ITEM 7. MANAGEMENT’S DISCUSSION
AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
This section reviews our financial condition
for each of the past two years and results of operations for each of the past three years. Certain reclassifications have been
made to prior periods to place them on a basis comparable with the current period presentation. Some tables may include additional
time periods to illustrate trends within our Consolidated Financial Statements and notes thereto. The results of operations reported
in the accompanying Consolidated Financial Statements are not necessarily indicative of results to be expected in future periods.
Important Note Regarding Forward-Looking Statements
This Annual Report on Form 10-K contains
or incorporates statements that we believe are “forward-looking statements” within the meaning of the Private Securities
Litigation Reform Act of 1995. Forward-looking statements generally relate to our financial condition, results of operations, plans,
objectives, outlook for earnings, revenues, expenses, capital and liquidity levels and ratios, asset levels, asset quality, financial
position, and other matters regarding or affecting the Company and its future business and operations. 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,” “believe,” “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 cause actual results and trends to differ materially
from those made, projected, or implied in or by the forward-looking statements depending on a variety of uncertainties or other
factors including, but not limited to: credit losses; technological risks and developments; cyber-security; threats, attacks or
events; rapid technological developments and changes; the Company’s liquidity and capital positions; the potential adverse
effects of unusual and infrequently occurring events, such as weather-related disasters, terrorist acts or public health events
(such as the current COVID-19 pandemic), and of 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; the effect of steps
the Company takes in response to the COVID-19 pandemic, the severity and duration of the pandemic, the uncertainty regarding new
variants of COVID-19 that have emerged, the speed and efficacy of vaccine and treatment developments, the impact of loosening or
tightening of government restrictions, the pace of recovery when the pandemic subsides and the heightened impact it has on many
of the risks described herein; legislative or regulatory changes and requirements, including the impact of the CARES Act, as amended
by the CAA, and other legislative and regulatory reactions to the COVID-19 pandemic; potential claims, damages, and fines related
to litigation or government actions, including litigation or actions arising from the Company’s participation in and administration
of programs related to the COVID-19 pandemic, including, among other things, under the CARES Act, as amended by the CAA; sensitivity
to the interest rate environment including a prolonged period of low interest rates, a rapid increase in interest rates or a change
in the shape of the yield curve; 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, 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; the Company’s strategic
branch network optimization plan; 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; containing costs and expenses; reliance on significant customer relationships;
general economic or business conditions; deterioration of the housing market and reduced demand for mortgages; deterioration in
the overall macroeconomic conditions or the state of the banking industry that could impact the 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
throughout this Report, including Part I, Item 1A, Risk Factors and any of our subsequent filings with the 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 because the assumptions, beliefs, expectations and projections about future events
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.
CARTER
BANKSHARES, INC. AND SUBSIDIARIES
ITEM 7. MANAGEMENT’S
DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS (continued)
Explanation of Use of Non-GAAP Financial Measures
In addition to the results of operations
presented in accordance with generally accepted accounting principles (“GAAP”) in the United States, management uses,
and this annual report references, adjusted net income and net interest income on a fully taxable equivalent, or (“FTE”),
basis, each of which is a non-GAAP financial measure. Management believes these measures provide 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. Although management believes that this non-GAAP financial measure
enhances an investor’s understanding of our business and performance, this non-GAAP financial measure should not be considered
an alternative to GAAP or considered to be more important 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.
The Company believes the presentation of
net interest income 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. Net interest income per the Consolidated Statements of (Loss) Income is reconciled to
net interest income adjusted to an FTE basis in the Net Interest Income section of the "Results of Operations – Year
ended December 31, 2020."
The Company believes the presentation of
adjusted net income to exclude the impact of a one-time goodwill impairment charge during 2020 will help an investor compare the
results of our core business operations with our operations for other fiscal years and with the results of operations of other
companies in the financial services industry. The following table reconciles adjusted net income to GAAP net income for the periods
presented:
Years Ended December 31,
Less: Goodwill Impairment Expense 62,192 - -
CARTER BANKSHARES, INC. AND SUBSIDIARIES
ITEM 7. MANAGEMENT’S
DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS (continued)
Critical Accounting Policies and Significant
Accounting Estimates
The Company’s accounting and reporting
policies conform to GAAP and predominant practice in the banking industry. The preparation of financial statements in accordance
with GAAP requires management to make estimates, assumptions and judgments that affect the amounts reported in the financial statements
and accompanying notes. Over time, these estimates, assumptions and judgments may prove to be inaccurate or vary from actual results
and may significantly affect our reported results and financial position for the periods presented or in future periods. We currently
view the determination of the allowance for loan losses, goodwill and income taxes to be critical, because they are highly dependent
on subjective or complex judgments, assumptions and estimates made by management.
Allowance for Loan Losses
We account for the credit risk associated
with our lending activities through the allowance and provision for loan losses. The allowance represents management’s best
estimate of probable incurred losses that have been incurred in our existing loan portfolio as of the balance sheet date. The provision
is a periodic charge to earnings in an amount necessary to maintain the allowance at a level that is appropriate based on management’s
assessment of probable estimated losses.
