What changed in this filing

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Item 2. Management’s Discussion and Analysis

2022-11-04 compared with 2022-08-03 · 348 added, 20 removed, 88 unchanged (81% of the section changed)

MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS - (continued)

Provision for Income Taxes

The provision for income taxes increased $4.1 million and $5.4 million to $5.0 million and $8.1 million for the three and nine months ended September 30, 2022, respectively, when compared to the same periods in 2021.

Pre-tax income increased $7.3 million and $13.9 million for the three and nine months ended September 30, 2022, respectively, when compared to the same periods in 2021.

The effective tax rate was 25.8% and 19.1% for the three and nine months ended September 30, 2022, respectively, compared to 7.7% and 9.5% for the same periods in 2021.

The increase in the effective tax rate is primarily due to a higher level of pre-tax income and lower level of tax-exempt interest income and updated information from the developer extending the in-service date on a new tax credit from 2022 to 2023.

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 bank owned life insurance (“BOLI”).

Financial Condition

September 30, 2022

Total assets decreased $19.4 million, to $4.1 billion at September 30, 2022 compared to December 31, 2021.

Federal Reserve Bank excess reserves decreased $154.4 million to $21.8 million at September 30, 2022 from $176.2 million at December 31, 2021 due to redeploying excess cash into higher yielding loans and securities.

Total portfolio loans increased $219.2 million, or 10.4% on an annualized basis, to $3.0 billion at September 30, 2022 compared to $2.8 billion at December 31, 2021 primarily due to consistent loan growth throughout 2022.

During the first nine months of 2022 and 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 $159.7 million in residential mortgages, $67.1 million in construction loans, $42.1 million in commercial real estate loans, and $2.3 million in other consumer loans offset by decreases of $32.6 million in the other category and $19.4 million in C&I loans.

Other real estate owned, (“OREO”), decreased $2.8 million at September 30, 2022 compared to December 31, 2021 due to sales and payments of OREO.

Closed retail bank offices decreased $0.2 million with remaining book values of $0.8 million, of which $0.7 million is under contract, at September 30, 2022 and $1.0 million at December 31, 2021.

The securities portfolio decreased $71.2 million and is currently 20.7% of total assets at September 30, 2022 compared to 22.3% of total assets at December 31, 2021.

The decrease is due to the Company’s strategy of redeploying securities maturities into higher yielding loan growth, as well as the increase in gross unrealized losses due to rising interest rates.

At September 30, 2022, total gross unrealized gains in the available-for-sale portfolio were $0.4 million, offset by $109.7 million of gross unrealized losses.

Refer to the “Securities Activity” section below for further discussion of unrealized losses in the available-for-sale securities portfolio.

Total deposits increased $27.5 million to $3.7 billion at September 30, 2022 compared to December 31, 2021.

The increases included $57.3 million in interest-bearing demand accounts, $54.0 million in money market accounts, and $41.2 million in savings accounts offset by the intentional decline of $95.7 million in CDs and a decline of $29.3 million in noninterest-bearing demand accounts.

At September 30, 2022, noninterest-bearing deposits comprised 19.3% of total deposits compared to 20.2% at December 31, 2021 and 19.7% at September 30, 2021.

CDs comprised 33.5%, 36.3% and 38.3% of total deposits at September 30, 2022, December 31, 2021 and September 30, 2021, respectively.

Total capital decreased by $92.8 million to $314.8 million at September 30, 2022 compared to $407.6 million at December 31, 2021.

The decrease in equity was primarily due to a $88.0 million, net of tax, decrease in other comprehensive loss due to changes in the fair value of available-for-sale securities, a $40.1 million decrease related to the repurchase of common stock through September 30, 2022, partially offset by net income of $34.5 million for the nine months ended September 30, 2022 that was retained by the Company.

The remaining difference of $0.8 million is related to stock-based compensation during the nine months ended September 30, 2022.

The ACL was 3.11% of total portfolio loans at September 30, 2022 compared to 3.41% as of December 31, 2021.

General reserves as a percentage of total portfolio loans were 3.09% at September 30, 2022 compared to 3.38% at December 31, 2021.

The decrease in the general reserves as a percentage of total portfolio loans was primarily driven by the release of $3.7 million of reserves that were allocated to the other segment due to principal pay-downs.

