Carter Bankshares, Inc. 10-Q

ITEM 2. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS - (continued) Financial Condition June 30, 2023 Total assets increased $179.5 million, to $4.4 billion at June 30, 2023 compared to $4.2 billion at December 31, 2022. Total portfolio loans increased $181.5 million, or 11.6% on an annualized basis, to $3.3 billion at June 30, 2023 compared to December 31, 2022 primarily due to loan growth in the CRE, residential mortgage and construction segments during the six months ended June 2023. The variances in loan segments for portfolio loans related to increases of $172.0 million in commercial real estate loans, $49.9 million in residential mortgages, $3.2 million in construction loans, offset by decreases of $30.6 million in C&I loans, $7.2 million in the other category and $5.8 million in other consumer loans. The securities portfolio decreased $14.9 million and is currently 18.7% of total assets at June 30, 2023 compared to 19.9% of total assets at December 31, 2022. The decrease is due to $42.0 million in security sales, curtailments and maturities deployed into higher yielding loan growth, offset by $24.9 million in purchases of small business administration bonds during the six months ended June 30, 2023. As of June 30, 2023, the securities portfolio was comprised of 46.9% variable rate securities with approximately 99.4% that will reprice at least once over the next 12 months. At June 30, 2023, total gross unrealized gains in the available-for-sale portfolio were $0.9 million, offset by $105.8 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. Federal Home Loan Bank (“FHLB”) stock, at cost increased $9.7 million to $19.4 million at June 30, 2023 compared to $9.7 million at December 31, 2022. The increase is due to the FHLB requirement to hold a specified level of stock based upon level of borrowings . Other real estate owned (“ OREO”) decre ase d $5.0 million at June 30, 2023 compared to December 31, 2022 due to the sale of one OREO property in June 2023. Closed retail bank offices had a book value of $1.0 million at June 30, 2023 and $1.1 million at December 31, 2022. Total deposits decreased $53.3 million to $3.6 billion at June 30, 2023 compared to December 31, 2022. The decrease related to a decline of $243.3 million in savings, money market and demand deposits due to customers migrating to higher-yielding CD products driven by rising market interest rates. At June 30, 2023, noninterest-bearing deposits comprised 19.2% of total deposits compared to 19.4% at December 31, 2022 and 18.8% at June 30, 2022. CDs comprised 40.6%, 34.7% and 33.6% of total deposits at June 30, 2023, December 31, 2022 and June 30, 2022, respectively. As of June 30, 2023, based on assumptions that the Bank uses to prepare its regulatory call report, approximately 88.3% of our total deposits of $3.6 billion were insured under standard FDIC insurance coverage limits, and approximately 11.7% of our total deposits were uninsured deposits over the standard FDIC insurance coverage limit. The Company’s deposit base is diversified and granular and is comprised of approximately 77.5% of retail deposits. Total capital of $344.2 million at June 30, 2023, reflects an increase of $15.6 million as compared to $328.6 million at December 31, 2022. The increase in total capital from December 31, 2022 is primarily due to a $3.6 million improvement in other comprehensive income due to changes in fair value of investment securities and net income of $21.6 million for the six months ended June 30, 2023, as well as, the transitional adjustment of $0.1 million, net of tax for the adoption of ASU 2023-02 less $10.4 million related to the repurchase of common stock. The remaining difference of $0.7 million is related to restricted stock activity for the six months ended June 30, 2023. The ACL was 2.83% of total portfolio loans at June 30, 2023 compared to 2.98% as of December 31, 2022. General reserves as a percentage of total portfolio loans were 1.21% at June 30, 2023 compared to 2.96% at December 31, 2022. The decrease in the general reserves as a percentage of total portfolio loans was primarily driven by the largest lending relationships movement from the general pool to the individually evaluated pool due to the transfer to nonaccrual during the second quarter of 2023 offset by loan growth. Management believes the ACL is adequate to absorb expected losses inherent in the loan portfolio. See the sections of this MD&A titled “Provision for Credit Losses,” “Credit Quality” and “Allowance for Credit Losses” for information about the factors that impacted the ACL and the provision for credit losses. The Company remains well capitalized. The Tier 1 capital ratio decreased to 11.46% at June 30, 2023 compared to 12.61% at December 31, 2022. The leverage ratio was 10.02% at June 30, 2023, compared to 10.29% at December 31, 2022 and the total risk-based capital ratio was 12.72% at June 30, 2023 compared to 13.86% at December 31, 2022. The decrease is related to the aforementioned repurchase of common stock of $10.4 million through June 30, 2023 and loan growth during the six months ended June 30, 2023. Another significant factor driving the ratios downward was the above mentioned large lending relationship movement to nonaccrual with the $11.3 million negative impact on interest income, combined with the movement of nonaccrual assets to higher risk rating categories. 