ITEM 1A. RISK FACTORS
Investments in the Company’s common stock involve risk. In addition to the other information set forth in this Annual Report on Form 10-K, including the information addressed above under “Important Note Regarding Forward-Looking Statements,” investors in the Company’s common stock should carefully consider the factors discussed below. The following discussion highlights the risks that we believe are material to the Company, but the following discussion does not necessarily include all risks that we may face, and an investor in the Company’s common stock should not interpret the disclosure of a risk in the following discussion to state or imply that the risk has not already materialized. These factors could materially and adversely affect the Company’s business, financial condition, liquidity, results of operations, and capital position, and could cause the Company’s actual results to differ materially from its historical results or the results contemplated by the forward-looking statements contained in this Annual Report on Form 10-K, in which case, the trading price of the Company’s common stock could decline.
Risks Related to Credit
A large percentage of the Company’s loans are secured by real estate, and an adverse change in the real estate market may result in losses and adversely affect our profitability.
Approximately 83% of the Company’s commercial loan portfolio as of December 31, 2021, was comprised of loans secured by real estate. An adverse change in the economy affecting occupancy and/or rental rates in the investment real estate market areas we serve could increase the likelihood of defaults. Real estate collateral securing the Company's loans are a secondary source of repayment in the event of unremedied defaults. The value of the Company's collateral could be impaired by changes in demand, rental rates and capitalization rates and could be insufficient to recover outstanding principal and interest. As a result, the Company’s profitability and financial condition could be negatively impacted by an adverse change in the real estate market.
The Company relies on independent appraisals to determine the value of the real estate which secures a significant portion of our loans, and the values indicated by such appraisals may not be realizable if foreclose on such loans is forced.
A significant portion of the Company’s loan portfolio consists of loans secured by real estate. We rely on independent appraisers to estimate the value of such real estate. Appraisals are only estimates of value and the independent appraisers may make mistakes of fact or judgment that adversely affect the reliability of their appraisals. In addition, events occurring after the initial appraisal may cause the value of the real estate to increase or decrease. As a result of any of these factors, the real estate securing some of the loans may be more or less valuable than anticipated at the time the loans were made. If a default occurs on a loan secured by real estate that is less valuable than originally estimated, the Company may not be able to recover the outstanding balance of the loan.
The Company’s level of credit risk is elevated due to the concentration of commercial real estate loans in its portfolio.
As of December 31, 2021, the Company’s exposure to loans secured by commercial purpose real estate, including investment real estate loans related to hospitality, retail and multifamily apartments (but excluding construction) equated to $1.5 billion, or 51.7% of its total loan portfolio. The average balance of these loans are generally larger and these loans generally involve a more complex degree of financial and credit risk than loans secured by residential real estate. Repayment of these loans is dependent on the success of the borrower’s underlying business and/or the borrower’s ability to generate leases in order to receive sufficient cash flow to service its debts. The financial and credit risk associated with these loans is a result of several factors, including macroeconomic conditions affecting supply, demand and property valuations, as well as larger balances in a smaller population of loans. The ongoing adverse economic effects of the COVID-19 pandemic could potentially exacerbate the financial and credit risk associated with these loans.
The Company’s exposure to hospitality at December 31, 2021 equated to approximately $418.6 million, or 14.9% of its total loan portfolio. These were mostly loans secured by upscale or top tier flagged hotels, which have historically exhibited low leverage and strong operating cash flows. The COVID-19 pandemic significantly impacted demand for both leisure and business travel resulting in overall declines in occupancy and room rates. The Company offered an assistance program that deferred payments in order to alleviate the financial pressures related to depressed revenues caused by the COVID-19 pandemic. The Company closely monitored these borrowers, identified underperforming operators and de-risked the portfolio through note sales. The recovery for the hospitality industry, especially leisure travel, has improved. Conditions in the
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hospitality industry, and especially leisure travel, have improved despite the fact that the COVID-19 pandemic is ongoing. We believe this is driven in part by the desire to vacation within a drivable distance, which enables social distancing and the avoidance of airline travel, and also in part by increasing COVID-19 vaccination and immunity rates in the United States. While we believe business travel is still depressed when compared to conditions prior to COVID-19, we believe borrowers focused on business travel were able to survive, in part due to the Company’s deferral programs. These programs ended on June 30, 2021 and these borrowers have returned to contractual payments and continue to perform. Property values have generally not deteriorated and, in certain circumstances, have increased. However, it is possible that additional COVID variants could impact demand and affect borrowers’ abilities to service debt. These developments, together with widespread labor shortages and additional shocks to economic conditions could generally impact operations and property valuations in hospitality and other commercial real estate exposures. As a result, our capital levels and results of operations could be adversely affected.
The Company’s exposure to commercial real estate construction loans at December 31, 2021 equated to approximately $355.4 million, or 12.6% of total portfolio loans. Construction loans are inherently risky. These risks include, but are not limited to, potential adverse changes in material costs resulting in cost overruns, the potential that the general contractors develop financial stress and are unable to complete projects and the speculative nature of lease up risk. A severe downturn in real estate could affect demand for leases, capitalization rates and property valuations, which could adversely affect our financial condition and results of operations.
Our allowance for credit losses may be insufficient.
The measure of our allowance for credit losses is dependent on the interpretation and application of the CECL methodology, which the Company adopted effective January 1, 2021, and which replaced the incurred loss methodology that was used by the Company and the Bank under GAAP prior to that date. The CECL methodology reflects expected credit losses and requires consideration of a broader range of reasonable and supportable information to inform credit loss estimates. Accordingly, the implementation of the CECL model changed the Company’s current method of providing allowance for credit losses (“ACL”) and resulted in material changes in the Company’s accounting for credit losses on financial instruments. The CECL model may create more volatility in the Company’s level of ACL, which, if materially increased, could adversely affect our business, financial condition, and results of operations.
We will implement further enhancements or changes to our methodology, models and the underlying assumptions, estimates and assessments, as needed. If the assumptions or estimates we use in adopting the new standard are incorrect or we need to change our underlying assumptions and estimates, there may be a material adverse impact on our results of operation and financial condition.
Our real estate lending business can result in increased costs associated with Other Real Estate Owned (“OREO”).
Because we originate loans secured by real estate, we may have to foreclose on the collateral property to protect our investment and may thereafter own and operate such property, in which case we are exposed to the risks inherent in the ownership of real estate. We use methods for valuing collateral for impaired loans and OREO that are in compliance with Accounting Standards Codification (“ASC”) Topic 310 Receivables. The methods require the use of assumptions that are subject to change based on events impacting real estate values. The amount that we may realize after a default is dependent upon factors outside of our control, including, but not limited to, general or local economic conditions, environmental cleanup liability, neighborhood values, interest rates, real estate tax rates, operating expenses of the mortgaged properties, and supply of and demand for properties. Certain expenditures associated with the ownership of income producing real estate, principally real estate taxes and maintenance costs, may adversely affect the net cash flows generated by the real estate. Therefore, the cost of operating income-producing real property may exceed the rental income earned from such property, and we may have to advance funds to protect our investment or we may be required to dispose of the real property at a loss.
Risks Related to Our Operations
A failure in or breach of our operational or security systems or infrastructure, or those of third parties, could disrupt the Company’s businesses, and adversely impact our results of operations, liquidity and financial condition, as well as cause reputational harm.
The Company’s operational and security systems, infrastructure, including our computer systems, data management, and internal processes, as well as those of third parties, are integral to our business. We rely on our associates and third parties in
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our day-to-day and ongoing operations, who may, as a result of human error, misconduct or malfeasance, or failure or breach of third-party systems or infrastructure, expose us to risk. We have taken measures to implement backup systems and other safeguards to support our operations, but our ability to conduct business may be adversely affected by any significant disruptions to us or to third parties with whom we interact. In addition, our ability to implement backup systems and other safeguards with respect to third-party systems is more limited than with our own systems.
The Company handles a substantial volume of customer and other financial transactions every day. Our financial, accounting, data processing, check processing, electronic funds transfer, loan processing, online and mobile banking, backup or other operating or security systems and infrastructure may fail to operate properly or become disabled or damaged as a result of a number of factors including events that are wholly or partially beyond our control. This could adversely affect our ability to process these transactions or provide these services. There could be sudden increases in customer transaction volume, electrical, telecommunications or other major physical infrastructure outages, natural disasters, events arising from local or larger scale political or social matters, including terrorist acts, and cyber-attacks. We continuously update these systems to support our operations and growth. This updating entails significant costs and creates risk associated with implementing new systems and integrating them with existing ones. Operational risk exposures could adversely impact our results of operations, liquidity and financial condition, and cause reputational harm.
A cyber-attack, information or security breach, or a technology failure of ours or of a third-party could adversely affect the Company’s ability to conduct business or manage exposure to risk, resulting in the disclosure or misuse of confidential or proprietary information, increase costs to maintain and update our operational systems, security systems, and infrastructure, and adversely impact results of operations, liquidity and financial condition, as well as cause reputation harm.
The Company’s business is highly dependent on the security and efficacy of our infrastructure, computer and data management systems, as well as those of third parties with whom we interact. Cyber security risks for financial institutions have significantly increased in recent years in part because of the proliferation of new technologies, the use of the internet and telecommunications technologies to conduct financial transactions, and the increased sophistication and activities of organized crime, hackers, terrorists and other external parties, including foreign state actors. Our operations rely on the secure processing, transmission, storage and retrieval of confidential, proprietary and other information in our computer and data management systems and networks, and in the computer and data management systems and networks of third parties. We rely on digital technologies, computer, database and email systems, software, and networks to conduct our operations. In addition, to access our network, products and services, our customers and third parties may use personal mobile devices or computing devices that are outside of our network environment.
Financial services institutions have been subject to, and are likely to continue to be the target of, cyber-attacks, including computer viruses, malicious or destructive code, phishing attacks, denial of service or other security breaches that could result in the unauthorized release, gathering, monitoring, misuse, loss or destruction of confidential, proprietary and other information of the institution, its associates or customers or of third parties, or otherwise materially disrupt network access or business operations. For example, denial of service attacks has been launched against a number of large financial institutions and several large retailers have disclosed substantial cyber security breaches affecting debit and credit card accounts of their customers. We have not experienced cyber security incidents in the past, but there is no assurance that we will not experience an attack in the future. Technology failures, cyber-attacks or other information or security breaches can cause material losses or other material consequences.
In addition to external threats, insider threats also represent a risk to us. Insiders, having legitimate access to our systems and the information contained in them, have the opportunity to make inappropriate use of the systems and information. We have policies, procedures and controls in place designed to prevent or limit this risk, but we cannot guarantee that policies, procedures and controls fully mitigate this risk.
As cyber threats continue to evolve, we may be required to expend significant additional resources to continue to modify and enhance our protective measures or to investigate and remediate any information security vulnerabilities or incidents. Any of these matters could result in our loss of customers and business opportunities, significant disruption to our operations and business, misappropriation or destruction of our confidential information and /or that of our customers, or damage to computers or systems of our customers and/or third parties, and could result in a violation of applicable privacy laws and other laws, litigation exposure, regulatory fines, penalties or intervention, loss of confidence in our security measures, reputational damage,
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reimbursement or other compensatory costs, and additional compliance costs. In addition, any of the matters described above could adversely impact our results of operations and financial condition.
The Company relies on third-party providers and other suppliers for a number of services that are important to our business. An interruption or cessation of an important service by any third-party could have a material adverse effect on our business.