Management determines and reviews with
the Board the adequacy of the allowance on a quarterly basis in accordance with the methodology described below:
CARTER BANKSHARES, INC. AND SUBSIDIARIES
ITEM 7. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS (continued)
There are many factors affecting the allowance
for loan losses; some are quantitative, while others require qualitative judgment. These factors require the use of estimates
related to the amount and timing of expected future cash flows, appraised values on impaired loans, estimated losses for each
loan category based on historical loss experience by category, and consideration of current economic trends and conditions, all
of which may be susceptible to significant judgment and change. To the extent that actual outcomes differ from estimates, additional
provisions for loan losses could be required that could adversely affect our earnings or financial position in future periods.
The loan portfolio represents the largest asset category on our Consolidated Balance Sheets.
The Company intends to adopt ASU 2016-13,
Measurement of Credit Losses, or CECL, in the first quarter of 2021, which will impact the measurement of the Company’s
allowance for credit losses (including the allowance for losses on lending-related commitments). CECL replaces the previous incurred
loss methodology, discussed above, which delays recognition until such loss is probable, with a methodology that reflects an estimate
of lifetime expected credit losses considering current economic condition and forecasts. Though other assets, including investment
securities and other receivables, are considered in-scope of the standard and will require a measurement of the allowance for
credit loss, the most significant impact of CECL remains within the Company’s loan portfolios and related lending commitments.
Fair Value Measurements
Fair value is the exchange price that
would be received for an asset or paid to transfer a liability (exit price) in the principal or most advantageous market for the
asset or liability in an orderly transaction between market participants on the measurement date. We use various valuation techniques
to determine fair value, including market, income and cost approaches. There are three levels of inputs that may be used to measure
fair values:
Level
1: Quoted prices (unadjusted) for identical assets or liabilities in active markets that an entity has the ability
to access as of the measurement date, or observable inputs.
Level
2: Significant other observable inputs other than Level 1 prices, such as quoted prices for similar assets or liabilities,
quoted prices in markets that are not active, and other inputs that are observable or can be corroborated by observable market
data.
Level
3: Significant unobservable inputs that reflect an entity’s own assumptions about the assumptions that market
participants would use in pricing an asset or liability.
CARTER BANKSHARES, INC. AND SUBSIDIARIES
ITEM 7. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS (continued)
In certain cases, the inputs used to measure
fair value may fall into different levels of the fair value hierarchy. When that occurs, we classify the fair value hierarchy
on the lowest level of input that is significant to the fair value measurement. We used the following methods and significant
assumptions to estimate fair value:
Securities:
The fair values of securities available-for-sale are determined by obtaining quoted prices on nationally recognized
securities exchanges, if available. This valuation method is classified as Level 1 in the fair value hierarchy. For securities
where quoted prices are not available, fair values are calculated on market prices of similar securities, or matrix pricing, which
is a mathematical technique, used widely in the industry to value debt securities without relying exclusively on quoted prices
for the specific securities but rather by relying on the securities’ relationship to other benchmark quoted securities.
Matrix pricing relies on the securities’ relationship to similarly traded securities, benchmark curves, and the benchmarking
of like securities. Matrix pricing utilizes observable market inputs such as benchmark yields, reported trades, broker/dealer
quotes, issuer spreads, two-sided markets, benchmark securities, bids, offers, reference data, and industry and economic events.
In instances where broker quotes are used, these quotes are obtained from market makers or broker-dealers recognized to be market
participants. This valuation method is classified as Level 2 in the fair value hierarchy. For securities where quoted prices or
market prices of similar securities are not available, fair values are calculated using discounted cash flows or other market
indicators. This valuation method is classified as Level 3 in the fair value hierarchy.
Impaired
Loans: Impaired loans with an outstanding balance equal to or greater than $1.0 million are evaluated for potential
specific reserves and adjusted, if a shortfall exists, to fair value less costs to sell. Fair value is measured based on the value
of the underlying collateral securing the loan if repayment is expected solely from the sale or operation of the collateral or
present value of estimated future cash flows discounted at the loan’s contractual interest rate if the loan is not determined
to be collateral dependent. All impaired loans with a specific reserve are classified as Level 3 in the fair value hierarchy.
Fair value for collateral dependent loans
is determined using several methods. Generally, the fair value of real estate is determined based on appraisals by qualified licensed
appraisers. These appraisals may utilize a single valuation approach or a combination of approaches including comparable sales
and the income approach. Adjustments are routinely made in the appraisal process by the appraisers to adjust for differences between
the comparable sales and income data available. These routine adjustments are made to adjust the value of a specific property
relative to comparable properties for variations in qualities such as location, size, and income production capacity relative
to the subject property of the appraisal. Such adjustments are typically significant and result in a Level 3 classification of
the inputs for determining fair value.
Subsequent to the initial impairment date,
existing impaired loans are reevaluated quarterly for additional impairment and adjustments to fair value less costs to sell are
made, where appropriate. For collateral dependent loans, the first stage of our impairment analysis involves management’s
inspection of the property in question to affirm the condition has not deteriorated since the previous impairment analysis date.
Management also engages in conversations with local real estate professionals and market participants to determine the likely
marketing time and value range for the property. The second stage involves an assessment of current trends in the regional market.