50 Table of Contents CARTER BANKSHARES, INC. ITEM 2. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS - (continued) The Bank also remained well capitalized as of June 30, 2023. The Bank’s Tier 1 Capital ratio was 11.34% at June 30, 2023 compared to 12.42% at December 31, 2022. The Bank’s leverage ratio was 9.76% at June 30, 2023 compared to 10.13% at December 31, 2022. The Bank’s Total Risk-Based Capital ratio was 12.60% at June 30, 2023 compared to 13.68% at December 31, 2022. Securities Activity The following table presents the composition of available-for-sale securities: (Dollars in Thousands) June 30, 2023 December 31, 2022 $ Change U.S. Treasury Securities $ 13,174 $ 17,866 $ (4,692) U.S. Government Agency Securities 51,508 49,764 1,744 Residential Mortgage-Backed Securities 100,163 103,685 (3,522) Commercial Mortgage-Backed Securities 35,402 34,675 727 Other Commercial Mortgage-Backed Securities 21,583 22,399 (816) Asset Backed Securities 138,722 141,383 (2,661) Collateralized Mortgage Obligations 169,077 176,622 (7,545) States and Political Subdivisions 233,431 228,146 5,285 Corporate Notes 58,310 61,733 (3,423) Total Debt Securities $ 821,370 $ 836,273 $ (14,903) 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 $14.9 million to $821.4 million at June 30, 2023 compared to $836.3 million at December 31, 2022. Securities comprise 18.7% of total assets at June 30, 2023 compared to 19.9% at December 31, 2022. The decrease is due to $42.0 million in security sales, curtailments and maturities deployed into higher yielding loan growth, offset by $24.9 million in purchases of small business administration bonds during the six months ended June 30, 2023. As of June 30, 2023, the securities portfolio was comprised of 46.9% variable rate securities with approximately 99.4% that will reprice at least once over the next 12 months. At June 30, 2023 total gross unrealized gains in the available-for-sale portfolio were $0.9 million, offset by $105.8 million of gross unrealized losses. At December 31, 2022, total gross unrealized gains in the available-for-sale portfolio were $0.3 million offset by $109.7 million of gross unrealized losses. The unrealized losses on debt securities are believed to be temporary primarily because these unrealized losses are due to reductions in market value caused by upward movement in interest rates since the securities purchase (as applicable), and not related to the credit quality of these securities. Our portfolio consists of 48.5% of securities issued by United States government sponsored entities and carry an implicit government guarantee. States and political subdivisions comprise 28.4% of the portfolio and are 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 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 slightly downward over the past three months, driving unrealized losses on these securities lower. 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. 51 Table of Contents CARTER BANKSHARES, INC. ITEM 2. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS - (continued) The Company expects that higher short-term rates may continue to improve yields on certain of the Company’s variable rate securities over the next six to twelve months. At June 30, 2023 the 5-year and 10-year U.S. Treasury yields were 4.13% and 3.81, respectively. At December 31, 2022, those same bond yields were 3.99% and 3.88%, respectively. The decrease of seven basis points in the 10-year treasury was offset by the increase in the 5-year treasury in the intermediate part of the yield curve which drove the reduction in unrealized losses for the first six months of 2023. 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 impairment will be recognized by establishing an ACL through provision for credit losses in the period the credit related impairment is identified, while any non-credit loss will be recognized in accumulated other comprehensive loss, net of applicable taxes. At June 30, 2023 and December 31, 2022, 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 most banking organizations to retain, through a one-time election, existing treatment for accumulated other comprehensive loss, 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) June 30, 2023 December 31, 2022 Commercial Commercial Real Estate $ 1,642,597 $ 1,470,562 Commercial and Industrial 279,156 309,792 Total Commercial Loans 1,921,753 1,780,354 Consumer Residential Mortgages 707,893 657,948 Other Consumer 38,736 44,562 Total Consumer Loans 746,629 702,510 Construction 356,805 353,553 Other 305,255 312,496 Total Portfolio Loans 3,330,442 3,148,913 Loans Held-for-Sale 173 — Total Loans $ 3,330,615 $ 3,148,913 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, 