The Company is dependent for the majority of our technology, including our core operating system, on third-party providers. If these companies were to discontinue providing services to us, we may experience significant disruptions to our business. In addition, each of these third parties faces the risk of a cyber-attack, information breach or loss, or technology failure. If any of our third-party service providers experience such difficulties, or if there is any other disruption in our relationships with them, we may be required to find alternative sources of such services, which may not be on comparable or commercially reasonable terms. We are dependent on these third-party providers securing their information systems, over which we have no control. A breach of our third-party providers’ information systems could adversely affect our ability to process transactions, service our clients or manage our exposure to risk and could result in the disclosure of sensitive, personal customer information, which could have a material adverse impact on our business through damage to our reputation, loss of customer business, remedial costs, additional regulatory scrutiny or exposure to civil litigation and possible financial liability. Assurance cannot be provided that we could negotiate terms with alternative service sources that are as favorable or could obtain services with similar functionality as found in our existing systems without the need to expend substantial resources, if at all, thereby resulting in a material adverse impact on our business and results of operations.
The Company is dependent on its management team, and the loss of its senior executive officers or other key associates could impair its relationship with its customers and adversely affect its business and financial results.
We believe that our growth and future success will depend in large part on the skills of our executive officers. We also depend upon the experience of the senior officers and other key personnel and their relationship with the communities they serve. The loss of the services of one or more of these officers or key personnel could have an adverse impact on the business of the Company because of their skills, knowledge of the market, years of industry experience and the difficulty promptly finding qualified replacement personnel.
Risks Related to Market Conditions, Interest Rates and Investments
The Company’s business is subject to interest rate risk and fluctuations in interest rates may adversely affect its earnings and capital levels.
The majority of our assets are monetary in nature and, as a result, we are subject to significant risk from changes in interest rates. Changes in interest rates can impact our net interest income as well as the valuation of our assets and liabilities. Also, our earnings are significantly dependent on net interest income, which is the difference between interest income on interest-earning assets, such as loans and securities, and interest expense on interest-bearing liabilities, such as deposits and borrowings. We expect we will experience “gaps” in the interest rate sensitivities of our assets and liabilities, meaning that either our interest-bearing liabilities will be more sensitive to changes in market interest rates than our interest-earning assets, or vice versa. In either event, if market interest rates should move contrary to our position, this “gap” will work against us and our earnings may be negatively affected.
A decrease in the general level of interest rates may, among other things, lead to an increase in prepayments on loans and increased competition for deposits. Conversely, an increase in the general level of interest rates may also, among other things, reduce the demand for loans or increase the rate of default on existing loans. Accordingly, changes in the general level of market interest rates may affect net yield on interest-earning assets, loan origination volume, loan portfolios, and funding costs which impact our overall results.
Although our asset-liability management strategy is designed to control our risk from changes in the general level of market interest rates, market interest rates will be affected by many factors outside of our control, including inflation, recession, changes in unemployment, other economic conditions, money supply and international disorder and instability in domestic and foreign financial markets. It is possible that significant or unexpected changes in interest rates may take place in the future, and we cannot always accurately predict the nature or magnitude of such changes or how such changes may affect our business.
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Uncertainty relating to London Interbank Offered Rate (“LIBOR”) calculation process and potential phasing out of LIBOR may adversely affect us.
On July 27, 2017, the Chief Executive of the United Kingdom Financial Conduct Authority, which regulates LIBOR, announced that it intends to stop persuading or compelling banks to submit rates for the calibration of LIBOR to the administrator of LIBOR after 2021. Intercontinental Exchange, Inc., the company that administers LIBOR, has stated that it intends to cease the publication of one week and two-month LIBOR rates immediately after the LIBOR publication on December 31, 2021, and the remaining LIBOR rates immediately following the LIBOR publication on June 30, 2023, and will consult on such intentions. It is not possible to predict what rate or rates may become accepted alternatives to LIBOR and it is impossible to predict the effect of any such alternatives on the value of LIBOR-based securities and variable rate loans, debentures, or other securities or financial arrangements, given LIBOR's role in determining market interest rates globally. Uncertainty as to the nature of alternative reference rates, including the Secured Overnight Financing Rate, (“SOFR”), and as to potential changes or other reforms to LIBOR may adversely affect LIBOR rates and the value of LIBOR-based loans and securities in our portfolio and may impact the availability and cost of hedging instruments and borrowings. If LIBOR rates are no longer available, and we are required to implement substitute indices for the calculation of interest rates under our loan agreements with our borrowers, we may incur significant expenses in effecting the transition. Furthermore, failure to adequately manage this transition process with our customers could adversely impact our reputation. Although we are currently unable to assess what the ultimate impact of the transition from LIBOR will be, failure to adequately manage the transition could have a material adverse effect on our business, financial condition and results of operations.
Risks Related to the COVID-19 Pandemic
The COVID-19 pandemic and resulting adverse economic conditions has adversely impacted the Company’s business and results, and could have a more material adverse impact on our business, financial condition and results of operations.
The ongoing COVID-19 global and national health emergency has caused significant disruptions in the global economies and financial markets. The spread of COVID-19 in the United States has caused illness, quarantines, cancellation of events and travel, business and school shutdowns, reductions in commercial activity and financial transactions, supply chain interruptions, increased unemployment, and overall economic and financial market instability. Many state and local governments have implemented and continue to maintain regulations and social guidelines, including social distancing restrictions, in light of the continuing COVID-19 pandemic.
The COVID-19 pandemic has caused disruptions to the Company’s business and could cause material disruptions to our business and operations in the future. Impacts to our business have included decreased operating effectiveness due to additional health and safety precautions we implemented at our branches and the transition of 20% of our workforce to home locations, decreases in customer traffic in our branches and increases in requests for forbearance and loan modifications. Further, loan payment deferment programs that we have implemented and government stimulus programs, like the PPP, may be masking credit deterioration in our loan portfolio by making less applicable standard measures of developing financial weakness in a client or portfolio, such as past due monitoring and non-accrual assessments. To the extent that commercial and social restrictions increase, the Company’s expenses, delinquencies, charge-offs, foreclosures and credit losses could materially increase, and we could experience reductions in interest and fee income. In addition, we anticipate that potential declines in credit quality could significantly affect the adequacy of our allowance for credit losses, which we expect could lead to increases in the provision for credit losses and related declines in our net income.
Unfavorable economic conditions and increasing unemployment figures may also make it more difficult for the Company to maintain deposit levels and loan origination volume and to obtain additional financing. Furthermore, such conditions have and may continue to cause the value of our Company’s investment portfolio and of collateral associated with our existing loans to decline. In addition, in March 2020, the FRB lowered the target range for the federal funds rate to a range from 0 to 0.25 percent, in part, as a result, of the COVID-19 pandemic. Although the FRB has indicated an intention to raise the federal funds rate in 2022, a prolonged period of very low interest rates could reduce the Company’s net interest income and have a material adverse impact on our cash flows and the market value of our investments or the manner in which we redeploy proceeds from maturing investments.
While we have taken and continue to take precautions to protect the safety and well-being of our associates and customers, no assurance can be given that the steps we’ve taken will be adequate or appropriate, nor can we predict the level of disruption to
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our associates’ ability to provide customer support and service. The continued or renewed spread of COVID-19 or variants thereof could negatively impact the availability of key personnel necessary to conduct the Company’s business, the business and operations of our third-party service providers who perform critical services for the Company’s business, or the businesses of many of our customers and borrowers. If COVID-19 is not successfully contained, we could experience a material adverse effect on our business, financial condition, results of operations and cash flow.
Among the factors outside the Company’s control that are likely to affect the impact the COVID-19 pandemic will ultimately have on the Company’s business are, without limitation:
•the pandemic’s course and severity;
•the uncertainty regarding new variants of COVID-19 that have emerged or may emerge in the future;
•the speed and efficacy of vaccine and treatment developments;
•the direct and indirect results of the pandemic, such as recessionary or inflationary economic trends, or impacts on employment levels, wages and benefits, commercial activity, the residential housing market, consumer spending and real estate and investment securities market values;
•political, legal and regulatory actions and policies in response to the pandemic, including the effects of restrictions on commerce and banking, such as moratoria and other suspensions of collections, foreclosures, and related obligations;
•the timing, magnitude and effect of public spending, directly or through subsidies, its direct and indirect effects on commercial activity and incentives of employers and individuals to resume or increase employment, wages and benefits and commercial activity;
•effects on the Company’s liquidity position due to changes in customers’ deposit and loan activity in response to the pandemic and its economic effects;
•the timing and availability of direct and indirect governmental support for various financial assets, including mortgage loans;
•the long-term effect of the economic downturn on the Company’s intangible assets such as our deferred tax asset;
•potential longer-term effects of increased government spending on the interest rate environment and borrowing costs for non-governmental parties;
•the ability of the Company’s associates to work effectively during the course of the pandemic;
•the ability of the Company’s third-party vendors to maintain a high-quality and effective levels of service;
•the possibility of increased fraud, cybercrime and similar incidents, due to vulnerabilities posed by the significant increases in our associates and customers handling their banking interactions remotely from home, or otherwise;
•required changes to the Company’s internal controls over financial reporting to reflect a rapidly changing work environment;
•potential longer-term shifts toward mobile banking, telecommuting and telecommerce;
•geographic variation in the severity and duration of the COVID-19 pandemic, particularly in Virginia and North Carolina, where the Company operates physically; and
•depending on the extent and duration of the COVID-19 pandemic, the price of our common stock could experience volatility and declines.
The Company continues to monitor the COVID-19 pandemic and related risks, although the rapid development and fluidity of the situation precludes any specific prediction as to its ultimate impact on the Company. However, if the COVID-19 pandemic continues to spread or otherwise result in a continuation or worsening of the current economic and commercial environments, our business, financial condition, results of operations and cash flows could be materially adversely affected.
The full effects of the COVID-19 pandemic may have a material adverse effect on the Company in numerous ways.
While the scope, duration, and full effects of COVID-19 are rapidly evolving and not fully known, the pandemic and related efforts to contain it have disrupted global economic activity, adversely affected the functioning of financial markets, impacted interest rates, inflation and increased economic and market uncertainty. If these effects continue for a prolonged period or result in sustained economic stress or recession, many of the risk factors identified in this Annual Report on Form 10-K could be exacerbated and such effects could have a material adverse impact on us in a number of ways related to credit, collateral, customer demand, funding, operations, interest rate risk and human capital.
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•Our results of operations may continue to be negatively impacted by general economic or business conditions and uncertainty, including the strength of economic conditions in our principal area of operations impacting the demand for our products and services.
•A low interest rate environment will negatively impact our net interest income and net interest margin.
•Credit losses may be higher and our provision for credit losses may continue to increase, due to deterioration in the financial condition of our commercial and consumer loan customers.
•Declining asset and collateral values may necessitate increases in our provision for credit losses and net charge-offs.
•The hospitality industry and portions of our hospitality loan portfolio may continue to suffer the negative effects of reduced travel, which could result in additional credit losses and net charge-offs.
•We may have an interruption or cessation of an important service provided by a third-party provider.
•Our liquidity and regulatory capital could be adversely impacted.
•Investors may have less confidence in the equity markets in general and in financial services industry in particular, which could have a negative impact on our stock price and resulting market valuation.
•The negative economic consequences of the pandemic may last longer in the areas where we do business, which could negatively affect our financial performance.
•We face heightened cyber security risks in connection with our operation in a remote working environment.
Even after the COVID-19 pandemic subsides, we believe the U.S. economy will likely require time to recover. It is uncertain how long this recovery will take. As a result, we anticipate our business may be adversely affected during this recovery.
Risks Related to Our Business Strategy
Our profitability depends significantly on economic conditions.
Our success depends primarily on the general economic conditions of the geographic markets in which we operate, primarily in Virginia and North Carolina. The local economic conditions in the areas where we operate have a significant impact on our commercial, real estate and construction loans, the ability of our borrowers to repay their loans and the value of the collateral securing these loans and on customer demand for loans, deposits and other bank products. A significant decline in general economic conditions, including a decline caused by the COVID-19 pandemic, inflation, recession, acts of terrorism, outbreak of hostilities (including the military conflict between Russia and Ukraine) or other international or domestic calamities, unemployment or other factors, all of which are beyond our control, could impact economic conditions and negatively affect our financial results.