After thorough consideration of these factors, management will either internally evaluate fair value or order a new appraisal.
In circumstances where we feel confident in its ability to collect and analyze salient information on the subject collateral and
its surrounding real estate market, an in house valuation shall be utilized. Factors which should be considered in an in house
valuation are timing of sale, location and neighborhood, size of the structure and land component, age of any improvements, and
other attributes as warranted by the Company. This determination is made on a property-by-property basis in light of circumstances
in the broader economic climate and our assessment of deterioration of real estate values in the market in which the property
is located. When we feel we cannot collect and analyze salient information on the subject collateral or the collateral’s
real estate market, a full appraisal will be utilized.
CARTER BANKSHARES, INC. AND SUBSIDIARIE
ITEM 7. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS (continued)
For non-collateral dependent loans, the
fair value is determined by updating the present value of estimated future cash flows using the loan’s existing rate to
reflect the payment schedule for the remaining life of the loan.
Other
Real Estate Owned (“OREO”): OREO is evaluated at the time of acquisition and is recorded at fair value
as determined by an appraisal or evaluation, less costs to sell. After acquisition, most OREO assets are revalued every twelve
months, or more frequently when deemed necessary by management based upon changes in market, or collateral conditions. For smaller
OREO assets with existing carrying values less than $0.5 million, management may elect to revalue the assets, at minimum, once
every twenty-four months based on the size of the exposure. Write-downs are recorded as a charge to operations, if necessary,
to reduce the carrying value of a property to the lower of its carrying value or fair value less cost to sell. Such adjustments
can be significant and result in a Level 3 classification of the inputs for determining fair value. At December 31, 2020
our OREO assets were in compliance with our OREO policy as set forth above, and substantially all of the assets were listed for
sale with credible third-party real estate brokers.
Goodwill
Goodwill assets with indefinite useful
lives are tested for impairment at least annually and written down and charged to results of operations only in periods in which
the recorded value is more than the estimated fair value. Intangible assets that have finite useful lives will continue to be
amortized over their useful lives and are periodically evaluated for impairment.
The unprecedented decline in economic
conditions triggered by the COVID-19 pandemic caused a significant decline in stock market valuations in March 2020, including
our stock price. These triggering events indicated that goodwill related to our single reporting unit may be impaired and we expected
to evaluate goodwill for impairment quarterly given the current environment.
During the first quarter of 2020, with
the recent volatility in the financial services industry and in our economic environment we determined it prudent to have a full
goodwill impairment analysis performed as of March 31, 2020 updated as of June 30, 2020. We performed the goodwill impairment
test by determining the fair value of the reporting unit. We engaged a third-party financial advisor to prepare the market and
income approaches in order to determine fair value. Their analysis supported the conclusion that the fair value of our common
stock at June 30, 2020 was greater than both stated and tangible common book value and therefore no impairment to the goodwill
was recorded at June 30, 2020.
As
we monitored our performance due to the COVID-19 pandemic and continued to experience declines in our stock price in relation
to other bank indices and the length of time that the market value of the reporting unit had been below its book value, we completed
another interim quantitative goodwill impairment analysis as of September 30, 2020. Various valuation methodologies were
considered when completing the quantitative impairment test to determine the estimated fair value of the reporting unit which
is then compared to its carrying value, including goodwill. Upon completing the quantitative impairment analysis as of September 30,
2020, the analysis estimated fair value of the reporting unit to be less than the carrying value. Therefore, we recorded a goodwill
impairment of $62.2 million, which represented the entire amount of goodwill allocated to the reporting unit. This was a non-cash
charge to earnings and had no impact on our regulatory capital ratios, cash flows, liquidity position, or our overall financial
strength.
CARTER BANKSHARES, INC. AND SUBSIDIARIES
ITEM 7. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS (continued)
Income Taxes
We estimate income tax expense based on
amounts expected to be owed to the tax jurisdictions where we conduct business. On a quarterly basis, management assesses the
reasonableness of its effective tax rate based upon its current estimate of the amount and components of net income, tax credits
and the applicable statutory tax rates expected for the full year.
Deferred income tax assets and liabilities
are determined using the asset and liability method and are reported in the Consolidated Balance Sheets. Under this method, deferred
tax assets and liabilities are recognized for the future tax consequences attributable to differences between the financial statement
carrying amounts of existing assets and liabilities and their respective tax bases. If current available information raises doubt
as to the realization of the deferred tax assets, a valuation allowance is established. Deferred tax assets and liabilities are
measured using enacted tax rates expected to be applied to taxable income in the years in which those temporary differences are
expected to be recovered or settled. Management assesses all available positive and negative evidence on a quarterly basis to
estimate if sufficient future taxable income will be generated to utilize the existing deferred tax assets. The amount of future
taxable income used in management’s valuation is based upon management approved forecasts, evaluation of historical earnings
levels, proven ability to raise capital to support growth or during times of economic stress and consideration of prudent and
feasible potential tax strategies. If future events differ from our current forecasts, a valuation allowance may be required,
which could have a material impact on our financial condition and results of operations.