2022, and Part II, Item 1A, “Risk Factors,” contained in our Quarterly Report on Form 10-Q for the period ended March 31, 2023 and this Quarterly Report on Form 10-Q. Total portfolio loans increased $181.5 million, or 11.6%, on an annualized basis, to $3.3 billion at June 30, 2023 compared to December 31, 2022 with strong production primarily in our CRE and residential mortgage portfolios. The CRE portfolio is monitored for potential concentrations of credit risk by market, property type and tenant concentrations. Given the continued rising rate environment our mortgage portfolio is experiencing more modest growth in 2023. At June 30, 2023, the loan portfolio was comprised of 25.3% floating rates which reprice monthly, 41.6%, variable rates that reprice at least once during the life of the loan and the remaining 33.1% are fixed rate loans. The Company is carefully monitoring the loan portfolio during 2023, including in light of market conditions that impact our borrowers and the interest rate environment. 52 Table of Contents CARTER BANKSHARES, INC. ITEM 2. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS - (continued) Aggregate commitments to our top 10 credit relationships were $638.3 million at June 30, 2023. The Other segment represents 47.3% of the top 10 credit relationships and $301.9 million has since transferred to nonaccrual during the second quarter of 2023, as described in more detail below under “Credit Quality” in this MD&A. 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 June 30, 2023 June 30, 2023 June 30, 2023 December 31, 2022 % of Gross Loans % of RBC 1. Hospitality, agriculture & energy $ 301,913 $ 309,107 $ (7,194) 9.06 % 61.97 % 2. Retail real estate & food services 54,232 55,625 (1,393) 1.63 % 11.13 % 3. Industrial & retail real estate 40,795 41,725 (930) 1.22 % 8.37 % 4. Multifamily development 40,000 40,000 — 1.20 % 8.21 % 5. Retail real estate 37,955 37,679 276 1.14 % 7.78 % 6. Non-Owner Occupied/Commercial Real Estate 33,538 17,308 16,230 1.01 % 6.88 % 7. Multifamily & student housing 33,349 33,998 (649) 1.00 % 6.85 % 8. Hospitality 32,987 33,587 (600) 0.99 % 6.77 % 9. Multifamily / Construction Real Estate 32,000 24,000 8,000 0.96 % 6.57 % 10. Multifamily Development 31,521 31,790 (269) 0.95 % 6.47 % Top Ten (10) Relationships $ 638,290 $ 624,819 $ 13,471 19.16 % 131.00 % Total Gross Loans $ 3,330,615 $ 3,148,913 $ 181,702 % of Total Gross Loans 19.16 % 19.84 % (0.68) % Concentration (25% of RBC) $ 121,797 $ 120,863 Unfunded commitments on lines of credit were $592.8 million at June 30, 2023 as compared to $512.7 million at December 31, 2022. The majority of unused commitments are for construction projects that will be drawn as the construction completes. Total utilization was 49.8% at June 30, 2023 and 52.2% at December 31, 2022. Unfunded commitments on commercial operating lines of credit was 49.0% at June 30, 2023 and 51.7% at December 31, 2022. 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 established transaction, relationship and 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 and are based on management’s risk tolerance relative to capital. 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. Although leverage is important, the Company is also focused on cash flow generation and uses multiple metrics to calculate a supportable loan amount. Supportable loan amounts have generally been more challenging given the increases in commodities pricing. 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. The Company significantly increased the standards for consumer unsecured lending by adjusting upward the required qualifying Fair Isaac Corporation (“FICO”) scores and restricting loan amounts at lower FICO scores. Deferred costs and fees included in the portfolio balances above were $6.6 million and $8.2 million at June 30, 2023 and December 31, 2022, respectively. Discounts on purchased 1-4 family loans included in the portfolio balances above were $146.6 thousand and $161.2 thousand at June 30, 2023 and December 31, 2022, 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 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 53 Table of Contents CARTER BANKSHARES, INC. ITEM 2. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS - (continued) loans from both sources until funded by the investor, typically a two-week period. There were $173.2 thousand and zero mortgage loans held-for-sale at June 30, 2023 and December 31, 2022, 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. Credit Quality On a monthly basis, a Criticized Asset Committee meets to review certain watch, special mention and substandard risk rated 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 policy changes 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 independently 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 determining the appropriateness of risk ratings for those loans reviewed and 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. 