Management believes, the ACL is adequate to absorb expected losses inherent in the loan portfolio.

CARTER BANKSHARES, INC.

MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS - (continued)

The Company remains well capitalized.

Our Tier 1 capital ratio decreased to 12.80% at September 30, 2022 compared to 14.21% at December 31, 2021.

Our leverage ratio was 10.11% at September 30, 2022, compared to 10.62% at December 31, 2021 and total risk-based capital ratio was 14.06% at September 30, 2022 compared to 15.46% at December 31, 2021.The decrease is related to the aforementioned repurchase of common stock of $40.1 million through September 30, 2022.

We adopted CECL effective January 1, 2021 and elected to implement the regulatory agencies’ capital transition relief over the permissible three-year period.

Securities Activity

The following table presents the composition of available-for-sale securities:

(Dollars in Thousands) September 30, 2022 December 31, 2021 $ Change

Treasury Securities $ 17,748 $ 4,413 $ 13,335

Government Agency Securities 2,914 3,478 (564)

Residential Mortgage-Backed Securities 104,568 110,013 (5,445)

Commercial Mortgage-Backed Securities 37,082 4,168 32,914

Asset Backed Securities 80,776 81,863 (1,087)

Collateralized Mortgage Obligations 266,611 287,614 (21,003)

Small Business Administration 50,443 108,914 (58,471)

States and Political Subdivisions 228,655 262,202 (33,547)

Corporate Notes 62,414 59,735 2,679

Total Debt Securities $ 851,211 $ 922,400 $ (71,189)

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 decreased by $71.2 million to $851.2 million at September 30, 2022 compared to $922.4 million at December 31, 2021.

Securities comprise 20.7% of total assets at September 30, 2022 compared to 22.3% at December 31, 2021.

The decrease is a result of redeploying securities maturities into higher yielding loan growth during 2022 and the continued decline in fair value.

We have further diversified the securities portfolio as to bond types, maturities and interest rate structures.

As of September 30, 2022, the securities portfolio was comprised of 48.0% variable rate securities with approximately 46.4% that will reprice at least once over the next 12 months.

At September 30, 2022 total gross unrealized gains in the available-for-sale portfolio were $0.4 million, offset by $109.7 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 are believed to be temporary primarily due to upward movement in interest rates, and not related to the credit quality of these securities.

Our portfolio consists of 49.9% of securities issued by United States government sponsored entities and carry an implicit government guarantee.

States and political subdivisions comprise 29.2% of the portfolio and largely general obligations or essential purpose revenue bonds, which have performed very well historically over all business cycles, and are rated AA and AAA.

We have the intent and ability to hold these securities to maturity and expect full recovery of the amortized cost.

The Company’s investment securities with intermediate and long-term maturities were the largest driver of these gross unrealized losses, as the market values of these securities are significantly impacted by the Treasury yield curve for similar durations (i.e., 5- and 10-year Treasury securities).

This portion of the Treasury yield curve has moved significantly upward over the past nine months, driving unrealized losses on these securities higher.

Although the Federal Reserve is in the middle of an aggressive effort to raise short-term interest rates to combat inflation, the Company does not expect higher short-term rates to adversely impact the fair values of the Company’s investment securities to the same extent as increases in longer-term rates.

The Company expects that higher short-term rates may improve yields on certain of the Company’s variable rate securities within the next six to twelve months.

CARTER BANKSHARES, INC.

MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS - (continued)

At December 31, 2021, the 5-year and 10-year U.S.

Treasury yields were 1.26% and 1.52%, respectively.

At September 30, 2022, those same bond yields were 4.06% and 3.83%, respectively.

Therefore, this increase of 280 and 231 basis points, 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 generally 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 Federal Reserve interest rate hikes.

Should the impairment of any of these securities become credit related, the cost basis of the investment will be reduced and the resulting loss will be recognized in net income in the period the credit related impairment is identified, while any non-credit loss will be recognized in other comprehensive loss.

At September 30, 2022 and December 31, 2021, the Company had no credit related net investment impairment losses.

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.

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.

