Note 3. Loans and Allowance for Loan Losses

For financial reporting purposes, Pinnacle Financial classifies its loan portfolio based on the underlying collateral utilized to secure each loan. This classification is consistent with those utilized in the Quarterly Report of Condition and Income filed with the Federal Deposit Insurance Corporation (FDIC).

Commercial loans receive risk ratings by the assigned financial advisor subject to validation by Pinnacle Financial's independent loan review department. Risk ratings are categorized as pass, special mention, substandard, substandard-nonaccrual or doubtful-nonaccrual. Pinnacle Financial believes that its categories follow those used by Pinnacle Bank's primary regulators. At March 31, 2014, approximately 74% of our loan portfolio was analyzed as a commercial loan type with a specifically assigned risk rating in the allowance for loan loss assessment. Consumer loans and small business loans are generally not assigned an individual risk rating but are evaluated as either accrual or nonaccrual based on the performance of the individual loans. However, certain consumer real estate-mortgage loans and certain consumer and other loans receive a specific risk rating due to the loan proceeds being used for commercial purposes even though the collateral may be of a consumer loan nature.

Risk ratings are subject to continual review by the loan officer. At least annually, our credit procedures require that every risk rated loan of $250,000 or more be subject to a formal credit risk review process. Each loan's risk rating is also subject to review by our independent loan review department, which reviews a substantial portion of our risk rated portfolio annually. Included in the coverage are independent loan reviews of loans in targeted higher-risk portfolio segments.

The following table presents our loan balances by primary loan classification and the amount within each risk rating category. Pass rated loans include all credits other than those included in special mention, substandard, substandard-nonaccrual and doubtful-nonaccrual which are defined as follows:

	Special mention loans have potential weaknesses that deserve management's close attention. If left uncorrected, these potential weaknesses may result in deterioration of the repayment prospects for the asset or in Pinnacle Financial's credit position at some future date.



Substandard loans are inadequately protected by the current sound worth and paying capacity of the obligor or of the collateral pledged, if any. Assets so classified must have a well-defined weakness or weaknesses that jeopardize collection of the debt. Substandard loans are characterized by the distinct possibility that Pinnacle Financial will sustain some loss if the deficiencies are not corrected.

	Substandard-nonaccrual loans are substandard loans that have been placed on nonaccrual status.

	Doubtful-nonaccrual loans have all the characteristics of substandard-nonaccrual loans with the added characteristic that the weaknesses make collection or liquidation in full, on the basis of currently existing facts, conditions and values, highly questionable and improbable.

The following table outlines the amount of each loan classification categorized into each risk rating category as of March 31, 2014 and December 31, 2013 (in thousands):

	Commercial real estate - mortgage		Consumer real estate - mortgage		Construction and land development		Commercial and industrial		Consumer and other		Total
March 31, 2014
Accruing loans
Pass	$	1,410,425	$	676,486	$	252,406	$	1,515,110	$	158,088	$	4,012,515
Special Mention		7,997		3,557		30,083		12,814		149		54,600
Substandard ⁽¹⁾		22,726		13,900		10,465		36,614		154		83,859
Total		1,441,148		693,943		292,954		1,564,538		158,391		4,150,974
Impaired loans
Nonaccrual loans
Substandard-nonaccrual		7,145		5,679		990		1,538		254		15,606
Doubtful-nonaccrual		-		-		-		-		-		-
Total nonaccrual loans		7,145		5,679		990		1,538		254		15,606
Troubled debt restructurings⁽²⁾
Pass		143		1,657		111		277		286		2,474
Special Mention		7,736		2,313		-		2,584		-		12,633
Substandard		-		-		-		-		-		-
Total troubled debt restructurings		7,879		3,970		111		2,861		286		15,107
Total impaired loans		15,024		9,649		1,101		4,399		540		30,713
Total loans	$	1,456,172	$	703,592	$	294,055	$	1,568,937	$	158,931	$	4,181,687

	Commercial real estate - mortgage		Consumer real estate - mortgage		Construction and land development		Commercial and industrial		Consumer and other		Total
December 31, 2013
Accruing loans
Pass	$	1,332,387	$	670,412	$	275,876	$	1,557,923	$	143,032	$	3,979,630
Special Mention		8,282		1,824		31,835		20,065		-		62,006
Substandard ⁽¹⁾		20,296		14,107		7,297		23,174		154		65,028
Total		1,360,965		686,343		315,008		1,601,162		143,186		4,106,664
Impaired loans
Nonaccrual loans
Substandard-nonaccrual		9,017		5,289		1,070		2,565		242		18,183
Doubtful-nonaccrual		-		-		-		-		-		-
Total nonaccrual loans		9,017		5,289		1,070		2,565		242		18,183
Troubled debt restructurings⁽²⁾
Pass		2,564		1,666		113		320		276		4,939
Special Mention		-		-		-		-		-		-
Substandard		10,889		2,318		-		1,500		-		14,707
Total troubled debt restructurings		13,453		3,984		113		1,820		276		19,646
Total impaired loans		22,470		9,273		1,183		4,385		518		37,829
Total loans	$	1,383,435	$	695,616	$	316,191	$	1,605,547	$	143,704	$	4,144,493

(1)

Potential problem loans represent those loans with a well-defined weakness and where information about possible credit problems of borrowers has caused management to have doubts about the borrower's ability to comply with present repayment terms. This definition is believed to be substantially consistent with the standards established by Pinnacle Bank's primary regulators for loans classified as substandard, excluding the impact of substandard nonaccrual loans and substandard troubled debt restructurings. Potential problem loans, which are not included in nonaccrual loans, amounted to approximately $83.9 million at March 31, 2014, compared to $65.0 million at December 31, 2013.

