortgage Obligations 316,798 305,009 Asset Backed Securities 86,545 85,440 Total Debt Securities $ 1,022,894 $ 982,041 At March 31, 2022 and December 31, 2021, 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 $ 164.6 million at March 31, 2022 and $ 178.6 million at December 31, 2021. 11 Table of Contents CARTER BANKSHARES, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS NOTE 3 – INVESTMENT SECURITIES (continued) Available-for-sale securities with unrealized losses at March 31, 2022 and December 31, 2021, aggregated by investment category and length of time the individual securities have been in a continuous unrealized loss position, were as follows: March 31, 2022 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 5 $ 18,609 $ ( 654 ) — $ — $ — 5 $ 18,609 $ ( 654 ) U.S. Government Agency Securities 2 3,237 ( 253 ) — — — 2 3,237 ( 253 ) Residential Mortgage-Backed Securities 37 105,273 ( 5,886 ) 7 10,137 ( 663 ) 44 115,410 ( 6,549 ) Commercial Mortgage-Backed Securities 8 13,340 ( 467 ) 51 16,557 ( 343 ) 59 29,897 ( 810 ) Asset Backed Securities 26 64,279 ( 775 ) 8 17,161 ( 337 ) 34 81,440 ( 1,112 ) Collateralized Mortgage Obligations 94 262,649 ( 11,055 ) 12 24,932 ( 786 ) 106 287,581 ( 11,841 ) Small Business Administration 9 13,725 ( 66 ) 3 4,302 ( 52 ) 12 18,027 ( 118 ) States and Political Subdivisions 140 231,573 ( 16,129 ) 13 13,295 ( 1,852 ) 153 244,868 ( 17,981 ) Corporate Notes 20 66,264 ( 2,736 ) 1 2,365 ( 135 ) 21 68,629 ( 2,871 ) Total Debt Securities 341 $ 778,949 $ ( 38,021 ) 95 $ 88,749 $ ( 4,168 ) 436 $ 867,698 $ ( 42,189 ) December 31, 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 2 $ 4,413 $ ( 29 ) — $ — $ — 2 $ 4,413 $ ( 29 ) U.S. Government Agency Securities 1 1,733 — — — — 1 1,733 — Residential Mortgage-Backed Securities 30 95,749 ( 2,030 ) 7 8,706 ( 151 ) 37 104,455 ( 2,181 ) Commercial Mortgage-Backed Securities 1 1,987 ( 40 ) — — — 1 1,987 ( 40 ) Asset Backed Securities 17 44,095 ( 129 ) 10 21,895 ( 176 ) 27 65,990 ( 305 ) Collateralized Mortgage Obligations 50 157,630 ( 1,945 ) 11 24,849 ( 365 ) 61 182,479 ( 2,310 ) Small Business Administration 11 18,813 ( 235 ) 53 19,630 ( 373 ) 64 38,443 ( 608 ) States and Political Subdivisions 56 88,746 ( 1,503 ) 8 7,874 ( 449 ) 64 96,620 ( 1,952 ) Corporate Notes 10 29,683 ( 317 ) 1 2,427 ( 73 ) 11 32,110 ( 390 ) Total Debt Securities 178 $ 442,849 $ ( 6,228 ) 90 $ 85,381 $ ( 1,587 ) 268 $ 528,230 $ ( 7,815 ) The Company adopted Topic 326, Financial Instruments—Credit Losses (Topic 326) on January 1, 2021 and did not record an allowance for credit losses, (“ACL”), on its investment securities during the quarter ended March 31, 2022 as the Company did no t have securities classified as held-to-maturity at March 31, 2022. 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 March 31, 2022 and December 31, 2021, no OTTI has been identified for any investment securities in our portfolio. We do not believe any individual unrealized loss as of March 31, 2022 represents an OTTI. At March 31, 2022, there were 436 securities in an unrealized loss position and at December 31, 2021, there were 268 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 likely that we will be required to sell any of the securities in an unrealized loss position before recovery of amortized cost. 12 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) March 31, 2022 December 31, 2021 Commercial Commercial Real Estate $ 1,343,206 $ 1,323,252 Commercial and Industrial 345,345 345,376 Total Commercial Loans 1,688,551 1,668,628 Consumer Residential Mortgages 483,382 457,988 Other Consumer 43,288 44,666 Total Consumer Loans 526,670 502,654 Construction 321,190 282,947 Other 357,593 357,900 Total Portfolio Loans $ 2,894,004 $ 2,812,129 Loans Held-for-Sale 196 228 Total Loans $ 2,894,200 $ 2,812,357 Troubled Debt Restructurings (“TDR”) The following table summarizes the Company’s TDRs as of the dates presented: March 31, 2022 December 31, 2021 (Dollars in Thousands) Performing TDRs Nonperforming TDRs Total TDRs Performing TDRs Nonperforming TDRs Total TDRs Commercial Commercial Real Estate $ 2,239 $ 3,014 $ 5,253 $ 2,679 $ 2,742 $ 5,421 Commercial and Industrial 11 — 11 14 — 14 Total Commercial TDRs 2,250 3,014 5,264 2,693 2,742 5,435 Consumer Residential Mortgages — — — — — — Other Consumer — — — — — — Total Consumer TDRs — — — — — — Construction — 808 808 527 808 1,335 Other 169,228 — 169,228 169,372 — 169,372 Total TDRs $ 171,478 $ 3,822 $ 175,300 $ 172,592 $ 3,550 $ 176,142 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 March 31, 2022, there were minimal commitments to lend additional funds for loans identified as TDRs. TDRs decreased $ 0.9 million, or 0.5 % to $ 175.3 million at March 31, 2022 compared to December 31, 2021. D uring the three months ended March 31, 2022, t he Company had one new TDR totaling $ 0.3 million in the commercial real estate segment, offset by $ 1.2 million of principal pay-downs. This new TDR loan was restructured with enhanced payment terms as a result of a forbearance agreement. TDRs of $ 3.8 million and $ 3.6 million as of March 31, 2022 and December 31, 2021 , respectively, were loans modified as TDRs that experienced a payment default subsequent to the rework date and were classified as nonperforming. During the three months ended March 31, 2022, the Company modified no loans that constituted a TDR that had significant commitments to lend additional funds. 13 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 months ended March 31, 2022 or March 31, 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. 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 quantifiable loss. This method is used consistently for all segments of the portfolio. The following table presents nonperforming assets as of the dates presented: Nonperforming Assets (Dollars in Thousands) March 31, 2022 December 31, 2021 Nonperforming Assets Nonaccrual loans $ 3,475 $ 3,847 Nonaccrual TDRs 3,822 3,550 Total Nonaccrual Loans 7,297 7,397 Other Real Estate Owned, or (“OREO”) 11,253 10,916 Total Nonperforming Assets $ 18,550 $ 18,313 As of March 31, 2022 and December 31, 2021, the Company had $ 854.9 thousand and $ 254.0 thousand, respectively, of residential real estate in the process of foreclosure. We also had $ 24.7 thousand at March 31, 2022 and $ 62.0 thousand at December 31, 2021 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 expected credit losses associated with the Company’s financial instruments over the life of those instruments as of the balance sheet date. 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 current expected credit losses, (“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. 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 14 Table of Contents CARTER BANKSHARES, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS NOTE 5 – ALLOWANCE FOR CREDIT LOSSES (continued) 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 loans in a given year. The annual loan review provides the Credit Risk Committee with an independent analysis of the following: 1) credit quality of the loan portfolio, 2) compliance with the loan policy, 3) adequacy of documentation in credit files and 4) validity of risk ratings. Since 2020 and continuing into 2022, the Company used a five step approach for loan review in the following categories: • Individual reviews of the top twenty large loan relationships (“LLRs”), which are defined as any individual commercial loan or aggregate commercial relationship totaling $ 2.0 million or more; 15 Table of Contents CARTER BANKSHARES, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS NOTE 5 – ALLOWANCE FOR CREDIT LOSSES (continued) • A sampling of small LLRs, which are defined as individual commercial loans or relationships with aggregate exposure of $ 2.0 million or more but not included in the top twenty LLRs; • A sampling review of Credit Risk Committee modifications, including new and existing loans to provide perspective on the appropriateness of the modification in relation to established policies and procedures; • A sampling review of non-organic commercial loans and those commercial loans approved outside of the Credit Risk Committee; and • Focus reviews of office and land development to evaluate segment risk rather than individual loan risk. Focus reviews are performed annually on a rotational basis. 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 institution’s credit position at some future date. 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. The ability of borrowers to repay commercial loans is dependent upon the success of their business and general economic conditions. Due to the greater potential for loss within our commercial portfolio, we monitor the commercial loan portfolio through an internal risk rating system. Loan risk ratings are assigned based upon the creditworthiness of the borrower and are reviewed on an ongoing basis according to our internal policies. Loans rated special mention or substandard have potential or well-defined weaknesses not generally found in high quality, performing loans, and require attention from management to limit loss. 16 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 the periods presented: March 31, 2022 Risk Rating (Dollars in Thousands) 2022 2021 2020 2019 2018 2017 and Prior Revolving Total Commercial Real Estate Pass $ 57,112 $ 201,879 $ 161,037 $ 206,487 $ 262,968 $ 408,942 $ 36,672 $ 1,335,097 Special Mention — 226 — — — 4,526 — 4,752 Substandard — — — 308 2,705 344 — 3,357 Total Commercial Real Estate $ 57,112 $ 202,105 $ 161,037 $ 206,795 $ 265,673 $ 413,812 $ 36,672 $ 1,343,206 Commercial and Industrial Pass $ 18,555 $ 50,907 $ 47,379 $ 17,226 $ 32,494 $ 165,618 $ 5,263 $ 337,442 Special Mention — — — — 6 — — 6 Substandard — 10 6 58 4,885 2,800 138 7,897 Total Commercial and Industrial $ 18,555 $ 50,917 $ 47,385 $ 17,284 $ 37,385 $ 168,418 $ 5,401 $ 345,345 Residential Mortgages Pass $ 21,999 $ 171,931 $ 86,745 $ 57,914 $ 76,535 $ 48,590 $ 15,216 $ 478,930 Special Mention — — — — 437 543 — 980 Substandard — — — 1,003 679 1,790 — 3,472 Total Residential Mortgages $ 21,999 $ 171,931 $ 86,745 $ 58,917 $ 77,651 $ 50,923 $ 15,216 $ 483,382 Other Consumer Pass $ 4,570 $ 7,981 $ 9,240 $ 692 $ 357 $ 20,052 $ 339 $ 43,231 Special Mention — — — — — — — — Substandard — 10 2 14 4 27 — 57 Total Other Consumer $ 4,570 $ 7,991 $ 9,242 $ 706 $ 361 $ 20,079 $ 339 $ 43,288 Construction Pass $ 6,853 $ 163,951 $ 91,596 $ 11,854 $ 15,822 $ 17,730 $ 11,890 $ 319,696 Special Mention — — — — — 74 — 74 Substandard — — 440 — 95 885 — 1,420 Total Construction $ 6,853 $ 163,951 $ 92,036 $ 11,854 $ 15,917 $ 18,689 $ 11,890 $ 321,190 Other Pass $ — $ — $ — $ — $ — $ 185,132 $ — $ 185,132 Special Mention — — — — — 3,233 — 3,233 Substandard — — — — 87,329 81,899 — 169,228 Total Other Loans $ — $ — $ — $ — $ 87,329 $ 270,264 $ — $ 357,593 Total Portfolio Loans Pass $ 109,089 $ 596,649 $ 395,997 $ 294,173 $ 388,176 $ 846,064 $ 69,380 $ 2,699,528 Special Mention — 226 — — 443 8,376 — 9,045 Substandard — 20 448 1,383 95,697 87,745 138 185,431 Total Portfolio Loans $ 109,089 $ 596,895 $ 396,445 $ 295,556 $ 484,316 $ 942,185 $ 69,518 $ 2,894,004 17 Table of Contents CARTER BANKSHARES, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS NOTE 5 – ALLOWANCE FOR CREDIT LOSSES (continued) December 31, 2021 Risk Rating (Dollars in Thousands) 2021 2020 2019 2018 2017 2016 and Prior Revolving Total Commercial Real Estate Pass $ 195,441 $ 165,100 $ 215,575 $ 292,857 $ 115,024 $ 292,197 $ 38,382 $ 1,314,576 Special Mention 229 — — — 4,205 826 — 5,260 Substandard — — 314 2,742 215 145 — 3,416 Total Commercial Real Estate $ 195,670 $ 165,100 $ 215,889 $ 295,599 $ 119,444 $ 293,168 $ 38,382 $ 1,323,252 Commercial and Industrial Pass $ 55,173 $ 50,087 $ 15,648 $ 38,298 $ 23,575 $ 150,656 $ 3,857 $ 337,294 Special Mention — — — 8 — — — 8 Substandard 14 — 308 4,815 2,798 — 139 8,074 Total Commercial and Industrial $ 55,187 $ 50,087 $ 15,956 $ 43,121 $ 26,373 $ 150,656 $ 3,996 $ 345,376 Residential Mortgages Pass $ 155,892 $ 91,023 $ 63,682 $ 73,333 $ 8,640 $ 48,087 $ 13,237 $ 453,894 Special Mention — — — — — 553 — 553 Substandard — — 1,008 743 188 1,602 — 3,541 Total Residential Mortgages $ 155,892 $ 91,023 $ 64,690 $ 74,076 $ 8,828 $ 50,242 $ 13,237 $ 457,988 Other Consumer Pass $ 9,353 $ 10,199 $ 979 $ 450 $ 186 $ 23,048 $ 339 $ 44,554 Special Mention — — — — — — — — Substandard 11 3 11 57 30 — — 112 Total Other Consumer $ 9,364 $ 10,202 $ 990 $ 507 $ 216 $ 23,048 $ 339 $ 44,666 Construction Pass $ 140,639 $ 82,523 $ 24,336 $ 9,739 $ 5,328 $ 3,407 $ 15,269 $ 281,241 Special Mention — — 175 — — 429 — 604 Substandard — 107 809 95 — 91 — 1,102 Total Construction $ 140,639 $ 82,630 $ 25,320 $ 9,834 $ 5,328 $ 3,927 $ 15,269 $ 282,947 Other Pass $ — $ — $ — $ — $ 122,848 $ 62,399 $ — $ 185,247 Special Mention — — — — — 3,281 — 3,281 Substandard — — — 87,329 40,882 41,161 — 169,372 Total Other Loans $ — $ — $ — $ 87,329 $ 163,730 $ 106,841 $ — $ 357,900 Total Portfolio Loans Pass $ 556,498 $ 398,932 $ 320,220 $ 414,677 $ 275,601 $ 579,794 $ 71,084 $ 2,616,806 Special Mention 229 — 175 8 4,205 5,089 — 9,706 Substandard 25 110 2,450 95,781 44,113 42,999 139 185,617 Total Portfolio Loans $ 556,752 $ 399,042 $ 322,845 $ 510,466 $ 323,919 $ 627,882 $ 71,223 $ 2,812,129 18 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 the periods presented. March 31, 2022 (Dollars in Thousands) 2022 2021 2020 2019 2018 2017 and Prior Revolving Total Commercial Real Estate Performing $ 57,112 $ 202,105 $ 161,037 $ 206,487 $ 262,967 $ 413,547 $ 36,672 $ 1,339,927 Nonperforming — — — 308 2,706 265 — 3,279 Total Commercial Real Estate $ 57,112 $ 202,105 $ 161,037 $ 206,795 $ 265,673 $ 413,812 $ 36,672 $ 1,343,206 Commercial and Industrial Performing $ 18,555 $ 50,917 $ 47,379 $ 17,226 $ 37,381 $ 168,415 $ 5,264 $ 345,137 Nonperforming — — 6 58 4 3 137 208 Total Commercial and Industrial $ 18,555 $ 50,917 $ 47,385 $ 17,284 $ 37,385 $ 168,418 $ 5,401 $ 345,345 Residential Mortgages Performing $ 21,999 $ 171,931 $ 86,745 $ 57,914 $ 77,214 $ 49,547 $ 15,216 $ 480,566 Nonperforming — — — 1,003 437 1,376 — 2,816 Total Residential Mortgages $ 21,999 $ 171,931 $ 86,745 $ 58,917 $ 77,651 $ 50,923 $ 15,216 $ 483,382 Other Consumer Performing $ 4,570 $ 7,991 $ 9,240 $ 695 $ 357 $ 20,076 $ 339 $ 43,268 Nonperforming — — 2 11 4 3 — 20 Total Other Consumer $ 4,570 $ 7,991 $ 9,242 $ 706 $ 361 $ 20,079 $ 339 $ 43,288 Construction Performing $ 6,853 $ 163,951 $ 91,929 $ 11,854 $ 15,917 $ 17,822 $ 11,890 $ 320,216 Nonperforming — — 107 — — 867 — 974 Total Construction $ 6,853 $ 163,951 $ 92,036 $ 11,854 $ 15,917 $ 18,689 $ 11,890 $ 321,190 Other Performing $ — $ — $ — $ — $ 87,329 $ 270,264 $ — $ 357,593 Nonperforming — — — — — — — — Total Other Loans $ — $ — $ — $ — $ 87,329 $ 270,264 $ — $ 357,593 Total Portfolio Loans Performing $ 109,089 $ 596,895 $ 396,330 $ 294,176 $ 481,165 $ 939,671 $ 69,381 $ 2,886,707 Nonperforming — — 115 1,380 3,151 2,514 137 7,297 Total Portfolio Loans $ 109,089 $ 596,895 $ 396,445 $ 295,556 $ 484,316 $ 942,185 $ 69,518 $ 2,894,004 19 Table of Contents CARTER BANKSHARES, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS NOTE 5 – ALLOWANCE FOR CREDIT LOSSES (continued) December 31, 2021 (Dollars in Thousands) 2021 2020 2019 2018 2017 2016 and Prior Revolving Total Commercial Real Estate Performing $ 195,670 $ 165,100 $ 215,575 $ 292,857 $ 119,229 $ 293,102 $ 38,382 $ 1,319,915 Nonperforming — — 314 2,742 215 66 — 3,337 Total Commercial Real Estate $ 195,670 $ 165,100 $ 215,889 $ 295,599 $ 119,444 $ 293,168 $ 38,382 $ 1,323,252 Commercial and Industrial Performing $ 55,187 $ 50,087 $ 15,648 $ 43,117 $ 26,373 $ 150,656 $ 3,857 $ 344,925 Nonperforming — — 308 4 — — 139 451 Total Commercial and Industrial $ 55,187 $ 50,087 $ 15,956 $ 43,121 $ 26,373 $ 150,656 $ 3,996 $ 345,376 Residential Mortgages Performing $ 155,892 $ 91,023 $ 63,682 $ 73,564 $ 8,640 $ 49,399 $ 13,237 $ 455,437 Nonperforming — — 1,008 512 188 843 — 2,551 Total Residential Mortgages $ 155,892 $ 91,023 $ 64,690 $ 74,076 $ 8,828 $ 50,242 $ 13,237 $ 457,988 Other Consumer Performing $ 9,364 $ 10,202 $ 979 $ 450 $ 211 $ 23,048 $ 339 $ 44,593 Nonperforming — — 11 57 5 — — 73 Total Other Consumer $ 9,364 $ 10,202 $ 990 $ 507 $ 216 $ 23,048 $ 339 $ 44,666 Construction Performing $ 140,639 $ 82,523 $ 24,511 $ 9,834 $ 5,328 $ 3,858 $ 15,269 $ 281,962 Nonperforming — 107 809 — — 69 — 985 Total Construction $ 140,639 $ 82,630 $ 25,320 $ 9,834 $ 5,328 $ 3,927 $ 15,269 $ 282,947 Other Performing $ — $ — $ — $ 87,329 $ 163,730 $ 106,841 $ — $ 357,900 Nonperforming — — — — — — — Total Other Loans $ — $ — $ — $ 87,329 $ 163,730 $ 106,841 $ — $ 357,900 Total Portfolio Loans Performing $ 556,752 $ 398,935 $ 320,395 $ 507,151 $ 323,511 $ 626,904 $ 71,084 $ 2,804,732 Nonperforming — 107 2,450 3,315 408 978 139 7,397 Total Portfolio Loans $ 556,752 $ 399,042 $ 322,845 $ 510,466 $ 323,919 $ 627,882 $ 71,223 $ 2,812,129 20 Table of Contents CARTER BANKSHARES, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS NOTE 5 – ALLOWANCE FOR CREDIT LOSSES (continued) The following tables include an aging analysis of the recorded investment of past due portfolio loans as the periods presented: March 31, 2022 (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 $ 1,339,809 $ 118 $ — $ 118 $ 3,279 $ 1,343,206 Commercial and Industrial 345,030 46 61 107 208 345,345 Residential Mortgages 480,433 133 — 133 2,816 483,382 Other Consumer 42,967 166 135 301 20 43,288 Construction 320,020 196 — 196 974 321,190 Other 357,593 — — — — 357,593 Total $ 2,885,852 $ 659 $ 196 $ 855 $ 7,297 $ 2,894,004 December 31, 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 $ 1,319,686 $ 229 $ — $ 229 $ 3,337 $ 1,323,252 Commercial and Industrial 344,628 80 217 297 451 345,376 Residential Mortgages 454,754 683 — 683 2,551 457,988 Other Consumer 44,132 367 94 461 73 44,666 Construction 281,962 — — — 985 282,947 Other 357,900 — — — — 357,900 Total $ 2,803,062 $ 1,359 $ 311 $ 1,670 $ 7,397 $ 2,812,129 Loans past due 90 days or more and still accruing were zero at March 31, 2022 and December 31, 2021. Loans past due 90 days are automatically transferred to nonaccrual status. Loans past due 30 to 89 days or more and still accruing decreased $ 0.8 million to $ 0.9 million at March 31, 2022 compared to $ 1.7 million at December 31, 2021 in all loan categories except construction, which increased $ 0.2 million. There were no nonaccrual or past due loans related to loans held-for-sale at March 31, 2022 or December 31, 2021. 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 March 31, 2022. For the three months ended March 31, 2022, the amount of interest income on nonaccrual loans was immaterial. March 31, 2022 (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 $ 3,337 $ 3,279 $ — $ — Commercial and Industrial 451 208 — — Residential Mortgages 2,551 2,816 — — Other Consumer 73 20 — — Construction 985 974 808 — Other — — — — Total Portfolio Loans $ 7,397 $ 7,297 $ 808 $ — 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 months ended March 31, 2022, no material amount of interest income was recognized on individually evaluated loans subsequent to their classification as individually evaluated loans. 21 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 collateral-dependent individually evaluated loans as of the periods presented. Changes in the fair value of the types of collateral for individually evaluated loans are reported as credit loss expense or a reversal of credit loss expense in the period of change. Type of Collateral March 31, 2022 December 31, 2021 (Dollars in Thousands) Real Estate Real Estate Commercial Real Estate $ 2,705 $ 2,742 Commercial and Industrial — — Residential Mortgages — — Other Consumer — — Construction 808 808 Other — — Total $ 3,513 $ 3,550 The following tables present activity in the ACL for the periods presented: Three Months Ended March 31, 2022 (Dollars in Thousands) Commercial Real Estate Commercial and Industrial Residential Mortgage Other Consumer Construction Other Total Loans Allowance for Credit Losses on Loans: Balance at Beginning of Period $ 17,297 $ 4,111 $ 4,368 $ 1,493 $ 6,939 $ 61,731 $ 95,939 Provision for Credit Losses on Loans 221 ( 529 ) 169 303 466 — 630 Charge-offs — — ( 17 ) ( 435 ) — — ( 452 ) Recoveries — 1 — 109 149 — 259 Net (Charge-offs) / Recoveries — 1 ( 17 ) ( 326 ) 149 — ( 193 ) Balance at End of Period $ 17,518 $ 3,583 $ 4,520 $ 1,470 $ 7,554 $ 61,731 $ 96,376 Three Months Ended March 31, 2021 (Dollars in Thousands) Commercial Real Estate Commercial and Industrial Residential Mortgage Other Consumer Construction Other Total Loans Allowance for Credit Losses on Loans: Balance at Beginning of Period $ 36,428 $ 5,064 $ 2,099 $ 2,479 $ 8,004 $ — $ 54,074 Impact of CECL Adoption 6,587 1,379 3,356 ( 877 ) ( 80 ) 51,277 $ 61,642 Provision for Credit Losses on Loans ( 673 ) ( 1,538 ) ( 255 ) 478 ( 879 ) 4,724 1,857 Charge-offs — ( 1 ) ( 195 ) ( 870 ) — — ( 1,066 ) Recoveries — 1 166 137 61 — 365 Net (Charge-offs) / Recoveries — — ( 29 ) ( 733 ) 61 — ( 701 ) Balance at End of Period $ 42,342 $ 4,905 $ 5,171 $ 1,347 $ 7,106 $ 56,001 $ 116,872 The adoption of ASU 2016-13 resulted in an increase to our ACL of $ 61.6 million on January 1, 2021 to the ACL and $ 2.9 million related to the life-of-loss reserve on unfunded loan commitments. The increase primarily included an expected credit loss of $ 51.3 million established based on a modified discounted cash flow method on expected cash flow changes in the future for the Other segment. 