Executive Summary / Key Takeaways

• Carter Bankshares ($CARE) is executing a strategic shift from balance sheet restructuring to prudent growth, focusing on organic expansion and opportunistic acquisitions like the pending First Reliance Bank branch purchase to enhance its market position in Virginia and North Carolina.
• First quarter 2025 results showed significant improvement, with net income increasing to $9.0 million (EPS $0.39) from $5.8 million (EPS $0.25) in Q1 2024, driven by higher net interest income and a substantial recovery provision for credit losses.
• A key challenge remains the resolution of a large, legacy nonaccrual credit relationship ($245.1 million balance at March 31, 2025), which continues to impact profitability and requires significant management focus, though curtailment payments and reserve adjustments reflect ongoing resolution efforts.
• The company's balance sheet exhibits a slight liability sensitivity, positioning it favorably for potential net interest income expansion in a declining interest rate environment, supported by a diversified deposit base and ample liquidity.
• While facing competitive pressures from larger, more technologically advanced regional banks and fintechs, CARE leverages its community-focused model and specific product offerings, but must continue investing in operational efficiency and digital capabilities to sustain long-term growth and profitability against rivals with stronger margins and faster processing times.

A Community Bank's Evolution: From Legacy Headwinds to Strategic Horizon

Carter Bankshares, Inc. ($CARE) operates as the holding company for Carter Bank & Trust, a state-chartered community bank deeply rooted in Virginia and North Carolina, serving its markets through a network of 65 branches. The bank's history reflects periods of growth, including past acquisitions, but also the lingering impact of legacy underwriting standards that, prior to significant enhancements in 2018, exposed the portfolio to vulnerabilities during real estate cycles. Management has since implemented stringent "underwriting guardrails" focusing on borrower cash flow, repayment capacity, and transaction limits to mitigate future credit risks.

The company is currently undergoing a strategic transformation, shifting its focus from balance sheet restructuring, necessitated by past challenges, towards a strategy of prudent growth. This involves enhancing its brand image, introducing new products, and aligning operations to support expansion, primarily organic but also through targeted acquisitions. A recent example of this strategic pivot is the announced purchase of two First Reliance Bank branches and associated deposits in Mooresville and Winston-Salem, North Carolina, expected to close in the second quarter of 2025, marking CARE's entry into the Winston-Salem market.

In the competitive landscape of the Southeastern U.S. banking market, CARE operates alongside larger regional players like Truist Financial Corporation (TFC), First Citizens BancShares, Inc. (FCNCA), Regions Financial Corporation (RF), and PNC Financial Services Group, Inc. (PNC), as well as facing pressure from online banks and fintechs. While these larger rivals often boast greater scale, broader product suites, and more advanced digital platforms, CARE carves out its niche through a community-focused approach and specific product differentiators like "Home of Lifetime Free Checking." However, the competitive analysis indicates that CARE generally lags its larger peers in key financial metrics such as Return on Equity (ROE) and operating margins, and faces higher operational costs per transaction or per branch compared to more automated competitors. Indirect competitors, particularly digital-only banks, pose a threat by offering lower-cost alternatives, potentially eroding CARE's deposit market share, while fintechs challenge traditional loan processing speeds. CARE's strategic response involves leveraging its local market knowledge and customer relationships while acknowledging the need to improve operational efficiency and digital capabilities to remain competitive.

The company's operational effectiveness is supported by its core banking systems and risk management tools. While the company does not appear to detail proprietary technological differentiators in the same vein as a manufacturing or software company, CARE utilizes standard banking technology for its operations, including an Asset Liability Model (ALM) for interest rate risk management and internal systems for loan underwriting and monitoring. The competitive analysis suggests that larger rivals like TFC and PNC benefit from more advanced digital tools and automation, leading to faster processing times and lower operating costs. CARE's recent investments in new software licenses and data processing upgrades, as noted in the increase in occupancy and data processing expenses, indicate ongoing efforts to enhance its operational infrastructure, though specific quantifiable benefits or performance targets for these initiatives are not detailed. The strategic brand refresh also implies underlying technological efforts to improve customer experience and digital interaction, aiming to counter the technological edge of competitors. The "so what" for investors is that while CARE's technology is foundational to its operations and risk management, it currently appears to be a competitive necessity rather than a significant differentiator, requiring continued investment to keep pace with industry advancements and competitor capabilities, which could impact future operating expenses and efficiency ratios.

Financial Performance Reflecting Transition and Legacy Impact

Carter Bankshares' financial performance in the first quarter of 2025 demonstrates progress in its strategic evolution, albeit still influenced by the resolution of legacy issues. Net income for the three months ended March 31, 2025, rose significantly to $9.0 million, or $0.39 diluted earnings per share, compared to $5.8 million, or $0.25 diluted earnings per share, for the same period in 2024. This improvement was primarily driven by growth in net interest income and a favorable swing in the provision for credit losses.

Net interest income increased by $1.7 million, or 6.0%, to $30.1 million in Q1 2025, up from $28.4 million in Q1 2024. On a fully taxable equivalent (FTE) basis, net interest income also saw a comparable increase. The net interest margin expanded by 10 basis points to 2.68% (2.70% FTE), benefiting from a seven-basis-point increase in the yield on average earning assets and a seven-basis-point decline in funding costs. The yield on average loans increased by 16 basis points to 5.38%, contributing significantly to the higher asset yield. Average interest-earning assets grew by $125.1 million, primarily due to a $141.5 million increase in average loans, funded partly by a decrease in average investment securities as proceeds from maturities and curtailments were strategically deployed into higher-yielding loans. Interest expense saw a modest increase of $0.2 million, or 0.9%, to $25.9 million, as growth in higher-cost interest-bearing demand and money market accounts, and CDs, offset a decrease in lower-cost savings and noninterest-bearing deposits due to customer migration towards higher yields. The balance sheet is characterized as slightly liability sensitive, suggesting potential for net interest income expansion if interest rates decline.