We face strong competition from financial services companies and other companies that offer banking services which could negatively affect our business.
We conduct our banking operations primarily in Virginia and North Carolina, including Fredericksburg, Charlottesville, Lynchburg, Roanoke, Christiansburg, Martinsville, Danville, Greensboro, Fayetteville, and Mooresville. Increased competition in these markets may result in reduced loans and deposits. Ultimately, we may not be able to compete successfully against current and future competitors. Many competitors offer the same banking services that we offer in our service area. These competitors include national banks, regional banks and other community banks. We also face competition from many other types of financial institutions, including without limitation, savings and loan institutions, finance companies, brokerage firms, insurance companies, credit unions, mortgage banks and other financial intermediaries. In particular, our competitors include several major financial companies whose greater resources may afford them a marketplace advantage by enabling them to maintain numerous banking locations and ATMs, conduct extensive promotional and advertising campaigns and offer a wider range of products, services and technologies.
Additionally, banks and other financial institutions with larger capitalization and financial intermediaries not subject to bank regulatory restrictions have larger lending limits and are thereby able to serve the credit needs of larger customers. Areas of competition include interest rates for loans and deposits, efforts to obtain deposits, and range and quality of products and services provided, including new technology-driven products and services. Technological innovation continues to contribute to greater competition in domestic and international financial services markets as technological advances enable more companies to provide financial services. We also face competition from out-of-state financial intermediaries that have opened loan
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production offices or that solicit deposits in our market areas. If we are unable to attract and retain banking customers, we may be unable to continue to grow our loan and deposit portfolios or may be required to increase the rates we pay on deposits or lower the rates we offer on loans and results of operations and financial condition may otherwise be adversely affected.
Our customers may increasingly decide not to use the Bank to complete their financial transactions, which would have a material adverse impact on our financial condition and operations.
Technology and other changes are allowing parties to complete financial transactions through alternative methods that have historically involved banks. For example, customers can now maintain funds that would have historically been held as bank deposits in brokerage accounts, mutual funds, or general-purpose reloadable prepaid cards. Customers can also complete transactions such as paying bills and/or transferring funds directly without the assistance of banks. We face increasing competition from fintech companies, as trends toward digital financial transactions have accelerated during the COVID-19 pandemic. The process of eliminating banks as intermediaries, known as “disintermediation,” could result in the loss of fee income, as well as the loss of customer deposits and the related income generated from those deposits. The loss of these revenue streams and the lower cost of deposits as a source of funds could have a material adverse effect on our financial condition and results of operations.
Risks Related to Regulatory Compliance and Legal Matters
We are subject to extensive government regulation and supervision.
Banking regulations are primarily intended to protect depositors’ funds, federal deposit insurance funds and the banking system as a whole, not security holders. These regulations affect our lending practices, capital structure, investment practices, dividend policy and growth, among other things. Congress and federal regulatory agencies continually review banking laws, regulations and policies for possible changes. Changes to statutes, regulations or regulatory policies, including changes in interpretation or implementation of statutes, regulations or policies, could affect us in substantial and unpredictable ways. Such changes could subject us to additional costs, limit the types of financial services and products we may offer and/or increase the ability of non-banks to offer competing financial services and products, among other things. For example, we currently derive a portion of our noninterest income from consumer overdraft fees, which have recently come under scrutiny by banking regulators and politicians. Such regulators or politicians could act to impose additional restrictions on overdraft fee programs which could reduce our noninterest income, increase our compliance costs, or increase our exposure to regulatory and legal claims related to our overdraft program. Failure to comply with laws, regulations, policies or supervisory guidance could result in enforcement and other legal actions by Federal or state authorities, including criminal and civil penalties, the loss of FDIC insurance, the revocation of a banking charter, other sanctions by regulatory agencies, civil money penalties and/or reputational damage. In this regard, government authorities, including the bank regulatory agencies, are pursuing aggressive enforcement actions with respect to compliance and other legal matters involving financial activities, which heightens the risks associated with actual and perceived compliance failures. See “Supervision and Regulation” included in Item 1, Business, of this Annual Report on Form 10-K for a more detailed description of the certain regulatory requirements applicable to the Bank.
The Company is subject to more stringent capital and liquidity requirements as a result of the Basel III regulatory capital reforms and the Dodd-Frank Act, which could adversely affect its return on equity and otherwise affect its business.
The Company and the Bank are each subject to capital adequacy guidelines and other regulatory requirements specifying minimum amounts and types of capital, which each must maintain. From time to time, regulators implement changes to these regulatory capital adequacy guidelines. In addition, regulators may require the Company to maintain higher levels of regulatory capital based on the Company’s condition, risk profile, or growth plans or conditions in the banking industry or economy. The capital adequacy standards applicable to the Company and the Bank impose stricter capital requirements and leverage limits than the requirements to which the Company and the Bank were subject in the past.
The application of more stringent capital requirements could, among other things, result in lower returns on equity, require the raising of additional capital, and result in regulatory actions if the Company were to be unable to comply with such requirements. Furthermore, the imposition of liquidity requirements in connection with the implementation of Basel III could result in the Company having to lengthen the term of its funding, restructure its business models, and/or increase its holdings of liquid assets. Implementation of changes to asset risk weightings for risk-based capital calculations, items included or deducted in calculating regulatory capital and/or additional capital conservation buffers could result in management modifying its
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business strategy, and could limit the Company’s ability to make distributions, including paying out dividends or buying back shares. If the Company and the Bank fail to meet these minimum capital guidelines and/or other regulatory requirements, the Company’s financial condition would be materially and adversely affected.
Failure to maintain effective systems of internal control over financial reporting and disclosure controls and procedures could have a material adverse effect on our results of operation and financial condition.
Effective internal controls over financial reporting and disclosure controls and procedures are necessary for us to provide reliable financial reports and effectively prevent fraud and to operate successfully as a public company. We are required to establish and maintain an adequate internal control structure over financial reporting. If we cannot provide reliable financial reports or prevent fraud, our reputation and operating results would be harmed. As part of our ongoing monitoring of internal control, we may discover material weaknesses or significant deficiencies in our internal control that require remediation. A “material weakness” is a deficiency, or a combination of deficiencies, in internal control over financial reporting, such that there is a reasonable possibility that a material misstatement of a company’s annual or interim financial statements will not be prevented or detected on a timely basis.
Our inability to maintain the operating effectiveness of the controls described above could result in a material misstatement to our financial statements or other disclosures, which could have an adverse effect on our business, financial condition or results of operations. In addition, any failure to maintain effective controls or to timely effect any necessary improvement of our internal and disclosure controls could, among other things, require significant investments of management time, funds and other resources in remediation efforts, result in losses from fraud or error or harm to our reputation, or cause investors to lose confidence in our reported financial information, all of which could have a material adverse effect on our results of operation and financial condition.
The Company is a defendant in a variety of litigation and other actions, which may have a material adverse effect on its financial condition, results of operation or business.
The Company may be involved from time to time in a variety of litigation arising out of its business, and the Company operates in a legal and regulatory environment that exposes it to potential significant litigation risk. The Company’s insurance may not cover all claims that may be asserted against it in legal or administrative actions or costs that it may incur defending such actions, and any claims asserted against it, regardless of merit or eventual outcome, may harm the Company’s reputation. Should the ultimate judgments or settlements and/or costs incurred in any litigation exceed any applicable insurance coverage, they could have a material adverse effect on the Company’s financial condition and results of operation for any period.
Our risk management framework may not be effective in mitigating risk and loss.
We maintain an enterprise risk management program that is designed to identify, quantify, monitor, report and control the risks we face. These risks include, but are not limited to, interest rate, credit, liquidity, operational, reputation, legal, compliance, economic and litigation risk. Although we assess our risk management program on an ongoing basis and make identified improvements to it, we can offer no assurances that this approach and risk management framework (including related controls) will effectively mitigate the risks listed above or limit losses that we may incur. If our risk management program has flaws or gaps, or if our risk management controls do not function effectively, our results of operations, financial condition or business may be adversely affected.
Our earnings are significantly affected by the fiscal and monetary policies of the federal government and its agencies.
The policies of the FRB affect us significantly. The FRB regulates the supply of money and credit in the United States. Its policies directly and indirectly influence the rate of interest earned on loans and paid on borrowings and interest-bearing deposits and can also affect the value of financial instruments we hold. Those policies determine, to a significant extent, our cost of funds for lending and investing, and can significantly impact the levels of inflation in the United States. Changes in those policies are beyond our control and are difficult to predict. FRB policies can also affect our borrowers, potentially increasing the risk that they may fail to repay their loans. For example, a tightening of the money supply by the FRB could reduce the demand for a borrower's products and services. This could adversely affect the borrower’s earnings and ability to repay a loan, which could have a material adverse effect on our financial condition and results of operations.
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ITEM 1A. RISK FACTORS - (continued)
Risks Related to Liquidity
We rely substantially on deposits obtained from customers in our target markets to provide liquidity and support growth.
Our primary funding and liquidity source to support our business strategies is a stable customer deposit base. Deposit levels may be affected by a number of factors, including interest rates paid by competitors, general interest rate levels, returns available to customers on alternative investments and general economic conditions. If our deposit levels fall, we could lose a relatively low-cost source of funding and our interest expense would likely increase as we obtain alternative funding to replace lost deposits. If local customer deposits are not sufficient to fund our normal operations and growth, we will look to outside sources, such as fed funds lines with other financial institutions or borrowings with the FHLB and we have access to the institutional CD market and the brokered deposit market. We may also seek to raise funds through the issuance of shares of our common stock, or other equity or equity-related securities, or debt securities including subordinated notes as additional sources of liquidity. A number of factors, many of which are outside the Company’s control, could make accessing such financing more difficult or more expensive, or could make such financing unavailable altogether, including the financial condition of the Company, rate disruptions in the capital markets, the attractiveness of investing in or lending to financial services companies generally, and competition for funding from other banks, holding companies or similar financial service companies, some of which could be substantially larger or have stronger credit ratings or profiles. If we are unable to access funding sufficient to support our business operations and growth strategies or are only able to access such funding on unattractive terms, we may not be able to implement our business strategies which may negatively affect our financial performance.
Our ability to meet contingency funding needs, in the event of a crisis that causes a disruption to our core deposit base, is dependent on access to wholesale markets, including funds provided by the FHLB of Atlanta.
We own stock in the FHLB of Atlanta, in order to qualify for membership in the FHLB system, which enables us to borrow on our line of credit with the FHLB that is secured by a blanket lien on select commercial loans, multifamily loans, residential mortgages and investment securities available-for-sale and is estimated to be equal to 25% of our assets approximating $1.0 billion, with available borrowing capacity subject to the amount of eligible collateral pledged at any given time. Changes or disruptions to the FHLB or the FHLB system in general may materially impact our ability to meet short and long-term liquidity needs or meet growth plans. Additionally, we cannot be assured that the FHLB will be able to provide funding to us when needed, nor can we be certain that the FHLB will provide funds specifically to us, should our financial condition and/or our regulators prevent access to our line of credit. The inability to access this source of funds could have a materially adverse effect on our ability to meet our customer’s needs. Our financial flexibility could be severely constrained if we were unable to maintain our access to funding or if adequate financing is not available at acceptable interest rates.
Risks Related to Owning Our Stock
The market price of our common stock may fluctuate significantly in response to a number of factors.
Our operating results may fluctuate due to a variety of factors, many of which are outside of our control, including the changing U.S. economic environment and changes in the commercial and residential real estate market, any of which may cause our stock price to fluctuate. If our operating results fall below the expectation of investors or securities analysts, the price of our common stock could decline substantially.