22 Table of Contents CARTER BANKSHARES, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS NOTE 6 – FAIR VALUE MEASUREMENTS We use fair value measurements when recording and disclosing certain financial assets and liabilities. Securities available-for-sale and derivative financial instruments are recorded at fair value on a recurring basis. Additionally, from time to time, we may be required to record other assets at fair value on a nonrecurring basis, such as loans held-for-sale, impaired loans, OREO, and certain other assets. Fair value is the price that would be received to sell an asset or paid to transfer a liability in the principal or most advantageous market in an orderly transaction between market participants at the measurement date. An orderly transaction is a transaction that assumes exposure to the market for a period prior to the measurement date to allow for marketing activities that are usual and customary for transactions involving such assets or liabilities; it is not a forced transaction. In determining fair value, we use various valuation approaches, including market, income and cost approaches. The fair value standard establishes a hierarchy for inputs used in measuring fair value that maximizes the use of observable inputs and minimizes the use of unobservable inputs by requiring that observable inputs be used when available. Observable inputs are inputs that market participants would use in pricing an asset or liability, which are developed based on market data we have obtained from independent sources. Unobservable inputs reflect our estimates of assumptions that market participants would use in pricing an asset or liability, which are developed based on the best information available in the circumstances. The fair value hierarchy gives the highest priority to unadjusted quoted market prices in active markets for identical assets or liabilities (Level 1 measurement) and the lowest priority to unobservable inputs (Level 3 measurement). There are three levels of inputs that may be used to measure fair values: Level 1: Quoted prices (unadjusted) for identical assets or liabilities in active markets that an entity has the ability to access as of the measurement date, or observable inputs. Level 2: Significant other observable inputs other than Level 1 prices, such as quoted prices for similar assets or liabilities, quoted prices in markets that are not active, and other inputs that are observable or can be corroborated by observable market data. Level 3: Significant unobservable inputs that reflect an entity’s own assumptions about the assumptions that market participants would use in pricing an asset or liability. A financial instrument’s level within the fair value hierarchy is based on the lowest level of input that is significant to the fair value measurement. We recognize transfers between any of the fair value hierarchy levels at the end of the reporting period in which the transfer occurred. The following are descriptions of the valuation methodologies that we use for financial instruments recorded at fair value on either a recurring or nonrecurring basis. Recurring Basis Securities Available-for-Sale: The fair values of securities available-for-sale are determined by obtaining quoted prices on nationally recognized securities exchanges, if available. This valuation method is classified as Level 1 in the fair value hierarchy. For securities where quoted prices are not available, fair values are calculated on market prices of similar securities, or matrix pricing, which is a mathematical technique, used widely in the industry to value debt securities without relying exclusively on quoted prices for the specific securities but rather by relying on the securities’ relationship to other benchmark quoted securities. Matrix pricing relies on the securities’ relationship to similarly traded securities, benchmark curves, and the benchmarking of like securities. Matrix pricing utilizes observable market inputs such as benchmark yields, reported trades, broker/dealer quotes, issuer spreads, two-sided markets, benchmark securities, bids, offers, reference data, and industry and economic events. In instances where broker quotes are used, these quotes are obtained from market makers or broker-dealers recognized to be market participants. This valuation method is classified as Level 2 in the fair value hierarchy. For securities where quoted prices or market prices of similar securities are not available, fair values are calculated using discounted cash flows or other market indicators. This valuation method is classified as Level 3 in the fair value hierarchy. Derivative Financial Instruments and Hedging Activities: The Company uses derivative instruments such as interest rate swaps for commercial loans with our customers. Upon entering into swaps with the borrower, the Company entered into 23 Table of Contents CARTER BANKSHARES, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS NOTE 6 – FAIR VALUE MEASUREMENTS (continued) 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. We calculate the fair value for derivatives using accepted valuation techniques, including discounted cash flow analysis on the expected cash flows of each derivative. Each valuation considers the contractual terms of the derivative, including the period to maturity, and uses observable market-based inputs, such as interest rate curves and implied volatilities. 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. Accordingly, interest rate swaps for commercial loans are classified as Level 2. 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 due to changes in interest rates. Nonrecurring Basis Individually Evaluated Loans: Individually evaluated loans with commitments 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 assessment of current trends in the regional market. After thorough consideration of these factors, management will order a new appraisal. 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. Fair value, when recorded, is generally based upon appraisals by approved, independent state certified appraisers. Appraisals on OREO may be discounted based on our historical knowledge, changes in market conditions from the time of appraisal or other information available to us. OREO and other repossessed assets marked to fair value are classified as Level 3. At March 31, 2022 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. 24 Table of Contents CARTER BANKSHARES, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS NOTE 6 – FAIR VALUE MEASUREMENTS (continued) Financial assets measured at fair value on a recurring basis are summarized below for the periods presented: March 31, 2022 (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: U.S. Treasury Securities $ 18,609 $ 18,609 $ — $ — U.S. Government Agency Securities 3,237 — 3,237 — Residential Mortgage-Backed Securities 115,722 — 115,722 — Commercial Mortgage-Backed Securities 43,645 — 43,645 — Asset Backed Securities 85,440 4,996 80,444 — Collateralized Mortgage Obligations 305,009 7,818 297,191 — Small Business Administration 68,706 3,296 65,410 — States and Political Subdivisions 270,743 4,115 266,628 — Corporate Notes 70,930 — 59,865 11,065 Total Securities Available-for-Sale 982,041 38,834 932,142 11,065 Derivatives 10,781 — 10,781 — Total $ 992,822 $ 38,834 $ 942,923 $ 11,065 Liabilities Derivatives $ 10,651 $ — $ 10,651 $ — Total $ 10,651 $ — $ 10,651 $ — December 31, 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: U.S. Treasury Securities $ 4,413 $ 4,413 $ — $ — U.S. Government Agency Securities 3,478 — 3,478 — Residential Mortgage-Backed Securities 110,013 — 110,013 — Commercial Mortgage-Backed Securities 4,168 — 4,168 — Asset Backed Securities 81,863 — 81,863 — Collateralized Mortgage Obligations 287,614 — 287,614 — Small Business Administration 108,914 — 108,914 — States and Political Subdivisions 262,202 — 262,202 — Corporate Notes 59,735 — 51,177 8,558 Total Securities Available-for-Sale 922,400 4,413 909,429 8,558 Derivatives 3,508 — 3,508 — Total $ 925,908 $ 4,413 $ 912,937 $ 8,558 Liabilities Derivatives $ 3,682 $ — $ 3,682 $ — Total $ 3,682 $ — $ 3,682 $ — We have invested in subordinated debt of other financial institutions. We have three securities totaling $ 11.1 million that are considered to be Level 3 securities at March 31, 2022 and two totaling $ 8.6 million at December 31, 2021. The change in the fair value of Level 3 securities available-for-sale from $ 8.6 million at December 31, 2021 to $ 11.1 million at March 31, 2022 is attributable to a change in the fair value level of an existing security in the amount of $ 2.9 million, offset by the change in calculated fair value of $ 0.4 million. The existing security was previously valued by an independent third party based upon a trade desktop evaluation, but is now performed internally using the same approach applied to the other Level 3 securities. The 25 Table of Contents CARTER BANKSHARES, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS NOTE 6 – FAIR VALUE MEASUREMENTS (continued) Level 3 fair value is benchmarked to other securities that have observable market values in Level 2 using comparable financial ratio analysis specific to the industry in which the underlying company operates. The underwriting includes considerations of capital adequacy, asset quality trends, management’s ability to continue efficient and profitable operations, 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: March 31, 2022 (Dollars in Thousands) Level 1 Level 2 Level 3 Fair Value OREO $ — $ — $ 11,253 $ 11,253 Individually Evaluated Loans $ — $ — $ 1,777 $ 1,777 December 31, 2021 (Dollars in Thousands) Level 1 Level 2 Level 3 Fair Value OREO $ — $ — $ 10,916 $ 10,916 Individually Evaluated Loans $ — $ — $ 1,777 $ 1,777 Individually evaluated loans had a net carrying amount of $ 1.8 million at March 31, 2022 with a valuation allowance of $ 0.9 million. Individually evaluated loans had a net carrying amount of $ 1.8 million at December 31, 2021 with a valuation allowance of $ 1.0 million. OREO, which is measured at the lower of carrying or fair value less costs to sell, had a net carrying amount of $ 11.3 million as of March 31, 2022, compared with $ 10.9 million at December 31, 2021. We had $ 0.1 million write-downs recorded on OREO for the three months ended March 31, 2022 and for the same period in 2021. The following table summarizes the Company’s assets that were measured at fair value on a nonrecurring basis for the periods presented: March 31, 2022 (Dollars in Thousands) Fair Value Valuation Technique Unobservable Inputs Weighted Range Average Assets Individually Evaluated Loans $ 1,777 Discounted Appraisals Management's Discount & Estimated Selling Costs 53.0 % 53.0 % Total Individually Evaluated Loans $ 1,777 OREO $ 9,801 Appraisals Estimated Selling Costs 10.0 % 10.0 % OREO 627 Executed Sales Agreement Estimated Selling Costs 5.0 % 5.0 % OREO 190 Internal Valuations Estimated Selling Costs 5.0 % 5.0 % OREO 635 Discounted Internal Valuations Management’s Discount & Estimated Selling Costs 7.3 % – 50.7 % 30.5 % Total OREO $ 11,253 December 31, 2021 (Dollars in Thousands) Fair Value Valuation Technique Unobservable Inputs Weighted Range Average Assets Individually Evaluated Loans 1,777 Discounted Appraisals Management's Discount & Estimated Selling Costs 53.0 % 53.0 % Total Individually Evaluated Loans $ 1,777 OREO $ 9,946 Appraisals Estimated Selling Costs 10.0 % 10.0 % OREO 190 Internal Valuations Estimated Selling Costs 5.0 % 5.0 % OREO 780 Discounted Internal Valuations Management’s Discount & Estimated Selling Costs 5.0 % - 50.7 % 20.3 % Total OREO $ 10,916 26 Table of Contents CARTER BANKSHARES, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS NOTE 6 – FAIR VALUE MEASUREMENTS (continued) A baseline discount rate has been established for impairment measurement. This baseline discount rate was back tested against historical OREO sales and therefore represents an average recovery rate based on the transaction sizes and asset types in the population examined. Management considers the unique attributes and characteristics of each specific individually evaluated 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 March 31, 2022 and December 31, 2021 are presented in the following tables. Fair values for March 31, 2022 and December 31, 2021 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. Fair Value Measurements at March 31, 2022 (Dollars in Thousands) Carrying Value Level 1 Level 2 Level 3 Total Financial Assets: Cash and Cash Equivalents $ 108,036 $ 38,534 $ 69,502 $ — $ 108,036 Securities Available-for-Sale 982,041 38,834 932,142 11,065 982,041 Loans Held-for-Sale 196 — — 196 196 Portfolio Loans, net 2,797,628 — — 2,770,247 2,770,247 Federal Home Loan Bank Stock, at Cost 2,067 — — NA NA Other Assets- Interest Rate Derivatives 10,781 — 10,781 — 10,781 Accrued Interest Receivable 16,727 34 3,791 12,902 16,727 Financial Liabilities: Deposits $ 3,728,278 $ 708,353 $ 1,735,455 $ 1,308,271 $ 3,752,079 Other Liabilities- Interest Rate Derivatives 10,651 — 10,651 — 10,651 FHLB Borrowings — — — — — Accrued Interest Payable 1,333 — — 1,333 1,333 Fair Value Measurements at December 31, 2021 (Dollars in Thousands) Carrying Value Level 1 Level 2 Level 3 Total Financial Assets: Cash and Cash Equivalents $ 277,799 $ 36,698 $ 241,101 $ — $ 277,799 Securities Available-for-Sale 922,400 4,413 909,429 8,558 922,400 Loans Held-for-Sale 228 — — 228 228 Portfolio Loans, net 2,716,190 — — 2,689,578 2,689,578 Federal Home Loan Bank Stock, at Cost 2,352 — — NA NA Other Assets- Interest Rate Derivatives 3,508 — 3,508 — 3,508 Accrued Interest Receivable 17,178 17 3,462 13,699 17,178 Financial Liabilities: Deposits $ 3,698,476 $ 747,909 $ 1,606,249 $ 1,369,228 $ 3,723,386 Other Liabilities- Interest Rate Derivatives 3,682 — 3,682 — 3,682 FHLB Borrowings 7,000 — — 7,035 7,035 Accrued Interest Payable 1,378 — — 1,378 1,378 27 Table of Contents CARTER BANKSHARES, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS 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. 