CARTER BANKSHARES, INC.
Management's Discussion and Analysis of Financial Condition and Results of
Operations ("MD&A"), is intended to help the reader understand our operations,
our present business environment, and our consolidated results of operations and
financial condition and highlights material changes in our financial condition
and results of operations as of and for the three and nine month periods ended
September 30, 2022 and September 30, 2021 . The MD&A is provided as a supplement
to, and should be read in conjunction with our Consolidated Financial Statements
and the accompanying notes thereto contained in Item 1 of this Quarterly Report
on Form 10-Q. Certain reclassifications have been made to prior periods to place
them on a basis comparable with the current period presentation. The results of
operations reported in the accompanying Consolidated Financial Statements are
not necessarily indicative of results to be expected in future periods. The MD&A
includes the following sections:
•Important Note Regarding Forward-Looking Statements
•Explanation of Use of Non-GAAP Financial Measures
•Critical Accounting Estimates
•Overview
•Results of Operations and Financial Condition
•Earnings Summary
•Liquidity and Capital Resources
•Regulatory Capital Requirements
•Contractual Obligations
•Off-Balance Sheet Arrangements
Important Note Regarding Forward-Looking Statements
This Quarterly Report on Form 10-Q contains or incorporates certain
forward-looking statements within the meaning of the Private Securities
Litigation Reform Act of 1995. Forward-looking statements include statements
that relate to our financial condition, market conditions, results of
operations, plans, objectives, outlook for earnings, revenues, expenses, capital
and liquidity levels and ratios, asset levels and asset quality. Forward looking
statements are typically identified by words or phrases such as "will likely
result," "expect," "anticipate," "estimate," "forecast," "project," "intend," "
believe," "assume," "strategy," "trend," "plan," "outlook," "outcome,"
"continue," "remain," "potential," "opportunity," "comfortable," "current,"
"position," "maintain," "sustain," "seek," "achieve" and variations of such
words and similar expressions, or future or conditional verbs such as will,
would, should, could or may.
Although we believe the assumptions upon which these forward-looking statements
are based are reasonable, any of these assumptions could prove to be inaccurate
and the forward-looking statements based on these assumptions could be
incorrect. The matters discussed in these forward-looking statements are subject
to various risks, uncertainties and other factors that could
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CARTER BANKSHARES, INC.
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS - (continued)
cause actual results and trends to differ materially from those made, projected,
or implied in or by the forward-looking statements including, but not limited to
the effects of:
•market interest rates and the impacts of market interest rates on economic conditions, customer behavior, and the Company's loan and securities portfolios;
•monetary and fiscal policies of the
•changes in accounting policies, practices, or guidance, for example, our adoption of CECL, including potential volatility in the Company's operating results due to application of the CECL methodology;
•cyber-security threats, attacks or events; rapid technological developments and changes;
•changes in the Company's liquidity and capital positions;
•concentrations of loans secured by real estate, particularly commercial real estate, and the potential impacts of changes in market conditions on the value of real estate collateral; •an insufficient ACL; •the potential adverse effects of unusual and infrequently occurring events, such as weather-related disasters, terrorist acts, war and other military conflicts (such as the ongoing war betweenRussia andUkraine ) or public health events (such as the COVID-19 pandemic), and of any governmental and societal responses thereto; these potential adverse effects may include, without limitation, adverse effects on the ability of the Company's borrowers to satisfy their obligations to the Company, on the value of collateral securing loans, on the demand for the Company's loans or its other products and services, on incidents of cyberattack and fraud, on the Company's liquidity or capital positions, on risks posed by reliance on third-party service providers, on other aspects of the Company's business operations and on financial markets and economic growth;
•a change in spreads on interest-earning assets and interest-bearing liabilities;
•regulatory supervision and oversight;
•legislation affecting the financial services industry as a whole, and the Company and the Bank, in particular;
•the outcome of pending and future litigation and governmental proceedings;
•increasing price and product/service competition;
•the ability to continue to introduce competitive new products and services on a timely, cost-effective basis; managing our internal growth and acquisitions;
•the possibility that the anticipated benefits from acquisitions cannot be fully realized in a timely manner or at all, or that integrating the acquired operations will be more difficult, disruptive or more costly than anticipated;
•material increases in costs and expenses;
•reliance on significant customer relationships;
•general economic or business conditions, including unemployment levels, continuing supply chain disruptions and slowdowns in economic growth;
•expansions or consolidations in the Company's branch network, including that the anticipated benefits of the Company's branch network optimization project are not fully realized in a timely manner or at all;
•deterioration of the housing market and reduced demand for mortgages; and
•re-emergence of turbulence in significant portions of the global financial and real estate markets that could impact our performance, both directly, by affecting our revenues and the value of our assets and liabilities, and indirectly, by affecting the economy generally and access to capital in the amounts, at the times and on the terms required to support our future businesses.
Many of these factors, as well as other factors, are described in this Quarterly Report, as well as in Part I, Item 1A, "Risk Factors" in our Annual Report on Form 10-K for the year endedDecember 31, 2021 and our subsequent filings with theSecurities and Exchange Commission ("SEC"). Forward-looking statements are based on beliefs and assumptions using information available at the time the statements are made. We caution you not to unduly rely on forward-looking statements 37 -------------------------------------------------------------------------------- Table of ContentsCARTER BANKSHARES, INC. ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS - (continued) because the assumptions, beliefs, expectations and projections about future events that are expressed in or implied by a forward-looking statement may, and often do, differ materially from actual results. Any forward-looking statement speaks only as to the date on which it is made, and we undertake no obligation to update, revise or clarify any forward-looking statement to reflect developments occurring after the statement is made.
Explanation of Use of Non-GAAP Financial Measures
In addition to the results of operations presented in accordance with generally accepted accounting principles inthe United States ("GAAP"), management uses, and this quarterly report references, net interest income on a fully taxable equivalent, or ("FTE"), basis, which is a non-GAAP financial measure. Management believes this measure provides information useful to investors in understanding our underlying business, operational performance and performance trends as it facilitates comparisons with the performance of other companies in the financial services industry. The Company believes the presentation of net interest income and net interest margin on an FTE basis ensures the comparability of net interest income arising from both taxable and tax-exempt sources and is consistent with industry practice. Interest income (GAAP) per the Consolidated Statements of Income is reconciled to net interest income adjusted on an FTE basis and net interest margin adjusted on an FTE basis in the "Results of Operations and Financial Condition - Net Interest Income" section of this MD&A. Although management believes that this non-GAAP financial measure enhances investors' understanding of our business and performance, this non-GAAP financial measure should not be considered an alternative to GAAP or considered to be more relevant than financial results determined in accordance with GAAP, nor is it necessarily comparable with similar non-GAAP measures which may be presented by other companies. Critical Accounting Estimates Our critical accounting estimates involving significant judgments and assumptions used in the preparation of the Consolidated Financial Statements as ofSeptember 30, 2022 have remained unchanged from the disclosures presented under the heading "Critical Accounting Estimates" in our Annual Report on Form 10-K for the year endedDecember 31, 2021 under the section "Management's Discussion and Analysis of Financial Condition and Results of Operations," and are incorporated herein by reference.