Our stock price can fluctuate significantly in response to a variety of factors including, among other things:
•volatility of stock market prices and volumes in general;
•changes in market valuations of similar companies;
•changes in the conditions of credit markets;
•changes in accounting policies or procedures as required by the FASB, or other regulatory agencies;
•legislative and regulatory actions, including the impact of the Dodd-Frank Act and related regulations, that may subject us to additional regulatory oversight which may result in increased compliance costs and/or require us to change our business model;
•government intervention in the U.S. financial system and the effects of and changes in trade and monetary and fiscal policies and laws, including the interest rate policies of the FRB;
•additions or departures of key members of management;
•fluctuations in our quarterly or annual operating results; and
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ITEM 1A. RISK FACTORS - (continued)
•changes in analysts’ estimates of financial performance.
Future issuances of the Company’s common stock could adversely affect the market price of the common stock and could be dilutive.
The Company is not restricted from issuing additional shares of common stock, and may issue securities that are convertible into or exchangeable for, or that represent the right to receive, shares of common stock. Issuances of a substantial number of shares of common stock, or the expectation that such issuances might occur, including in connection with acquisitions by the Company, could materially adversely affect the market price of the shares of common stock and could be dilutive to shareholders. Because the Company’s decision to issue equity securities in the future will depend on market conditions and other factors, it cannot predict or estimate the amount, timing, or nature of possible future stock issuances. Accordingly, the Company’s shareholders bear the risk that future stock issuances will reduce market prices and dilute their stock holdings in the Company.
Common stock is equity and is subordinate to the Company’s existing and future indebtedness and effectively subordinated to all the indebtedness and other non-equity claims against the Bank.
Shares of the Company’s common stock are equity interests and do not constitute indebtedness. As such, shares of the common stock will rank junior to all of the Company’s indebtedness and to other non-equity claims against the Company and its assets available to satisfy claims against it, including in the event of the Company’s liquidation. The Company is permitted to incur additional debt. Upon liquidation, lenders and holders of the Company’s debt securities would receive distributions of the Company’s available assets prior to holders of the Company’s common stock. Furthermore, the Company’s right to participate in a distribution of assets upon the Bank’s liquidation or reorganization is subject to the prior claims of the Bank’s creditors, including holders of any depositors of the Bank or any debt issued by the Bank.
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ITEM 1B. UNRESOLVED STAFF COMMENTS
Not applicable.
ITEM 2. PROPERTIES
The Company’s principal executive office is located at 1300 Kings Mountain Road in Martinsville, Virginia. There are also two other corporate administrative locations that house its operations center and various other corporate functions. We offer our community banking services through 69 combined depository locations in Virginia and North Carolina at December 31, 2021, 56 offices are located in Virginia and 13 are located in North Carolina. Two of these depository banking locations are held under lease contracts. In addition, the Bank leases a loan production office and a commercial banking office. Management believes the terms of the various leases are consistent with market standards and were arrived at through arm’s length bargaining. The leases are described in Note 8, Premises and Equipment, of the Notes to Consolidated Financial Statements in Item 8 of this Annual Report on Form 10-K.
ITEM 3. LEGAL PROCEEDINGS
In the normal course of business, the Company is subject to various legal and administrative proceedings and claims. Legal and administrative proceedings are subject to inherent uncertainties and unfavorable rulings could occur, and the timing and outcome of any legal or administrative proceeding cannot be predicted with certainty. As of December 31, 2021, the Company is not involved in any material pending or threatened legal proceedings other than proceedings occurring in the ordinary course of business.
ITEM 4. MINE SAFETY DISCLOSURES
Not applicable.
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ITEM 5. MARKET FOR REGISTRANT’S COMMON EQUITY, RELATED STOCKHOLDER MATTERS AND ISSUER PURCHASES OF EQUITY SECURITIES
PART II
Market for Common Stock and Dividends
The Company’s common stock trades on NASDAQ, under the ticker symbol “CARE.” As of the close of business on March 8, 2022, we had 2,379 shareholders of record.
Dividends
On October 14, 2016, prior to the Reorganization, the board of directors of the Bank (the "Bank Board") determined that it was prudent not to declare a quarterly cash dividend on the Bank's common stock beginning in the fourth quarter of 2016. Notwithstanding the Bank’s history of paying a quarterly cash dividend on its common stock, the Bank Board believed this decision was necessary and appropriate as the Bank committed, and now the Company commits, additional resources to assist with regulatory compliance, preserve capital during the COVID-19 pandemic, and makes significant investments in new technology and human resources. While recognizing the importance of dividends to its shareholders, the Board of Directors of the Company (the “Board”) has determined that preservation of capital is of paramount importance at this time.
The Bank Board paid a special one-time cash dividend of $0.14 per share on March 3, 2020. This was a one-time dividend and there are no immediate plans to reinstate a quarterly dividend. The amount and timing of future dividends, if any, remains subject to the discretion of the Board and will depend upon a number of factors, including future earnings, financial condition, liquidity and capital requirements of the Company, applicable governmental regulations and other factors deemed relevant by the Board.
Repurchases of Shares of Common Stock
The following table is a summary of our purchases of common stock during the fourth quarter of 2021:
(1) On December 13, 2021, the Company authorized, effective December 10, 2021, a common stock repurchase program to purchase up to two million shares of the Company’s common stock over a period of twelve months. As of December 31, 2021, 30,407 shares of common stock have been repurchased under this program at an average price of $15.22 per share. The program authorizes the purchase of the Company’s common stock in open market transactions or privately negotiated transactions, including pursuant to a trading plan in accordance with Rule 10b5-1 and/or Rule 10b-18 promulgated under the Securities Exchange Act of 1934, as amended. The authorization permits management to repurchase shares of the Company’s common stock from time to time at management’s discretion. The actual means and timing of any shares purchased under the program will depend on a variety of factors, including the market price of the Company’s common stock, general market and economic conditions, and applicable legal and regulatory requirements. The repurchase program is authorized through December 9, 2022, although it may be modified or terminated by the Board at any time. The repurchase program does not obligate the Company to purchase any particular number of shares.
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ITEM 5. MARKET FOR REGISTRANT’S COMMON EQUITY, RELATED STOCKHOLDER MATTERS AND ISSUER PURCHASES OF EQUITY SECURITIES - (continued)
Five-Year Cumulative Total Return
The following chart compares the cumulative total shareholder return on our common stock with the cumulative total return of the NASDAQ Composite Index and S&P U.S. BMI Banks Index, which includes the stocks of banks, thrifts and bank and financial holding companies listed on all major exchanges (NYSE, AMEX, NASDAQ) in the S&P Global Market Intelligence’s coverage universe. All SNL indices were retired in 2021, therefore we have replaced that index with the S&P U.S. BMI Banks Index.
Period Ending
(1)An investment in Carter Bankshares, Inc. prior to November 2020 represents an investment in Carter Bank & Trust.
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ITEM 6. [RESERVED]
ITEM 7. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
OVERVIEW
The following Management’s Discussion and Analysis of Financial Condition and Results of Operations (“MD&A”) is intended to help the reader understand Carter Bankshares, Inc., our operations, and our present business environment. 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 8 of this Annual Report on Form 10-K. The MD&A includes the following sections:
•Explanation of Use of Non-GAAP Financial Measures
•Critical Accounting Policies and Estimates
•Our Business
•Results of Operations and Financial Condition
•Capital Resources
•Contractual Obligations
•Off-Balance Sheet Arrangements
•Liquidity
•Inflation
•Stock Repurchase Program
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.
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 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 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 Income (Loss) 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, 2021."
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.
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ITEM 7. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS - (continued)
Critical Accounting Estimates
The Company’s 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 credit losses to be critical, because it is made in accordance with GAAP, is highly dependent on subjective or complex judgments, assumptions and estimates made by management and have had or is reasonably likely to have a material impact on the Company’s financial condition and results of operations.
We have identified the following critical accounting estimates:
Allowance for Credit Losses (“ACL”)
The ACL represents an amount which, in management's judgment, is adequate to absorb expected credit losses on outstanding loans at the balance sheet date based on the evaluation of the size and current risk characteristics of the loan portfolio, past events, current conditions, reasonable and supportable forecasts of future economic conditions and prepayment experience. The ACL is measured and recorded upon the initial recognition of a financial asset. The ACL is reduced by charge-offs, net of recoveries of previous losses, and is increased or decreased by a provision for credit losses, which is recorded as a current period operating expense.
Determination of an appropriate ACL is inherently complex and requires the use of significant and highly subjective estimates. The reasonableness of the ACL is reviewed quarterly by management.
Management believes it uses relevant information available to make determinations about the ACL and that it has established the existing allowance in accordance with GAAP. However, the determination of the ACL requires significant judgment, and estimates of expected credit losses in the loan portfolio can vary from the amounts actually observed. While management uses available information to recognize expected credit losses, future additions to the ACL may be necessary based on changes in the loans comprising the portfolio, changes in the current and forecasted economic conditions, changes to the interest rate environment which may directly impact prepayment and curtailment rate assumptions, and changes in the financial condition of borrowers.
The ACL “base case” model is derived from various economic forecasts provided by widely recognized sources. Management evaluates the variability of market conditions by examining the peak and trough of economic cycles. These peaks and troughs are used to stress the base case model to develop a range of potential outcomes. Management then determines the appropriate reserve through an evaluation of these various outcomes relative to current economic conditions and known risks in the portfolio. For the year ended December 31, 2021 the range of outcomes would produce a 17% reduction or a 27% increase in reserves based on the best and worst case scenarios, respectively.
Refer to Note 1, Summary of Significant Accounting Policies, for further detailed descriptions of our estimation process and methodology related to the ACL and Note 6, Allowance for Credit Losses, of this Annual Report on Form 10-K.
Our Business
Carter Bankshares, Inc. (the “Company”) is a bank holding company headquartered in Martinsville, Virginia with assets of $4.1 billion at December 31, 2021. 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 2020 Annual Report of the Virginia Bureau of Financial Institutions, our Company continues to be the fourth largest state-chartered bank by asset size at year end 2020. 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.
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ITEM 7. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS - (continued)
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 this strategy to successfully build our brand and grow our business in our markets.
The Company’s Response to COVID-19
Lending Operations
The Company elected to take advantage of Section 4014 of the Coronavirus Aid, Relief, and Economic Security Act (“CARES Act”) provision to temporarily delay adoption of the CECL methodology. The Company was subject to the adoption of the Current Expected Credit Loss (“CECL”) accounting method under the FASB ASU 2016-03 and related amendments, Financial Instruments – Credit Losses (Topic 326) on January 1, 2020 and has since implemented CECL on January 1, 2021. Refer to Note 1, Basis of Presentation and Note 6, Allowance for Credit Losses, of the Notes to Consolidated Financial Statements for additional disclosures relating to CECL in this Annual Report on Form 10-K.
The Company quickly responded to the pandemic and the CARES Act, offering the option of payment deferrals, participation in the Paycheck Protection Program (“PPP”), fee waivers and other relief actions to customers. In 2021 and, to date in 2022, we continued to prioritize the safety of our associates and customers by taking precautions to protect both customers and associates through enhanced cleaning services, social distancing and personal protective equipment requirements for both. A portion of the Company’s workforce continues to work remotely.
Under the CARES Act, the PPP is an amendment to a program administered as part of the Small Business Administration’s (“SBA”)’s 7-A loan program. The Bank became an approved SBA 7-A lender in November 2019. The PPP is a guaranteed, unsecured loan program created to fund certain payroll and operating costs of eligible businesses, organizations and self-employed persons during the COVID-19 pandemic. Initially, $349 billion was approved and designated for the 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 through a referral relationship with a third-party, non-bank lender. When an additional $310 billion in funds were approved and designated for the PPP, we opted to set up an internal, automated loan process utilizing our core system provider.