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 at the dates presented: Fair Values of Derivative Instruments Asset Derivatives (Included in Other Assets) March 31, 2022 December 31, 2021 (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 1 $ 122 $ 4 — $ — $ — Interest Rate Swap Contracts – Commercial Loans 62 389,910 10,777 66 446,490 3,508 Total Derivatives not Designated as Hedging Instruments 63 $ 390,032 $ 10,781 66 $ 446,490 $ 3,508 Fair Values of Derivative Instruments Liability Derivatives (Included in Other Liabilities) March 31, 2022 December 31, 2021 (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 1 $ 122 $ 4 — $ — $ — Interest Rate Swap Contracts – Commercial Loans 62 389,910 10,647 66 446,490 3,682 Total Derivatives not Designated as Hedging Instruments 63 $ 390,032 $ 10,651 66 $ 446,490 $ 3,682 28 Table of Contents CARTER BANKSHARES, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS NOTE 7 – DERIVATIVE INSTRUMENTS AND HEDGING ACTIVITIES – (continued) The following table indicates the income recognized on derivatives for the periods presented: For the Three Months Ended March 31, (Dollars in Thousands) 2022 2021 Derivatives not Designated as Hedging Instruments Interest Rate Lock Commitments – Mortgage Loans $ 4 $ — Forward Sale Contracts – Mortgage Loans ( 4 ) — Interest Rate Swap Contracts – Commercial Loans 304 429 Total Derivative Income $ 304 $ 429 Presenting offsetting derivatives that are subject to legally enforceable netting arrangements with the same party is permitted. For example, we may have a derivative asset and a derivative liability with the same counterparty to a swap transaction and are permitted to offset the asset position and the liability position resulting in a net presentation. The following table indicates the gross amounts of commercial loan swap derivative assets and derivative liabilities, the amounts offset and the carrying values in the Consolidated Balance Sheets at the dates presented: Asset Derivatives (Included in Other Assets) Liability Derivatives (Included in Other Liabilities) (Dollars in Thousands) March 31, 2022 December 31, 2021 March 31, 2022 December 31, 2021 Derivatives not Designated as Hedging Instruments Gross Amounts Recognized $ 10,777 $ 3,508 $ 10,647 $ 3,682 Gross Amounts Offset — — — — Net Amounts Presented in the Consolidated Balance Sheets 10,777 3,508 10,647 3,682 Gross Amounts Not Offset (1) — — — ( 4,080 ) Net Amount $ 10,777 $ 3,508 $ 10,647 $ ( 398 ) (1) Amounts represent collateral posted for the periods presented. NOTE 8 – FEDERAL HOME LOAN BANK BORROWINGS Borrowings serve as an additional source of liquidity for the Company. Federal Home Loan Bank, or (“FHLB”) borrowings were zero at March 31, 2022 and $ 7.0 million at December 31, 2021. 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. Total loans pledged as collateral were $ 1.1 billion at both March 31, 2022 and December 31, 2021. There were no securities available-for-sale pledged as collateral at both March 31, 2022 and December 31, 2021. 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 $ 693.0 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 March 31, 2022. The Company had the capacity to borrow up to an additional $ 667.3 million from the FHLB at December 31, 2021. The following table represents the balance of long-term borrowings and the weighted average interest rate as of the periods presented: (Dollars in Thousands) March 31, 2022 December 31, 2021 Long-term Borrowings $ — $ 7,000 Weighted Average Interest Rate — % 1.61 % During the year ending December 31, 2021 the Company prepaid four FHLB advances totaling $ 28.0 million with a weighted average cost to borrow of 1.0 %. One FHLB advance totaling $ 3.0 million was repaid at maturity in the fourth quarter of 2021. The remaining FHLB advances totaling $ 25.0 million were repaid ahead of their scheduled maturity date and had unamortized prepayment fees related to the early repayment of the borrowings totaling $ 43 thousand at December 31, 2021. The FHLB borrowing of $ 7.0 million was prepaid in January 2022 outside of its scheduled maturity. There were no new FHLB borrowings during the three months ended March 31, 2022. 29 Table of Contents CARTER BANKSHARES, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS NOTE 9 – COMMITMENTS AND CONTINGENCIES Commitments to extend credit 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 represented 54.1 % and 55.3 %, of the commitments to extend credit at March 31, 2022 and December 31, 2021, 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 following table sets forth our commitments and letters of credit as of the dates presented: (Dollars in Thousands) March 31, 2022 December 31, 2021 Commitments to Extent Credit $ 493,765 $ 513,482 Standby Letters of Credit 26,154 27,083 Total $ 519,919 $ 540,565 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. The life-of-loan reserve for unfunded commitments is included in other liabilities on our Consolidated Balance Sheets. The following table presents activity in the life-of-loss reserve on unfunded loan commitments as of the dates presented: Three Months Ended March 31, (Dollars in Thousands) 2022 2021 Life-of-Loss Reserve on Unfunded Loan Commitments Balance at Beginning of Period $ 1,783 $ 144 Impact of Adopting ASU 2016-13 — 2,908 Balance after Adoption of ASU 2016-13 $ 1,783 $ 3,052 Provision for Unfunded Commitments ( 236 ) ( 282 ) Total $ 1,547 $ 2,770 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 $ 0.2 million for the three months ended March 31, 2022 and $ 0.3 million for the three months ended March 31, 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. 30 Table of Contents CARTER BANKSHARES, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS NOTE 10 – TAX EFFECTS ON OTHER COMPREHENSIVE LOSS The following table presents the change in components of other comprehensive loss for the periods presented, net of tax effects: Three Months Ended March 31, 2022 Three Months Ended March 31, 2021 (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 Arising during the period $ ( 43,032 ) $ 9,037 $ ( 33,995 ) $ ( 10,494 ) $ 2,204 $ ( 8,290 ) Reclassification Adjustment for Losses (Gains) included in Net Income 24 ( 5 ) 19 ( 3,610 ) 758 ( 2,852 ) Other Comprehensive Loss $ ( 43,008 ) $ 9,032 $ ( 33,976 ) $ ( 14,104 ) $ 2,962 $ ( 11,142 ) NOTE 11 – STOCK REPURCHASE PLAN On December 13, 2021, announced that its Board authorized, effective December 10, 2021, a common stock repurchase program to purchase up to two million shares of the Company’s common stock in the aggregate over a period of twelve months . During the quarter ended March 31, 2022, 1,523,157 shares of common stock had been repurchased under this program at an average price of $ 16.17 per share. During the year ended December 31, 2021 the Company repurchased 30,407 shares of common stock at a total cost of $ 0.5 million, or an average of $ 15.22 per share. As of April 28, 2022, the repurchase program to purchase up to two million shares of the Company’s common stock was fully executed. The specific timing, price and quantity of repurchases will be at the Company’s discretion and will depend on a variety of factors, including general market conditions, the trading price of common stock, legal and contractual requirements, applicable securities laws and the Company’s financial performance. The repurchase plan does not obligate the Company to repurchase any particular number of shares. 31 Table of Contents CARTER BANKSHARES, INC. ITEM 2. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS Management’s Discussion and Analysis of Financial Condition and Results of Operations (“MD&A”), is intended to help the reader understand our operations, our present business environment, and our consolidated results of operations and financial condition and highlights material changes in our financial condition and results of operations as of and for the three month periods ended March 31, 2022 and March 31, 2021. The MD&A is provided as a supplement to, and should be read in conjunction with our Consolidated Financial Statements and the accompanying notes thereto contained in Item 1 of this Quarterly Report on Form 10-Q. Certain reclassifications have been made to prior periods to place them on a basis comparable with the current period presentation. The results of operations reported in the accompanying Consolidated Financial Statements are not necessarily indicative of results to be expected in future periods. The MD&A includes the following sections: • Important Note Regarding Forward-Looking Statements • Explanation of Use of Non-GAAP Financial Measures • Critical Accounting Policies and Estimates • Overview • Results of Operations and Financial Condition • Earnings Summary • Liquidity and Capital Resources • Regulatory Capital Resources • Contractual Obligations • Off-Balance Sheet Arrangements Important Note Regarding Forward-Looking Statements This Quarterly Report on Form 10-Q contains or incorporates statements that we believe are “forward-looking statements” within the meaning of the Private Securities Litigation Reform Act of 1995. Forward looking statements are typically identified by words or phrases such as “will likely result,” “expect,” “anticipate,” “estimate,” “forecast,” “project,” “intend,” “ believe,” “assume,” “strategy,” “trend,” “plan,” “outlook,” “outcome,” “continue,” “remain,” “potential,” “opportunity,” “comfortable,” “current,” “position,” “maintain,” “sustain,” “seek,” “achieve” and variations of such words and similar expressions, or future or conditional verbs such as will, would, should, could or may. Forward-looking statements in this Quarterly Report on Form 10-Q include, but are not limited to, statements related to the COVID-19 pandemic and its potential additional impact on the Company, its markets and its customers, potential asset quality and net interest income developments, and the Company’s efficiency initiatives, and may otherwise relate to our financial condition, results of operations, plans, objectives, outlook for earnings, revenues, expenses, capital and liquidity levels and ratios, asset levels, asset quality, litigation to which the Company is or has been a party and the potential impacts thereof, and other matters regarding or affecting the Company and its future business and operations. Although we believe the assumptions upon which these forward-looking statements are based are reasonable, any of these assumptions could prove to be inaccurate and the forward-looking statements based on these assumptions could be incorrect. The matters discussed in these forward-looking statements are subject to various risks, uncertainties and other factors that could cause actual results and trends to differ materially from those made, projected, or implied in or by the forward-looking statements depending on a variety of uncertainties or other factors including, but not limited to: • changes in accounting policies, practices, or guidance, including for example, our adoption of Current Expected Credit Loss (“CECL”); • general economic or business conditions, or changes in interest rates; • technological risks and developments; • cyber-security threats, attacks or events; • the Company’s liquidity and capital positions; • the potential adverse effects of unusual and infrequently occurring events, or the prospect of these events, such as weather-related disasters, terrorist acts, war and other military conflicts (such as the ongoing war between Russia and Ukraine) or public health events (such as the current COVID-19 pandemic), and the governmental and societal responses thereto; • these potential adverse effects may include, without limitation, adverse effects on the ability of the Company's borrowers to satisfy their obligations to the Company, on the value of collateral securing loans, on the demand for the 32 Table of Contents CARTER BANKSHARES, INC. ITEM 2. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS – (continued) Company's loans or its other products and services, on incidents of cyberattacks and fraud, on the Company’s results of operations, liquidity or capital resources, on risks posed by reliance on third-party service providers, on other aspects of the Company's business operations and on financial markets and economic growth; • the effect of steps the Company takes or has taken in response to the COVID-19 pandemic, the severity and duration of the pandemic, and the impact it has on exacerbating many of the risks described herein and in our Annual Report on Form 10-K for the year ended December 31, 2021 ; • potential claims, damages, and fines related to litigation or government actions; • sensitivity to the interest rate environment including a prolonged period of low interest rates, a rapid increase in interest rates or a change in the shape of the yield curve; • inflation; • the replacement of LIBOR; • a change in spreads on interest-earning assets and interest-bearing liabilities; • regulatory supervision and oversight, including the failure to comply with state and federal banking agency laws and regulations; • legislative and regulatory changes and requirements affecting the financial services industry as a whole, and the Company, in particular; the outcome of pending and future litigation and governmental proceedings; • increased competition; • the ability to continue to introduce competitive new products and services at competitive prices and on a timely, cost-effective basis; • the Company's ability to recruit and retain qualified employees and implement adequate succession planning to mitigate the loss of key members of its senior management team; • the Company’s strategic branch network optimization plan; • managing our internal growth and acquisitions; • the possibility that the anticipated benefits from acquisitions cannot be fully realized in a timely manner or at all, or that integrating the acquired operations will be more difficult, disruptive or more costly than anticipated; • containing costs and expenses; • reliance on significant customer relationships; • credit losses; • the potential impact of climate change and related government regulation on the Company and its customers; • deterioration of the housing market and reduced demand for mortgages; • deterioration in the overall macroeconomic conditions or the state of the banking industry that could impact the re-emergence of turbulence in significant portions of the global financial and real estate markets that could impact our performance, both directly, by affecting our revenues and the value of our assets and liabilities, and indirectly, by affecting the economy generally and access to capital in the amounts, at the times and on the terms required to support our future businesses. Many of these factors, as well as other factors, are described in this Quarterly Report, as well as in Part I, Item 1A, “Risk Factors” in our Annual Report on Form 10-K for the year ended December 31, 2021 and our subsequent filings with the Securities and Exchange Commission (“SEC”). Forward-looking statements are based on beliefs and assumptions using information available at the time the statements are made. We caution you not to unduly rely on forward-looking statements because the assumptions, beliefs, expectations and projections about future events that are expressed in or implied by a forward-looking statement may, and often do, differ materially from actual results. Any forward-looking statement speaks only as to the date on which it is made, and we undertake no obligation to update, revise or clarify any forward-looking statement to reflect developments occurring after the statement is made. Explanation of Use of Non-GAAP Financial Measures In addition to the results of operations presented in accordance with generally accepted accounting principles (“GAAP”) in the United States, management uses, and this quarterly report references, net interest income on a fully taxable equivalent, or (“FTE”), basis, which is a non-GAAP financial measure. Management believes this measure provides information useful to investors in understanding our underlying business, operational performance and performance trends as it facilitates 33 Table of Contents CARTER BANKSHARES, INC. ITEM 2. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS – (continued) comparisons with the performance of other companies in the financial services industry. The Company believes the presentation of net interest income on an FTE basis ensures the comparability of net interest income arising from both taxable and tax-exempt sources and is consistent with industry practice. Net interest income is reconciled to net interest income to an FTE basis (non-GAAP) in the Net Interest Income section of the "Results of Operations and Financial Condition." Although management believes that this non-GAAP financial measure enhances investors’ understanding of our business and performance, this non-GAAP financial measure should not be considered an alternative to GAAP or considered to be more relevant than financial results determined in accordance with GAAP, nor is it necessarily comparable with similar non-GAAP measures which may be presented by other companies. Critical Accounting Estimates Our critical accounting estimates involving significant judgments and assumptions used in the preparation of the Consolidated Financial Statements as of March 31, 2022 have remained unchanged from the disclosures presented in our Annual Report on Form 10-K for the year ended December 31, 2021 under the section “Management’s Discussion and Analysis of Financial Condition and Results of Operations,” and are incorporated herein by reference. Overview Carter Bankshares, Inc. (the “Company”) is a bank holding company headquartered in Martinsville, Virginia with assets of $4.1 billion at March 31, 2022. The Company is the parent company of its wholly owned subsidiary, Carter Bank & Trust (the “Bank”). The Bank is an insured, Virginia state-chartered bank, which operates branches in Virginia and North Carolina. The Company provides a full range of financial services with retail, and commercial banking products and insurance. Our common stock trades on the Nasdaq Global Select Market under the ticker symbol “CARE.” The Company earns revenue primarily from interest on loans and securities and fees charged for financial services provided to our customers. The Company incurs expenses for the cost of deposits, provision for credit losses and other operating costs such as salaries and employee benefits, data processing, occupancy and tax expense. Our mission is to strive to be the preferred lifetime financial partner for our customers and shareholders, and the employer of choice in the communities the Company is privileged to serve. Our strategic plan focuses on restructuring the balance sheet to provide more diversification and higher yielding assets to increase the net interest margin. Another area of focus is the transformation of the infrastructure of the Company to provide a foundation for operational efficiency and provide new products and services for our customers that will ultimately increase noninterest income. Our focus continues to be on loan and deposit growth with a shift in the composition of deposits to more low cost core deposits with less dependence in higher cost certificates of deposits (“CDs”), as well as, implementing opportunities to increase fee income while closely monitoring our operating expenses. The Company is focused on executing this strategy to successfully build our brand and grow our business in our markets. Results of Operations and Financial Condition Earnings Summary Highlights for the Three Months Ended March 31, 2022 • Net interest income increased $1.7 million, or 6.4%, to $28.2 million for the three months ended March 31, 2022 compared to $26.5 million for the same period in 2021 due primarily to the ongoing reduction in funding costs; • The provision for credit losses decreased to $0.6 million for the three months ended March 31, 2022, compared to $1.9 million for the same period in 2021 due to improved qualitative reserves and lower net charge-offs, partialy offset by loan growth; • Total noninterest income decreased $3.6 million to $5.3 million for the three months ended March 31, 2022 compared to the same period in 2021due to a reduction in gains on sales of securities; 34 Table of Contents CARTER BANKSHARES, INC. ITEM 2. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS - (continued) • Total noninterest expense decreased $1.1 million to $22.5 million for the three months ended March 31, 2022 compared to $23.6 million for the same period in 2021 resulting from our retail branch optimization project, higher profit sharing and vacation carryover in the fourth quarter of 2021 as well as lower medical costs in the first three months of 2022; and • Provision for income taxes increased $0.4 million to $1.3 million for the three months ended March 31, 2022 compared to $0.9 million for the same period in 2021. We reported net income of $9.3 million, or $0.36 diluted earnings per share, for the three months ended March 31, 2022 compared to net income of $9.4 million, or $0.36 diluted earnings per share, for the three months ended March 31, 2021. Three Months Ended March 31, PERFORMANCE RATIOS 2022 2021 Return on Average Assets 0.92 % 0.92 % Return on Average Shareholders’ Equity 9.57 % 9.72 % Portfolio Loans to Deposit Ratio 77.62 % 80.51 % Allowance for Credit Losses to Total Portfolio Loans 3.33 % 3.93 % Net Interest Income Our principal source of revenue is net interest income. Net interest income represents the difference between the interest and fees earned on interest-earning assets and the interest paid on interest-bearing liabilities. Net interest income is affected by changes in the average balance of interest-earning assets, interest-bearing liabilities, as well as changes in interest rates and spreads. The level and mix of interest-earning assets and interest-bearing liabilities is managed by our Asset and Liability Committee (“ALCO”), in order to mitigate interest rate and liquidity risks of the balance sheet. A variety of ALCO strategies were implemented, within prescribed ALCO risk parameters, to produce what the Company believes is an acceptable level of net interest income. Net interest income and the net interest margin are presented on an FTE basis. The FTE basis (non-GAAP) adjusts net interest income and net interest margin for the tax benefit of income on certain tax-exempt loans and securities using the applicable federal statutory tax rate for each period (which was 21% for the periods presented) and the dividend-received deduction for equity securities. The Company believes this FTE basis presentation provides a relevant comparison between taxable and non-taxable sources of interest income. Refer to the “Explanation of Use of Non-GAAP Financial Measures” above for additional discussion of non-GAAP measures. Total net interest income increased $1.7 million, or 6.4%, to $28.2 million for the three months ended March 31, 2022 compared to $26.5 million for the same period in 2021. This increase was primarily due to the ongoing reduction in funding costs. Net interest income, on an FTE basis (non-GAAP), increased $1.5 million, or 5.7%, to $28.5 million for the three months ended March 31, 2022 compared to $27.0 million for the same period in 2021. For the three months ended March 31, 2022, the increase in net interest income, on an FTE basis (non-GAAP), was driven by lower interest income of $0.4 million and lower interest expense of $1.9 million compared to the same period in 2021. Net interest margin increased 15 basis points to 2.88% for the three months ended March 31, 2022 compared to 2.73% for the same period in 2021. The net interest margin, on an FTE basis (non-GAAP), increased 13 basis points to 2.91% for the three months ended March 31, 2022 compared to 2.78% for the same period in 2021. The Company continues to focus on the expansion of net interest income and the net interest margin. 35 Table of Contents CARTER BANKSHARES, INC. ITEM 2. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS - (continued) The following table reconciles net interest income per the Consolidated Statements of Income to net interest income on an FTE basis, and net interest margin to net interest margin on an FTE basis (non-GAAP), for the periods presented: Three Months Ended March 31, (Dollars in Thousands) 2022 2021 Total Interest Income $ 32,678 $ 32,957 Total Interest Expense 4,456 6,428 Net Interest Income per Consolidated Statements of Net Income 28,222 26,529 Adjustment to FTE Basis 298 462 Net Interest Income (FTE)(non-GAAP) $ 28,520 $ 26,991 Net Interest Margin 2.88 % 2.73 % Adjustment to FTE Basis 0.03 % 0.05 % Net Interest Margin (FTE)(non-GAAP) 2.91 % 2.78 % Average Balance Sheet and Net Interest Income Analysis (FTE) The following table provides information regarding the average balances, interest and rates earned on interest-earning assets and the average balances, interest and rates paid on interest-bearing liabilities for the periods presented: Three Months Ended March 31, 2022 Three Months Ended March 31, 2021 (Dollars in Thousands) Average Balance Income/ Expense Rate Average Balance Income/ Expense Rate ASSETS Interest-Bearing Deposits with Banks $ 140,080 $ 62 0.18 % $ 174,731 $ 50 0.12 % Tax-Free Investment Securities (2) 26,579 211 3.22 % 51,589 413 3.25 % Taxable Investment Securities 960,645 3,732 1.58 % 708,250 2,987 1.71 % Total Securities 987,224 3,943 1.62 % 759,839 3,400 1.81 % Tax-Free Loans (1)(2) 154,117 1,206 3.17 % 223,012 1,787 3.25 % Taxable Loans (1) 2,690,781 27,745 4.18 % 2,777,423 28,145 4.11 % Total Loans 2,844,898 28,951 4.13 % 3,000,435 29,932 4.05 % Federal Home Loan Bank Stock 2,139 20 3.79 % 4,805 37 3.12 % Total Interest-Earning Assets 3,974,341 $ 32,976 3.36 % 3,939,810 $ 33,419 3.44 % Noninterest Earning Assets 154,971 182,283 Total Assets $ 4,129,312 $ 4,122,093 LIABILITIES AND SHAREHOLDERS' EQUITY Interest-Bearing Demand $ 463,980 $ 277 0.24 % $ 378,886 $ 215 0.23 % Money Market 510,286 284 0.23 % 309,624 266 0.35 % Savings 705,759 178 0.10 % 644,806 162 0.10 % Certificates of Deposit 1,308,799 3,660 1.13 % 1,620,543 5,652 1.41 % Total Interest-Bearing Deposits 2,988,824 4,399 0.60 % 2,953,859 6,295 0.86 % Federal Home Loan Bank Borrowings 1,400 6 1.74 % 33,889 96 1.15 % Other Borrowings 4,358 51 4.75 % 2,307 37 6.50 % Total Borrowings 5,758 57 4.01 % 36,196 133 1.49 % Total Interest-Bearing Liabilities 2,994,582 4,456 0.60 % 2,990,055 6,428 0.87 % Noninterest-Bearing Liabilities 739,556 740,892 Shareholders' Equity 395,174 391,146 Total Liabilities and Shareholders' Equity $ 4,129,312 $ 4,122,093 Net Interest Income (2) $ 28,520 $ 26,991 Net Interest Margin (2) 2.91 % 2.78 % (1) Nonaccruing loans are included in the daily average loan amounts outstanding. (2) Tax-exempt income is on an FTE basis (non-GAAP) using the statutory federal corporate income tax rate of 21 percent. Interest income decreased $0.3 million, or 0.8%, for the three months ended March 31, 2022 compared to the same period in 2021. Interest income, on an FTE basis (non-GAAP), decreased $0.4 million, or 1.3% for the three months ended March 31, 2022 compared to the same period in 2021. The change was primarily due to increases in average interest-earning assets of $34.5 million for the three months ended March 31, 2022, offset by a lower interest rate yield of eight basis points compared to 36 Table of Contents CARTER BANKSHARES, INC. ITEM 2. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS - (continued) the same period in 2021. Average interest-bearing deposits with banks decreased $34.7 million and the average rate earned increased six basis points for the three months ended March 31, 2022 compared to the same period in 2021. Average loan balances decreased $155.5 million for the three months ended March 31, 2022 compared to the same periods in 2021 due to large commercial paydowns in 2021. Average Paycheck Protection Program (“PPP”) loans totaled $0.6 million as of March 31, 2022 compared to $31.2 million as of March 31, 2021 which contributed to the decline in average loan balances, as a result of the continued forgiveness on PPP loans processed by the Small Business Administration. The average rate earned on loans increased eight basis points for the three months ended March 31, 2022 compared to the same period in 2021 primarily due to the increase in short-term interest rates mid-March 2022. At March 31, 2022, the loan portfolio was comprised of 31.0% floating rates which reprice monthly, 39.0% variable rates that reprice at least once during the life of the loan and the remaining 30.0% are fixed rate loans. Average investment securities increased $227.4 million and the average rate earned decreased 19 basis points for the three months ended March 31, 2022 compared to the same period in 2021. The change in investment securities is the result of active balance sheet management to deploy excess cash. Our portfolio has been diversified as to bond types, maturities, and interest rate structures. As of March 31, 2022, the securities portfolio was comprised of 47.6% variable rate securities with approximately 40.6% that will reprice at least once over the next 12 months. Interest expense decreased $1.9 million for the three months ended March 31, 2022 compared to the same period in 2021. The decrease was primarily due to the intentional runoff of higher cost CDs in the first quarter of 2022 and in 2021. Interest expense on deposits decreased $1.9 million for the three months ended March 31, 2022 compared to the same period in 2021 primarily due to the decline in the average balance of CDs and the reduction in average rates paid on the Company’s CDs. The average balances on CDs decreased $311.7 million or 19.2% for the three months ended March 31, 2022 compared to the same period in 2021 primarily due to the aforementioned intentional runoff of these higher cost CDs. The average balances on our core deposits including money market accounts, interest-bearing demand accounts and savings accounts all increased by $200.7 million, $85.1 million and $61.0 million, respectively, for the three months ended March 31, 2022 compared to the same periods in 2021. The average rate paid on these core deposit accounts remained relatively unchanged except the average rate paid on money market accounts decreased 12 basis points for the three months ended March 31, 2022 compared to the same period in 2021. The average balances on borrowings decreased $30.4 million due to prepayments and scheduled maturities. Overall, the cost of interest-bearing liabilities decreased 27 basis points for the three months ended March 31, 2022 compared to the same period in 2021. 37 Table of Contents CARTER BANKSHARES, INC. ITEM 2. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS - (continued) The following table sets forth for the periods presented a summary of the changes in interest earned and interest paid resulting from changes in volume and changes in rates: Three Months Ended March 31, 2022 Compared to March 31, 2021 (Dollars in Thousands) Volume (3) Rate (3) Increase/ (Decrease) Interest Earned on: Interest-Bearing Deposits with Banks $ (11) $ 23 $ 12 Tax-free Investment Securities (2) (199) (3) (202) Taxable Investment Securities 996 (251) 745 Total Securities 797 (254) 543 Tax-free Loans (1)(2) (540) (41) (581) Taxable Loans (1) (888) 488 (400) Total Loans (1,428) 447 (981) Federal Home Loan Bank Stock (24) 7 (17) Total Interest-Earning Assets $ (666) $ 223 $ (443) Interest Paid on: Interest-Bearing Demand $ 50 $ 12 $ 62 Money Market 133 (115) 18 Savings 15 1 16 Certificates of Deposit (981) (1,011) (1,992) Total Interest-Bearing Deposits (783) (1,113) (1,896) Federal Home Loan Bank Borrowings (123) 33 (90) Other Borrowings 26 (12) 14 Total Borrowings (97) 21 (76) Total Interest-Bearing Liabilities $ (880) $ (1,092) $ (1,972) Change in Net Interest Margin $ 214 $ 1,315 $ 1,529 (1) Nonaccruing loans are included in the daily average loan amounts outstanding. (2) Tax-exempt income is on an FTE basis (non-GAAP) using the statutory federal corporate income tax rate of 21 percent. (3) Changes to rate/volume are allocated to both rate and volume on a proportionate dollar basis. Provision for Credit Losses The Company recognizes provision expense for the allowance for credit losses, (“ACL”), based on the difference between the existing balance of ACL reserves and the ACL reserve balance necessary to adequately absorb expected credit losses associated with the Company’s financial instruments. Similarly, the Company recognizes provision expense for unfunded commitments based on the difference between the existing balance of reserves for unfunded commitments and the reserve balance for unfunded commitments necessary to adequately absorb expected credit losses associated with those commitments. The Company adopted ASU 2016-03 on January 1, 2021, and increased the ACL by $64.5 million for the Day 1 adjustment which included $61.6 million to the ACL and $2.9 million related to the life-of-loss reserve on unfunded loan commitments. The ACL was 3.33% of total portfolio loans at March 31, 2022, compared to 3.41% of total portfolio loans, at December 31, 2021. The provision for credit losses decreased $1.3 million to $0.6 million for the three months ended March 31, 2022 compared to $1.9 million for the same period in 2021. The provision for unfunded commitments included a release of $0.2 million for the three months ended March 31, 2022 and a release of $0.3 million for the same period in 2021. For the three months ended March 31, 2022, the decrease in the provision for credit losses was primarily driven by improved qualitative reserves, lower loan charge-offs, offset by loan growth. Refer to Note 5, Allowance for Credit Losses, in the Notes to Consolidated Financial Statements in Item 1 of this Quarterly Report on Form 10-Q for additional information related to our ACL. 38 Table of Contents CARTER BANKSHARES, INC. ITEM 2. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS - (continued) Noninterest Income Three Months Ended March 31, (Dollars in Thousands) 2022 2021 $ Change % Change (Losses) Gains on Sales of Securities, net $ (24) $ 3,610 $ (3,634) (100.7) % Service Charges, Commissions and Fees 1,953 1,809 144 8.0 % Debit Card Interchange Fees 1,932 1,831 101 5.5 % Insurance Commissions 269 294 (25) (8.5) % Bank Owned Life Insurance Income 334 340 (6) (1.8) % Gains on Sales and Write-downs of Bank Premises, net 383 — 383 NM Other Real Estate Owned Income 10 71 (61) (85.9) % Commercial Loan Swap Fee Income — 219 (219) (100.0) % Other 478 778 (300) (38.6) % Total Noninterest Income $ 5,335 $ 8,952 $ (3,617) (40.4) % Total noninterest income decreased $3.6 million, or 40.4%, to $5.3 million for the three months ended March 31, 2022 compared to the same period in 2021. The decrease was primarily related to declines in net security gains of $3.6 million, a decrease in commercial loan swap fee income of $0.2 million and a $0.3 million decrease in other noninterest income. These decreases were partially offset by gains of $0.4 million on sales and write-downs of bank premises, net, a $0.1 million increase in service charges, commissions and fees and a $0.1 million increase in debit card interchange fees. The decline in security gains is due to the rising interest rate environment resulting in lower securities prices in the market that discouraged sales. The variances shown in commercial loan swap fee income is related to the timing and demand for this product in the current rising interest rate environment. The increases in service charges on deposit accounts and debit card interchange fees were primarily due to new accounts, incentives and increased account activity. The decrease in other noninterest income was related to the first quarter of 2021 as we had recorded a $0.2 million incentive true-up from a third-party and experienced fair value declines of $0.1 million related to our interest rate swap contracts with commercial customers. Noninterest Expense Three Months Ended March 31, (Dollars in Thousands) 2022 2021 $ Change % Change Salaries and Employee Benefits $ 11,757 $ 12,582 $ (825) (6.6) % Occupancy Expense, net 3,352 3,514 (162) (4.6) % FDIC Insurance Expense 368 643 (275) (42.8) % Other Taxes 804 762 42 5.5 % Advertising Expense 239 170 69 40.6 % Telephone Expense 488 600 (112) (18.7) % Professional and Legal Fees 1,219 1,224 (5) (0.4) % Data Processing 841 921 (80) (8.7) % Losses on Sales and Write-downs of Other Real Estate Owned, net 159 212 (53) (25.0) % Losses on Sales and Write-downs on Bank Premises, net — 43 (43) (100.0) % Debit Card Expense 633 632 1 0.2 % Tax Credit Amortization 615 427 188 44.0 % Other Real Estate Owned Expense 41 54 (13) (24.1) % Other 1,995 1,821 174 9.6 % Total Noninterest Expense $ 22,511 $ 23,605 $ (1,094) (4.6) % Total noninterest expense decreased $1.1 million, or 4.6%, for the three months ended March 31, 2022 compared to the same period in 2021. The decrease for the three months ended March 31, 2022 was driven by $0.8 million decrease in salaries and employee benefits and $0.3 million decrease in FDIC insurance expense. The decrease in salaries and employee benefits was primarily related to a decline in salaries as a result of our retail branch optimization project and a decrease in medical costs. The $0.3 million decrease in FDIC assessment resulted from improved financial metrics of the Bank that are used to perform the assessment. 39 Table of Contents CARTER BANKSHARES, INC. ITEM 2. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS - (continued) Provision for Income Taxes The provision for income taxes increased $0.4 million to $1.3 million for the three months ended March 31, 2022 compared to $0.9 million for the same period in 2021. Pre-tax income increased $0.4 million for the three months ended March 31, 2022 compared to the same period in 2021. Our effective tax rate was 12.5% for the three months ended March 31, 2022 compared to 9.0% for the same period in 2021. The increase in the effective tax rate is primarily due to a higher level of pre-tax income and a lower level of tax-exempt interest income. The Company ordinarily generates an annual effective tax rate that is less than the statutory rate of 21% due to benefits resulting from tax-exempt interest income, tax credit projects and BOLI, which are relatively consistent regardless of the level of pre-tax income. Financial Condition March 31, 2022 Total assets decreased $10.5 million, to $4.1 billion at March 31, 2022 compared to December 31, 2021. Federal Reserve Bank excess reserves decreased $133.2 million to $43.0 million at March 31, 2022 from $176.2 million at December 31, 2021 due to active balance sheet management. Total portfolio loans increased $81.9 million, or 11.8% on an annualized basis, to $2.9 billion at March 31, 2022 compared to December 31, 2021 primarily due to higher loan growth in the first quarter of 2022. During 2021, loan growth was muted by large commercial loan payoffs and loan sales. The variances in loan segments for portfolio loans related to increases of $38.2 million in construction loans, $25.4 million in residential mortgages and $20.0 million in commercial real estate loans offset by decreases of $1.4 million in other consumer and $0.3 million in the other category. Other real estate owned, (“OREO”), increased $0.3 million at March 31, 2022 compared to December 31, 2021 due to two branch closures completed in the first three months of 2022. This is part of our branch network optimization project that aligns with our strategic goals to enhance franchise value and improve operating efficiency. Closed retail bank offices increased $0.5 million and have a remaining book value of $1.5 million at March 31, 2022 compared to $1.0 million at December 31, 2021. The securities portfolio increased $59.6 million and is currently 23.8% of total assets at March 31, 2022 compared to 22.3% of total assets at December 31, 2021. The increase is due to the bank’s strategy of redeploying excess cash into higher yielding assets, including both loans and bonds. The bank was able to take advantage of increased interest rates available in most bond categories, while keeping its balance of purchasing a mix of both fixed and floating rate instruments. Total deposits increased $29.8 million to $3.7 billion at March 31, 2022 compared to December 31, 2021. The increases included $63.8 million in money market accounts, $37.9 million in savings accounts and $27.5 million in interest-bearing demand accounts, offset by the intentional decline of $59.8 million in CDs and a decline of $39.6 million in noninterest-bearing demand accounts. At March 31, 2022, noninterest-bearing deposits comprised 19.0% compared to 20.2% and 19.9% of total deposits at December 31, 2021 and March 31, 2021, respectively. CDs comprised 34.5%, 36.3% and 41.2% of total deposits at March 31, 2022, December 31, 2021 and March 31, 2021, respectively. Total capital decreased by $49.0 million to $358.6 million at March 31, 2022 compared to $407.6 million at December 31, 2021. The decrease in equity was primarily due to a $34.0 million, net of tax, decrease in other comprehensive loss due to changes in the fair value of available-for-sale securities, a $24.6 million decrease related to the repurchase of common stock through March 31, 2022, partially offset by net income of $9.3 million for the three months ended March 31, 2022. The remaining difference of $0.3 million is related to stock-based compensation during the three months ended March 31, 2022. The ACL was 3.33% of total portfolio loans at March 31, 2022 compared to 3.41% as of December 31, 2021. General reserves as a percentage of total portfolio loans were 3.30% at March 31, 2022 compared to 3.38% at December 31, 2021. Management believes, the ACL is adequate to absorb expected losses inherent in the loan portfolio. The Company remains well capitalized. Our Tier 1 capital ratio decreased to 12.98% at March 31, 2022 compared to 14.21% at December 31, 2021. Our leverage ratio was 10.00% at March 31, 2022, compared to 10.62% at December 31, 2021 and total risk-based capital ratio was 14.24% at March 31, 2022 compared to 15.46% at December 31, 2021. We adopted CECL effective January 1, 2021 and elected to implement the regulatory agencies’ capital transition relief over the permissible three-year period. 40 Table of Contents CARTER BANKSHARES, INC. ITEM 2. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS - (continued) Securities Activity The following table presents the composition of available-for-sale securities: (Dollars in Thousands) March 31, 2022 December 31, 2021 $ Change U.S. Treasury Securities $ 18,609 $ 4,413 $ 14,196 U.S. Government Agency Securities 3,237 3,478 (241) Residential Mortgage-Backed Securities 115,722 110,013 5,709 Commercial Mortgage-Backed Securities 43,645 4,168 39,477 Asset Backed Securities 85,440 81,863 3,577 Collateralized Mortgage Obligations 305,009 287,614 17,395 Small Business Administration 68,706 108,914 (40,208) States and Political Subdivisions 270,743 262,202 8,541 Corporate Notes 70,930 59,735 11,195 Total Debt Securities $ 982,041 $ 922,400 $ 59,641 The Company invests in various securities in order to maintain a source of liquidity, to satisfy various pledging requirements, to increase net interest income and as a tool of the ALCO to diversify and reposition the balance sheet for interest rate risk purposes. Securities are subject to market risks that could negatively affect the level of liquidity available to us. Security purchases are subject to our investment policy that is approved annually by our Board and administered through ALCO and our treasury function. The securities portfolio increased by $59.6 million to $982.0 million at March 31, 2022 compared to $922.4 million at December 31, 2021. Securities comprise 23.8% of total assets at March 31, 2022 compared to 22.3% at December 31, 2021. The increase is a result of active balance sheet management. We have further diversified the securities portfolio as to bond types, maturities and interest rate structures. As of March 31, 2022, the securities portfolio was comprised of 47.6% variable rate securities with approximately 40.6% that will reprice at least once over the next 12 months. At March 31, 2022 total gross unrealized gains in the available-for-sale portfolio were $1.3 million, offset by $42.2 million of gross unrealized losses. At December 31, 2021, total gross unrealized gains in the available-for-sale portfolio were $10.0 million offset by $7.8 million of gross unrealized losses. The unrealized losses on debt securities were primarily attributable to changes in interest rates, and not related to the credit quality of these securities. At December 31, 2021, the 5-year and 10-year U.S. Treasury yields were 1.26% and 1.52%, respectively. For the three months ended March 31, 2022, those same bond yields were 2.42% and 2.32%, respectively. Therefore, this increase of 116 bps and 80 bps, respectively in the intermediate part of the yield curve largely caused the reduction in bond prices for fixed rate bonds in that maturity range. Note, the effects were greater for longer maturity bonds, such as municipal bonds. On the other hand, floating rate bonds largely held consistent values, as those interest rates adjust in line with Fed interest rate hikes. Management evaluates the securities portfolio for other-than-temporary impairment (“OTTI”) on a quarterly basis. At March 31, 2022 and December 31, 2021, the Company did not record any OTTI. The performance of the debt and equity securities markets could generate impairments in future periods requiring realized losses to be reported. Refer to Note 3, Investment Securities, in the Notes to Consolidated Financial Statements in Item 1 of this Quarterly Report on Form 10-Q for additional information related to our securities. 