Accrued taxes payable or receivable represent
the net estimated amount due to or due from taxing jurisdictions and are reported in other liabilities and other assets, respectively,
in the Consolidated Balance Sheets. Management evaluates and assesses the relative risks and appropriate tax treatment of transactions
and filing positions after considering statutes, regulations, judicial precedent and other information and maintains tax accruals
consistent with its evaluation of these relative risks and merits. Changes to the estimate of accrued taxes occur periodically
due to changes in tax rates, interpretations of tax laws, the status of examinations being conducted by taxing authorities and
changes to statutory, judicial and regulatory guidance. These changes, when they occur, can affect deferred taxes and accrued
taxes, as well as the current period’s income tax expense and can be significant to our operating results.
Recent Accounting Pronouncements
and Developments
Note 1 Summary
of Significant Accounting Policies in the Notes to Consolidated Financial Statements, which is included in Part II, Item 8
of this Report, discusses new accounting pronouncements that we have adopted during 2020.
In December 2019, the FASB issued
ASU No. 2019-12, “Income Taxes (Topic 740): Simplifying the Accounting for Income Taxes.” The amendments in this
ASU simplifies the accounting for income taxes by removing certain exceptions and improves the consistent application of GAAP
by clarifying and amending other existing guidance. The amendments in this ASU will be effective on January 1, 2021 and are
not expected to have any impact on our consolidated financial statements.
In March 2020, the FASB issued ASU
No. 2020-04, “Reference Rate Reform (Topic 848): Facilitation of the Effects of Reference Rate Reform on Financial
Reporting.” The amendments in this ASU provide optional guidance for a limited period of time to ease the potential burden
in accounting for or recognizing the effects of reference rate reform on financial reporting. The amendments provide optional
expedients and exceptions for applying GAAP to loan and lease agreements, derivative contracts, and other transactions affected
by the anticipated transition away from LIBOR toward new interest rate benchmarks. Modified contracts that meet certain scope
guidance are eligible for relief from the modification accounting requirements in US GAAP. The optional guidance generally allows
for the modified contract to be accounted for as a continuation of the existing contract and does not require contract remeasurement
at the modification date or reassessment of a previous accounting determination. The amendments in this ASU are effective as of
March 12, 2020 through December 31, 2022. We are evaluating the impacts of this ASU and have not yet determined whether
LIBOR transition and this ASU will have material effects on our business operations and consolidated financial statements.
CARTER BANKSHARES, INC. AND SUBSIDIARIES
ITEM 7. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS (continued)
In June 2016, the FASB issued ASU
No. 2016-13, “Financial Instruments – Credit Losses (Topic 326): Measurement of Credit Losses on Financial Instruments”,
universally referred to as Current Expected Credit Loss (“CECL”). The amendments in this ASU, among other things,
require the measurement of all expected credit losses for financial assets held at the reporting date based on historical experience,
current conditions, and reasonable and supportable forecasts. Financial institutions and other organizations will now use forward-looking
information to better inform their credit loss estimates. Many of the loss estimation techniques applied today will still be permitted,
although the inputs to those techniques will change to reflect the full amount of expected credit losses. In addition, the ASU
amends the accounting for credit losses on available-for-sale debt securities and purchased financial assets with credit deterioration.
For periodic report filers that are not smaller reporting companies, such as the Company, this standard (Topic 326) is effective
as of January 1, 2020.
The
Company has elected to take advantage of Section 4014 of the Coronavirus Aid, Relief, and Economic Security Act (the
“CARES Act”) provision to temporarily delay adoption of the CECL methodology. The Bank was subject to the adoption
of the CECL accounting method under ASU 2016-03 and related amendments, Financial Instruments – Credit Losses (Topic 326).
However, the Bank elected under the CARES Act to defer the implementation of CECL until the earlier of when the national emergency
related to the outbreak of COVID-19 ends or December 31, 2020 which was later extended to January 1, 2022. The Company
intends to adopt in the first quarter of 2021 as allowed under the provisions of the CARES Act. The Bank’s CECL Committee,
which includes members from Credit Administration, Accounting/Finance, Risk Management and Internal Audit, has oversight by the
Chief Executive Officer, Chief Financial Officer, and Chief Credit Officer. We engaged a third-party to assist us in developing
our CECL model and to assist with evaluation of data and methodologies related to this standard.
As part of its process of adopting CECL,
management implemented a third-party software solution and determined appropriate loan segments, methodologies, model assumptions
and qualitative components. Our CECL model includes portfolio loan segmentation based upon similar risk characteristics and both
a quantitative and qualitative component of the calculation which incorporates a forecasting component of certain economic variables.
Our implementation plan also includes the assessment and documentation of appropriate processes, policies and internal controls.
Management had a third-party independent consultant review and validate our CECL model.
Parallel runs utilizing data from the
current and previous quarters in 2020 and 2019, incorporate elements of our operational procedures and internal controls. Our
current parallel run includes the composition, characteristics and quality of our loan portfolio as well as current market economic
conditions and forecasts as of the adoption date.