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. Nonperforming assets consist of nonaccrual loans and OREO. The following table summarizes nonperforming assets for the dates presented: (Dollars in Thousands) June 30, 2023 December 31, 2022 $ Change Nonaccrual Loans Commercial Real Estate $ 2,512 $ 2,304 $ 208 Commercial and Industrial 113 204 (91) Residential Mortgages 3,288 3,265 23 Other Consumer 12 8 4 Construction 2,908 864 2,044 Other 301,913 — 301,913 Total Nonperforming Loans 310,746 6,645 304,101 Other Real Estate Owned 3,379 8,393 (5,014) Total Nonperforming Assets $ 314,125 $ 15,038 $ 299,087 Nonperforming assets increased $299.1 million to $314.1 million at June 30, 2023 compared to December 31, 2022. During the second quarter of 2023, the Company placed commercial loans that resided in the Other segment of the Company’s loan portfolio, relating to the Bank’s largest lending relationship which has an aggregate principal amount of $301.9 million, on 54 Table of Contents CARTER BANKSHARES, INC. ITEM 2. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS - (continued) nonaccrual status due to loan maturities and failure to pay in full. These nonperforming loans are 97.2% of the Company's total nonperforming loans and 96.1% of the Company's total nonperforming assets. Based on analyses of the credit relationship and various cash flow assumptions in the alternative modeling the Company established specific reserves with respect to these loans of $53.6 million at June 30, 2023, representing 17.8%, of these loans aggregate principal amount. At June 30, 2023, all of the Bank’s loans related to this lending relationship are on nonaccrual status. The following is an analysis of nonperforming loans by loan portfolio segment for the dates presented, and each segment’s relative contribution to total nonperforming loans: June 30, 2023 December 31, 2022 (Dollars in Thousands) Amount % of NPLs Amount % of NPLs Commercial Real Estate $ 2,512 0.8 % $ 2,304 34.7 % Commercial & Industrial 113 — % 204 3.1 % Residential Mortgages 3,288 1.1 % 3,265 49.1 % Other Consumer 12 — % 8 0.1 % Construction 2,908 0.9 % 864 13.0 % Other 301,913 97.2 % — — % Balance End of Period 310,746 100.0 % 6,645 100.0 % The Company believes it is well secured based on the net carrying value of the credit relationship and appropriately reserved for potential losses with respect to all such loans based on information currently available. The Company utilized various cash flow assumptions in the alternative modeling which resulted in a valuation allowance of $53.6 million at June 30, 2023. As the borrowers on these loans operate in the hospitality, agriculture, and energy sectors, this credit relationship is secured by, among other collateral, commercial real estate properties in these sectors including but not limited to top-tier hospitality properties. When evaluating the net carrying value of this credit relationship at June 30, 2023, the Company utilized discounted cash flow valuation techniques to evaluate the current condition of certain of the borrowers’ operating businesses and those borrowers’ capacity to repay. That evaluation resulted in the Company establishing a valuation allowance of $53.6 million at June 30, 2023. The Company has initiated collection processes with respect to such loans and intends to explore all alternatives for repayment. However, we cannot give any assurance as to the timing or amount of future payments or collections on such loans. For a discussion of collection proceedings with respect to these loans, see Part II, Item 1, “Legal Proceedings” of this Quarterly Report on Form 10-Q. Closed retail bank offices have a remaining book value of $1.0 million at June 30, 2023 and $1.1 million at December 31, 2022, and are recorded in OREO on the Company’s balance sheet. Past Company legacy underwriting standards relied heavily on loan to value and did not necessarily consider the income characteristics of the borrower or the repayment capacity of collateral with respect to speculative land financing. An overreliance on value as a primary repayment source can become compromised during real estate cycles. As a result, management has worked through these legacy credits and has installed a number of underwriting guardrails that consider the global cash flows and repayment capability of borrowers and/or guarantors, the proportion of speculation, transaction limits and introduced sensitivity analysis in order to determine supportable loan amounts. While these guardrails do not insulate the Company from credit cycles, we believe it should reduce the experience of defaults. At both June 30, 2023 and December 31, 2022, respectively, the Company’s loans held-for-sale were all accruing. 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. 55 Table of Contents CARTER BANKSHARES, INC. ITEM 2. 