Overview
Carter Bankshares, Inc. (the "Company") is a bank holding company headquartered inMartinsville, Virginia with assets of$4.1 billion atSeptember 30, 2022 . The Company is the parent company of its wholly owned subsidiary,Carter Bank & Trust (the "Bank"). The Bank is an insured,Virginia state-chartered bank, which operates branches inVirginia andNorth Carolina . The Company provides a full range of financial services with retail, and commercial banking products and insurance. Our common stock trades on the Nasdaq Global Select Market under the ticker symbol "CARE". The Company earns revenue primarily from interest on loans and securities and fees charged for financial services provided to our customers. The Company incurs expenses for the cost of deposits, provision for credit losses and other operating costs such as salaries and employee benefits, data processing, occupancy and tax expense. Our mission is to strive to be the preferred lifetime financial partner for our customers and shareholders, and the employer of choice in the communities the Company is privileged to serve. Our strategic plan focuses on restructuring the balance sheet to provide more diversification and higher yielding assets to increase the net interest margin. Another area of focus is the transformation of the infrastructure of the Company to provide a foundation for operational efficiency and provide new products and services for our customers that will ultimately increase noninterest income.
Our focus continues to be on loan and deposit growth with a shift in the composition of deposits to more low cost core deposits with less dependence in higher cost certificates of deposits ("CDs"), as well as, implementing opportunities to increase fee income while closely monitoring our operating expenses. The Company is focused on executing this strategy to successfully build our brand and grow our business in our markets.
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CARTER BANKSHARES, INC.
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS - (continued)
Results of Operations and Financial Condition
Earnings Summary
Highlights for the Three Months Ended
•Net interest income increased$8.3 million , or 28.3%, to$37.7 million for the three months endedSeptember 30, 2022 compared to$29.4 million for the same period in 2021 primarily due an increase of 69 basis points in the yield on earning assets due to the rising interest rate environment offset by a reduction of 13 basis points in funding costs;
•The recovery for credit losses was
•Total noninterest income decreased
•Total noninterest expense decreased
•Provision for income taxes increased$4.1 million to$5.0 million for the three months endedSeptember 30, 2022 compared to$0.9 million for the same period in 2021.
Highlights for the Nine Months Ended
•Net interest income increased$15.3 million , or 18.4%, to$98.4 million for the nine months endedSeptember 30, 2022 compared to the same period in 2021 primarily due an increase of 33 basis points in the yield on earning assets due to the rising interest rate environment offset by a reduction of 20 basis points in funding costs; •The provision for credit losses remained relatively consistent at$2.4 million for the nine months endedSeptember 30, 2022 , compared to the same period in 2021; •Total noninterest income decreased$6.9 million to$16.2 million for the nine months endedSeptember 30, 2022 compared to$23.1 million for the same period in 2021 due primarily to a reduction in gains on sales of securities; •Total noninterest expense decreased$6.7 million to$69.4 million for the nine months endedSeptember 30, 2022 compared the same period in 2021 primarily resulting from our retail branch optimization project and the reversal of tax credit amortization due to an in-service date extension to 2023; and •Provision for income taxes increased$5.4 million to$8.1 million for the nine months endedSeptember 30, 2022 compared to$2.7 million for the same period in 2021.
Balance Sheet Highlights (period-end balances,
•The securities portfolio decreased$71.2 million and is currently 20.7% of total assets compared to 22.3% of total assets. The decrease is due to the Company's strategy of redeploying securities maturities into higher yielding loan growth and the continued decline in fair value due to rising market interest rates;
•Total portfolio loans increased
•The portfolio loans to deposit ratio was 81.4%, compared to 76.0%, as loan growth outpaced deposit growth;
•Total deposits increased
•The ACL to total portfolio loans ratio was 3.11% compared to 3.41%. The ACL on portfolio loans totaled$94.2 million atSeptember 30, 2022 , compared to$95.9 million with the decrease driven by a purchased syndicated C&I loan that was charged-down by$3.4 million , of which$2.6 million was previously reserved, loan growth and increased qualitative reserves, offset by declines in the other segment due to principal pay-downs; and 39 -------------------------------------------------------------------------------- Table of ContentsCARTER BANKSHARES, INC. ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS - (continued) •During the second quarter of 2022, the Company's Board of Directors authorized an additional common share repurchase program to purchase up to 750,000 shares of the Company's common stock, subject to theFederal Reserve's non-objection letter, which was received onJuly 26, 2022 . Since this date the Company repurchased 464,208 shares at an average price of$16.62 per share. The Company reported net income of$14.4 million or$0.59 diluted earnings per share for the three months endedSeptember 30, 2022 and$34.5 million , or$1.38 diluted earnings per share, for the nine months endedSeptember 30, 2022 compared to net income of$11.2 million , or$0.42 diluted earnings per share and$26.0 million , or$0.98 diluted earnings per share, for the same periods in 2021. Three Months Ended September 30, Nine Months Ended September 30, PERFORMANCE RATIOS 2022 2021 2022 2021 Return on Average Assets 1.38 % 1.07 % 1.12 % 0.84 % Return on Average Shareholders' Equity 16.75 % 10.95 % 12.80 % 8.76 % Portfolio Loans to Deposit Ratio 81.36 % 78.66 % 81.36 % 78.66 % Allowance for Credit Losses to Total Portfolio Loans 3.11 % 3.44 % 3.11 % 3.44 % Net Interest Income Our principal source of revenue is net interest income. Net interest income represents the difference between the interest and fees earned on interest-earning assets and the interest paid on interest-bearing liabilities. Net interest income is affected by changes in the average balance of interest-earning assets, interest-bearing liabilities, as well as changes in interest rates and spreads. The level and mix of interest-earning assets and interest-bearing liabilities is managed by ourAsset and Liability Committee ("ALCO"), in order to mitigate interest rate and liquidity risks of the balance sheet. A variety of ALCO strategies were implemented, within prescribed ALCO risk parameters, to produce what the Company believes is an acceptable level of net interest income. Net interest income and the net interest margin are presented on an FTE basis. The FTE basis (non-GAAP) adjusts net interest income and net interest margin for the tax benefit of income on certain tax-exempt loans and securities using the applicable federal statutory tax rate for each period (which was 21% for the periods presented) and the dividend-received deduction for equity securities. The Company believes this FTE basis presentation provides a relevant comparison between taxable and non-taxable sources of interest income. Refer to the "Explanation of Use of Non-GAAP Financial Measures" above for additional discussion regarding the non-GAAP measures used in this Quarterly Report on Form 10-Q. Total net interest income increased$8.3 million , or 28.3% to$37.7 million and$15.3 million , or 