Carter Bankshares, Inc. 10-Q

ITEM 2. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS - (continued) Closed-end installment loans, amortizing loans secured by real estate and any other loans with payments scheduled monthly are reported past due when the borrower is in arrears two or more monthly payments. Other multi-payment obligations with payments scheduled other than monthly are reported past due when one scheduled payment is due and unpaid for 30 days or more. We monitor delinquency on a monthly basis, including loans that are at risk for becoming delinquent and early stage delinquencies in order to identify emerging patterns and potential problem loans. Troubled Debt Restructuring (“TDRs”) are loans that we, for economic or legal reasons related to a borrower’s financial difficulties, grant a concession to the borrower that we would not otherwise grant. The Company strives to identify borrowers in financial difficulty early and work with them to modify terms and conditions before their loan defaults and/or is transferred to nonaccrual status. Modified terms that might be considered a TDR generally include extension of maturity dates at a stated interest rate lower than the current market rate for a new loan with similar characteristics, reductions in contractual interest rates or principal deferment. While unusual, there may be instances of principal forgiveness. Short-term modifications that are considered insignificant are generally not considered a TDR unless there are other concessions granted. An accruing loan that is characterized as a TDR can remain in accrual status if, based on a current credit analysis, collection of principal and interest in accordance with the modified terms is reasonably assured, and the borrower has demonstrated sustained historical performance for a reasonable period before the modification. All TDRs are considered to be impaired loans and will be reported as impaired loans for their remaining lives, unless a subsequent restructuring includes an interest rate equal to or greater than the rate that would be accepted at the time of the restructuring for a new loan with comparable risk, we fully expect that the remaining principal and interest will be collected according to the restructured agreement or the contractual terms of the original loan agreement are restored. Generally, the Company individually evaluates all impaired loans, which includes TDRs, with a commitment greater than or equal to $1.0 million for individually evaluated loan reserves. In addition, the Company may evaluate credits that have complex loan structures for impairment, even if the commitment is less than $1.0 million. Nonaccrual TDRs can be returned to accruing status if the ultimate collectability of all contractual amounts due, according to the restructured agreement, is not in doubt and there is a period of a minimum of six months of satisfactory payment performance by the borrower either immediately before or after the restructuring. As an example, consider a substandard commercial construction loan that is currently 90 days past due where the loan is restructured to extend the maturity date for a period longer than would be considered an insignificant period of time. The post-modification interest rate given to the borrower is considered to be lower than the current market rate for new debt with similar risk and all other terms remain the same according to the original loan agreement. This loan will be considered a TDR as the borrower is experiencing financial difficulty and a concession has been granted due to the significant extension, resulting in payment delay as well as the rate being lower than current market rate for new debt with similar risk. The loan will be reported as a nonaccrual TDR and an impaired loan. In addition, the loan could be charged down to the fair value of the collateral if a confirmed loss exists. If the loan subsequently performs, by means of making on-time payments according to the newly restructured terms for a period of six months, and it is expected that all remaining principal and interest will be collected according to the terms of the restructured agreement, the loan will be returned to accrual status and reported as an accruing TDR. The loan will remain an impaired loan for the remaining life of the loan because the interest rate was not adjusted to be equal to or greater than the rate that