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 reserves by segment for the periods presented: June 30, 2023 December 31, 2022 (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 $ 19,144 49.3 % $ 17,992 46.7 % Commercial & Industrial 3,293 8.4 % 3,980 9.9 % Residential Mortgages 10,386 21.2 % 8,891 20.9 % Other Consumer 1,058 1.2 % 1,329 1.4 % Construction 6,603 10.7 % 6,942 11.2 % Other 53,660 9.2 % 54,718 9.9 % Balance End of Period $ 94,144 100.0 % $ 93,852 100.0 % The decline in the ACL attributable to the other segment was primarily due to $1.3 million of principal pay-downs during the six months ended June 30, 2023 that occurred during the first quarter of 2023. The ACL was $94.1 million, or 2.83%, of total portfolio loans at June 30, 2023 compared to $93.9 million, or 2.98%, of total portfolio loans at December 31, 2022. The following table summarizes the credit quality ratios and their components as of June 30, 2023 and December 31, 2022: (Dollars in Thousands) June 30, 2023 December 31, 2022 Allowance for Credit Losses to Total Portfolio Loans Allowance for Credit Losses $ 94,144 $ 93,852 Total Portfolio Loans 3,330,442 3,148,913 Allowance for Credit Losses to Total Portfolio Loans 2.83 % 2.98 % Nonperforming Loans to Total Portfolio Loans Nonperforming Loans $ 310,746 $ 6,645 Total Portfolio Loans 3,330,442 3,148,913 Nonperforming Loans to Total Portfolio Loans 9.33 % 0.21 % Allowance for Credit Losses to Nonperforming Loans Allowance for Credit Losses $ 94,144 $ 93,852 Nonperforming Loans 310,746 6,645 Allowance for Credit Losses to Nonperforming Loans 30.30 % 1,412.37 % Net Charge-offs to Average Portfolio Loans Net Charge-offs (annualized) $ 2,436 $ 4,506 Average Total Portfolio Loans 3,245,299 2,988,785 Net Charge-offs to Average Portfolio Loans 0.08 % 0.15 % 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 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 $1.7 million and $0.9 million for the three and six months ended June 30, 2023, respectively, when compared to the same periods in 2022. The decrease for the three and six months ended June 30, 2023 in the provision for credit losses was primarily driven by the release of specific reserves on three loans, offset by loan growth and increased reserves due to the above mentioned loan entering nonaccrual status. For more information about the Company’s provision for credit losses, see the discussion above under “Provision for Credit Losses” in this MD&A. The provision for unfunded commitments increased $0.1 million and $0.4 million for the three and six months ended June 30, 2023, respectively, compared to the same periods in 2022 related to increases in real estate construction and increased pressure on the reserve rate. There are three basic factors that influence the reserve rates associated with unfunded commitments for real 56 Table of Contents CARTER BANKSHARES, INC. ITEM 2. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS - (continued) estate construction loans. First, the reserve 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 $0.6 million and $1.2 million for the three and six months ended June 30, 2023, respectively, compared to $0.2 million and $0.4 million for the same period in 2022. During the first three and six months of 2023, net charge-offs were primarily recognized in the other consumer segment. As a percentage of average portfolio loans, on an annualized basis, net charge-offs were 0.08% for both the three and six months ended June 30, 2023 and 0.03% for both the same periods of 2022, respectively. At June 30, 2023, nonperforming loans increased $304.1 million to $310.7 million since December 31, 2022. Nonperforming loans as a percentage of total portfolio loans were 9.33% and 0.21% as of June 30, 2023 and December 31, 2022, respectively. Nonperforming loans increased during the second quarter of 2023 as the Company placed commercial loans that were in the Other segment of the Company’s loan portfolio, relating to the Bank’s largest lending relationship which has an aggregate principal amount of $301.9 million, on nonaccrual status due to loan maturities and failure to pay in full. For more information about the Company’s nonperforming loans and about this lending relationship, see the discussion above under “Credit Quality” in this MD&A. The following tables represent credit exposures by internally assigned risk ratings as of the periods presented: June 30, 2023 (Dollars in Thousands) Commercial Real Estate Commercial and Industrial Residential Mortgage Other Consumer Construction Other Total Portfolio Loans Pass $ 1,639,037 $ 276,199 $ 703,789 $ 38,707 $ 353,718 $ 3,342 $ 3,014,792 Special Mention 291 2,838 531 — 64 — 3,724 Substandard 3,269 119 3,573 29 3,023 301,913 311,926 Doubtful — — — — — — — Loss — — — — — — — Total Portfolio Loans $ 1,642,597 $ 279,156 $ 707,893 $ 38,736 $ 356,805 $ 305,255 $ 3,330,442 Performing $ 1,640,085 $ 279,043 $ 704,605 $ 38,724 $ 353,897 $ 3,342 $ 3,019,696 Nonperforming 2,512 113 3,288 12 2,908 301,913 310,746 Total Portfolio Loans $ 1,642,597 $ 279,156 $ 707,893 $ 38,736 $ 356,805 $ 305,255 $ 3,330,442 December 31, 2022 (Dollars in Thousands) Commercial Real Estate Commercial and Industrial Residential Mortgage Other Consumer Construction Other Total Portfolio Loans Pass $ 1,457,340 $ 303,893 $ 653,044 $ 44,495 $ 352,516 $ 180,745 $ 2,992,033 Special Mention 10,796 2,887 983 — 69 — 14,735 