18.4%, to$98.4 million for the three and nine months endedSeptember 30, 2022 , respectively, compared to the same periods in 2021. These increases were primarily due to the increase in yield on loans and securities due to the rising interest rate environment and ongoing reduction in funding costs. Net interest income, on an FTE basis (non-GAAP), increased$8.3 million , or 27.8%, to$38.0 million and$15.0 million , or 17.7% to$99.3 million for the three and nine months endedSeptember 30, 2022 , respectively, compared to$29.7 million and$84.3 million for the same periods in 2021. The increases in net interest income, on an FTE basis (non-GAAP), were driven by higher interest income of$7.4 million and$10.7 million in the three and nine months endedSeptember 30, 2022 , respectively, when compared to the same periods in 2021, offset by lower interest expense of$0.9 million and$4.3 million in the three and nine months endedSeptember 30, 2022 , respectively, when compared to the same periods in 2021. Net interest margin increased 80 basis points to 3.72% and 48 basis points to 3.28% for the three and nine months endedSeptember 30, 2022 , respectively, when compared to the same periods in 2021. Net interest margin, on an FTE basis (non-GAAP), increased 79 basis points to 3.75% and 47 basis points to 3.31% for the three and nine months endedSeptember 30, 2022 , respectively, when compared to the same periods in 2021. The Company continues to focus on the expansion of net interest income and net interest margin. The third quarter and first nine months of 2022 were positively impacted by an increase in the yield on loans and investment securities due to the rising interest rate environment as well as the continued decline in funding costs. The three and first nine months of 2022 were also positively impacted by the collection of fees and enhanced pricing on loans related to one large credit relationship. Certain of these loans may not be renewed at maturity and/or may not otherwise impact the net interest income and net interest margin as significantly in future periods. In addition, rising market interest rates may begin to increase the Company's funding costs in future periods. 40 -------------------------------------------------------------------------------- Table of ContentsCARTER BANKSHARES, INC. ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS - (continued)
The following table reconciles interest income and net interest income per the Consolidated Statements of Income to interest income on an FTE basis, net interest income on an FTE basis, and net interest margin on an FTE basis (non-GAAP), for the periods presented:
Three Months Ended September 30, Nine Months Ended September 30,
(Dollars in Thousands) 2022 2021 2022 2021
Interest Income (FTE)(Non-GAAP)
Interest and Dividend Income (GAAP) $ 42,327 $ 34,913 $ 111,966 $ 100,964
Tax Equivalent Adjustment 279 330 870 1,178
Interest and Dividend Income (FTE)
(Non-GAAP) 42,606 35,243 112,836 102,142
Average Earning Assets $ 4,024,880 $ 3,988,343 $ 4,006,788 $ 3,967,087
Yield on Interest-earning Assets (GAAP) 4.17 % 3.47 % 3.74 % 3.40 %
Yield on Interest-earning Assets (FTE)
(Non-GAAP) 4.20 % 3.51 % 3.77 % 3.44 %
Net Interest Income (GAAP) $ 37,725 $ 29,401 $ 98,406 $ 83,133
Tax Equivalent Adjustment 279 330 870 1,178
Net Interest Income (FTE) (Non-GAAP) 38,004 29,731 99,276 84,311
Average Earning Assets $ 4,024,880 $ 3,988,343 $ 4,006,788 $ 3,967,087
Net Interest Margin (GAAP) 3.72 % 2.92 % 3.28 % 2.80 %
Net Interest Margin (FTE) (Non-GAAP) 3.75 % 2.96 % 3.31 % 2.84 %
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CARTER BANKSHARES, INC.
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS - (continued)
Average Balance Sheet and Net Interest Income Analysis (FTE)
The following table provides information regarding the average balances,
interest and rates earned on interest-earning assets and the average balances,
interest and rates paid on interest-bearing liabilities for the periods
presented:
Three Months Ended September 30, 2022 Three Months Ended September 30, 2021
Income/ Income/
(Dollars in Thousands) Average Balance Expense Rate Average Balance Expense Rate
ASSETS
Interest-Bearing Deposits with Banks$ 25,151 $ 134 2.11 %$ 191,047 $ 76 0.16 % Tax-Free Investment Securities(2) 30,073 215 2.84 % 26,849 221 3.27 % Taxable Investment Securities 942,571 5,466 2.30 % 836,957 3,163 1.50 %Total Securities 972,644 5,681 2.32 % 863,806 3,384 1.55 % Tax-Free Loans(1)(2) 141,082 1,115 3.14 % 174,680 1,350 3.07 % Taxable Loans(1) 2,883,790 35,652 4.90 % 2,755,595 30,403 4.38 % Total Loans 3,024,872 36,767 4.82 % 2,930,275 31,753 4.30 % Federal Home Loan Bank Stock 2,213 24 4.30 % 3,215 30 3.70 % Total Interest-Earning Assets 4,024,880$ 42,606 4.20 % 3,988,343$ 35,243 3.51 % Noninterest Earning Assets 109,307 169,554 Total Assets$ 4,134,187 $ 4,157,897 LIABILITIES AND SHAREHOLDERS' EQUITY Interest-Bearing Demand$ 500,281 $ 462 0.37 %$ 424,517 $ 278 0.26 % Money Market 552,718 395 0.28 % 420,946 307 0.29 % Savings 731,931 192 0.10 % 668,436 176 0.10 % Certificates of Deposit 1,257,907 3,420 1.08 % 1,435,716 4,623 1.28 % Total Interest-Bearing Deposits 3,042,837 4,469 0.58 % 2,949,615 5,384 0.72 % Federal Funds Purchased 3,432 23 2.66 % - - - % Federal Home Loan Bank Borrowings 3,913 31 3.14 % 30,000 89 1.18 % Other Borrowings 6,326 79 4.95 % 3,437 39 4.50 % Total Borrowings 13,671 133 3.86 % 33,437 128 1.52 % Total Interest-Bearing Liabilities 3,056,508 4,602 0.60 % 2,983,052 5,512 0.73 % Noninterest-Bearing Liabilities 736,441 769,871 Shareholders' Equity 341,238 404,974 Total Liabilities and Shareholders' Equity$ 4,134,187 $ 4,157,897 Net Interest Income(2)$ 38,004 $ 29,731 Net Interest Margin(2) 3.75 % 2.96 % (1)Nonaccruing loans are included in the daily average loan amounts outstanding. (2)Tax-exempt income is on an FTE basis (non-GAAP) using the statutory federal corporate income tax rate of 21 percent. 42 -------------------------------------------------------------------------------- Table of ContentsCARTER BANKSHARES, INC. ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS - (continued) Nine Months Ended September 30, 2022 Nine Months Ended September 30, 2021 Average Income/ Average Income/ (Dollars in Thousands) Balance Expense Rate Balance Expense Rate ASSETS Interest-Bearing Deposits with Banks$ 64,858 $ 257 0.53 %$ 185,603 $ 182 0.13 % Tax-Free Investment Securities(2) 30,188 663 2.94 % 37,064 906 3.27 % Taxable Investment Securities 959,456 13,650 1.90 % 770,636 9,288 1.61 %Total Securities 989,644 14,313 1.93 % 807,700 10,194 1.69 % Tax-Free Loans(1)(2) 147,372 3,480 3.16 % 198,185 4,703 3.17 % Taxable Loans(1) 2,802,692 94,720 4.52 % 2,771,860 86,965 4.19 % Total Loans 2,950,064 98,200 4.45 % 2,970,045 91,668 4.13 % Federal Home Loan Bank Stock 2,222 66 3.97 % 3,739 98 3.50 % Total Interest-Earning Assets 4,006,788$ 112,836 3.77 % 3,967,087$ 102,142 3.44 % Noninterest Earning Assets 128,105 174,194 Total Assets$ 4,134,893 $ 4,141,281 LIABILITIES AND SHAREHOLDERS' EQUITY Interest-Bearing Demand$ 484,076 $ 1,082 0.30 %$ 402,663 $ 727 0.24 % Money Market 530,560 989 0.25 % 361,204 877 0.32 % Savings 724,472 559 0.10 % 657,101 507 0.10 % Certificates of Deposit 1,278,905 10,650 1.11 % 1,522,384 15,328 1.35 % Total Interest-Bearing Deposits 3,018,013 13,280 0.59 % 2,943,352 17,439 0.79 % Federal Funds Purchased 2,168 27 1.67 % - - - % Federal Home Loan Bank Borrowings 3,978 47 1.58 % 31,282 276 1.18 % Other Borrowings 5,637 206 4.89 % 3,090 116 5.02 % Total Borrowings 11,783 280 3.18 % 34,372 392 1.52 % Total Interest-Bearing Liabilities 3,029,796 13,560 0.60 % 2,977,724 17,831 0.80 % Noninterest-Bearing Liabilities 744,597 767,207 Shareholders' Equity 360,500 396,350 Total Liabilities and Shareholders' Equity$ 4,134,893 $ 4,141,281 Net Interest Income(2)$ 99,276 $ 84,311 Net Interest Margin(2) 3.31 % 