41 Table of Contents CARTER BANKSHARES, INC. ITEM 2. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS - (continued) Loan Composition The following table summarizes our loan portfolio for the periods presented: (Dollars in Thousands) March 31, 2022 December 31, 2021 Commercial Commercial Real Estate $ 1,343,206 $ 1,323,252 Commercial and Industrial 345,345 345,376 Total Commercial Loans 1,688,551 1,668,628 Consumer Residential Mortgages 483,382 457,988 Other Consumer 43,288 44,666 Total Consumer Loans 526,670 502,654 Construction 321,190 282,947 Other 357,593 357,900 Total Portfolio Loans 2,894,004 2,812,129 Loans Held-for-Sale 196 228 Total Loans $ 2,894,200 $ 2,812,357 Our loan portfolio represents our most significant source of interest income. The risk that borrowers are unable to pay such obligations is inherent in the loan portfolio. Other conditions such as downturns in the borrower's industry or the overall economic climate can significantly impact the borrower’s ability to pay. For a discussion of the risk factors relevant to our business and operations, please refer to Part I, Item 1A, “Risk Factors,” contained in our Annual Report on Form 10-K for the year ended December 31, 2021. Total portfolio loans increased $81.9 million, or 2.9%, to $2.9 billion at March 31, 2022 compared to December 31, 2021 with strong production in our commercial real estate, residential mortgage and construction portfolios. The commercial portfolio is monitored for potential concentrations of credit risk by market, property type and tenant concentrations. At March 31, 2022, the loan portfolio was comprised of 31.0% floating rates which reprice monthly, 39.0% variable rates that reprice at least once during the life of the loan and the remaining 30.0% are fixed rate loans. The Company is carefully monitoring the loan portfolio during 2022, including in light of market conditions that impact our borrowers and the interest rate environment. Our exposure to the hospitality industry at March 31, 2022 equated to approximately $406.2 million, or 14.0% of total portfolio loans. These were mostly loans secured by upscale or top tier flagged hotels, which have historically exhibited low leverage and strong operating cash flows. Beginning in the second quarter of 2021, we observed improvements in occupancy and the average daily rates for our hotel clients following sharp declines as a result of the pandemic. However, our clients continue to face challenges with respect to labor, which we believe impedes their ability to turnover rooms resulting in occupancy constraints. This has caused, or may cause, them to operate with lower levels of liquidity and an inability to reserve for capital improvements and may adversely affect their ability to pay property expenses, capital improvements and/or repay existing indebtedness. Contractual payments have been restored since the expiration of our deferral program on June 30, 2021. These developments, together with the current economic conditions, generally, may adversely impact the value of real estate collateral in hospitality and other commercial real estate exposure. As a result, our financial condition, capital levels and results of operations could be adversely affected. Aggregate commitments to our top 10 credit relationships were $717.7 million at March 31, 2022. The Other segment represents 48.7% of the top 10 credit relationships. 42 Table of Contents CARTER BANKSHARES, INC. ITEM 2. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS - (continued) The following table summarizes our top 10 relationships and a description of industries represented for the periods presented: Dollars in Thousands For the Periods Ending Change March 31, 2022 % of Gross Loans March 31, 2022 % of RBC March 31, 2022 December 31, 2021 1. Hospitality, agriculture & energy $349,818 $350,010 ($192) 12.09 % 76.62 % 2. Retail real estate & food services 57,025 56,073 952 1.97 % 12.49 % 3. Hospitality 55,151 55,634 (483) 1.91 % 12.08 % 4. Industrial & retail real estate 45,176 45,653 (477) 1.56 % 9.89 % 5. Retail real estate 37,799 38,250 (451) 1.31 % 8.28 % 6. Hospitality 35,456 35,664 (208) 1.23 % 7.77 % 7. Multifamily & student housing 35,042 35,405 (363) 1.21 % 7.67 % 8. Hospitality 34,269 34,463 (194) 1.18 % 7.51 % 9. Multifamily development 34,190 36,720 (2,530) 1.18 % 7.49 % 10. Special/limited use 33,736 33,736 — 1.17 % 7.39 % Top Ten (10) Relationships 717,662 721,608 (3,946) 24.80 % 157.18 % Total Gross Loans 2,894,200 2,812,357 81,843 % of Total Gross Loans 24.80 % 25.66 % (0.86) % Concentration (25% of RBC) $114,146 $120,781 Unfunded commitments on lines of credit were $435.1 million at March 31, 2022 as compared to $433.1 million at December 31, 2021. The majority of unused commitments are for construction projects that will be drawn as the construction completes. Total utilization was 54.4% at March 31, 2022 and 52.2% at December 31, 2021. Unfunded commitments on commercial operating lines of credit was 54.6% at March 31, 2022 and 51.7% at December 31, 2021. We attempt to limit our exposure to credit risk by diversifying our loan portfolio by segment, geography, collateral and industry while 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 that operate with low financial and operating leverage. The repayment capacity of the borrower should exceed the policy and guidelines for secured loans. Deferred costs and fees included in the portfolio balances above were $5.2 million and $4.5 million at March 31, 2022 and December 31, 2021, respectively. Discounts on purchased 1-4 family loans included in the portfolio balances above were $183.6 thousand and $190.6 thousand at March 31, 2022 and December 31, 2021, respectively. From time to time, we have mortgage loans held-for-sale derived from two sources. First, we purchase mortgage loans on a short-term basis from a partner financial institution that have fully executed sales contracts to end investors. Second, we originate and close mortgages with fully executed contracts with investors to purchase shortly after closing. We then hold these mortgage loans from both sources until funded by the investor, typically a two-week period. Mortgage loans held-for-sale were $0.2 million and $0.2 million at March 31, 2022 and December 31, 2021, respectively. Refer to Note 4, Loans and Loans Held-for-Sale, in the Notes to Consolidated Financial Statements in Item 1 of this Quarterly Report on Form 10-Q for additional information related to our loans. 43 Table of Contents CARTER BANKSHARES, INC. ITEM 2. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS - (continued) Credit Quality On a monthly basis, a Criticized Asset Committee meets to review certain special mention and substandard loans within prescribed policy thresholds. These loans typically represent the highest risk of loss to the Company. Action plans are established and these loans are monitored through regular contact with the borrower and loan officer, review of current financial information and other documentation, review of all loan or potential loan restructures or modifications and the regular re-evaluation of assets held as collateral. On a quarterly basis, the Credit Risk Committee of the Board meets to review our loan portfolio metrics, approve segment limits, approve the adequacy of ACL, and findings from Loan Review identified in the previous quarter. Annually, this same committee approves credit related policies and policy enhancements as they become available. Additional credit risk management practices include continuous reviews of our lending policies and procedures to support sound underwriting practices, concentrations, delinquencies and annual portfolio stress testing. Our Loan Review department serves as a mechanism to individually monitor credit quality and assess the effectiveness of credit risk management practices to provide oversight of all lending activities. The loan review function has the primary responsibility for assessing commercial credit administration and credit decision functions of consumer and mortgage underwriting, as well as providing input to the loan risk rating process. Our policy is to place loans in all categories in nonaccrual status when collection of interest or principal is doubtful, or generally when interest or principal payments are 90 days or more past due based on contractual terms. Consumer unsecured loans and secured loans are evaluated for charge-off after the loan becomes 90 days past due. Unsecured loans are fully charged-off and secured loans are charged-off to the estimated fair value of the collateral less the cost to sell. Nonperforming assets consist of nonaccrual loans, nonaccrual troubled debt restructurings, (“TDRs”), and OREO. The following table summarizes nonperforming assets for the dates presented: (Dollars in Thousands) March 31, 2022 December 31, 2021 $ Change Nonperforming Loans Commercial Real Estate $ 265 $ 595 $ (330) Commercial and Industrial 208 451 (243) Residential Mortgages 2,816 2,551 265 Other Consumer 20 73 (53) Construction 166 177 (11) Other — — — Total Nonperforming Loans 3,475 3,847 (372) Nonperforming Troubled Debt Restructurings Commercial Real Estate 3,014 2,742 272 Commercial and Industrial — — — Residential Mortgages — — — Other Consumer — — — Construction 808 808 — Other — — — Total Nonperforming Troubled Debt Restructurings 3,822 3,550 272 Total Nonperforming Loans and Troubled Debt Restructurings 7,297 7,397 (100) Other Real Estate Owned 11,253 10,916 337 Total Nonperforming Assets $ 18,550 $ 18,313 $ 237 Nonperforming assets increased $0.2 million to $18.6 million at March 31, 2022 compared to December 31, 2021. The increase was primarily due to a $0.3 million an increase in OREO, offset by a $0.1 million decline in nonperforming loans. C losed retail bank offices increased $0.5 million and have a remaining book value of $1.5 million at March 31, 2022 compared to $1.0 million at December 31, 2021. During the first quarter of 2022, two branch closures were completed as part of our branch network optimization project that aligns with our strategic goals to enhance franchise value and improve operating efficiency. 44 Table of Contents CARTER BANKSHARES, INC.