Loan Composition

The following table summarizes our loan portfolio for the periods presented:

(Dollars in Thousands) September 30, 2022 December 31, 2021

Commercial Real Estate $ 1,365,348 $ 1,323,252

Commercial and Industrial 325,973 345,376

Total Commercial Loans 1,691,321 1,668,628

Residential Mortgages 617,681 457,988

Other Consumer 47,006 44,666

Total Consumer Loans 664,687 502,654

Construction 350,037 282,947

Other 325,304 357,900

Total Portfolio Loans 3,031,349 2,812,129

Loans Held-for-Sale 1,513 228

Total Loans $ 3,032,862 $ 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 $219.2 million, or 10.4%, on an annualized basis, to $3.0 billion at September 30, 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.

The Bank experienced strong growth in the residential mortgage loan portfolio during 2022.

However, given the expectation of continued higher mortgage rates next year, we expect more modest growth.

At September 30, 2022, the loan portfolio was comprised of 28.9% floating rates which reprice monthly, 39.9%, variable rates that reprice at least once during the life of the loan and the remaining 31.2% 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 September 30, 2022 equated to approximately $368.2 million, or 12.1%, 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

CARTER BANKSHARES, INC.

MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS - (continued)

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 September 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 $669.8 million at September 30, 2022.

The Other segment represents 48.1% of the top 10 credit relationships.

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 September 30, 2022 September 30, 2022

September 30, 2022 December 31, 2021 % of Gross Loans % of RBC

Hospitality, agriculture & energy $ 321,893 $ 350,010 $ (28,117) 10.61 % 68.72 %

Retail real estate & food services 58,920 56,073 2,847 1.94 % 12.58 %

Industrial & retail real estate 42,188 45,653 (3,465) 1.39 % 9.01 %

Multifamily development 40,000 36,720 3,280 1.32 % 8.54 %

Retail real estate 38,073 38,250 (177) 1.26 % 8.13 %

Hospitality 35,007 35,664 (657) 1.16 % 7.47 %

Multifamily & student housing 34,320 35,405 (1,085) 1.13 % 7.33 %

Hospitality 33,809 34,463 (654) 1.12 % 7.22 %

Special/limited use 33,736 33,736 — 1.11 % 7.20 %

Multifamily development 31,891 29,389 2,502 1.05 % 6.81 %

Top Ten (10) Relationships $ 669,837 $ 695,363 $ (25,526) 22.09 % 143.01 %

Total Gross Loans $ 3,032,862 $ 2,812,357 $ 220,505

% of Total Gross Loans 22.09 % 24.73 % (2.64) %

Concentration (25% of RBC) $ 117,100 $ 120,781

Unfunded commitments on lines of credit were $455.8 million at September 30, 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 52.6% at September 30, 2022 and 52.2% at December 31, 2021.

Unfunded commitments on commercial operating lines of credit was 53.9% at September 30, 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 $7.8 million and $4.5 million at September 30, 2022 and December 31, 2021, respectively.

Discounts on purchased 1-4 family loans included in the portfolio balances above were $169.5 thousand and $190.6 thousand at September 30, 2022 and December 31, 2021, respectively.

CARTER BANKSHARES, INC.

MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS - (continued)

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 has 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.

There were zero mortgage loans held-for-sale at September 30, 2022 and $0.2 million at December 31, 2021.

During the third quarter of 2022, a $4.9 million purchased syndicated C&I loan was charged-down $3.4 million and the remaining $1.5 million was transferred to held-for-sale.

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.

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 trends in our lending footprint and 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 and OREO.

The following table summarizes nonperforming assets for the dates presented:

(Dollars in Thousands) September 30, 2022 December 31, 2021 $ Change

Nonperforming Loans

Commercial Real Estate $ 2,416 $ 3,337 $ (921)

Commercial and Industrial 201 451 (250)

Residential Mortgages 3,509 2,551 958

Other Consumer 9 73 (64)

Construction 875 985 (110)

Total Nonperforming Loans 7,010 7,397 (387)

Other Real Estate Owned 8,134 10,916 (2,782)

Total Nonperforming Assets $ 15,144 $ 18,313 $ (3,169)

Nonperforming assets decreased $3.2 million to $15.1 million at September 30, 2022 compared to December 31, 2021.

The decrease was primarily due to a $2.8 million decrease in OREO, driven primarily by sales and payments.

Closed retail bank offices have a remaining book value of $0.8 million at September 30, 2022, of which $0.7 million are under contract, and $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.