2.84 % (1)Nonaccruing loans are included in the daily average loan amounts outstanding. (2)Tax-exempt income is on an FTE basis (non-GAAP) using the statutory federal corporate income tax rate of 21 percent. Interest income increased$7.4 million , or 21.2% and$11.0 million , or 10.9%, for the three and nine months endedSeptember 30, 2022 , respectively, compared to the same periods in 2021. Interest income, on an FTE basis (non-GAAP), increased$7.4 million , or 20.9% and$10.7 million , or 10.5% for the three and nine months endedSeptember 30, 2022 , respectively, compared to the same periods in 2021. The change was primarily due to increases in average interest-earning assets of$36.5 million and$39.7 million in the three and nine months endedSeptember 30, 2022 , respectively, compared to the same periods in 2021, and higher interest rate yields on interest-earning assets of 69 basis points and 33 basis points for the three and nine months endedSeptember 30, 2022 , respectively, compared to the same periods in 2021 due to the rising interest rate environment in fiscal year 2022. For the three and nine months endedSeptember 30, 2022 compared to the same periods in 2021, average interest-bearing deposits with banks decreased$165.9 million and$120.7 million , respectively, and the average rate earned increased 195 and 40 basis points, respectively, as funds were deployed into higher yielding loans and securities. Average loan balances increased$94.6 million for the three months endedSeptember 30, 2022 and decreased$20.0 million for the nine months endedSeptember 30, 2022 when compared to the same periods in 2021. Loan growth during the three months endedSeptember 30, 2022 was the primary influence for the quarterly increase, offset by large commercial paydowns in the first nine months of 2022 and 2021 and the decline in average Paycheck Protection Program ("PPP") loans, due to the continued forgiveness by theSmall Business Administration , which contributed to the decline for the nine months endedSeptember 30, 2022 . The average rate earned on loans increased 52 and 32 basis points for the three and nine months endedSeptember 30, 2022 , respectively, compared to the same periods in 2021 primarily due to increased short-term interest rates during 2022. AtSeptember 30, 2022 , the loan portfolio was comprised of 28.9% floating rate loans which reprice monthly, 39.9% variable rate loans that reprice at least once during the life of the loan and 31.2% fixed rate loans that do not reprice during the life of the loan. 43 -------------------------------------------------------------------------------- Table of ContentsCARTER BANKSHARES, INC. ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS - (continued) Average investment securities increased$108.8 million and$181.9 million for the three and nine months endedSeptember 30, 2022 , respectively, compared to the same periods in 2021. The average rate earned on investment securities increased 77 basis points and 24 basis points for the three and nine months endedSeptember 30, 2022 compared to the same periods in 2021. The change in investment securities is the result of active balance sheet management to deploy excess cash combined with the continued decline in fair value. The portfolio has been diversified as to bond types, maturities, and interest rate structures. As ofSeptember 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. Having a significant percentage of variable rate securities is an important strategy during times of rising interest rates. Bond prices generally fall when interest rates increase, which can result in unrealized losses. However, variable rate securities do not carry as much interest rate risk so there is much less price volatility. This variable rate structure is expected to limit the impact of rising rates on the Company's unrealized losses on debt securities. Interest expense decreased$0.9 million and$4.3 million for the three and nine months endedSeptember 30, 2022 , respectively, when compared to the same periods in 2021. The decrease was primarily due to the intentional runoff of higher cost CDs in 2021 and the first nine months of 2022. Interest expense on deposits decreased$0.9 million and$4.2 million for the three and nine months endedSeptember 30, 2022 , respectively, when compared to the same periods in 2021 primarily due to the decline in the average balance of CDs and the reduction in average rates paid on CDs. The average balances on CDs decreased$177.8 million or 12.4% and$243.5 million , or 16.0% for the three and nine months endedSeptember 30, 2022 , respectively, when compared to the same periods in 2021 primarily due to the aforementioned intentional runoff of these higher cost CDs. The average balances on our interest bearing core deposits, including money market accounts, interest-bearing demand accounts and savings accounts all increased by$131.8 million ,$75.8 million and$63.5 million , respectively, for the three months endedSeptember 30, 2022 , and by$169.4 million ,$81.4 million and$67.4 million , respectively, for the nine months endedSeptember 30, 2022 , when compared to the same periods in 2021. The average rates paid on interest-bearing demand accounts increased 11 and six basis points for the three and nine months endedSeptember 30, 2022 and the average rate paid on money market accounts decreased one and seven basis points for the three and nine months endedSeptember 30, 2022 , respectively, when compared to the same periods in 2021. The average rates paid on savings accounts for both the three and nine months endedSeptember 30, 2022 remained relatively unchanged. The average balances on borrowings decreased$19.8 million and$22.6 million for the three and nine months endedSeptember 30, 2022 , respectively, when compared to the same periods in 2021 due to prepayments and scheduled maturities. As a result, the cost of interest-bearing liabilities decreased 13 and 20 basis points for the three and nine months endedSeptember 30, 2022 , respectively, when compared to the same periods in 2021. 44 -------------------------------------------------------------------------------- Table of ContentsCARTER BANKSHARES, INC. ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS - (continued) The following table sets forth for the periods presented a summary of the changes in interest earned and interest paid resulting from changes in volume and changes in rates: Three Months Ended September 30, 2022 Nine Months Ended September 30, 2022 Compared to September 30, 2021 Compared to September 30, 2021 Increase/ Increase/ (Dollars in Thousands) Volume(3) Rate(3) (Decrease) Volume(3) Rate (Decrease) Interest Earned on: Interest-Bearing Deposits with Banks$ (120) $ 178
25 (31) (6) (157) (86) (243)
Taxable Investment Securities 440 1,863 2,303 2,512 1,850 4,362
Total Securities 465 1,832 2,297 2,355 1,764 4,119
Tax-free Loans(1)(2) (265) 30 (235) (1,200) (23) (1,223)
Taxable Loans(1) 1,462 3,787 5,249 977 6,778 7,755
Total Loans 1,197 3,817 5,014 (223) 6,755 6,532
Federal Home Loan Bank Stock (10) 4 (6) (44) 12 (32)
Total Interest-Earning Assets $ 1,532 $ 5,831 $ 7,363 $ 1,906 $ 8,788 $ 10,694
Interest Paid on:
Interest-Bearing Demand $ 56 $ 128 $ 184 $ 163 $ 192 $ 355
Money Market 94 (6) 88 347 (235) 112
Savings 17 (1) 16 52 - 52
Certificates of Deposit (533) (670) (1,203) (2,248) (2,430) (4,678)
Total Interest-Bearing Deposits (366) (549) (915) (1,686) (2,473) (4,159)
Federal Funds Purchased 23 - 23 27 - 27
Federal Home Loan Bank Borrowings (122) 64 (58) (300) 71 (229)
Other Borrowings 36 4 40 93 (3) 90
Total Borrowings (63) 68 5 (180) 68 (112)
Total Interest-Bearing
Liabilities (429) (481) (910) (1,866) (2,405) (4,271)
Change in Net Interest Margin $ 1,961 $ 6,312 $ 8,273 $ 3,772 $ 11,193 $ 14,965
(1)Nonaccruing loans are included in the daily average loan amounts
outstanding.
