Carter Bankshares, Inc. 10-Q

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 June 30, 2022 and $7.0 million at December 31, 2021. Information pertaining to FHLB advances is summarized in the following table: (Dollars in Thousands) June 30, 2022 December 31, 2021 Balance at Period End $ — $ 7,000 Average Balance during the Period $ 4,011 $ 25,986 Average Interest Rate during the Period 0.80 % 1.20 % Maximum Month-end Balance during the Period $ 20,000 $ 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 June 30, 2022 and December 31, 2021, respectively. Dividends recorded on this restricted stock were $22 thousand and $42 thousand for the three and six months ended June 30, 2022 compared to $31 thousand and $68 thousand for the same periods in 2021. 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 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. The Company’s 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 $728.5 million of unpledged available-for-sale investment securities as an additional source of liquidity. An important component of the Company’s 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 June 30, 2022, the Bank had $755.6 million in highly liquid assets, 56 Table of Contents CARTER BANKSHARES, INC. ITEM 2. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS - (continued) which consisted of $0.8 million in interest-bearing deposits in other financial institutions, $26.3 million in FRB Excess Reserves and $728.5 million in unpledged securities. This resulted in highly liquid assets to total assets ratio of 18.3% at June 30, 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) June 30, 2022 December 31, 2021 Cash and Due From Banks $ 43,194 $ 36,698 Interest-bearing Deposits in Other Financial Institutions 745 64,905 Federal Reserve Bank Excess Reserves 26,301 176,196 Unpledged Investment Securities 728,515 743,836 Excess Pledged Securities 22,861 28,417 FHLB Borrowing Availability 773,628 667,307 Unsecured Lines of Credit 145,000 145,000 Total Liquidity Sources $ 1,740,244 $ 1,862,359 Regulatory Capital Requirements Total shareholders’ equity decreased by $73.5 million to $334.1 million at June 30, 2022 compared to $407.6 million at December 31, 2021. The decrease in equity was primarily due to a $61.7 million, net of tax, decline in other comprehensive loss due to changes in the fair value of available-for-sale securities due to unrealized losses driven by increases in market interest rates, a $32.4 million decrease related to the repurchase of common stock through June 30, 2022, partially offset by net income of $20.1 million for the six months ended June 30, 2022. The remaining difference of $0.5 million is related to stock-based compensation during the six months ended June 30, 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 June 30, 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 June 30, 2022, the Bank continues to maintain its capital position with a leverage ratio of 9.93% as compared to the regulatory guideline of 5.00% to be well-capitalized and a risk-based Common Equity Tier 1 ratio of 12.67% compared to the regulatory guideline of 6.50% to be well-capitalized. The Bank’s risk-based Tier 1 and Total Capital ratios were 12.67% and 13.93%, 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. 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. 57 Table of Contents CARTER BANKSHARES, INC. ITEM 2. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS - (continued) The Basel III Capital Rules require the Company and the Bank to maintain minimum Common Equity Tier 1, Tier 1 and Total Capital ratios, along with a capital conservation buffer, effectively resulting in new minimum capital ratios (which are shown in the table below). The capital conservation buffer is designed to absorb losses during periods of economic stress. Banking institutions with a ratio of Common Equity Tier 1 capital to risk-weighted assets above the minimum but below the conservation buffer (or below the combined capital conservation buffer and countercyclical capital buffer, when the latter is applied) will face constraints on dividends, equity repurchases and compensation based on the amount of the shortfall. The Basel III Capital Rules also provide for a “countercyclical capital buffer” that is applicable to only certain covered institutions and does not have any current applicability to the Company or the Bank. The following table summarizes the actual risk-based capital amounts and ratios for the Company and the Bank for the dates presented: (Dollars in Thousands) Minimum Required Basel III Well Capitalized (1) June 30, 2022 December 31, 2021 Amount Ratio Amount Ratio Carter Bankshares, Inc. Leverage Ratio 4.00 % NA $ 419,491 9.96 % $ 443,940 10.62 % Common Equity Tier 1 (to Risk-weighted Assets) 7.00 % NA 419,491 12.70 % 443,940 14.21 % Tier 1 Capital (to Risk-weighted Assets) 8.50 % NA 419,491 12.70 % 443,940 14.21 % Total Capital (to Risk-weighted Assets) 10.50 % NA 461,107 13.96 % 483,124 15.46 % Carter Bank & Trust Leverage Ratio 4.00 % 5.00 % $ 418,300 9.93 % $ 438,533 10.49 % Common Equity Tier 1 (to Risk-weighted Assets) 7.00 % 6.50 % 418,300 12.67 % 438,533 14.04 % Tier 1 Capital (to Risk-weighted Assets) 8.50 % 8.00 % 418,300 12.67 % 438,533 14.04 % Total Capital (to Risk-weighted Assets) 10.50 % 10.00 % 459,905 13.93 % 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 June 30, 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. Off-Balance Sheet Arrangements As of June 30, 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. 58 Table of Contents CARTER BANKSHARES, INC.