In addition, ASU 2016-13 amends the accounting
for credit losses on certain debt securities. Based upon the nature and characteristics of our securities portfolio at the adoption
date, management does not expect to record any allowance for credit losses on its debt securities as a result of adopting ASU
2016-13.
The ultimate impact of adopting ASU 2016-13,
and at each subsequent reporting period, is highly dependent on credit quality, macroeconomic forecasts and conditions, composition
of our loans and available-for-sale securities portfolio, along with other management judgments. The transition adjustment to
record the allowance for loan losses (“ALL”) will be applied using a cumulative effect adjustment to retained earnings.
CARTER BANKSHARES, INC. AND SUBSIDIARIES
ITEM 7. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS (continued)
Executive Overview
Carter
Bankshares, Inc. (the “Company”) is bank holding company headquartered in Martinsville, Virginia with assets
of $4.2 billion at December 31, 2020. 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 in Virginia and
North Carolina. The Company provides a full range of financial services with retail, and commercial banking products and insurance.
Per the 2019 Annual Report of the Virginia Bureau of Financial Institutions, our Company continues to be the fourth largest state-chartered
bank by assets size at year end 2019. 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 loan losses and other operating costs such as salaries and employee benefits, data processing,
occupancy and tax expense.
Our mission is that the Company strives
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 our strategy to successfully build our brand and grow our business
in our markets.
FRB Reserve Programs and Initiatives
The CARES Act encourages the FRB, in coordination
with the Secretary of the Treasury, to establish or implement various programs to help midsize businesses, nonprofits, and municipalities,
including (i) a Midsize Business/Nonprofit Organization Program to provide financing to banks and other lenders to make direct
loans to eligible businesses and nonprofit organizations with between 500 and 10,000 employees and (ii) the Municipal Liquidity
Facility, provide liquidity to the financial system that supports states and municipalities. On April 9, 2020, the FRB announced
and solicited comments regarding the Main Street Lending Program, which would implement certain of these recommendations.
Separately and in response to COVID-19,
the FRB’s Federal Open Market Committee (the “FOMC”) has set the federal funds target rate – i.e., the
interest rate at which depository institutions such as the Company lend reserve balances to other depository institutions overnight
on an uncollateralized basis – to an historic low. On March 16, 2020, the FOMC set the federal funds target rate at
0-0.25%. Consistent with FRB policy, the FRB has committed to the use of overnight reverse repurchase agreements as a supplementary
policy tool, as necessary, to help control the federal funds rate and keep it in the target range set by the FOMC.
In addition, the FRB has expanded the
size and scope of three existing programs to mitigate the economic impact of the COVID-19 pandemic: (i) the Primary Market
Corporate Credit Facility; (ii) the Secondary Market Corporate Credit Facility; and (iii) the Term Asset-Backed Securities
Loan Facility. The FRB has also established two new program facilities – the Money Market Mutual Fund Liquidity Facility
and the Commercial Paper Funding Facility – to broaden its support for the flow of credit to households and businesses during
COVID-19.
CARTER BANKSHARES, INC. AND SUBSIDIARIES
ITEM 7. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS (continued)
Temporary Regulatory Capital Relief
related to Impact of CECL
Concurrent with enactment of the CARES
Act, the federal bank regulatory authorities issued an interim final rule to provide banking organizations that are required
to implement CECL before the end of 2020 the option to delay the estimated impact on regulatory capital by up to two years, with
a three-year transition period to phase out the cumulative benefit to regulatory capital provided during the two-year delay.
Temporary Bank Secrecy Act (“BSA”)
Reporting Relief
The U.S. Department of the Treasury’s
Financial Crimes Enforcement Network (“FinCEN”) has provided targeted relief from certain BSA reporting requirements
and have provided updated guidance to financial institutions on complying with such requirements during COVID-19. Specifically,
FinCEN has (i) granted targeted relief to financial institutions participating in the PPP, stating that PPP loans to existing
customers will not require reverification under applicable BSA requirements, unless reverification is otherwise required under
the financial institution’s risk-based BSA compliance program, (ii) acknowledged that there may be “reasonable
delays in compliance” due to COVID-19, and (iii) temporarily suspended implementation of its February 2020 ruling,
which would have entailed significant changes to currency transaction reporting filing requirements for transactions involving
sole proprietorships and entities operating under a “doing business as” or other assumed name.
The Company’s Response to COVID-19
Lending Operations
The Company elected to take advantage
of Section 4014 of the CARES Act provision to temporarily delay adoption of the CECL methodology. The Company is subject
to the adoption of the CECL accounting method under the FASBASU 2016-03 and related amendments, Financial Instruments –
Credit Losses (Topic 326). However, we elected under the CARES Act to defer the implementation of CECL until January 1, 2021.
The Company quickly responded to the pandemic
and the CARES Act, offering the option of payment deferrals, participation in the PPP, fee waivers and other relief actions to
customers. Banks have been identified as essential services and have remained open during the order. On October 31, 2020,
we opened 3 additional branch lobbies and as of December 31, 2020, the Company had opened the lobbies of 36 branches. However,
the Company continues to serve its customers in the remaining branches through modified hours in both the drive-ins and branch
services via appointment. Every opportunity is being taken to protect both customers and employees through enhanced cleaning services,
social distancing and personal protective equipment requirements for both. Approximately 20% of the Company’s workforce
is working remotely.