(2)Tax-exempt income is on an FTE basis (non-GAAP) using the statutory federal
corporate income tax rate of 21 percent.
(3)Changes to rate/volume are allocated to both rate and volume on a
proportionate dollar basis.
Provision (Recovery) for Credit Losses
The Company recognizes (recovery) provision for the allowance for credit losses
("ACL") based on the difference between the existing balance of ACL reserves and
the ACL reserve balance necessary to adequately absorb expected credit losses
associated with the Company's financial instruments. Similarly, the Company
recognizes provision (recovery) expense for unfunded commitments based on the
difference between the existing balance of reserves for unfunded commitments and
the reserve balance for unfunded commitments necessary to adequately absorb
expected credit losses associated with those commitments. The Company adopted
ASU 2016-03 on January 1, 2021 , and increased the ACL by $64.5 million for the
Day 1 adjustment which included $61.6 million to the ACL and $2.9 million
related to the life-of-loss reserve on unfunded loan commitments.
The ACL was 3.11% of total portfolio loans at September 30, 2022 , compared to
3.41% of total portfolio loans, at December 31, 2021 . The provision for credit
losses increased $0.3 million to $(0.1) million for the three months ended
September 30, 2022 and remained relatively unchanged at $2.4 million for the
nine months ended September 30, 2022 , when 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 of $3.0 million and a $4.9
million purchased syndicated C&I loan that was charged-down $3.4 million , of
which $2.6 million was previously reserved, and then transferred to
held-for-sale for $1.5 million , offset by the release of $3.7 million of
reserves that were allocated to the other segment due to principal pay-downs.
The increase in qualitative reserves were factors attributable to the
residential mortgage and commercial construction portfolios. Project costs
continue to escalate due to supply chain and labor disruptions as well as
increased material costs. Absent material cost increases, supply chain and labor
disruptions cause the overall construction duration to increase, increasing
interest costs to the borrower. The bank has observed a handful of significant
cost overruns on CRE projects. To date, these cost overruns have either been
funded by the borrower and/or project sponsors or partially funded by the Bank
within acceptable underwriting
45
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Table of Contents
CARTER BANKSHARES, INC.
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS - (continued)
guidelines. The Company continues to monitor these trends by diligently collecting data on commercial construction projects and analyzing risk presented to the Company's loan portfolio.
The provision (recovery) for unfunded commitments increased
Refer to Note 5, Allowance for Credit Losses, in the Notes to Consolidated Financial Statements in Item 1 of this Quarterly Report on Form 10-Q for additional information related to our ACL.
Noninterest Income
Three Months Ended September 30, Nine Months Ended September 30,
(Dollars in Thousands) 2022 2021 $ Change % Change 2022 2021 $ Change % Change
(Losses) Gains on Sales of
Securities, net $ (4) $ 1,341 $ (1,345) (100.3) % $ 48 $ 6,450 $ (6,402) (99.3) %
Service Charges, Commissions
and Fees 1,750 1,660 90 5.4 % 5,452 4,958 494 10.0 %
Debit Card Interchange Fees 1,788 1,751 37 2.1 % 5,570 5,456 114 2.1 %
Insurance Commissions 876 427 449 105.2 % 1,713 1,099 614 55.9 %
Bank Owned Life Insurance
Income 341 349 (8) (2.3) % 1,009 1,031 (22) (2.1) %
(Losses) Gains on Sales and
Write-downs of Bank Premises,
net (4) - (4) NM 342 - 342 NM
Other Real Estate Owned Income 13 7 6 85.7 % 35 82 (47) (57.3) %
Commercial Loan Swap Fee Income 18 1,096 (1,078) (98.4) % 774 2,057 (1,283) (62.4) %
Other 457 284 173 60.9 % 1,231 1,972 (741) (37.6) %
Total Noninterest Income $ 5,235 $ 6,915 $ (1,680) (24.3) % $ 16,174 $ 23,105 $ (6,931) (30.0) %
Total noninterest income decreased $1.7 million , or 24.3%, to $5.2 million for
the three months ended September 30, 2022 and decreased $6.9 million , or 30.0%,
to $16.2 million for the nine months ended September 30, 2022 when compared to
the same periods in 2021. These decreases were primarily related to declines in
net security gains of $1.3 million and $6.4 million in the three and nine months
ended September 30, 2022 , respectively. The decline in security gains was due to
the rising interest rate environment resulting in lower securities prices in the
market that discouraged sales.
Changes in total noninterest income for the three months ended September 30,
2022 also included a decrease of $1.1 million in commercial loan swap
fee income related to the timing and demand for this product in the current
rising interest rate environment. Offsetting the decreases were increases of
$0.4 million in insurance commissions due to increases in insurance provider
income and an increase of $0.2 million in other noninterest income related to an
increase in fair value due to our interest rate swap contracts with commercial
customers in the third quarter of 2022. Also contributing to the offsetting
decrease was was a $0.1 million increase in service charges on deposit accounts
primarily driven by volume.