The Federal Reserve Bank (“FRB”) implemented a liquidity facility available to financial institutions participating in the PPP. However, we 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. The vast majority of these PPP loans have been forgiven.
The Bank provided loan payment deferrals to customers under Section 4013 of the CARES Act and regulatory interagency guidance regarding loan modifications. The Bank launched successive deferral programs with short-term expirations. The Part I program was launched on March 23, 2020 and expired on August 31, 2020. The deferrals in Part I provided for deferral of principal and up to the deferral of principal and interest, if requested through the expiry. The Part II program extended deferrals through December 31, 2020 subject to the collection of updated financial information and validation of need. For these borrowers the Bank requested verification of business and/or guarantor liquidity to ascertain the viability of the business in a post-pandemic environment. Prior to the extension of the CARES Act, the Bank launched the Part III program, which offered borrowers in the Part II program an extension of deferrals through June 30, 2021. Borrowers who opted into the Part III program were required to provide monthly financial statements and remit payments on a quarterly basis equal to the lesser of: i) 90% of free cash flow (EBITDA) or, ii) the otherwise contractual payment (“recapture payment”). Following the expiration of the deferral programs on June 30, 2021, for term loans, payments were applied to accrued interest first and once accrued interest is current, payments will be applied to principal. Deferred principal will be due at maturity. For interest only loans, such as lines of credit, deferred interest will be due at maturity. Cumulative deferred interest totaled $12.0 million as of June 30, 2021, but declined to $1.8 million as of December 31, 2021.
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ITEM 7. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS - (continued)
The Bank also participated in the PPP established by the CARES Act. During the first round of PPP, we approved 451 loans that were referred to an online small business lender, totaling $17.9 million. Through the second round we had approved 515 loan applications totaling $39.9 million through our internal lending program, of which 498 loans totaling $38.5 million have been fully forgiven by the SBA. The $57.8 million in PPP loans originated during the first two rounds of PPP generated $1.5 million in fees, which have been, or will be, recognized in income as loans are forgiven, or over the remaining life of the loan for any portion that is not forgiven. On December 22, 2020 Congress passed legislation that was signed into law on December 27, 2020, making available a third round of PPP funding. We provided access to the program through our internal lending program for our current business customers. As of December 31, 2021, we had approved 136 loan applications totaling $11.0 million, of which 125 loans totaling $9.8 million have been fully forgiven by the SBA and generated an additional $0.6 million in fees. These loans, as they were forgiven, generated fee income of $0.1 million and $0.2 million, and $1.1 million and $0.3 million, for the three and twelve months ended December 31, 2021 and December 31, 2020, respectively.
Our interest income could be reduced due to the COVID-19 pandemic. 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, but recognize the breadth of the economic impact may affect our borrowers’ ability to repay in future periods.
Our exposure to the hospitality industry at December 31, 2021 equated to approximately $418.6 million, or 14.9% 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. These risk considerations were factored into qualitative adjustments included in the ACL. As a result, we anticipate that our financial condition, capital levels and results of operations could be adversely affected.
Retail Operations
The Company continues 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 2021 and, to date in 2022, we continued to prioritize the safety of our associates and customers by offering drive-up and appointment only services due to the COVID-19 pandemic. Retail leadership continues to monitor branch traffic and local conditions daily and makes adjustments as needed. All branches are equipped with video conferencing and online tools that enable virtual servicing. We continue to pay all associates according to their normal work schedule, even if their hours were reduced and no associates were furloughed. Associates whose job responsibilities can be effectively carried out remotely are working from home. Associates whose critical duties require their continued presence on-site are utilizing personal protection equipment and observing social distancing and cleaning protocols.
Our fee income for 2020 was negatively impacted due to COVID-19 by approximately $1.5 million. Beginning on July 20, 2020, certain account fees that were waived for customers affected by the COVID-19 pandemic were reinstated. In keeping with guidance from regulators, we actively worked with customers affected by the COVID-19 pandemic to waive fees from a variety of sources, such as, but not limited to, insufficient funds and overdraft fees and account maintenance fees. As of December 31, 2021, we had no fee waivers specific to the COVID-19 pandemic. We believe these reductions in fees were temporary.
Capital Resources and Liquidity
As of December 31, 2021, all of the Company’s capital ratios were in excess of all regulatory requirements. We believe the economic recession brought about by the COVID-19 pandemic improved during the year ended December 31, 2021.
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ITEM 7. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS - (continued)
We maintain access to multiple sources of liquidity. Funding sources accessible to the Company include borrowing availability at the Federal Home Loan Bank (“FHLB”), equal to 25% of the Company’s assets approximating $1.0 billion, subject to the amount of eligible collateral pledged, and of which $667.3 million remained available at December 31, 2021, 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 $743.8 million of unpledged available-for-sale securities as an additional source of liquidity at December 31, 2021. 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.
Results of Operations and Financial Condition
Earnings Summary
2021 Highlights
•Net interest income increased $6.1 million, or 5.8%, to $111.2 million for the full year 2021 compared to $105.1 million for the full year 2020 primarily due to the enhanced return on restructured loan assets and collection of significant late fees on those loan assets, as well as a decline in funding costs during 2021.
•The provision for credit losses totaled $3.4 million for the year ended December 31, 2021, compared to $18.0 million for the full year ended December 31, 2020.
•Total noninterest income increased $2.3 million to $28.9 million for the full year 2021 compared to $26.6 million for the full year 2020.
•Total noninterest expense decreased $56.5 million to $102.3 million for the full year 2021 compared to $158.8 million for the full year 2020.
•Provision for income taxes increased $3.3 million to $4.1 million for the full year 2021 compared to $0.8 million for the full year 2020.
We reported net income of $31.6 million, or $1.19 diluted earnings per share, for the year ended December 31, 2021 compared to a net loss of $45.9 million, or $1.74 per share, for the year ended December 31, 2020.
Years Ended December 31,
Return on Average Assets 0.76 % (1.12) % 0.65 %
Return on Average Shareholders' Equity 7.92 % (9.78) % 5.76 %
Allowance for Credit Losses to Total Portfolio Loans 3.41 % 1.83 % 1.34 %
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 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
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ITEM 7. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS - (continued)
federal statutory tax rate of 21% for each period 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 Income (Loss) to net interest income on an FTE basis for the periods presented:
(Dollars in Thousands) Years Ended December 31,
Net Interest Income (FTE) (non-GAAP) 2.84 % 2.80 % 3.05 %
Average Balance Sheet and Net Interest Income Analysis (FTE)
Total net interest income increased $6.1 million, or 5.8%, to $111.2 million in 2021, as compared to $105.1 million in 2020. Net interest income, on an FTE basis (non-GAAP), increased $5.2 million, or 4.8%, to $112.7 million in 2021 as compared to $107.5 million in 2020. The increase in net interest income, on an FTE basis, is driven by $13.1 million decrease in interest expense, offset by a $7.9 million decrease in interest income during 2021 as compared to 2020. The low interest rate environment and large commercial paydowns during 2021 has a negative impact on both net interest income and the net interest margin, but continues to be offset by a lower cost of funds as well as the positive impact of enhanced pricing on restructured loans and related late fees. Net interest margin increased six basis points to 2.80% in 2021 compared to 2.74% in 2020. The net interest margin, on an FTE basis (non-GAAP), increased four basis points to 2.84% in 2021 compared to 2.80% in 2020, primarily due to the aforementioned enhanced return on restructured loan assets and the collection of related fees during 2021. The intentional runoff of higher cost CDs continues to drive the decline in the overall cost of funds.
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ITEM 7. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS - (continued)
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 years ended December 31:
ASSETS
LIABILITIES AND SHAREHOLDERS' EQUITY
Federal Funds Purchased — — — % 55 1 1.82 % — — —
(1)Nonaccruing loans are included in the daily average loan amounts outstanding.
(2)Tax-exempt income is on an FTE basis using the statutory federal corporate income tax rate of 21 percent.
(3)Loan and deposit balances include held-for-sale transactions in connection with sale of Bank branches.
Interest income decreased $7.0 million, or 5.0% for 2021 compared to 2020. Interest income, on an FTE basis (non-GAAP), decreased $7.9 million, or 5.5%, for 2021 compared to 2020. The change was primarily due to increases in average interest-earning assets of $138.0 million for 2021, offset by a lower interest rate yield of 33 basis points compared to 2020. Average interest-bearing deposits with banks increased $90.0 million in 2021, and the average rate paid decreased 15 basis points for 2021 compared to 2020. Average loan balances decreased $38.6 million, primarily due to large commercial payoffs and loan sales, during 2021 compared to 2020, which included PPP loan production that began in the second quarter of 2020. Average PPP loans totaled $19.3 million during 2021. The average rate earned on loans decreased 13 basis points for 2021 compared to 2020 primarily due to lower short-term interest rates. Average investment securities increased $88.1 million and the average rate earned decreased 50 basis points for 2021 compared to 2020. The change in investment securities is the result of active balance sheet management as our portfolio has been diversified as to bond types, maturities, and interest rate structures.
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ITEM 7. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS - (continued)
Interest expense decreased $13.1 million for 2021 compared to 2020. The decrease was primarily due to lower short-term interest rates in 2021 as compared to 2020 in addition to the intentional runoff of higher cost CDs. Interest expense on deposits decreased $13.1 million for 2021 compared to 2020 primarily due to the decline in the average balance of CDs. The decrease of $334.4 million or 18.4% in the average balance of CDs for 2021 compared to 2020 was primarily due to the aforementioned intentional runoff of these higher cost CDs. Money market and interest-bearing demand accounts increased $186.2 million and $92.7 million, respectively for 2021 compared to 2020 primarily due to our deposit acquisition strategy. The average rate paid on interest-bearing deposits decreased 45 basis points for 2021 compared to 2020 primarily due to the aforementioned intentional runoff of higher cost CDs and lower short-term interest rates. Overall, the cost of interest-bearing liabilities decreased 45 basis points for 2021 compared to 2020.
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:
Interest Earned on:
Interest Paid on:
Federal Funds Purchased — (1) (1) 1 — 1
(1)Nonaccruing loans are included in the daily average loan amounts outstanding.
(2)Tax-exempt income is on an FTE basis 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 for Credit Losses
The Company recognizes provision expense for 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 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 elected to defer its adoption of CECL in accordance with relief provided under the CARES Act and the adoption became effective January 1, 2021. At January 1, 2021, we increased the ACL by $64.5 million, which includes $61.6 million for the Day 1 CECL adjustment and $2.9 million
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ITEM 7. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS - (continued)
related to the life-of-loan reserve on unfunded loan commitments. The ACL as a percentage of total portfolio loans was 3.41% at December 31, 2021 and 1.83% at December 31, 2020.
Provision expense decreased $14.6 million to $3.4 million for the year ended 2021 compared to $18.0 million for the year ended 2020. The decline in provision expense was because of increased qualitative loss factors as a result of the estimated economic impact of COVID-19 during 2020 and the relatively stable economy and improving COVID-19 conditions from the date of adoption through December 31, 2021.
During 2021, management observed that $62.2 million of loans that were previously in the deferral program were recovering at rates much lower than peers. Accordingly, management sold all of these loans during the third and fourth quarters of 2021 after workout strategies had been exhausted.
A release of $1.3 million was recorded in 2021 related to the provision for unfunded commitments. Per the guidance related to CECL, unfunded loan commitments are included as part of the provision for credit losses rather than noninterest expense, where it was previously recorded.