Under the CARES Act, PPP is an amendment
to the SBA 7-A loan program. The Bank became an approved SBA 7A lender in November of 2019. PPP is a guaranteed, unsecured
loan program created to fund certain payroll and operating costs of eligible businesses, organizations and self-employed persons
during COVID-19. Initially, $349 billion were approved and designated for PPP in order for the SBA to guarantee 100% of collective
loans made under the program to eligible small businesses, nonprofits, veteran’s organizations, and tribal businesses. The
Company participated in the initial round of funding though a referral relationship with a third-party, non-bank lender. When
an additional $310 billion in funds were approved and designated for PPP, we opted to stand up an internal, automated loan process
utilizing our core system provider. As of December 31, 2020 we processed either through a third-party or internally 966 PPP
loans totaling $57.8 million, represented by $17.9 million and $39.9 million processed in round one and round two, respectively.
During 2021 the Company has continued making PPP loans pursuant to the additional PPP authorization that was contained in the
December 2020 COVID-19 relief law.
CARTER BANKSHARES, INC. AND SUBSIDIARIES
ITEM 7. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS (continued)
The FRB implemented a liquidity facility
available to financial institutions participating in the PPP. However, the Company opted to fund all PPP loans through our internal
liquidity sources. These loans are fully guaranteed by the SBA and do not represent a credit risk. We expect the vast majority
of these PPP loans will be forgiven based upon a preliminary review of the loans.
The Company provides deferrals to customers
under Section 4013 of the CARES Act and regulatory interagency statements on loan modifications, which suspends the requirement
to categorize these deferrals as TDRs. The Part I program was launched in March 2020 and expired at the end of August 2020.
The deferrals in Part I typically provided deferral of both principal and interest through the expiry. The Part II program
was launched in July 2020 and expired at the end of December 2020. The deferrals in this program were needs based and
required the collection of updated financial information and in certain situations, the validation of liquidity to support the
business. Prior to the extension of the CARES Act, the Company launched the Part III program that offered borrowers in the
Part II program an extension of deferrals through June 2021. For those borrowers who opted into the Part III program,
they are required to provide monthly financial statements and remit payments on a quarterly basis based on excess cash flows,
if any, up to their otherwise contractual payment. Management expects the majority of deferrals in the Part III program to
be principal only deferrals. At the end of the deferral period, for term loans, payments will be applied to accrued interest first
and will resume principal payments once accrued interest is current. Deferred principal will be due at maturity. For interest
only loans, such as lines of credit, deferred interest will be due at maturity.
As of December 31, 2020, we had 83
total customers opt for deferrals under Part III of the program which continues through June 30, 2021, with an aggregate
principal balance of $388.6 million with $11.1 million in deferred principal and interest payments. The weighted average deferment
period for these loans is 5.9 months. Approximately $313.9 million, comprised of 56 loan modifications, were in the hospitality
industry.
The following table provides detail of
the Bank’s deferred loans as of December 31, 2020:
Weighted Average Deferment Total Deferment
Commercial
Obligations of State and Political Subdivisions - - - - - -
Residential Mortgages - - - - - -
Other Consumer - - - - - -
Consumer Construction - - - - - -
Total Consumer Loans - - - - - -
CARTER BANKSHARES, INC. AND SUBSIDIARIES
ITEM 7. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS (continued)
Our interest income could be reduced due
to COVID-19. In keeping with guidance from regulators, we are actively working with COVID-19 affected borrowers to defer their
payments, interest, and fees. Interest and fees will still accrue to income through normal GAAP accounting. Should eventual credit
losses on these deferred payments emerge, interest income and fees accrued would need to be reversed. In such a scenario, interest
income in future periods could be negatively impacted. At this time, we are unable to project the significance of such an impact,
if any but recognize the breadth of the economic impact may affect our borrowers’ ability to repay in future periods.
The Company’s exposure to hospitality
at December 31, 2020 equated to approximately $497.2 million, or 16.9% 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.
However, we anticipate that a significant portion of our borrowers in the hotel industry will continue to operate at occupancy
levels at or below breakeven which has caused, or will cause, them to draw on their existing lines of credit with other financial
institutions or other sources of liquidity and may adversely affect their ability to repay existing indebtedness. 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, we anticipate that our financial condition, capital levels and results
of operations could be adversely affected.
The total balance of allowance for loan
losses increased $15.3 million during 2020 which was comprised of an increase in specific reserves of $9.1 million and an increase
in general reserves of $6.2 million. The $6.2 million increase in general reserves included an increase of $16.1 million in qualitative
reserves offset by a decrease of $9.9 million in quantitative reserves due to improvements in the Company’s loss history.