In addition, two former closed offices were also moved to OREO.

During the nine months ended September 30, 2022, a total of five branch office locations were sold and four are under contract.

CARTER BANKSHARES, INC.

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 Disclosures Prior to Our Adoption of ASU No.

Prior to our adoption of ASU No.

2022-02, the Company accounted for a Troubled Debt Restructurings (“TDRs”) as a loan which, for economic or legal reasons related to a borrower’s financial difficulties, granted 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 have been considered a TDR generally included 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 have been instances of principal forgiveness.

Short-term modifications that were considered insignificant were generally not considered a TDR unless there were other concessions granted.

On April 1, 2022, the Company adopted ASU 2022-02, which eliminated TDR accounting prospectively for all restructurings occurring on or after January 1, 2022.

Refer to Note 1, Basis of Presentation, in the Notes to Consolidated Financial Statements in Item 1 of this Quarterly Report on Form 10-Q for additional information related to ASU No.

Generally, the Company individually evaluates all loans experiencing financial difficulty, 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.

CARTER BANKSHARES, INC.

MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS - (continued)

Allowance for Credit Losses

The following is the allocation of the ACL balance by segment for the periods presented:

September 30, 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 $ 17,375 45.0 % $ 17,297 47.0 %

Commercial & Industrial 3,798 10.8 % 4,111 12.3 %

Residential Mortgages 5,622 20.4 % 4,368 16.3 %

Other Consumer 1,616 1.5 % 1,493 1.6 %

Construction 8,688 11.5 % 6,939 10.1 %

Other 57,065 10.7 % 61,731 12.7 %

Balance End of Year $ 94,164 100.0 % $ 95,939 100.0 %

The following table summarizes the credit quality ratios and their components as of September 30, 2022 and December 31, 2021:

(Dollars in Thousands) September 30, 2022 December 31, 2021

Allowance for Credit Losses to Total Portfolio Loans

Allowance for Credit Losses $ 94,164 $ 95,939

Total Portfolio Loans 3,031,349 2,812,129

Allowance for Credit Losses to Total Portfolio Loans 3.11 % 3.41 %

Nonperforming Loans to Total Portfolio Loans

Nonperforming Loans $ 7,010 $ 7,397

Total Portfolio Loans 3,031,349 2,812,129

Nonperforming Loans to Total Portfolio Loans 0.23 % 0.26 %

Allowance for Credit Losses to Nonperforming Loans

Allowance for Credit Losses $ 94,164 $ 95,939

Nonperforming Loans 7,010 7,397

Allowance for Credit Losses to Nonperforming Loans 1,343.28 % 1,297.00 %

Net Charge-offs to Average Portfolio Loans

Net Charge-offs (annualized) $ 5,538 $ 23,127

Average Total Portfolio Loans 2,949,906 2,927,083

Net Charge-offs to Average Portfolio Loans 0.19 % 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 previous table.

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 (recovery) for credit losses, which includes a provision (recovery) 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 increased $0.3 million to $(0.1) million for the three months ended September 30, 2022 and decreased slightly to $2.4 million for the nine months ended September 30, 2022 compared to the same periods in 2021.

The increase for the three months ended September 30, 2022 was primarily driven by loan growth, increased qualitative reserves and a purchased syndicated commercial and industrial (“C&I”) loan that was charged-down by $3.4 million, of which $2.6 million was previously reserved, offset by the release of $3.7 million in the other segment due to principal pay-downs.

The provision (recovery) for unfunded commitments increased $0.2 million and $1.1 million for the three and nine months ended September 30, 2022 when compared to the same periods in 2021 due to changes in reserve rates.

The reserve for unfunded commitments is largely comprised of unfunded commitments related to real estate construction loans.

There are three basic factors that influence the reserve rates associated with unfunded commitments for construction loans.

First, the reserve

CARTER BANKSHARES, INC.

MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS - (continued)

rate is extrapolated from the reserve rates calculated for certain commercial real estate funded loans within the ACL model.

These reserve rates are influenced by the same factors cited in the ACL model such as economic forecasts, average portfolio life, etc.

Refer to Note 1, Basis of Presentation, in the Notes to Consolidated Financial Statements in Item 1 of this Quarterly Report on Form 10-Q for additional information related to the ACL Policy and the discussion of these factors.