would be accepted at the time of the restructuring for a new loan with comparable risk. Allowance for Credit Losses The following is the allocation of the ACL balance by segment for the periods presented: March 31, 2022 December 31, 2021 (Dollars in Thousands) Amount % of Loans in each Category to Total Portfolio Loans Amount % of Loans in each Category to Total Portfolio Loans Commercial Real Estate $ 17,518 46.4 % $ 17,297 47.0 % Commercial & Industrial 3,583 11.9 % 4,111 12.3 % Residential Mortgages 4,520 16.7 % 4,368 16.3 % Other Consumer 1,470 1.5 % 1,493 1.6 % Construction 7,554 11.1 % 6,939 10.1 % Other 61,731 12.4 % 61,731 12.7 % Balance End of Year $ 96,376 100.0 % $ 95,939 100.0 % 45 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 the credit quality ratios and their components as of March 31, 2022 and December 31, 2021: (Dollars in Thousands) March 31, 2022 December 31, 2021 Allowance for Credit Losses to Total Portfolio Loans Allowance for Credit Losses $ 96,376 $ 95,939 Total Portfolio Loans 2,894,004 2,812,129 Allowance for Credit Losses to Total Portfolio Loans 3.33 % 3.41 % Nonperforming Loans to Total Portfolio Loans Nonperforming Loans $ 7,297 $ 7,397 Total Portfolio Loans 2,894,004 2,812,129 Nonperforming Loans to Total Portfolio Loans 0.25 % 0.26 % Allowance for Credit Losses to Nonperforming Loans Allowance for Credit Losses $ 96,376 $ 95,939 Nonperforming Loans 7,297 7,397 Allowance for Credit Losses to Nonperforming Loans 1,320.76 % 1,297.00 % Net Charge-offs to Average Portfolio Loans Net Charge-offs (annualized) $ 783 $ 23,127 Average Total Portfolio Loans 2,844,668 2,927,083 Net Charge-offs to Average Portfolio Loans 0.03 % 0.79 % See the Credit Quality and Allowance for Credit Losses sections within this MD&A for an analysis of the factors that drove the changes in the ACL ratios presented in the table above. The net charge-offs of $23.1 million for the full year 2021 was primarily attributable to the resolution of five problem relationships during 2021, in which the majority of losses were anticipated and previously reserved. The provision for credit losses, which includes a provision for losses on loans and on unfunded commitments, is a charge to earnings to maintain the ACL at a level consistent with management's assessment of expected losses in the loan portfolio at the balance sheet date. The provision for credit losses decreased $1.3 million to $0.6 million for the three months ended March 31, 2022 compared to the same period in 2021. The decrease in the provision for credit losses was primarily driven by improved qualitative reserves and net charge-offs totaling $0.2 million, offset by higher loan balances. The provision for unfunded commitments in the first quarter of 2022 was a release of $0.2 million compared to a release of $0.3 million in the first quarter of 2021. Net charge-offs were $0.2 million for the three months ended March 31, 2022 compared to $0.7 million for the same period in 2021. As a percentage of average total portfolio loans, on an annualized basis, net charge-offs were 0.03% and 0.10% for the three months ended March 31, 2022 and March 31, 2021, respectively. At March 31, 2022, nonperforming loans declined $0.1 million, or 1.4%, to $7.3 million since December 31, 2021. Nonperforming loans as a percentage of total portfolio loans were 0.25% and 0.26% as of March 31, 2022 and December 31, 2021, respectively. 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. 46 Table of Contents CARTER BANKSHARES, INC. ITEM 2. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS - (continued) The following tables represent credit exposures by internally assigned risk ratings as of the periods presented: March 31, 2022 (Dollars in Thousands) Commercial Real Estate Commercial and Industrial Residential Mortgage Other Consumer Construction Other Total Portfolio Loans Pass $ 1,335,097 $ 337,442 $ 478,930 $ 43,231 $ 319,696 $ 185,132 $ 2,699,528 Special Mention 4,752 6 980 — 74 3,233 9,045 Substandard 3,357 7,897 3,472 57 1,420 169,228 185,431 Doubtful — — — — — — — Loss — — — — — — — Total Portfolio Loans $ 1,343,206 $ 345,345 $ 483,382 $ 43,288 $ 321,190 $ 357,593 $ 2,894,004 Performing $ 1,339,927 $ 345,137 $ 480,566 $ 43,268 $ 320,216 $ 357,593 $ 2,886,707 Nonperforming 3,279 208 2,816 20 974 — 7,297 Total Portfolio Loans $ 1,343,206 $ 345,345 $ 483,382 $ 43,288 $ 321,190 $ 357,593 $ 2,894,004 December 