Substandard 2,426 3,012 3,921 67 968 131,751 142,145 Doubtful — — — — — — — Loss — — — — — — — Total Portfolio Loans $ 1,470,562 $ 309,792 $ 657,948 $ 44,562 $ 353,553 $ 312,496 $ 3,148,913 Performing $ 1,468,258 $ 309,588 $ 654,683 $ 44,554 $ 352,689 $ 312,496 $ 3,142,268 Nonperforming 2,304 204 3,265 8 864 — 6,645 Total Portfolio Loans $ 1,470,562 $ 309,792 $ 657,948 $ 44,562 $ 353,553 $ 312,496 $ 3,148,913 Special mention, substandard and doubtful loans at June 30, 2023 increased $158.8 million to $315.7 million compared to $156.9 million at December 31, 2022. The decrease of $11.0 million in special mention is primarily due to the upgrade of a $9.8 million credit to a pass rating. The increase of $169.8 million in substandard loans is primarily related to the above mentioned large nonaccrual lending relationship in the other loan category. The $301.9 million of loans related to the Bank’s 57 Table of Contents CARTER BANKSHARES, INC. ITEM 2. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS - (continued) largest lending relationship were nonperforming and rated as substandard as of June 30, 2023. At December 31, 2022 the largest lending relationship in the other segment loans were all accruing and totaled $309.1 million of which, $177.3 million of those loans were pass-rated and $131.8 million of those loans were substandard-rated. 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. Deposits The following table presents the composition of deposits for the periods presented: (Dollars in Thousands) June 30, 2023 December 31, 2022 $ Change % Change Noninterest-Bearing Demand $ 686,124 $ 703,334 $ (17,210) (2.4) % Interest-Bearing Demand 489,971 496,948 (6,977) (1.4) % Money Market 422,780 484,238 (61,458) (12.7) % Savings 526,588 684,287 (157,699) (23.0) % Certificates of Deposit 1,451,540 1,261,526 190,014 15.1 % Total Deposits $ 3,577,003 $ 3,630,333 $ (53,330) (1.5) % Deposits are the Company’s primary source of funds. The Company believes that the deposit base is stable and that the Company has the ability to attract new depositors while diversifying the deposit composition. Total deposits at June 30, 2023 decreased $53.3 million, or 1.5%, from December 31, 2022. The decrease related to a decline of $243.3 million in demand, money market and savings deposits, offset by an increase of $190.0 million in CDs, which was primarily due to customers migrating between deposit products as interest rates have risen. At June 30, 2023, noninterest-bearing deposits comprised 19.2% of total deposits compared to 19.4% at December 31, 2022 and 18.8% at June 30, 2022. CDs comprised 40.6%, 34.7% and 33.6% of total deposits at June 30, 2023, December 31, 2022 and June 30, 2022, respectively. As of June 30, 2023, based on assumptions that the Bank uses to prepare its regulatory call report, approximately 88.3% of our total deposits of $3.6 billion were insured under standard FDIC insurance coverage limits, and approximately 11.7% of our total deposits were uninsured deposits over the standard FDIC insurance coverage limit. The Company’s deposit base is diversified and granular and is comprised of approximately 77.5% of retail deposits. The following table presents additional information in relation to deposits: (Dollars in Thousands) June 30, 2023 December 31, 2022 Deposits from the Certificate of Deposit Account Registry Services ("CDARS") $ — $ 922 Noninterest-Bearing Public Funds Deposits 43,083 27,086 Interest-Bearing Public Funds Deposits 145,780 180,243 Total Deposits not Covered by Deposit Insurance (1) 418,599 493,013 Certificates of Deposits not Covered by Deposit Insurance 233,495 159,030 Deposits for Certain Directors, Executive Officers and their Affiliates 1,768 2,910 (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 June 30, 2023 are summarized as follows: (Dollars in Thousands) Amount Percent Three Months or Less $ 13,186 5.6 % Over Three Months Through Twelve Months 131,942 56.5 % Over Twelve Months Through Three Years 66,808 28.6 % Over Three Years 21,559 9.3 % Total $ 233,495 100.0 % 58 Table of Contents CARTER BANKSHARES, INC. ITEM 2. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS - (continued) Borrowings and Federal Funds Purchased Borrowings are an additional source of liquidity for the Company. We had $407.1 million FHLB borrowings at June 30, 2023 and $180.6 million at December 31, 2022. The Company had $7.9 million overnight federal funds purchased at June 30, 2023 and $17.9 million in overnight federal funds purchased at December 31, 2022. The level and composition of borrowed funds fluctuates over time based on many factors including market conditions, loan growth, investment securities, deposits and capital considerations. We manage our borrowed funds to provide a reliable source of liquidity. Information pertaining to FHLB borrowings and federal funds purchased is summarized in the following table: (Dollars in Thousands) June 30, 2023 December 31, 2022 Balance at Period End Federal Home Loan Bank Borrowings $ 407,135 $ 180,550 Federal Funds Purchased $ 7,900 $ 17,870 Average Balance