Second, since the category of construction is generic, management applies a weighting of the reserve rates associated with certain commercial real estate loans.

The proportion of these segments affect the weighting.

Third, volume changes impact the total reserve calculation.

Net charge-offs were $3.7 million and $4.1 million for the three and nine months ended September 30, 2022, respectively, compared to the same periods in 2021.

During the three months ended September 30, 2022, the Company charged-down $3.4 million on a $4.9 million purchased syndicated C&I loan and transferred $1.5 million to held-for-sale.

As a percentage of average total portfolio loans, on an annualized basis, net charge-offs were 0.49% and 0.19% for the three and nine months ended September 30, 2022 compared to 1.30% and 0.85% for the same periods in 2021.

At September 30, 2022, nonperforming loans decreased $0.4 million, or 5.2%, to $7.0 million since December 31, 2021.

Nonperforming loans as a percentage of total portfolio loans were 0.23% and 0.26% as of September 30, 2022 and December 31, 2021, respectively.

The ACL was 3.11% of total portfolio loans at September 30, 2022, compared to 3.41% of total portfolio loans, at December 31, 2021.

The following tables represent credit exposures by internally assigned risk ratings as of the periods presented:

September 30, 2022

(Dollars in Thousands) Commercial Real Estate Commercial and Industrial Residential Mortgage Other Consumer Construction Other Total Portfolio Loans

Pass $ 1,351,618 $ 320,069 $ 612,481 $ 46,917 $ 348,848 $ 180,768 $ 2,860,701

Special Mention 10,910 — 992 — 207 1,145 13,254

Substandard 2,820 5,904 4,208 89 982 143,391 157,394

Doubtful — — — — — — —

Loss — — — — — — —

Total Portfolio Loans $ 1,365,348 $ 325,973 $ 617,681 $ 47,006 $ 350,037 $ 325,304 $ 3,031,349

Performing $ 1,362,932 $ 325,772 $ 614,172 $ 46,997 $ 349,162 $ 325,304 $ 3,024,339

Nonperforming 2,416 201 3,509 9 875 — 7,010

Total Portfolio Loans $ 1,365,348 $ 325,973 $ 617,681 $ 47,006 $ 350,037 $ 325,304 $ 3,031,349

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 September 30, 2022 decreased $24.7 million to $170.6 million compared to $195.3 million at December 31, 2021.

The increase of $3.5 million in special mention is primarily related to one large CRE

CARTER BANKSHARES, INC.

MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS - (continued)

loan that downgraded from pass, offset by payments and an upgrade to pass on one credit.

The decrease of $28.2 million in substandard loans related to paydowns in the other loan category during the second and third quarters of 2022.

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 the ACL.

The following table presents the composition of deposits for the periods presented:

(Dollars in Thousands) September 30,

2022 December 31,

2021 $ Change % Change

Noninterest-Bearing Demand $ 718,549 $ 747,909 $ (29,360) (3.9) %

Interest-Bearing Demand 509,949 452,644 57,305 12.7 %

Money Market 517,031 463,056 53,975 11.7 %

Savings 731,747 690,549 41,198 6.0 %

Certificate of Deposits 1,248,653 1,344,318 (95,665) (7.1) %

Total Deposits $ 3,725,929 $ 3,698,476 $ 27,453 0.7 %

Deposits are the Company’s primary source of funds.

The Company believes that the deposit base is stable and has the ability to attract new depositors while diversifying the deposit composition.

Total deposits at September 30, 2022 increased $27.5 million, or 0.7%, from December 31, 2021.

The increase in deposits primarily related to an increase in our core deposits of $123.1 million, or 7.0% 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 $95.7 million, or 7.1% in CDs at September 30, 2022 compared to December 31, 2021 is due to the intentional runoff of higher cost CDs.

Noninterest-bearing deposits comprised 19.3% and 20.2% of total deposits at September 30, 2022 and December 31, 2021, respectively.