Along with the $6.4 million decline in net security gains previously mentioned
for the nine months ended September 30, 2022 , the Company also experienced
declines of $1.3 million in commercial loan swap fee income and $0.7 million in
other noninterest income. Partially offsetting these decreases were the
following increases, $0.6 million in insurance commissions, $0.5 million in
service charges, commissions and fees, $0.3 million in gains on sales and
write-downs of bank premises, net, and $0.1 million in debit card interchange
fees. Similar fluctuations as the three-month period ended September 30, 2022 ,
the decline in other noninterest income for the nine month period ended
September 30, 2022 related to premiums on the sale of bank branches. The
increases related to debit card interchange fees were driven by higher customer
activity and the $0.3 million gains on sales and write-downs of bank premises,
net was due to a $0.4 million eminent domain settlement on a previously closed
branch in the first quarter of 2022.
46
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Table of Contents
CARTER BANKSHARES, INC.
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS - (continued)
Noninterest Expense
Three Months Ended September 30, Nine Months Ended September 30,
(Dollars in Thousands) 2022 2021 $ Change % Change 2022 2021 $ Change % Change
Salaries and Employee Benefits
$ 704 5.5 %$ 37,721 $ 39,084 $ (1,363) (3.5) % Occupancy Expense, net 3,412 3,333 79 2.4 % 10,060 10,298 (238) (2.3) % FDIC Insurance Expense 543 582 (39) (6.7) % 1,540 1,882 (342) (18.2) % Other Taxes 848 825 23 2.8 % 2,471 2,305 166 7.2 % Advertising Expense 368 196 172 87.8 % 874 586 288 49.1 % Telephone Expense 448 519 (71) (13.7) % 1,390 1,707 (317) (18.6) % Professional and Legal Fees 1,310 1,244 66 5.3 % 3,731 3,908 (177) (4.5) % Data Processing 833 1,018 (185) (18.2) % 2,516 2,893 (377) (13.0) % Losses on Sales and Write-downs of Other Real Estate Owned, net 169 608 (439) (72.2) % 268 3,423 (3,155) (92.2) % Losses on Sales and Write-downs on Bank Premises, net - 7 (7) (100.0) % - 114 (114) (100.0) % Debit Card Expense 797 700 97 13.9 % 2,089 2,045 44 2.2 % Tax Credit Amortization (764) 427 (1,191) (278.9) % 466 1,281 (815) (63.6) % Other Real Estate Owned Expense 38 84 (46) (54.8) % 220 280 (60) (21.4) % Other 1,941 2,326 (385) (16.6) % 6,038 6,243 (205) (3.3) % Total Noninterest Expense$ 23,463 $ 24,685 $ (1,222) (5.0) %$ 69,384 $ 76,049 $ (6,665) (8.8) % Total noninterest expense decreased$1.2 million and$6.7 million for the three and nine months endedSeptember 30, 2022 , respectively, when compared to the same periods in 2021. For the three months endedSeptember 30, 2022 the most significant decrease for the period was a decline of$1.2 million in tax credit amortization. The decrease resulted from the reversal of$1.4 million amortization expense for one of the Bank's partnerships due to updated information from the developer, extending the in-service date to 2023. Also impacting the fluctuations for the three-month period were decreases of$0.4 million for losses on sales and write-downs of OREO, net,$0.4 million in other noninterest expense and$0.2 million in data processing expenses. These decreases were offset by an increase of$0.7 million in salaries and employee benefits and an increase of$0.2 million in advertising expense. The losses on sales and write-downs of OREO, net, related to sales and properties under contract during the third quarter of 2022. The decrease in other noninterest expense of$0.4 million related to a finder's fee for the sale of two credit relationships in the third quarter of 2021 and the decrease in data processing expense is due to new modules added to our core processor also in the third quarter of 2021. The increase in salaries and employee benefits primarily relates to a$0.5 million profit sharing adjustment in the third quarter of 2022. The decrease in noninterest expense for the nine-month period endedSeptember 30, 2022 when compared to the same period in 2021 was primarily driven by a$3.2 million decrease on sales and write-downs of OREO, net. This nonrecurring write-down of$3.0 million was related to the closing of bank branches in the second quarter of 2021 that were transferred to OREO and marketed for sale. Also impacting the nine-month decrease was a$1.4 million decline in salaries and employee benefits, a$0.8 million in tax credit amortization, a$0.4 million decline in data processing expenses, a$0.3 million decrease inFDIC insurance expense, a$0.3 million in telephone expenses,$0.2 million decrease in occupancy expense, net, and$0.2 million decrease in professional and legal fees. These various decreases were offset by an increase of$0.3 million in advertising expenses and a$0.2 million increase in other taxes. The decline in salaries and employee benefits was due to lower medical expenses and our retail branch optimization project offset by the$0.5 million profit sharing adjustment in the third quarter of 2022. The decrease in tax credit amortization related to the reversal of amortization expense for one of the Bank's partnerships mentioned above offset by a new historic tax credit that began in early 2022. The decrease inFDIC expense was due to improved financial metrics of the Bank that are used to perform the assessment. 47 -------------------------------------------------------------------------------- Table of ContentsCARTER BANKSHARES, INC. ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS - (continued) Provision for Income Taxes The provision for income taxes increased$4.1 million and$5.4 million to$5.0 million and$8.1 million for the three and nine months endedSeptember 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 endedSeptember 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 endedSeptember 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 atSeptember 30, 2022 compared toDecember 31, 2021 .Federal Reserve Bank excess reserves decreased$154.4 million to$21.8 million atSeptember 30, 2022 from$176.2 million atDecember 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 atSeptember 30, 2022 compared to$2.8 billion atDecember 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 atSeptember 30, 2022 compared toDecember 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, atSeptember 30, 2022 and$1.0 million atDecember 31, 2021 . The securities portfolio decreased$71.2 million and is currently 20.7% of total assets atSeptember 30, 2022 compared to 22.3% of total assets atDecember 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. AtSeptember 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 atSeptember 30, 2022 compared toDecember 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. AtSeptember 30, 2022 , noninterest-bearing deposits comprised 19.3% of total deposits compared to 20.2% atDecember 31, 2021 and 19.7% atSeptember 30, 2021 . CDs comprised 33.5%, 36.3% and 38.3% of total deposits atSeptember 30, 2022 ,December 31, 2021 andSeptember 30, 2021 , respectively. Total capital decreased by$92.8 million to$314.8 million atSeptember 30, 2022 compared to$407.6 million atDecember 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 throughSeptember 30, 2022 , partially offset by net income of$34.5 million for the nine months endedSeptember 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 endedSeptember 30, 2022 . The ACL was 3.11% of total portfolio loans atSeptember 30, 2022 compared to 3.41% as ofDecember 31, 2021 . General reserves as a percentage of total portfolio loans were 3.09% atSeptember 30, 2022 compared to 3.38% atDecember 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. 48 -------------------------------------------------------------------------------- Table of ContentsCARTER BANKSHARES, INC. ITEM 2. 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% atSeptember 30, 2022 compared to 14.21% atDecember 31, 2021 . Our leverage ratio was 10.11% atSeptember 30, 2022 , compared to 10.62% atDecember 31, 2021 and total risk-based capital ratio was 14.06% atSeptember 30, 2022 compared to 15.46% atDecember 31 , 2021.The decrease is related to the aforementioned repurchase of common stock of$40.1 million throughSeptember 30, 2022 . We adopted CECL effectiveJanuary 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: September 30, December 31, (Dollars in Thousands) 2022 2021 $ Change U.S. Treasury Securities$ 17,748 $ 4,413 $ 13,335 U.S. 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 2,679Total 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 atSeptember 30, 2022 compared to$922.4 million atDecember 31, 2021 . Securities comprise 20.7% of total assets atSeptember 30, 2022 compared to 22.3% atDecember 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 ofSeptember 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. AtSeptember 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. AtDecember 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 byUnited 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 andAAA . 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 theTreasury yield curve for similar durations (i.e., 5- and 10-yearTreasury securities). This portion of theTreasury yield curve has moved significantly upward over the past nine months, driving unrealized losses on these securities higher. Although theFederal 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. 49 -------------------------------------------------------------------------------- Table of ContentsCARTER BANKSHARES, INC. ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS - (continued) AtDecember 31, 2021 , the 5-year and 10-yearU.S. Treasury yields were 1.26% and 1.52%, respectively. AtSeptember 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 withFederal 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. AtSeptember 30, 2022 andDecember 31, 2021 , the Company had no credit related net investment impairment losses.