31, 2021 (Dollars in Thousands) Commercial Real Estate Commercial and Industrial Residential Mortgage Other Consumer Construction Other Total Portfolio Loans Pass $ 1,314,576 $ 337,294 $ 453,894 $ 44,554 $ 281,241 $ 185,247 $ 2,616,806 Special Mention 5,260 8 553 — 604 3,281 9,706 Substandard 3,416 8,074 3,541 112 1,102 169,372 185,617 Doubtful — — — — — — — Loss — — — — — — — Total Portfolio Loans $ 1,323,252 $ 345,376 $ 457,988 $ 44,666 $ 282,947 $ 357,900 $ 2,812,129 Performing $ 1,319,915 $ 344,925 $ 455,437 $ 44,593 $ 281,962 $ 357,900 $ 2,804,732 Nonperforming 3,337 451 2,551 73 985 — 7,397 Total Portfolio Loans $ 1,323,252 $ 345,376 $ 457,988 $ 44,666 $ 282,947 $ 357,900 $ 2,812,129 Special mention, substandard and doubtful loans at March 31, 2022 decreased $0.8 million to $194.5 million compared to $195.3 million at December 31, 2021, with a decrease of $0.6 million in special mention and a decrease of $0.2 million in substandard. Additionally, 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. 47 Table of Contents CARTER BANKSHARES, INC. ITEM 2. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS - (continued) Deposits The following table presents the composition of deposits for the periods presented: (Dollars in Thousands) March 31, 2022 December 31, 2021 $ Change % Change Noninterest-Bearing Demand $ 708,353 $ 747,909 $ (39,556) (5.3) % Interest-Bearing Demand 480,192 452,644 27,548 6.1 % Money Market 526,838 463,056 63,782 13.8 % Savings 728,425 690,549 37,876 5.5 % Certificate of Deposits 1,284,470 1,344,318 (59,848) (4.5) % Total Deposits $ 3,728,278 $ 3,698,476 $ 29,802 0.8 % Deposits are our primary source of funds. We believe that our deposit base is stable and that we have the ability to attract new depositors while diversifying the deposit composition. Total deposits at March 31, 2022 increased $29.8 million, or 0.8%, from December 31, 2021. The increase in deposits primarily related to an increase in our core deposits of $89.7 million, or 15.4% on an annualized basis. Our core deposits include noninterest-bearing demand accounts, interest-bearing demand deposits, money market accounts and savings accounts. The decrease of $59.8 million, or 4.5% in CDs at March 31, 2022 compared to December 31, 2021 is due to the intentional runoff of higher cost CDs. Noninterest-bearing deposits comprised 19.0% and 20.2% of total deposits at March 31, 2022 and December 31, 2021, respectively. The following table presents additional information about our deposits: (Dollars in Thousands) March 31, 2022 December 31, 2021 Deposits from the Certificate of Deposit Account Registry Services (CDARS) $ 139 $ 139 Noninterest-Bearing Public Funds Deposits 16,330 58,393 Interest-Bearing Public Funds Deposits 155,813 123,968 Total Deposits not Covered by Deposit Insurance (1) 419,768 396,626 Certificates of Deposits not Covered by Deposit Insurance 132,960 147,134 Deposits for Certain Directors, Executive Officers and their Affiliates 2,497 3,032 (1) These deposits are presented on an estimated basis. This estimate was determined based on the same methodologies and assumptions used for regulatory reporting requirements. Maturities of CDs over $250,000 or more not covered by deposit insurance at March 31, 2022 are summarized as follows: (Dollars in Thousands) Amount Percent Three Months or Less $ 19,350 14.5 % Over Three Months Through Twelve Months 40,121 30.2 % Over Twelve Months Through Three Years 53,554 40.3 % Over Three Years 19,935 15.0 % Total $ 132,960 100.0 % 48 Table of Contents CARTER BANKSHARES, INC. ITEM 2. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS - (continued) Federal Home Loan Bank Borrowings (“FHLB”) Borrowings are an additional source of liquidity for the Company. We had no FHLB borrowings at March 31, 2022 and $7.0 million at December 31, 2021. Information pertaining to FHLB advances is summarized in the following table: (Dollars in Thousands) March 31, 2022 December 31, 2021 Balance at Period End $ — $ 7,000 Average Balance during the Period $ 1,400 $ 25,986 Average Interest Rate during the Period 1.63 % 1.20 % Maximum Month-end Balance during the Period $ — $ 35,000 Average Interest Rate at Period End — % 1.61 % The Company held FHLB Atlanta stock of $2.1 million and $2.4 million at March 31, 2022 and December 31, 2021, respectively. Dividends recorded on this restricted stock were $20 thousand and $37 thousand for