during the Period Federal Home Loan Bank Borrowings $ 345,834 $ 29,849 Federal Funds Purchased $ 9,831 $ 5,711 Average Interest Rate during the Period Federal Home Loan Bank Borrowings 4.94 % 3.90 % Federal Funds Purchased 5.07 % 3.29 % Maximum Month-end Balance during the Period Federal Home Loan Bank Borrowings $ 435,135 $ 180,550 Federal Funds Purchased $ 46,965 $ 23,020 Average Interest Rate at Period End Federal Home Loan Bank Borrowings 5.10 % 4.48 % Federal Funds Purchased 5.40 % 4.65 % The Company held FHLB of Atlanta stock of $19.4 million and $9.7 million at June 30, 2023 and December 31, 2022, respectively. The increase in FHLB stock was due to increased borrowings. Dividends recorded on restricted stock were $315.6 thousand and $555.4 thousand for the three and six months ended June 30, 2023, respectively, compared to $22.1 thousand and $41.7 thousand for the same periods in 2022. 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 9, 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. 59 Table of Contents CARTER BANKSHARES, INC. ITEM 2. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS - (continued) 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 $1.1 billion, subject to the amount of eligible collateral pledged, federal funds lines with six other correspondent financial institutions with an available amount of $137.1 million, access to the institutional CD market, and the brokered deposit market. In addition to the lines referenced above, the Company also has $602.7 million of unpledged available-for-sale investment securities that may be sold or pledged as collateral that can serve as an additional source of liquidity. Please refer to the Liquidity Sources table below for available funding with the FHLB and our unsecured lines of credit with correspondent banks. As of June 30, 2023, approximately 88.3% of our total deposits of $3.6 billion were insured under standard FDIC insurance coverage limits, and approximately 11.7% of our total deposits were uninsured deposits over the standard FDIC insurance coverage limit. 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 June 30, 2023, the Bank had $611.3 million in highly liquid assets, which consisted of Federal Reserve Board Excess Reserves and interest-bearing deposits in other financial institutions of $8.4 million, $602.7 million in unpledged securities and $173.2 thousand in loans held-for-sale. This resulted in highly liquid assets to total assets ratio of 13.9% at June 30, 2023. Total available liquidity to uninsured deposits was 324.5% at June 30, 2023. As of June 30, 2023, the Company has approximately $322.3 million in par value of securities that are eligible to be pledged under the Bank Term Funding Program (“BTFP”), but the Bank has not borrowed under or otherwise accessed the BTFP. The following table provides detail of liquidity sources as of the periods presented: (Dollars in Thousands) June 30, 2023 December 31, 2022 Cash and Due From Banks, including Interest-bearing Deposits $ 53,275 $ 46,869 Unpledged Investment Securities 602,674 611,845 Excess Pledged Securities 57,136 46,305 FHLB Borrowing Availability 508,369 676,746 Unsecured Lines of Credit 137,100 127,130 Total Liquidity Sources $ 1,358,554 $ 1,508,895 The following table provides total liquidity sources and ratios as of June 30, 2023: (Dollars in Thousands) June 30, 2023 Total Liquidity Sources $ 1,358,554 Highly Liquid Assets to Total Assets 13.9% Highly Liquid Assets to Uninsured Deposits 146.0 % Total Available Liquidity to Uninsured Deposits 324.5 % Regulatory Capital Requirements Total capital of $344.2 million at June 30, 2023, reflects an increase of $15.6 million as compared to $328.6 million at December 31, 2022. The increase in total capital from December 31, 2022 is primarily due to a $3.6 million improvement in other comprehensive income due to changes in fair value of investment securities and net income of $21.6 million for the six months ended June 30, 2023, as well as, the transitional adjustment of $0.1 million, net of tax for the adoption of ASU 2023-02, less $10.4 million related to the Company’s repurchase of common stock. The remaining difference of $0.7 million is related to restricted stock activity for the six months ended June 30, 2023. 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 60 Table of Contents CARTER BANKSHARES, INC. ITEM 2. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS - (continued) 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. 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, 2023 and December 31, 2022, 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, 2023, the Bank continues to maintain its capital position with a leverage ratio of 9.76% as compared to the regulatory guideline of 5.00% to be well-capitalized and a risk-based Common Equity Tier 1 ratio of 11.34% compared to the regulatory guideline of 6.50% to be well-capitalized. The Bank’s risk-based Tier 1 and Total Capital ratios were 11.34% and 12.60%, 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 loss, which currently does not affect regulatory capital. The Company elected to retain this treatment which reduces the volatility of regulatory capital levels. 