The $16.1 million increase in qualitative reserves included $9.6 million due to general economic uncertainties and specific concerns
regarding disruptions to the Company’s hospitality clients caused by the COVID-19 pandemic and an additional $6.5 million
based on general economic, geo-political and other risk factors determined by management. These qualitative reserves are intended
to reflect not only the risks of continued weak economic conditions on our loan portfolio, but also loss estimates identified
in loan portfolios deemed to be at risk from the COVID-19 pandemic. The Company adjusted qualitative risk factors under its incurred
loss model for economic conditions, changes in payment deferral procedures, expected changes in collateral values due to reduced
cash flows and external factors such as government actions. Management believes the uncertainty regarding customers' ability to
repay loans could be adversely impacted by the COVID-19 pandemic given higher unemployment rates, requests for payment deferrals,
temporary business shutdowns and reduced consumer and business spending.
Retail Operations
The Company will continue to promote digital
banking options through our website. Customers are encouraged to utilize online and mobile banking tools and our customer contact
center for personal and automated telephone banking services. Retail branches are staffed and available to assist customers
by offering lobby appointments, drive-up and virtual servicing.
In March 2020, we closed all branch
lobbies to customer activity, offering drive-up and appointment only services. On October 31, 2020, we opened 31 branch lobbies
and as of December 31, 2020, we had 36 branch lobbies open. Retail leadership continues to monitor branch traffic and
local conditions daily making adjustments as needed. All branches are equipped with video conferencing and online tools
that enable virtual servicing. When we make the decision to open the remainder of our branch lobbies, plans are in
place to resume full-service lobby operations augmented with the virtual and online servicing enhancements deployed over the past
year. We continue to pay all employees according to their normal work schedule, even if their hours have been reduced.
No employees have been furloughed. Employees whose job responsibilities can be effectively carried out remotely are working from
home. Employees whose critical duties require their continued presence on-site are utilizing personal protection equipment and
observing social distancing and cleaning protocols.
CARTER BANKSHARES, INC. AND SUBSIDIARIES
ITEM 7. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS (continued)
Our fee income for 2020 was negatively
impacted due to COVID-19 by approximately $1.5 million. In keeping with guidance from regulators, we are actively working with
COVID-19 affected customers to waive fees from a variety of sources, such as, but not limited to, insufficient funds and overdraft
fees and account maintenance fees, etc. These reductions in fees are thought, at this time, to be temporary in conjunction
with the length of the expected COVID-19 related economic crisis. Beginning on July 20, 2020, certain account fees were reinstated.
The breadth of the economic impact is likely to continue to impact our fee income in future periods.
Capital Resources and Liquidity
As of December 31, 2020, all of the
Company’s capital ratios were in excess of all regulatory requirements. An extended economic recession brought about by
the COVID-19 pandemic could adversely impact our reported regulatory capital ratios.
We maintain access to multiple sources
of liquidity. Funding sources accessible to the Company include borrowing availability at the FHLB, equal to 25% of the Company’s
assets approximating $1.0 billion, subject to the amount of eligible collateral pledged, federal funds unsecured lines with six
other correspondent financial institutions in the amount of $145.0 million and access to the institutional CD market through brokered
CDs. In addition to the above resources, the Company also has $632.7 million of unpledged available-for-sale securities as an
additional source of liquidity at December 31, 2020. 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 Company is monitoring and will continue
to monitor the impact of the COVID-19 pandemic and has taken and will continue to take steps to mitigate the potential risks and
impact on our liquidity and capital resources. Due to the economic uncertainty, we are taking a prudent approach to capital management
and have established access to the FRB’s PPP Lending Facility.
Earnings Summary
We recognized a net loss of $45.9 million,
or ($1.74) per share in 2020, resulting in a decrease of $72.4 million, or 272.6% compared to net income of $26.6 million, or
$1.01 per share for the same period in 2019. The decrease was primarily due to a one-time goodwill impairment charge of $62.2
million that was recorded in the third quarter of 2020. Excluding this one-time charge, adjusted net income was $16.3 million
in 2020. Also contributing to the net loss and the decrease in net income and adjusted net income for the year was an increase
in the provision for loan losses of $14.6 million. Net income is reconciled to adjusted net income, which is a non-GAAP financial
measure, below in the “Explanation of Use of Non-GAAP Financial Measures” section of this MD&A.
Net interest
income decreased $7.2 million, or 6.4%, to $105.1 million in 2020 compared to $112.3 million for the same period in 2019. Net
interest margin decreased 23 basis points to 2.74% in 2020 compared to 2.97% in 2019. The net interest margin, on a fully taxable
equivalent basis, (or “FTE”), decreased 25 basis points to 2.80% in 2020 compared to 3.05% in 2019. The decreases
in short-term interest rates had a negative impact on both net interest income and the net interest margin, but are offset by
a lower cost of funds. The yield on interest-earning assets decreased 54 basis points in 2020, offset by a 34 basis point decline
in funding costs as compared to 2019. Net interest margin is reconciled to net interest income adjusted to an FTE basis, which
is a non-GAAP financial measure, below in the “Net Interest Income” section of this MD&A.