Refer to Note 3,
TheBasel 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 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 Consumer 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
Total portfolio loans increased$219.2 million , or 10.4%, on an annualized basis, to$3.0 billion atSeptember 30, 2022 compared toDecember 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. AtSeptember 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 atSeptember 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 50 -------------------------------------------------------------------------------- Table of ContentsCARTER BANKSHARES, INC. ITEM 2. 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 onSeptember 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
The following table summarizes our top 10 relationships and a description of industries represented for the periods presented:
For the Periods Ending September 30, 2022 September 30, 2022
Dollars in Thousands September 30, 2022 December 31, 2021 Change % of Gross Loans % of RBC
1. Hospitality, agriculture & $ 321,893 $ 350,010
10.61 % 68.72 %
energy
2. Retail real estate & food 58,920 56,073 2,847 1.94 % 12.58 %
services
3. Industrial & retail real 42,188 45,653 (3,465) 1.39 % 9.01 %
estate
4. Multifamily development 40,000 36,720 3,280 1.32 % 8.54 %
5. Retail real estate 38,073 38,250 (177) 1.26 % 8.13 %
6. Hospitality 35,007 35,664 (657) 1.16 % 7.47 %
7. Multifamily & student 34,320 35,405 (1,085) 1.13 % 7.33 %
housing
8. Hospitality 33,809 34,463 (654) 1.12 % 7.22 %
9. Special/limited use 33,736 33,736 - 1.11 % 7.20 %
10. 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 atSeptember 30, 2022 as compared to$433.1 million atDecember 31, 2021 . The majority of unused commitments are for construction projects that will be drawn as the construction completes. Total utilization was 52.6% atSeptember 30, 2022 and 52.2% atDecember 31, 2021 . Unfunded commitments on commercial operating lines of credit was 53.9% atSeptember 30, 2022 and 51.7% atDecember 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 atSeptember 30, 2022 andDecember 31, 2021 , respectively. Discounts on purchased 1-4 family loans included in the portfolio balances above were$169.5 thousand and$190.6 thousand atSeptember 30, 2022 andDecember 31, 2021 , respectively. 51 -------------------------------------------------------------------------------- Table of ContentsCARTER BANKSHARES, INC. ITEM 2. 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 atSeptember 30, 2022 and$0.2 million atDecember 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) Other - - - 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 atSeptember 30, 2022 compared toDecember 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 atSeptember 30, 2022 , of which$0.7 million are under contract, and$1.0 million atDecember 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 endedSeptember 30, 2022 , a total of five branch office locations were sold and four are under contract. 52 -------------------------------------------------------------------------------- Table of ContentsCARTER BANKSHARES, INC. ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS - (continued) Closed-end installment loans, amortizing loans secured by real estate and any other loans with payments scheduled monthly are reported past due when the borrower is in arrears two or more monthly payments. Other multi-payment obligations with payments scheduled other than monthly are reported past due when one scheduled payment is due and unpaid for 30 days or more. We monitor delinquency on a monthly basis, including loans that are at risk for becoming delinquent and early stage delinquencies in order to identify emerging patterns and potential problem loans.
Troubled Debt Restructuring Disclosures Prior to Our Adoption of ASU No. 2022-02
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. 2022-02.
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.
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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 balance by segment for the periods
presented:
September 30, 2022 December 31, 2021
% of Loans in each % of Loans in each
Category to Total Category to Total
(Dollars in Thousands) Amount Portfolio Loans Amount 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
(Dollars in Thousands)
$ 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
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CARTER BANKSHARES, INC.
ITEM 2. 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
The following tables represent credit exposures by internally assigned risk ratings as of the periods presented:
September 30, 2022
Commercial Real Commercial and Residential Other Total Portfolio
(Dollars in Thousands) Estate Industrial Mortgage Consumer Construction Other 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
Commercial Real Commercial and Residential Other Total Portfolio
(Dollars in Thousands) Estate Industrial Mortgage Consumer Construction Other 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
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CARTER BANKSHARES, INC.
ITEM 2. 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.
Deposits
The following table presents the composition of deposits for the periods
presented:
September 30, December 31,
(Dollars in Thousands) 2022 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:
September 30, December 31,
(Dollars in Thousands) 2022 2021Deposits 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
(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 % 56
-------------------------------------------------------------------------------- Table of ContentsCARTER BANKSHARES, INC. ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS - (continued)
Federal Home Loan Bank Borrowings ("FHLB")
Borrowings are an additional source of liquidity for the Company. We had$30.0 million FHLB borrowings atSeptember 30, 2022 and$7.0 million atDecember 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) September 30, 2022 December 31, 2021 Balance at Period End $ 30,000 $ 7,000 Average Balance during the Period $ 3,978 $
25,986
Average Interest Rate during the Period 1.58 % 1.20 % Maximum Month-end Balance during the Period $ 30,000 $
35,000
Average Interest Rate at Period End 3.13 %
1.61 %
The Company held FHLB ofAtlanta stock of$3.2 million and$2.4 million atSeptember 30, 2022 andDecember 31, 2021 , respectively. Dividends recorded on this restricted stock were$24 thousand and$66 thousand for the three and nine months endedSeptember 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. We hold FHLB stock because we are a member of the FHLB ofAtlanta . The FHLB requires members to purchase and hold a specified level of FHLB stock based upon the members' asset values, level of borrowings and participation in other programs offered. Stock in the FHLB is non-marketable and is redeemable at the discretion of the FHLB. Members do not purchase stock in the FHLB for the same reasons that traditional equity investors acquire stock in an investor-owned enterprise. Rather, members purchase stock to obtain access to the products and services offered by the FHLB. Unlike equity securities of traditional for-profit enterprises, the stock of the FHLB does not provide its holders with an opportunity for capital appreciation because, by regulation, FHLB stock can only be purchased, redeemed and transferred at par value.