The following table presents additional information in relation to deposits:

(Dollars in Thousands) September 30,

2022 December 31,

Deposits from the Certificate of Deposit Account Registry Services (CDARS) $ 922 $ 139

Noninterest-Bearing Public Funds Deposits 22,117 58,393

Interest-Bearing Public Funds Deposits 160,054 123,968

Total Deposits not Covered by Deposit Insurance (1)

410,703 396,626

Certificates of Deposits not Covered by Deposit Insurance 145,530 147,134

Deposits for Certain Directors, Executive Officers and their Affiliates 3,178 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 September 30, 2022 are summarized as follows:

(Dollars in Thousands) Amount Percent

Three Months or Less $ 15,830 10.9 %

Over Three Months Through Twelve Months 63,239 43.5 %

Over Twelve Months Through Three Years 52,138 35.8 %

Over Three Years 14,323 9.8 %

Total $ 145,530 100.0 %

CARTER BANKSHARES, INC.

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.

We had $30.0 million FHLB borrowings at September 30, 2022 and $7.0 million at December 31, 2021.

These borrowings were a result of higher loan demand in the later part of the third quarter of 2022 as a short-term funding source.

Information pertaining to FHLB advances is summarized in the following table:

(Dollars in Thousands) June 30, 2022 December 31, 2021

(Dollars in Thousands) September 30, 2022 December 31, 2021

Balance at Period End $ 30,000 $ 7,000

3 unchanged sentences

Average Interest Rate at Period End 3.13 % 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 Company held FHLB of Atlanta stock of $3.2 million and $2.4 million at September 30, 2022 and December 31, 2021, respectively.

Dividends recorded on this restricted stock were $24 thousand and $66 thousand for the three and nine months ended September 30, 2022 compared to $30 thousand and $98 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.

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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,

ALCO policy guidelines define a ratio of highly liquid assets to total assets by graduated

CARTER BANKSHARES, INC.

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.

risk tolerance levels of minimal, moderate and high.

At September 30, 2022, the Bank had $652.1 million in highly liquid assets, which consisted of $5.1 million in interest-bearing deposits in other financial institutions, $21.8 million in FRB Excess Reserves, $623.7 million in unpledged securities and $1.5 million in syndicated C&I loans held-for-sale.

This resulted in highly liquid assets to total assets ratio of 15.9% at September 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

(Dollars in Thousands) September 30, 2022 December 31, 2021

Cash and Due From Banks $ 38,749 $ 36,698

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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.

Total shareholders’ equity decreased by $92.8 million to $314.8 million at September 30, 2022 compared to $407.6 million at December 31, 2021.

The decrease in equity was primarily due to a $88.0 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 $40.1 million decrease related to the repurchase of common stock through September 30, 2022, partially offset by net income of $34.5 million for the nine months ended September 30, 2022 that was retained by the Company .

The remaining difference of $0.8 million is related to stock-based compensation during the nine months ended September 30, 2022.

The Company and the Bank are subject to various capital requirements administered by the federal banking regulators.

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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.

Quantitative measures established by regulations to ensure capital adequacy require us to maintain minimum amounts and ratios.

Prompt corrective action regulations provide five classifications:

2 unchanged sentences

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.

At September 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.

At September 30, 2022, the Bank continues to maintain its capital position with a leverage ratio of 10.06% as compared to the regulatory guideline of 5.00% to be well-capitalized and a risk-based Common Equity Tier 1 ratio of 12.74% compared to the regulatory guideline of 6.50% to be well-capitalized.

The Bank’s risk-based Tier 1 and Total Capital ratios were 12.74% and 14.00%, respectively, which places the Bank above the federal bank regulatory agencies’ well-capitalized guidelines of 8.00% and 10.00%, respectively.

11 unchanged sentences

Capitalized (1)

June 30, 2022 December 31, 2021

September 30, 2022 December 31, 2021

Amount Ratio Amount Ratio

9 unchanged sentences

Total Capital (to Risk-weighted Assets) 10.50 % 10.00 % 466,035 14.00 % 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.

(1) To be “well capitalized” under the prompt corrective action, framework, which, 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.

5 unchanged sentences

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.

As of September 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.

As of September 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.

CARTER BANKSHARES, INC.

Compared sentence by sentence after normalising whitespace, quotation marks, case and digits, so re-formatting and restated figures do not read as changed language. Wording changes appear as one removal and one addition. The current filing and the prior one are authoritative.

What changed 10-Q

Item 2. Management’s Discussion and Analysis