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. 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, 2023 December 31, 2022 Amount Ratio Amount Ratio Carter Bankshares, Inc. Leverage Ratio 4.00 % NA $ 438,904 10.02 % $ 439,606 10.29 % Common Equity Tier 1 (to Risk-weighted Assets) 7.00 % NA 438,904 11.46 % 439,606 12.61 % Tier 1 Capital (to Risk-weighted Assets) 8.50 % NA 438,904 11.46 % 439,606 12.61 % Total Capital (to Risk-weighted Assets) 10.50 % NA 487,186 12.72 % 483,450 13.86 % Carter Bank & Trust Leverage Ratio 4.00 % 5.00 % $ 433,615 9.76 % $ 432,711 10.13 % Common Equity Tier 1 (to Risk-weighted Assets) 7.00 % 6.50 % 433,615 11.34 % 432,711 12.42 % Tier 1 Capital (to Risk-weighted Assets) 8.50 % 8.00 % 433,615 11.34 % 432,711 12.42 % Total Capital (to Risk-weighted Assets) 10.50 % 10.00 % 481,832 12.60 % 476,496 13.68 % (1) To be “well capitalized” under the prompt corrective action framework applies to the Bank only. In December 2018, the Office of the Comptroller of the Currency, the Federal Reserve System, (“FRB”), and the 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 61 Table of Contents CARTER BANKSHARES, INC. ITEM 2. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS - (continued) 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, 2023, 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, 2022. Off-Balance Sheet Arrangements As of June 30, 2023, 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, 2022 (the “2022 Annual Report”). ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK Market Risk Market risk is defined as the degree to which changes in interest rates, foreign exchange rates, commodity prices, or equity prices can adversely affect a financial institution’s earnings or capital. For financial institutions, market risk primarily reflects exposures to changes in interest rates. Interest rate fluctuations affect earnings by changing net interest income and other interest-sensitive income and expense levels. Interest rate changes affect capital by changing the net present value of a financial institution’s future cash flows, and the cash flows themselves, as rates change. Accepting this risk is a normal part of banking and can be an important source of profitability and enhancement of shareholder value. However, excessive interest rate risk can threaten a financial institution’s earnings, capital, liquidity, and solvency. Our sensitivity to changes in interest rate movements is continually monitored by the ALCO. The ALCO utilizes an asset liability model (“ALM”) to monitor and manage market risk by simulating various rate shock scenarios and analyzing the results of the rate shocks on the Company’s projected net interest income (“NII”) and economic value of equity (“EVE”). The rate shock scenarios used in the ALM span over multiple time horizons and yield curve shapes and include parallel and non-parallel shifts to ensure the ALCO can mitigate future earnings and market value fluctuations due to changes in market interest rates. Within the context of the ALM, NII rate shock simulations explicitly measure the exposure to earnings from changes in market rates of interest over a defined time horizon. These robust simulations include assumptions of how the balance sheet will react in different rate environments including loan prepayment speeds, the average life of non-maturing deposits, and how sensitive each interest-earning asset and interest-bearing liability is to changes in the market rates (betas). Under simulation analysis, our current financial position is combined with assumptions regarding future business to calculate net interest income under various hypothetical rate scenarios. Reviewing these various measures provides us with a more comprehensive view of our interest rate risk profile. NII rate shock simulation results are compared to a base case NII result to provide an estimate of the impact that simulated market rate changes may have on 12 months and 24 months of pretax NII. The base case earnings scenario together with various rate shock earning scenarios are modeled utilizing both a static and growth balance sheet. A static balance sheet is a no-growth balance sheet in which all maturing and/or repricing cash flows are reinvested in the same product at the existing product spread over a prescribed index. Parallel rate shock analyses assume an immediate parallel shift in market interest rates across all horizons of the yield curve and also include management’s assumptions regarding the impact of interest rate changes on non-maturity deposit products (noninterest-bearing demand, interest-bearing demand, money market, and savings) and changes in the prepayment behavior of loans and securities with embedded optionality. Our policy guidelines limit the change in pretax NII over a 12-month horizon using rate shocks of +/- 100, 200, 300, and 400 basis points. We have temporarily 62 CARTER BANKSHARES, INC.