Refer to Note 8, Federal Home Loan Bank Borrowings, in the Notes to Consolidated Financial Statements in Item 1 of this Quarterly Report on Form 10-Q for additional information related to borrowings.
Liquidity and Capital Resources
Liquidity is defined as a financial institution's ability to meet its cash and collateral obligations at a reasonable cost. This includes the ability to satisfy the financial needs of depositors who want to withdraw funds or borrowers needing to access funds to meet their credit needs. In order to manage liquidity risk the Company's Board has delegated authority to the ALCO for formulation, implementation and oversight of liquidity risk management for the Company. The ALCO's goal is to maintain adequate levels of liquidity at a reasonable cost to meet funding needs in both a normal operating environment and for potential liquidity stress events. The ALCO monitors and manages liquidity through various ratios, reviewing cash flow projections, performing stress tests and by having a detailed contingency funding plan. The ALCO policy guidelines define graduated risk tolerance levels. If our liquidity position moves to a level that has been defined as high risk, specific actions are required, such as increased monitoring or the development of an action plan to reduce the risk position. The Company's primary funding and liquidity source is a stable customer deposit base. Management believes that we have the ability to retain existing deposits and attract new deposits, mitigating any funding dependency on other more volatile sources. Although deposits are the primary source of funds, the Company has identified various other funding sources that can be used as part of our normal funding program when either a structure or cost efficiency has been identified. Additional funding sources accessible to the Company include borrowing availability at the FHLB, equal to 25.0% of the Company's assets approximating$1.0 billion , subject to the amount of eligible collateral pledged, federal funds lines with six other correspondent financial institutions in the amount of$145.0 million , access to the institutional CD market, and the brokered deposit market. In addition to the lines referenced above, the Company also has$623.7 million of unpledged available-for-sale investment securities as an additional source of liquidity.
An important component of the Company's ability to effectively respond to potential liquidity stress events is maintaining a cushion of highly liquid assets. Highly liquid assets are those that can be converted to cash quickly, with little or no loss in value, to meet financial obligations. ALCO policy guidelines define a ratio of highly liquid assets to total assets by graduated
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CARTER BANKSHARES, INC.
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS - (continued)
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:
September 30,
(Dollars in Thousands) 2022 December 31, 2021
Cash and Due From Banks $ 38,749 $ 36,698
Interest-bearing Deposits in Other Financial Institutions 5,129 64,905
Federal Reserve Bank Excess Reserves 21,830 176,196
Unpledged Investment Securities 623,653 743,836
Excess Pledged Securities 61,980 28,417
FHLB Borrowing Availability 807,846 667,307
Unsecured Lines of Credit 145,000 145,000
Total Liquidity Sources $ 1,704,187 $ 1,862,359 Regulatory Capital Requirements
Total shareholders' equity decreased by$92.8 million to$314.8 million atSeptember 30, 2022 compared to$407.6 million atDecember 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 throughSeptember 30, 2022 , partially offset by net income of$34.5 million for the nine months endedSeptember 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 endedSeptember 30, 2022 . The Company and the Bank are subject to various capital requirements administered by the federal banking regulators. Failure to meet the minimum capital requirements can initiate certain mandatory and possibly additional discretionary actions by regulators that, if undertaken, could have a direct material effect on our financial statements. Under capital adequacy guidelines and the regulatory framework for prompt corrective action, we must meet specific capital guidelines that involve quantitative measures of assets, liabilities and certain off-balance sheet items as calculated under regulatory accounting practices. The capital amounts and classifications are also subject to qualitative judgments by the regulators about components, risk weightings and other factors. Prompt corrective action provisions are not applicable to bank holding companies. Quantitative measures established by regulations to ensure capital adequacy require us to maintain minimum amounts and ratios. 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. AtSeptember 30, 2022 andDecember 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. AtSeptember 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. We believe that we have the ability to raise additional capital, if necessary. TheBasel 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. 58 -------------------------------------------------------------------------------- Table of ContentsCARTER BANKSHARES, INC. ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS - (continued) The Basel III Capital Rules require the Company and the Bank to maintain minimum Common Equity Tier 1, Tier 1 and Total Capital ratios, along with a capital conservation buffer, effectively resulting in new minimum capital ratios (which are shown in the table below). The capital conservation buffer is designed to absorb losses during periods of economic stress. Banking institutions with a ratio of Common Equity Tier 1 capital to risk-weighted assets above the minimum but below the conservation buffer (or below the combined capital conservation buffer and countercyclical capital buffer, when the latter is applied) will face constraints on dividends, equity repurchases and compensation based on the amount of the shortfall. The Basel III Capital Rules also provide for a "countercyclical capital buffer" that is applicable to only certain covered institutions and does not have any current applicability to the Company or the Bank.
The following table summarizes the actual risk-based capital amounts and ratios for the Company and the Bank for the dates presented:
Minimum Required Well September 30, 2022 December 31, 2021
(Dollars in Thousands) Basel III Capitalized(1) Amount Ratio Amount Ratio
Carter Bankshares, Inc.
Leverage Ratio 4.00 % NA $ 426,489 10.11 % $ 443,940 10.62 %
Common Equity Tier 1 (to
Risk-weighted Assets) 7.00 % NA 426,489 12.80 % 443,940 14.21 %
Tier 1 Capital (to Risk-weighted
Assets) 8.50 % NA 426,489 12.80 % 443,940 14.21 %
Total Capital (to Risk-weighted
Assets) 10.50 % NA 468,398 14.06 % 483,124 15.46 %
Carter Bank & Trust
Leverage Ratio 4.00 % 5.00 % $ 424,140 10.06 % $ 438,533 10.49 %
Common Equity Tier 1 (to
Risk-weighted Assets) 7.00 % 6.50 % 424,140 12.74 % 438,533 14.04 %
Tier 1 Capital (to Risk-weighted
Assets) 8.50 % 8.00 % 424,140 12.74 % 438,533 14.04 %
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, framework, which, applies to the Bank only.
InDecember 2018 , theOffice of the Comptroller of the Currency , (the "OCC"), theFederal Reserve System , ("FRB"), and theFederal Deposit Insurance Corporation , ("FDIC"), approved a final rule to address changes to credit loss accounting under GAAP, including banking organizations' implementation of CECL. The final rule provides banking organizations the option to phase in over a three-year period the Day 1 adverse effects on regulatory capital that may result from the adoption of the new accounting standard. OnMarch 27, 2020 , the regulators issued interim final rule ("IFR"), "Regulatory Capital Rule: Revised Transition of the Current Expected Credit Losses Methodology for Allowances" in response to the disrupted economic activity from the spread of COVID-19. The IFR maintains the three-year transition option in the previous rule and provides banks the option to delay for two years an estimate of CECL's effect on regulatory capital, relative to the incurred loss methodology's effect on regulatory capital, followed by a three-year transition period (five-year transition option). We adopted CECL effectiveJanuary 1, 2021 and elected to implement the capital transition relief over the permissible three-year period.
Contractual Obligations
As ofSeptember 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 ofSeptember 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. 59
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