Net charge-offs were $23.1 million for the full year 2021 compared to $2.7 million for the full year 2020. The increase in net charge-offs was primarily attributable to the resolution of five problem relationships during 2021, in which the majority of losses were anticipated and previously reserved. As a percentage of average portfolio loans, on an annualized basis, net charge-offs were 0.79% and 0.09% for the years ended 2021 and 2020, respectively. See the “Allowance for Credit Losses” section of this MD&A for additional details regarding our charge-offs.
Nonperforming loans (“NPLs”) decreased significantly at December 31, 2021 by $24.6 million, or 76.9% to $7.4 million compared to $32.0 million at December 31, 2020. The decrease was primarily due to the resolution of our largest NPL relationship during 2021 and a significant reduction of our second largest NPL relationship. NPLs as a percentage of total portfolio loans were 0.26% at December 31, 2021 compared to 1.09% at December 31, 2020. See the “Credit Quality” section of this MD&A for more detail on our NPLs.
Discussion of net interest income for the year ended December 31, 2019 has been omitted as such discussion was provided in Part II, Item 7. “Management’s Discussion and Analysis,” under the heading “Net Interest Income” in the Company’s Annual Report on Form 10-K for the year ended December 31, 2020, which was filed with the SEC on March 12, 2021, and is incorporated herein by reference.
Noninterest Income
Years Ended December 31,
(Dollars in Thousands) 2021 2020 $ Change % Change
Gains on Sales of Securities, net $ 6,869 $ 6,882 $ (13) (0.2) %
For the year ended December 31, 2021 compared to December 31, 2020, the increase of $2.3 million in total noninterest income was driven by increases in service charges, commissions and fee accounts of $2.0 million, debit card interchange fees of $1.4 million, $0.7 million increase in other income primarily due to a year-to-date gain of $0.5 million on the sale of four bank branches and higher insurance commissions of $0.2 million. The above increases were offset by lower commercial loan swap fee income of $1.6 million and a decrease in OREO income of $0.3 million. Service charges, commission and fees increased due to reinstating fees that were previously waived during 2020 for customers affected by the COVID-19 pandemic and debit
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ITEM 7. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS - (continued)
card interchange fees increased due to increased usage. The fluctuations in commercial loan swap fee income are due primarily to the timing and demand for this product in the current low interest rate environment.
Discussion of noninterest income for the year ended December 31, 2019 has been omitted as such discussion was provided in Part II, Item 7. “Management’s Discussion and Analysis,” under the heading “Noninterest Income” in the Company’s Annual Report on Form 10-K for the year ended December 31, 2020, which was filed with the SEC on March 12, 2021, and is incorporated herein by reference.
Noninterest Expense
(Dollars in Thousands) Years Ended December 31,
Losses on Sales and Write-downs of Bank Premises, net 231 99 132 133.3 %
Unfunded Loan Commitment Expense — (252) 252 NM
NM - percentage not meaningful
Total noninterest expense decreased $56.5 million to $102.3 million for the full year 2021 compared to $158.8 million compared to the full year 2020. The decline was driven by the one-time charge resulting from goodwill impairment of $62.2 million recorded in the third quarter of 2020. Offsetting the decrease were increases of $2.2 million in losses on sales and write-downs of OREO, net primarily due to nonrecurring write-downs related to closed bank branches. There were also increases of $1.8 million in salaries and employee benefits, a $1.1 million increase in data processing expense and a $0.6 million increase in tax credit amortization. The increase in salaries and employee benefits was due to increased profit sharing incentives of $1.1 million and higher medical expenses of $1.7 million, offset by lower salaries of $1.3 million due to our branch network optimization project. Higher data processing expenses resulted from increased customer accounts and new modules added to our core processor and the increase in tax credit amortization was due to new historic tax credits entered into throughout 2021.
Discussion of noninterest expense for the year ended December 31, 2019 has been omitted as such discussion was provided in Part II, Item 7. “Management’s Discussion and Analysis,” under the heading “Noninterest Expense” in the Company’s Annual Report on Form 10-K for the year ended December 31, 2020, which was filed with the SEC on March 12, 2021, and is incorporated herein by reference.
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ITEM 7. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS - (continued)
Provision for Income Taxes
The provision for income taxes increased $3.3 million to $4.1 million for the year ended December 31, 2021 compared to $0.8 million for December 31, 2020. Pre-tax income increased $80.8 million for the year ended 2021 compared to 2020. A full goodwill impairment charge in the amount of $62.2 million was recorded in the third quarter of 2020. Our effective tax rate was 11.5% for the year ended December 31, 2021 compared to negative 1.7% for December 31, 2020. The increase in the effective tax rate is primarily due to a higher level of pre-tax income and a lower level of tax-exempt interest income for the year ended December 31, 2021 and the nondeductible goodwill impairment charge for the year ended December 31, 2020. 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”), which are relatively consistent regardless of the level of pre-tax income.
Discussion of provision for income taxes for the year ended December 31, 2019 has been omitted as such discussion was provided in Part II, Item 7. “Management’s Discussion and Analysis,” under the heading “Provision for Income Taxes” in the Company’s Annual Report on Form 10-K for the year ended December 31, 2020, which was filed with the SEC on March 12, 2021, and is incorporated herein by reference.
Financial Condition
December 31, 2021
Total assets of $4.1 billion decreased $45.4 million, or 1.1%, from December 31, 2020. Total portfolio loans at December 31, 2021 were $2.8 billion, decreasing $135.0 million, or 4.6%, year over year. We experienced a decline in total loans during 2021 primarily due to large commercial loan payoffs of approximately $312.3 million, $62.2 million of loan sales and mortgage refinancing sold in the secondary markets. The variances between loan segments for portfolio loans are also related to the adoption of Topic 326. See the impact of Topic 326 in Note 1, Summary of Significant Accounting Policies, in the Notes to Consolidated Financial Statements in Item 8 of thisAnnual Report on Form 10-K. We made changes to our loan portfolio segments to align with the methodology applied in determining the allowance under CECL. The new segmentation breaks out an Other category from the original loan categories, which applies only to the current year 2021 and was not applied to periods during 2020 and prior years, therefore showing fluctuations in all categories. At January 1, 2021, the initial break-out of Other loans related to the adoption of Topic 326 totaled $379.9 million consisting of $140.8 million of Commercial Real Estate, (“CRE”), $78.1 million of Commercial and Industrial (“C&I”), $50.8 million of Residential Mortgages and $110.2 million of Construction. This segment of loans has unique risk attributes considered inconsistent with current underwriting standards. The analysis applied to this segment resulted in an expected credit loss of $51.3 million at adoption. Loans held-for-sale were $0.2 million at December 31, 2021 a decrease of $25.2 million over prior year.
The Company’s investment portfolio increased $143.7 million, or 18.5%, from December 31, 2020. Deposits increased $13.8 million from December 31, 2020 primarily due to our core deposits offset by the runoff of higher cost CDs and $84.7 million of deposits held-for-assumption in connection with the sale of four bank branches, which were completed during the second quarter of 2021. Shareholders’ equity at December 31, 2021 was $407.6 million, a $32.6 million or 7.4% decrease from $440.2 million at December 31, 2020.
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ITEM 7. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS - (continued)
Securities
The following table presents the composition of available-for-sale securities for the periods presented:
(Dollars in Thousands) 2021 2020 $ Change
U.S. Treasury Securities $ 4,413 $ — $ 4,413
U.S. Government Agency Securities 3,478 — 3,478
The balances and average rates of our securities portfolio are presented below as of December 31:
Balance Weighted-AverageYield Balance Weighted-AverageYield
U.S. Treasury Securities $ 4,413 1.35 % $ — — %
U.S. Government Agency Securities 3,478 1.73 % — — %
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 approved annually by our Board and administered through ALCO and our treasury function.
The securities portfolio increased $143.7 million at December 31, 2021 compared to December 31, 2020. Securities comprise 22.3% of total assets at December 31, 2021 compared to 18.6% at December 31, 2020. The increase is a result of active balance sheet management and the Company’s excess cash position. We further diversified the securities portfolio as to bond types, maturities and interest rate structures.
At December 31, 2021, total gross unrealized gains in the available-for-sale portfolio were $10.0 million offset by $7.8 million of gross unrealized losses. At December 31, 2020, total gross unrealized gains in the available-for-sale portfolio were $22.6 million offset by $2.7 million of gross unrealized losses.
Management evaluates the securities portfolio for other-than-temporary impairment (“OTTI”) on a quarterly basis. During the years ended December 31, 2021 and December 31, 2020 the Company did not record any OTTI. The performance of the debt and equity securities markets could generate impairments in future periods requiring realized losses to be reported.
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ITEM 7. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS - (continued)
The following table sets forth the maturities of securities at December 31, 2021 and the weighted average yields of such securities.
Available-for-Sale Securities
(Dollars in Thousands) Maturing
Amount Yield Amount Yield Amount Yield Amount Yield
U.S. Treasury Securities $ — — % $ — — % $ 4,413 1.35 % $ — — %
U.S. Government Agency Securities — — % — — % 3,478 1.73 % — — %
Residential Mortgage-Backed Securities(2) 14 2.26 % — — % — — % 109,999 0.44 %
Commercial Mortgage-Backed Securities(2) — — % — — % 4,168 2.02 % — — %
Corporate Notes — — % — — % 59,735 4.08 % — — %
(1)Weighted -average yields are calculated on a taxable-equivalent basis using the federal statutory tax rate of 21 percent.
(2) Securities not due at a single maturity date
At December 31, 2021 the Company had no held-to-maturity securities; however, if at a future date we classify securities as held-to-maturity, our disclosures will show the weighted average yield for each range of maturities.
At December 31, 2021, the Company held 52% fixed rate and 48% floating rate securities.The floating rate securities may have a stated maturity greater than ten years, but the interest rate generally adjusts monthly.Therefore, the duration on these securities is short, generally less than one year, and will therefore not be as sensitive to interest rate changes.
Refer to Note 4, Investment Securities, in the Notes to Consolidated Financial Statements in Item 8 of this Annual Report on Form 10-K for additional information related to our securities.
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ITEM 7. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS - (continued)
Loan Composition
The following table summarizes our loan portfolio as of the periods presented:
December 31,
Commercial
Consumer
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.
Total portfolio loans decreased $135.0 million, or 4.6% to $2.8 billion at December 31, 2021 compared to $2.9 billion at December 31, 2020. We experienced a decline in total loans during 2021 primarily due to large commercial loan payoffs, $62.2 million of loan sales and mortgage refinancing sold in the secondary markets. The variances between loan segments for portfolio loans also relates to the adoption of Topic 326 as we adjusted our loan portfolio segments to align with the methodology applied in determining the allowance under CECL.
The commercial portfolio is monitored for potential concentrations of credit risk by market, loan type, property type and tenants.
Our exposure to the hospitality industry at December 31, 2021 equated to approximately $418.6 million, or 14.9% 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. Beginning in the second quarter of 2021, we observed improvements in occupancy and the average daily rates for our hotel clients following sharp declines throughout the pandemic. However, like many service industries our clients continue to face challenges with respect to labor, which impedes their ability to turnover rooms resulting in occupancy constraints. This has caused, or may cause, them to operate with lower levels of liquidity and an inability to reserve for capital improvements and may adversely affect their ability to pay property expenses, capital improvements and/or repay existing indebtedness. Contractual payments have been restored since the expiration of our deferral program on June 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 $721.6 million at December 31, 2021. The Other segment represents 49.6% of the top 10 credit relationships.
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ITEM 7. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS - (continued)
The following table summarizes our top 10 relationships and a description of industries represented for the periods presented:
Dollars in Thousands For the Periods Ending
Concentration Threshold (25% of Risk-based Capital ("RBC")) $ 120,781 $ 116,300
Unfunded commitments on lines of credit were $433.1 million at December 31, 2021 as compared to $410.7 million at December 31, 2020. The majority of unused commitments are for construction projects that will be drawn as the construction completes. Total utilization was 52.2% at December 31, 2021 and 47.8% at December 31, 2020. Unfunded commitments on commercial operating lines of credit was 51.7% at December 31, 2021 and 48.3% at December 31, 2020.