CARTER BANKSHARES, INC. AND SUBSIDIARIES
ITEM 7. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS (continued)
The provision for loan losses increased
$14.6 million, or 429.0% to $18.0 million during 2020 compared to $3.4 million in 2019. The total balance of reserves increased
$15.3 million during 2020 which was comprised of an increase in specific reserves of $9.1 million and an increase in general reserves
of $6.2 million. The $6.2 million increase in general reserves included an increase of $16.1 million in qualitative reserves offset
by a decrease of $9.9 million in quantitative reserves due to improvements in the Company’s loss history. The $16.1 million
increase in qualitative reserves included $9.6 million due to general economic uncertainties and specific concerns regarding disruptions
to the Company’s hospitality clients caused by the COVID-19 pandemic and an additional $6.5 million based on general economic,
geo-political and other risk factors determined by management.
At December 31, 2020, nonperforming
loans and TDRs were $32.0 million compared to $42.1 million at December 31, 2019, a decrease of $10.1 million, or 24.0%.
Net charge-offs were $2.7 million in 2020 compared to $3.8 million in 2019. As a percentage of total portfolio loans, net charge-offs
were 0.09% at December 31, 2020 compared to 0.13% at December 31, 2019. Nonperforming loans as a percentage of total
portfolio loans was 1.09% and 1.46% as of December 31, 2020 and December 31, 2019, respectively.
Total noninterest income increased $9.7
million, or 57.6%, to $26.6 million for the full year 2020 compared to $16.9 million for the same period in 2019, primarily driven
by the impact of a $6.9 million in net securities gains. Securities gains increased $4.7 million to $6.9 million during 2020 compared
to $2.2 million during 2019 to take advantage of market opportunities and reposition and diversify holdings in the securities
portfolio. Other key factors impacting total noninterest income during 2020 were $4.1 million of commercial loan swap fee income
throughout 2020, due to the high demand for this product in the current low interest rate environment and $0.7 million of higher
debit card interchange fees, $0.5 million of higher insurance commissions and $0.5 million in other noninterest income. These
increases were offset by lower service charges, commissions and fees of $0.3 million due to COVID-19 waivers and OREO income of
$0.3 million. OREO income declined due to the sale of several large commercial properties that generated income.
Total noninterest expense increased $60.8
million, or 62.0%, to $158.8 million for the full year 2020 compared to $98.0 million for the same period in 2019, primarily driven
by the impact of a $62.2 million one-time goodwill impairment charge during the third quarter of 2020. Other key factors impacting
total noninterest expense during 2020 were a $1.6 million increase in occupancy expenses, a $1.0 million increase in FDIC expense
due to the $1.1 million one-time credit for eligible institutions available in the third quarter of 2019, a $0.4 million increase
in data processing licensing fee and a $0.5 million increase in professional and legal fees. Offsetting these increases were decreases
of $3.3 million related to losses on sales and write-downs of OREO due to the write-down of $1.1 million on five closed retail
branch offices moved to OREO in the third quarter of 2020, a $1.2 million decrease in tax credit amortization and a decrease of
$0.5 million in salaries and employee benefits attributable to our branch network optimization project.
The provision for income taxes decreased
$0.4 million to $0.8 million in 2020 compared to $1.2 million in 2019. The decrease in pretax income of $72.9 million for the
full year 2020 was primarily due to the full goodwill impairment charge of $62.2 million that was recorded in the third quarter
of 2020. Our effective tax rate was (1.7%) for 2020 as compared to 4.4% in 2019. The $62.2 million goodwill impairment charge
was the reason for the decreased effective tax rate in 2020. The goodwill impairment charge was not tax deductible. We ordinarily
generate an annual effective tax rate that is less than the statutory rate of 21% due to benefits resulting from tax-exempt interest
and tax credit projects, which are relatively consistent regardless of the level of pretax income.
CARTER BANKSHARES, INC. AND SUBSIDIARIES
ITEM 7. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS (continued)
RESULTS OF OPERATIONS
Year Ended December 31, 2020
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 and interest-bearing liabilities and changes in interest rates and spreads. The level and mix of interest-earning assets
and interest-bearing liabilities is managed by our Asset 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.
The interest income on interest-earning
assets and the net interest margin are presented on an FTE basis, which is a non-GAAP measure. The FTE basis adjusts 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 years ended December 31, 2020, 2019 and 2018) and the dividend-received deduction for equity securities.
The Company believes this FTE presentation provides a relevant comparison between taxable and non-taxable sources of interest
income.
The following table reconciles net interest
income per the Consolidated Statements of (Loss) Income to net interest income on an FTE basis for the periods presented:
Years Ended December 31,
Net Interest Income (FTE) (non-GAAP) 2.80 % 3.05 % 3.10 %
Average Balance Sheet and Net Interest
Income Analysis (FTE)
Total
net interest income decreased $7.2 million, or 6.4%, to $105.1 million in 2020, as compared to $112.3 million in 2019. Net interest
income, on an FTE basis (non-GAAP), decreased $7.9 million, or 6.8%, to $107.5 million in 2020 as compared to $115.4 million in
2019. The decrease in net interest income, on an FTE basis, is driven by an $18.8 million decrease in interest income, offset
by a $10.9 million decrease in interest expense during 2020 as compared to 2019. The decreases in short-term interest rates
had a negative impact on both net interest income and the net interest margin, but are offset by a lower cost of funds. Net interest
margin decreased 23 basis points to 2.74% in 2020 compared to 2.97% in 2019. The net interest margin, on an FTE basis (non-GAAP),