A notable factor impacting the bottom line was the recovery provision for credit losses, which decreased by $2.0 million, resulting in a recovery of $2.0 million in Q1 2025 compared to a minimal provision in Q1 2024. This significant change was largely attributable to a lower reserve rate applied to the company's largest credit relationship in the "Other" loan segment and $6.9 million in curtailment payments received from this relationship during the quarter, which reduced its outstanding balance. Net loan charge-offs were $0.1 million in Q1 2025, down from $0.5 million in Q1 2024, representing 0.01% and 0.06% of average portfolio loans, respectively.

Total noninterest income increased substantially by $1.9 million, or 36.8%, to $6.9 million in Q1 2025, primarily driven by a $1.9 million gain from a Bank Owned Life Insurance (BOLI) death benefit and higher market values on a community development fund investment. Total noninterest expense increased by $1.8 million, or 6.8%, to $28.0 million, reflecting increases in occupancy, advertising (related to the brand refresh), and data processing expenses, partially offset by decreases in salaries and employee benefits, professional and legal fees (lower costs related to the large nonperforming loan), and FDIC insurance expense (due to the reduced assessment base). The provision for income taxes increased to $2.2 million from $1.4 million, corresponding to the higher pre-tax income, with the effective tax rate remaining relatively stable around 19.6%.

Comparing CARE's financial performance to its larger peers highlights areas for improvement. While CARE's Net Profit Margin (14.57% TTM) is within a reasonable range, its Operating Profit Margin (13.51% TTM) suggests higher operational costs relative to revenue compared to competitors like FCNCA (30-35% operating margin) and PNC (30-35% operating margin).

The competitive analysis also points to stronger ROE and revenue growth rates for these larger institutions. This underscores the importance of CARE's strategic focus on improving efficiency and growing its loan and deposit base to enhance profitability and better compete with more scaled and efficient rivals.

Addressing Challenges and Charting the Future

The most significant challenge confronting CARE remains the resolution of the large credit relationship with the Justice Entities. This relationship, with an aggregate principal balance of $245.1 million at March 31, 2025, constitutes the vast majority (93.7%) of the company's nonperforming loans. While the company believes it is well secured and has established specific reserves of $27.1 million (11.0% of the balance) based on discounted cash flow analysis and collateral valuations, the timing and amount of future collections remain uncertain, and the situation is subject to potential claims from other creditors. The ongoing curtailment payments ($6.9 million in Q1 2025) are a positive step in reducing the exposure, and the decrease in the specific reserve rate reflects updated analysis, but this remains a critical area of focus for management and a key risk for investors. The increase in nonperforming loans during Q1 2025, primarily due to a $9.5 million CRE relationship moving to nonaccrual status, further highlights the ongoing importance of credit risk management, particularly within the CRE portfolio, which represents a significant concentration (52.0% of total portfolio loans).

CARE's balance sheet structure, characterized by a slight liability sensitivity, positions it to potentially benefit from declining interest rates, which could lead to an increase in net interest income as funding costs reprice faster than asset yields. The ALM earnings simulation supports this, projecting a more advantageous increase in net interest income in a declining rate environment compared to a rising one. The company's liquidity position appears sound, with ample cash, unpledged securities ($447.2 million), and significant borrowing capacity at the FHLB and through correspondent lines, providing flexibility to meet funding needs. The deposit base is diversified, with approximately 18.4% uninsured deposits, a figure management monitors closely, especially in light of broader industry concerns.

Strategically, CARE is focused on executing its prudent growth plan. This involves leveraging its community banking model to drive organic loan and deposit growth in its existing markets and integrating the acquired branches to expand its footprint and customer base. Efforts to increase noninterest income and control operating expenses are also central to improving profitability and efficiency, aiming to narrow the gap with more efficient competitors. The company's well-capitalized status provides a solid foundation to support this growth strategy and absorb potential future credit losses.

Key risks to the investment thesis include the successful resolution of the large nonaccrual loan, the potential impact of further interest rate fluctuations on net interest income and securities valuations, the ability to effectively compete with larger, more technologically advanced institutions and fintechs, and the execution risk associated with integrating the acquired branches and implementing the brand refresh strategy. Changes in economic conditions, particularly within CARE's operating footprint and the CRE market, could also impact asset quality and loan demand.

Conclusion

Carter Bankshares is navigating a pivotal period, marked by a strategic pivot towards prudent growth while actively managing the resolution of significant legacy credit challenges. The first quarter of 2025 demonstrated promising financial momentum, driven by improved net interest income and a favorable credit provision, signaling potential benefits from its balance sheet positioning in the current interest rate environment.

However, the overhang of the large nonaccrual loan and the need to enhance operational efficiency and digital capabilities to compete effectively with larger, more agile rivals remain critical factors. CARE's community-focused model and strategic initiatives to grow organically and through targeted acquisitions provide a pathway for future performance improvement. Investors should closely monitor the progress in resolving the nonperforming loan portfolio, the trajectory of net interest margin in response to interest rate changes, and the company's ability to execute its growth strategy and improve efficiency in a competitive banking landscape. The success of these efforts will ultimately determine the long-term value creation for CARE shareholders.