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 have 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. Mortgage loans held-for-sale were $0.2 million and $25.4 million at December 31, 2021 and December 31, 2020, respectively.
In addition to mortgage loans held-for-sale, the Company had $9.8 million in loans held-for-sale in connection with sale of Bank branches at December 31, 2020 that sold in the second quarter of 2021.
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ITEM 7. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS - (continued)
The following tables present the maturity schedule of portfolio loan types at December 31, 2021:
Maturity
Fixed interest rates
Other — — — — —
Variable interest rates
Refer to Note 5, Loans and Loans Held-For-Sale, in the Notes to Consolidated Financial Statements in Item 8 of this Annual Report on Form 10-K 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 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.
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ITEM 7. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS - (continued)
Nonperforming assets (“NPAs”) consist of nonaccrual loans, nonaccrual troubled debt restructurings (“TDRs”) and other real estate owned (“OREO”). The following table summarizes nonperforming assets for the dates presented:
(Dollars in Thousands) December 31,
Nonperforming Loans
Commercial Real Estate $ 595 $ 224
Commercial and Industrial 451 456
Other — —
Nonperforming Troubled Debt Restructurings
Commercial and Industrial — —
Residential Mortgages — —
Other Consumer — —
Other — —
Total Nonperforming Troubled Debt Restructurings 3,550 24,986
Nonperforming Loans to Total Portfolio Loans 0.26 % 1.09 %
NPLs decreased significantly by $24.6 million, or 76.9% compared to December 31, 2020, primarily due to the resolution of our largest NPL relationship and a significant decrease in the second largest NPL relationship, partly offset by new loans placed on nonaccrual status during 2021. The two largest NPL relationships had an aggregate principal balance of $21.4 million at December 31, 2020. We recognized charge-offs totaling $8.2 million related to these relationships during the second quarter of 2021 resulting in the release of $4.8 million of individually evaluated loan reserves. The $8.2 million in charge-offs consisted of a $6.3 million charge-off triggered by a settlement of the debt and proceeds received while the remaining $1.9 million charge-off was triggered by the sale of the underlying collateral through a purchase agreement approved by the bankruptcy court. Nonperforming construction loans decreased primarily due to paydowns from borrower asset sales on four loans related to one relationship during the fourth quarter of 2021. Paydowns on this relationship totaled $2.4 million and charge-offs totaled $1.9 million leaving a remaining book balance of $0.8 million that is adequately secured by collateral. Offsetting the declines were new NPLs totaling $2.8 million, of which $2.7 million is one loan. NPLs as a percentage of total portfolio loans were 0.26% at December 31, 2021 compared to 1.09% at December 31, 2020.
OREO decreased $4.8 million, or 30.6%, at December 31, 2021 compared to December 31, 2020 due to the sale of 23 branches and six OREO properties during 2021. Closed retail bank office carrying values decreased $1.5 million and have a remaining book value of $1.0 million at December 31, 2021 compared to $2.5 million at December 31, 2020. During 2021, 20 branch closures were completed and 16 of these were sold as part of our branch network optimization project that aligns with our strategic goals to enhance franchise value and improve operating efficiency.
There were no nonaccrual loans related to loans held-for-sale at December 31, 2021. As of December 31, 2020 total nonaccrual loans include $7 thousand in loans held-for-sale in connection with sale of Bank branches.
Refer to Note 6, Allowance for Credit Losses, in the Notes to Consolidated Financial Statements in Item 8 of this Annual Report on Form 10-K for additional information related to our nonperforming loans and OREO.
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ITEM 7. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS - (continued)
The following table summarizes past due loans for the dates presented:
(Dollars in Thousands) December 31,
Loans 30 to 89 Days Past Due
Commercial
Commercial Real Estate $ 229 $ 3,816
Commercial and Industrial 297 384
Consumer
Construction — 284
Other — —
Portfolio loans past due 30 to 89 days or more and still accruing decreased $4.7 million, or 74.0% to $1.7 million at December 31, 2021 compared to $6.4 million at December 31, 2020, primarily in the commercial real estate segment. There were no loans during the year ended December 31, 2021 and December 31, 2020 that were past due more than 90 days and still accruing.
Closed-end installment loans, amortizing loans secured by real estate and any other loans with payments scheduled monthly are reported past due when the borrower is in arrears two or more monthly payments. Other multi-payment obligations with payments scheduled other than monthly are reported past due when one scheduled payment is due and unpaid for 30 days or more. We monitor delinquency on a monthly basis, including loans that are at risk for becoming delinquent and early stage delinquencies in order to identify emerging patterns and potential problem loans.
Troubled Debt Restructuring (“TDRs”) are loans that we, for economic or legal reasons related to a borrower’s financial difficulties, grant 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 be considered a TDR generally include 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 be instances of principal forgiveness. Short-term modifications that are considered insignificant are generally not considered a TDR unless there are other concessions granted.
An accruing loan that is characterized as a TDR can remain in accrual status if, based on a current credit analysis, collection of principal and interest in accordance with the modified terms is reasonably assured, and the borrower has demonstrated sustained historical performance for a reasonable period before the modification. All TDRs are considered to be impaired loans and will be reported as impaired loans for their remaining lives, unless a subsequent restructuring includes an interest rate equal to or greater than the rate that would be accepted at the time of the restructuring for a new loan with comparable risk, we fully expect that the remaining principal and interest will be collected according to the restructured agreement or the contractual terms of the original loan agreement are restored. Generally, the Company individually evaluates all impaired loans, which includes TDRs, 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 balance 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.
As an example, consider a substandard commercial construction loan that is currently 90 days past due where the loan is restructured to extend the maturity date for a period longer than would be considered an insignificant period of time. The post-modification interest rate given to the borrower is considered to be lower than the current market rate for new debt with similar risk and all other terms remain the same according to the original loan agreement. This loan will be considered a TDR as the borrower is experiencing financial difficulty and a concession has been granted due to the significant extension, resulting in payment delay as well as the rate being lower than current market rate for new debt with similar risk. The loan will be reported
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ITEM 7. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS - (continued)
as a nonaccrual TDR and an impaired loan. In addition, the loan could be charged down to the fair value of the collateral if a confirmed loss exists. If the loan subsequently performs, by means of making on-time payments according to the newly restructured terms for a period of six months, and it is expected that all remaining principal and interest will be collected according to the terms of the restructured agreement, the loan will be returned to accrual status and reported as an accruing TDR. The loan will remain an impaired loan for the remaining life of the loan because the interest rate was not adjusted to be equal to or greater than the rate that would be accepted at the time of the restructuring for a new loan with comparable risk.
Allowance for Credit Losses
The following summarizes our allowance for credit loss experience at December 31 for each of the years presented:
Impact of CECL Adoption 61,642 — —
Charge-offs:
Other — — —
Recoveries:
Commercial Real Estate 159 707 —
Commercial and Industrial 291 2 —
Other — — —
Net Charge-offs to Average Portfolio Loans 0.79% 0.09% 0.13%
Allowance for Credit Losses to Total Portfolio Loans 3.41% 1.83% 1.34%
Total net charge-offs increased to $23.1 million for the year ended December 31, 2021 compared to $2.7 million for the year ended December 31, 2020 primarily in the commercial real estate segment. In the quarter ended June 30, 2021, we released $4.8 million of specific reserves in connection with the resolution of our two largest CRE nonperforming relationships and recognized $8.2 million in charge-offs. In the quarter ended September 30, 2021, the Bank sold nine CRE loans within two performing relationships with an unpaid principal balance of $50.2 million, which resulted in charge-offs of $9.2 million and a net release of reserves of $3.1 million. Finally, in the quarter ended December 31, 2021, we sold an additional two notes, which resulted in $2.2 million net charge-offs and added $0.5 million to provision expense. We also recorded a $1.9 million net charge-off for a nonperforming lot development relationship.
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ITEM 7. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS - (continued)
The following is the Allocation of the ACL balance by segment as of December 31 for the years presented below:
While the variances within the loan segments relate to the Day 1 impact of CECL, our ACL has a higher concentration of commercial loans including CRE, C&I and construction. The ability of borrowers to repay commercial loans is dependent upon the success of their business and general economic conditions. Due to the greater potential for loss within our commercial portfolio, we monitor the commercial loan portfolio through an internal risk rating system. Loan risk ratings are assigned based upon the creditworthiness of the borrower and are reviewed on an ongoing basis according to our internal policies. Loans rated special mention or substandard have potential or well-defined weaknesses not generally found in high quality, performing loans, and require attention from management to limit loss.
The following table summarizes the credit quality ratios and their components as of December 31 for the years presented below:
Allowance for Credit Losses to Total Portfolio Loans
Allowance for Credit Losses to Total Portfolio Loans 3.41 % 1.83 %
Nonperforming Loans to Total Portfolio Loans
Nonperforming Loans to Total Portfolio Loans 0.26 % 1.09 %
Allowance for Credit Losses to Nonperforming Loans
Allowance for Credit Losses to Nonperforming Loans 1,297.00 % 168.96 %
Net Charge-offs to Average Portfolio Loans
Net Charge-offs to Average Portfolio Loans 0.79 % 0.09 %
A discussion of the factors that drove the material changes in the ACL ratios presented in the table above, such as the significant reduction in nonperforming loans and the significant increase in net charge-offs have been communicated in the paragraphs preceding this table within the Credit Quality and Allowance for Credit Losses sections within this MD&A.
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CARTER BANKSHARES, INC. AND SUBSIDIARIES
ITEM 7. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS - (continued)
Prior to the adoption of Topic 326 on January 1, 2021, we calculated our ACL using an incurred loan loss methodology. The following tables are disclosures related to the allowance for credit losses in prior periods.
The following table summarizes the ACL balance as of December 31, 2020:
(Dollars in Thousands) 2020
Collectively Evaluated for Impairment $ 38,824
Individually Evaluated for Impairment 15,250
Total Allowance for Credit Losses $ 54,074
The ACL was $95.9 million, or 3.41%, of total portfolio loans at December 31, 2021 compared to $54.1 million, or 1.83% December 31, 2020.
Refer to Note 6, Allowance for Credit Losses, in the Notes to Consolidated Financial Statements in Item 8 of this Annual Report on Form 10-K for additional information related to our ACL.
Deposits
The daily average balance of deposits and rates paid on deposits are summarized in the following table for the years ended December 31:
(Dollars in Thousands) AverageBalance Rate AverageBalance Rate
The following table presents additional information about our year-end deposits:
Noninterest-Bearing Public Funds Deposits 58,393 34,457
Total Deposits not Covered by Deposit Insurance(1) 396,626 377,398
Certificates of Deposits not Covered by Deposit Insurance 147,134 181,057
(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.
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CARTER BANKSHARES, INC. AND SUBSIDIARIES
ITEM 7. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS - (continued)
Maturities of CDs over $250,000 or more not covered by deposit insurance at December 31, 2021 are summarized as follows:
(Dollars in Thousands) Amount Percent
Over Three Months Through Twelve Months 38,980 26.5 %
Over Twelve Months Through Three Years 52,850 35.9 %
Refer to Note 12, Deposits, in the Notes to Consolidated Financial Statements in Item 8 of this Annual Report on Form 10-K for additional information related to our deposits.