the three months ended March 31, 2022 and March 31, 2021, respectively. The investment is carried at cost and evaluated for impairment based on the ultimate recoverability of the par value. We hold FHLB stock because we are a member of the FHLB of Atlanta. The FHLB requires members to purchase and hold a specified level of FHLB stock based upon the members’ asset values, level of borrowings and participation in other programs offered. Stock in the FHLB is non-marketable and is redeemable at the discretion of the FHLB. Members do not purchase stock in the FHLB for the same reasons that traditional equity investors acquire stock in an investor-owned enterprise. Rather, members purchase stock to obtain access to the products and services offered by the FHLB. Unlike equity securities of traditional for-profit enterprises, the stock of the FHLB does not provide its holders with an opportunity for capital appreciation because, by regulation, FHLB stock can only be purchased, redeemed and transferred at par value. Refer to Note 8, Federal Home Loan Bank Borrowings, in the Notes to Consolidated Financial Statements in Item 1 of this Quarterly Report on Form 10-Q for additional information related to our borrowings. Liquidity and Capital Resources Liquidity is defined as a financial institution’s ability to meet its cash and collateral obligations at a reasonable cost. This includes the ability to satisfy the financial needs of depositors who want to withdraw funds or borrowers needing to access funds to meet their credit needs. In order to manage liquidity risk the Company’s Board has delegated authority to the ALCO for formulation, implementation and oversight of liquidity risk management for the Company. The ALCO’s goal is to maintain adequate levels of liquidity at a reasonable cost to meet funding needs in both a normal operating environment and for potential liquidity stress events. The ALCO monitors and manages liquidity through various ratios, reviewing cash flow projections, performing stress tests and by having a detailed contingency funding plan. The ALCO policy guidelines define graduated risk tolerance levels. If our liquidity position moves to a level that has been defined as high risk, specific actions are required, such as increased monitoring or the development of an action plan to reduce the risk position. Our primary funding and liquidity source is a stable customer deposit base. Management believes that we have the ability to retain existing deposits and attract new deposits, mitigating any funding dependency on other more volatile sources. Although deposits are the primary source of funds, the Company has identified various other funding sources that can be used as part of our normal funding program when either a structure or cost efficiency has been identified. Additional funding sources accessible to the Company include borrowing availability at the FHLB, equal to 25.0% of the Company’s assets approximating $1.0 billion, subject to the amount of eligible collateral pledged, federal funds lines with six other correspondent financial institutions in the amount of $145.0 million, access to the institutional CD market, and the brokered deposit market. In addition to the lines referenced above, the Company also has $817.4 million of unpledged available-for-sale investment securities as an additional source of liquidity. An important component of our ability to effectively respond to potential liquidity stress events is maintaining a cushion of highly liquid assets. Highly liquid assets are those that can be converted to cash quickly, with little or no loss in value, to meet financial obligations. ALCO policy guidelines define a ratio of highly liquid assets to total assets by graduated risk tolerance levels of minimal, moderate and high. At March 31, 2022, the Bank had $887.1 million in highly liquid assets, which consisted of $26.5 million in interest-bearing deposits in other financial institutions, $43.0 million in FRB Excess Reserves, $817.4 49 Table of Contents CARTER BANKSHARES, INC. ITEM 2. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS - (continued) million in unpledged securities and $0.2 million in mortgage loans held-for-sale. This resulted in highly liquid assets to total assets ratio of 21.5% at March 31, 2022. If an extended recession caused large numbers of our deposit customers to withdraw their funds, we might become more reliant on volatile or more expensive sources of funding. The following table provides detail of liquidity sources as of the periods presented: (Dollars in Thousands) March 31, 2022 December 31, 2021 Cash and Due From Banks $ 38,534 $ 36,698 Interest-bearing Deposits in Other Financial Institutions 26,462 64,905 Federal Reserve Bank Excess Reserves 43,040 176,196 Unpledged Investment Securities 817,354 743,836 Excess Pledged Securities 21,450 28,417 FHLB Borrowing Availability 692,964 667,307 Unsecured Lines of Credit 145,000 145,000 Total Liquidity Sources $ 1,784,804 $ 1,862,359 Regulatory Capital Requirements Total shareholders’ equity 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 shareholders’ 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 and 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 Company and the Bank are subject to various capital requirements administered by the federal banking regulators. Failure to meet the minimum capital requirements can initiate certain mandatory and possibly additional discretionary actions by regulators that, if undertaken, could have a direct material effect on our financial statements. Under capital adequacy guidelines and the regulatory framework for prompt corrective action, we must meet specific capital guidelines that involve quantitative measures of assets, liabilities and certain off-balance sheet items as calculated under regulatory accounting practices. The capital amounts and classifications are also subject to qualitative judgments by the regulators about components, risk weightings and other factors. Prompt corrective action provisions are not applicable to bank holding companies. Quantitative measures established by regulations to ensure capital adequacy require us to maintain minimum amounts and ratios as shown in the following table. Prompt corrective action regulations provide five classifications: well capitalized, adequately capitalized, undercapitalized, significantly undercapitalized, and critically undercapitalized, although these terms are not used to represent overall financial condition. If adequately capitalized, regulatory approval is required to accept brokered deposits. If undercapitalized, capital distributions are limited, as is asset growth and expansion, and capital restoration plans are required. At March 31, 2022 and December 31, 2021, the most recent regulatory notifications categorized the Bank as well-capitalized under the regulatory framework for prompt corrective action. There are no conditions or events since that notification that management believes have changed the institution’s category. At March 31, 2022, the Bank continues to maintain its capital position with a leverage ratio of 9.91% as compared to the regulatory guideline of 5.00% to be well-capitalized and a risk-based Common Equity Tier 1 ratio of 12.86% compared to the regulatory guideline of 6.50% to be well-capitalized. The Bank’s risk-based Tier 1 and Total Capital ratios were 12.86% and 14.12%, respectively, which places the Bank above the federal bank regulatory agencies’ well-capitalized guidelines of 8.00% and 10.00%, respectively. We believe that we have the ability to raise additional capital, if necessary. In July 2013 the federal banking agencies issued a final rule to implement the Basel III Final Rules and the minimum leverage and risk-based capital requirements of the Dodd-Frank Act. The final rule established a comprehensive capital framework and went into effect on January 1, 2015 for smaller banking organizations such as the Company. The rule also requires the Company and the Bank to maintain a capital conservation buffer composed of Common Equity Tier 1 capital in an amount greater than 2.50% of total risk-weighted assets beginning in 2019. The capital conservation buffer was phased-in, in equal 50 Table of Contents CARTER BANKSHARES, INC. ITEM 2. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS - (continued) increments from 2016 through 2019. As a result, starting in 2019, the Company and the Bank were required to maintain a Common Equity Tier 1 risk-based capital ratio greater than 7.0%, a Tier 1 risk-based capital ratio greater than 8.5%, and a Total risk-based capital ratio greater than 10.5%; otherwise, they will be subject to restrictions on capital distributions and discretionary bonus payments. Federal regulators periodically propose amendments to the regulatory capital rules and the related regulatory framework and consider changes to the capital standards that could significantly increase the amount of capital needed to meet applicable standards. The timing of adoption, ultimate form and effect of any such proposed amendments cannot be predicted. The community bank leverage ratio final rule was effective on January 1, 2020 and allows qualifying community banking organizations to calculate a leverage ratio to measure capital adequacy. Qualifying banking organizations that have less than $10 billion total assets, a leverage ratio of greater than 9%, and meet other criteria such as off-balance sheet exposures and trading assets limits. Banks opting into this framework are not required to calculate or report risk-based capital. We did not adopt this framework; therefore, capital ratios are calculated and reported as detailed above. The Basel rules also permit banking organizations with less than $15.0 billion in assets to retain, through a one-time election, existing treatment for accumulated other comprehensive income, which currently does not affect regulatory capital. The Company elected to retain this treatment which reduces the volatility of regulatory capital levels. The following table summarizes risk-based capital amounts and ratios for the Company and the Bank for the dates presented: (Dollars in Thousands) Adequately Capitalized Well Capitalized (1) March 31, 2022 December 31, 2021 Amount Ratio Amount Ratio Carter Bankshares, Inc. Leverage Ratio 4.00 % NA $ 416,193 10.00 % $ 443,940 10.62 % Common Equity Tier 1 (to Risk-weighted Assets) 4.50 % NA 416,193 12.98 % 443,940 14.21 % Tier 1 Capital (to Risk-weighted Assets) 6.00 % NA 416,193 12.98 % 443,940 14.21 % Total Capital (to Risk-weighted Assets) 8.00 % NA 456,583 14.24 % 483,124 15.46 % Carter Bank & Trust Leverage Ratio 4.00 % 5.00 % $ 412,230 9.91 % $ 438,533 10.49 % Common Equity Tier 1 (to Risk-weighted Assets) 4.50 % 6.50 % 412,230 12.86 % 438,533 14.04 % Tier 1 Capital (to Risk-weighted Assets) 6.00 % 8.00 % 412,230 12.86 % 438,533 14.04 % Total Capital (to Risk-weighted Assets) 8.00 % 10.00 % 452,611 14.12 % 477,710 15.29 % (1) To be “well capitalized” under the prompt corrective action provisions in the Basel III framework. “Well capitalized” applies to the Bank only. In December 2018, the Office of the Comptroller of the Currency, (the “OCC”), the Federal Reserve System, (“FRB”), and the Federal Deposit Insurance Corporation, (“FDIC”), approved a final rule to address changes to credit loss accounting under GAAP, including banking organizations’ implementation of CECL. The final rule provides banking organizations the option to phase in over a three-year period the Day 1 adverse effects on regulatory capital that may result from the adoption of the new accounting standard. On March 27, 2020, the regulators issued interim final rule (“IFR”), “Regulatory Capital Rule: Revised Transition of the Current Expected Credit Losses Methodology for Allowances” in response to the disrupted economic activity from the spread of COVID-19. The IFR maintains the three-year transition option in the previous rule and provides banks the option to delay for two years an estimate of CECL’s effect on regulatory capital, relative to the incurred loss methodology’s effect on regulatory capital, followed by a three-year transition period (five-year transition option). We adopted CECL effective January 1, 2021 and elected to implement the capital transition relief over the permissible three-year period. Contractual Obligations As of March 31, 2022, there have been no material changes outside the ordinary course of business to the information about the Company’s contractual obligations and cash commitments disclosed in Part II, Item 7, “Management's Discussion and Analysis," under the heading “Contractual Obligations” in the Company's Annual Report on Form 10-K for the year ended December 31, 2021. 51 Table of Contents CARTER BANKSHARES, INC. ITEM 2. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS - (continued) Off-Balance Sheet Arrangements As of March 31, 2022, there have been no material changes to the off-balance sheet arrangements disclosed in Part II, Item 7, "Management's Discussion and Analysis," under the heading "Off-Balance Sheet Arrangements" in the Corporation's Annual Report on Form 10-K for the year ended December 31, 2021.