Federal Home Loan Bank (“FHLB”) Borrowings
Information pertaining to FHLB advances at December 31 is summarized in the table below:
Average Interest Rate during the Period 1.20 % 1.18 % 1.63 %
Average Interest Rate at Period End 1.61 % 1.13 % 1.63 %
The Company held FHLB Atlanta stock of $2.4 million and $5.1 million at December 31, 2021 and December 31, 2020, respectively. Dividends recorded on this restricted stock were $121 thousand and $218 thousand for the years ended December 31, 2021 and December 31, 2020, respectively. The investment is carried at cost and evaluated for impairment based on the ultimate recoverability of the par value. We hold FHLB stock because we are a member of the FHLB of Atlanta. The FHLB requires members to purchase and hold a specified level of FHLB stock based upon the members’ asset values, level of borrowings and participation in other programs offered. Stock in the FHLB is non-marketable and is redeemable at the discretion of the FHLB. Members do not purchase stock in the FHLB for the same reasons that traditional equity investors acquire stock in an investor-owned enterprise. Rather, members purchase stock to obtain access to the products and services offered by the FHLB. Unlike equity securities of traditional for-profit enterprises, the stock of the FHLB does not provide its holders with an opportunity for capital appreciation because, by regulation, FHLB stock can only be purchased, redeemed and transferred at par value.
Refer to Note 13, Federal Home Loan Bank Borrowings, in the Notes to Consolidated Financial Statements in Item 8 of this Annual Report on Form 10-K for additional information related to our borrowings.
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ITEM 7. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS - (continued)
Capital Resources
The following table summarizes ratios for the Company for December 31:
Common Equity Tier 1
Tier 1 Ratio
Total Risk-Based Capital Ratio
Leverage Ratio
Total shareholders’ equity decreased by $32.6 million to $407.6 million at December 31, 2021 compared to $440.2 million at December 31, 2020. The decrease was primarily due to the $50.7 million cumulative-effect adjustment related to the adoption of Topic 326, a $14.0 million, net of tax, decrease in other comprehensive loss due to changes in the fair value of available-for-
sale securities and $0.5 million related to the repurchase of common stock, partially offset by net income of $31.6 million. The remaining difference of $1.0 million is related to stock-based compensation during the year ended December 31, 2021.
The Company continues to maintain its capital position with a leverage ratio of 10.62% as compared to the regulatory guideline of 5.00% to be well-capitalized and a risk-based Common Equity Tier 1 ratio of 14.21% compared to the regulatory guideline of 6.50% to be well-capitalized. Our risk-based Tier 1 and Total Capital ratios were 14.21% and 15.46%, respectively, which places the Company 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.
In July 2013 the federal banking agencies issued a final rule to implement the Basel III Final Rules and the minimum leverage and risk-based capital requirements of the Dodd-Frank Act. The final rule established a comprehensive capital framework and went into effect on January 1, 2015 for smaller banking organizations such as the Company. The rule also requires the Company and the Bank to maintain a capital conservation buffer composed of Common Equity Tier 1 capital in an amount greater than 2.50% of total risk-weighted assets beginning in 2019. The capital conservation buffer was phased-in, in equal increments from 2016 through 2019. As a result, starting in 2019, the Company and the Bank were required to maintain a Common Equity Tier 1 risk-based capital ratio greater than 7.0%, a Tier 1 risk-based capital ratio greater than 8.5%, and a Total risk-based capital ratio greater than 10.5%; otherwise, they will be subject to restrictions on capital distributions and discretionary bonus payments.
Federal regulators periodically propose amendments to the regulatory capital rules and the related regulatory framework and consider changes to the capital standards that could significantly increase the amount of capital needed to meet applicable standards. The timing of adoption, ultimate form and effect of any such proposed amendments cannot be predicted.
The community bank leverage ratio final rule was effective on January 1, 2020 and allows qualifying community banking organizations to calculate a leverage ratio to measure capital adequacy. Qualifying banking organizations that have less than $10 billion total assets, a leverage ratio of greater than 9%, and meet other criteria such as off-balance sheet exposures and trading assets limits. Banks opting into this framework are not required to calculate or report risk-based capital. We did not adopt this framework; therefore, capital ratios are calculated and reported as detailed above.
Refer to Note 21, Capital Adequacy, in the Notes to Consolidated Financial Statements in Item 8 of this Annual Report on Form 10-K for additional information related to our capital.
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ITEM 7. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS - (continued)
Contractual Obligations
Contractual obligations represent future cash commitments and liabilities under agreements with third parties and exclude contingent contractual liabilities for which we cannot reasonably predict future payments. The Company has various financial obligations, including contractual obligations and commitments that may require future cash payments. The following table presents as of December 31, 2021, significant fixed and determinable contractual obligations to third parties by payment date:
Payments Due In
Federal Home Loan Bank Borrowings (2) 7,000 — — — 7,000
(1)Excludes Interest
(2) The FHLB borrowing of $7.0 million was prepaid in January 2022 outside of its scheduled maturity.
Lease contracts are described in Note 8, Premises and Equipment, of the Consolidated Financial Statements included in Item 8 of this Annual Report on Form 10-K. Purchase obligations primarily represent obligations under agreement with a third-party data processing vendor and communications charges.
Off-Balance Sheet Arrangements
In the normal course of business, the Company offers our customers lines of credit and letters of credit to meet their financing objectives. The undrawn or unfunded portion of these facilities do not represent outstanding balances and therefore are not reflected in our financial statements as loans receivable. The Company provides lines of credit to our clients to memorialize the commitment to finance the completion of construction projects and revolving lines of credit to operating companies to finance their working capital needs. Lines of credit for construction projects represent $283.9 million, or 55.3% and $391.4 million, or 66.2% of the commitments to extend credit identified in the table below at December 31, 2021 and December 31, 2020, respectively. The Company provides letters of credit, generally, for the benefit or our customers to provide assurance to various municipalities that construction projects will be completed according to approved plans and specifications. These instruments involve elements of credit and interest rate risk and our exposure to credit loss, in the event the customer does not satisfy the terms of the agreement, could be equal to the contractual amount of the obligation less the value of any collateral. The Company analyzes this risk and calculates a reserve for unfunded commitments. The same credit policies are applied in granting these facilities as those used for underwriting loans. Lines of credit to finance construction projects include a construction end date, at which time the loan is expected to convert to a mini-perm loan. A department independent of our lending group monitors construction commitments of $1.0 million or more. Lines of credit to operating companies to finance working capital include a maturity date and may include various financial covenants. Letters of credit include an expiration date unless it is a standby letter of credit which automatically renews but generally provide for a termination clause on an annual basis given sufficient notice to the beneficiary. The Company typically charges an annual fee for the issuance of letters of credit. Because letters of credit are expected to expire without being drawn upon, these commitments do not necessarily represent future cash requirements of the Company.
The following table sets forth the commitments and letters of credit as of December 31:
Estimates of the fair value of these off-balance sheet items were not made because of the short-term nature of these arrangements and the credit standing of the counterparties.
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CARTER BANKSHARES, INC. AND SUBSIDIARIES
ITEM 7. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS - (continued)
Liquidity
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.
Our 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% 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 $743.8 million of unpledged available-for-sale investment securities as an additional source of liquidity.
An important component of our ability to effectively respond to potential liquidity stress events is maintaining a cushion of highly liquid assets. Highly liquid assets are those that can be converted to cash quickly, with little or no loss in value, to meet financial obligations. ALCO policy guidelines define a ratio of highly liquid assets to total assets by graduated risk tolerance levels of minimal, moderate and high. At December 31, 2021, the Bank had $985.1 million in highly liquid assets, which consisted of $64.9 million in interest-bearing deposits in other financial institutions, $176.2 million in FRB Excess Reserves, $743.8 million in unpledged securities and $0.2 million in mortgage loans held-for-sale. This resulted in highly liquid assets to total assets ratio of 23.8% at December 31, 2021.
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 December 31:
Interest Bearing Deposits in Other Financial Institutions 64,905 39,954
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ITEM 7. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS - (continued)
Inflation
Management is aware of the significant effect inflation has on interest rates and can have on financial performance. The Company’s ability to cope with this is best determined by analyzing its capability to respond to changing interest rates and its ability to manage noninterest income and expense. The mix of interest-rate sensitive assets and liabilities is monitored through ALCO in order to reduce the impact of inflation on net interest income. The effects of inflation are controlled by reviewing the prices of our products and services, by introducing new products and services and by controlling overhead expenses. Unlike most industrial companies, virtually all the assets and liabilities of a financial institution are monetary in nature. As a result, interest rates have a more significant impact on a financial institution’s performance than the effects of general levels of inflation.
Stock Repurchase Plan
On December 13, 2021, the Company authorized, effective December 10, 2021, a common stock repurchase program to purchase up to two million shares of the Company’s common stock in the aggregate over a period of twelve months. As of December 31, 2021, 30,407 shares of common stock had been repurchased under this program at an average price of $15.22 per share.
The specific timing, price and quantity of repurchases will be at our discretion and will depend on a variety of factors, including general market conditions, the trading price of common stock, legal and contractual requirements, applicable securities laws and the Company’s financial performance. The repurchase plan does not obligate us to repurchase any particular number of shares.
The Stock Repurchase Plan is also described in Item 5, Market for the Registrant’s Common Equity, Related Stockholder Matters, and Issuer Purchases of Equity Securities, of this Annual Report on Form 10-K.
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ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
Market Risk
Market risk is defined as the degree to which changes in interest rates, foreign exchange rates, commodity prices, or equity prices can adversely affect a financial institution’s earnings or capital. For financial institutions, market risk primarily reflects exposures to changes in interest rates. Interest rate fluctuations affect earnings by changing net interest income and other interest-sensitive income and expense levels. Interest rate changes affect capital by changing the net present value of a financial institution’s future cash flows, and the cash flows themselves, as rates change. Accepting this risk is a normal part of banking and can be an important source of profitability and enhancement of shareholder value. However, excessive interest rate risk can threaten a financial institution’s earnings, capital, liquidity, and solvency. Our sensitivity to changes in interest rate movements is continually monitored by the ALCO.
The ALCO utilizes an asset liability model (“ALM”) to monitor and manage market risk through net interest income simulation for various rate shock scenarios and economic value of equity (“EVE”), simulation for various rate shock scenarios. The rate shock scenarios used in the ALM span over multiple time horizons and yield curve shapes and include parallel and non-parallel shifts to ensure the ALCO can mitigate future earnings and market value fluctuations due to changes in market interest rates.
Within the context of the ALM, net interest income rate shock simulations explicitly measure the exposure to earnings from changes in market rates of interest over a defined time horizon. These robust simulations include assumptions of how the balance sheet will react in different rate environments including loan prepayment speeds, the average life of non-maturing deposits, and how sensitive each interest-earning asset and interest-bearing liability is to changes in the market rates (betas). Under simulation analysis, our current financial position is combined with assumptions regarding future business to calculate net interest income under various hypothetical rate scenarios. Reviewing these various measures provides us with a more comprehensive view of our interest rate risk profile.
Net interest income rate shock simulation results are compared to a base case to provide an estimate of the impact that market rate changes may have on 12 months and 24 months of pretax net interest income. The base case and rate shock analyses are performed on a static and growth balance sheet. A static balance sheet is a no-growth balance sheet in which all maturing and/or repricing cash flows are reinvested in the same product at the existing product spread. Rate shock analyses assume an immediate parallel shift in market interest rates and also include management assumptions regarding the impact of interest rate changes on non-maturity deposit products (noninterest-bearing demand, interest-bearing demand, money market, and savings) and changes in the prepayment behavior of loans and securities with optionality. Our policy guidelines limit the change in pretax net interest income over a 12-month horizon using rate shocks of +/- 100, 200, 300, and 400 basis points. We have temporarily suspended the -200, -300, and -400 basis point rate shock analyses. Due to the low interest rate environment, we believe the impact to net interest income when evaluating the -200, -300, and -400 basis point rate shock scenarios do not provide meaningful insight into our interest rate risk position.