(2)	Troubled debt restructurings are presented as an impaired loan; however, they continue to accrue interest at contractual rates.

At March 31, 2014 and December 31, 2013, all loans classified as nonaccrual were deemed to be impaired. The principal balances of these nonaccrual loans amounted to $15.6 million and $18.2 million at March 31, 2014 and December 31, 2013, respectively, and are included in the tables above. For the three months ended March 31, 2014, the average balance of nonaccrual loans was $16.1 million as compared to $21.5 million for the twelve months ended December 31, 2013. At the date such loans were placed on nonaccrual status, Pinnacle Financial reversed all previously accrued interest income against current year earnings. Had these nonaccrual loans been on accruing status, interest income would have been higher by $283,000 for the three months ended March 31, 2014 and by $292,000 for the three months ended March 31, 2013.

The following table details the recorded investment, unpaid principal balance and related allowance and average recorded investment of our nonaccrual loans at March 31, 2014 and December 31, 2013 by loan classification and the amount of interest income recognized on a cash basis throughout the fiscal year-to-date period then ended, respectively, on these loans that remain on the balance sheets (in thousands):

	At March 31, 2014						Three Months Ended March 31, 2014
	Recorded investment		Unpaid principal balance		Related allowance⁽¹⁾		Average recorded investment		Interest income recognized
Collateral dependent nonaccrual loans:
Commercial real estate – mortgage	$	5,192	$	5,712	$	-	$	5,225	$	-
Consumer real estate – mortgage		2,413		2,476		-		2,427		-
Construction and land development		545		545		-		545		-
Commercial and industrial		1,060		1,168		-		1,074		-
Consumer and other		-		-		-		-		-
Total	$	9,210	$	9,901	$	-	$	9,271	$	-

Cash flow dependent nonaccrual loans:
Commercial real estate – mortgage	$	1,953	$	2,152	$	161	$	1,964	$	-
Consumer real estate – mortgage		3,266		3,514		875		3,289		-
Construction and land development		445		516		14		450		-
Commercial and industrial		478		658		162		879		-
Consumer and other		254		270		86		260		-
Total	$	6,396	$	7,110	$	1,298	$	6,842	$	-
Total nonaccrual loans	$	15,606	$	17,011	$	1,298	$	16,113	$	-

	At December 31, 2013:						For the year ended December 31, 2013
	Recorded investment		Unpaid principal balance		Related allowance⁽¹⁾		Average recorded investment		Interest income recognized
Collateral dependent nonaccrual loans:
Commercial real estate – mortgage	$	7,035	$	7,481	$	-	$	6,522	$	-
Consumer real estate – mortgage		2,162		2,209		-		2,234		-
Construction and land development		545		545		-		938		-
Commercial and industrial		1,828		1,901		-		3,911		-
Consumer and other		-		-		-		-		-
Total	$	11,570	$	12,136	$	-	$	13,605	$	-

Cash flow dependent nonaccrual loans:
Commercial real estate – mortgage	$	1,982	$	2,166	$	142	$	2,448	$	-
Consumer real estate – mortgage		3,127		3,334		722		3,405		-
Construction and land development		525		609		33		568		-
Commercial and industrial		737		1,029		218		1,216		-
Consumer and other		242		252		72		242		-
Total	$	6,613	$	7,390	$	1,187	$	7,879	$	-
Total nonaccrual loans	$	18,183	$	19,526	$	1,187	$	21,484	$	-

(1)	Collateral dependent loans are typically charged-off to their net realizable value pursuant to requirements of our primary regulators and no specific allowance is carried related to those loans.

Pinnacle Financial's policy is that once a loan is placed on nonaccrual status each subsequent payment is reviewed on a case-by-case basis to determine if the payment should be applied to interest or principal pursuant to regulatory guidelines. Pinnacle Financial recognized no interest income from cash payments received on nonaccrual loans during the three months ended March 31, 2014 or during the year ended December 31, 2013.

Impaired loans also include loans that Pinnacle Bank has elected to formally restructure when, due to the weakening credit status of a borrower, the restructuring may facilitate a repayment plan that seeks to minimize the potential losses that Pinnacle Bank may otherwise incur. If on nonaccrual status as of the date of restructuring, the loans are included in nonaccrual loans. Loans that have been restructured that were performing as of the restructure date and continue to perform in accordance with the restructured terms are reported separately as troubled debt restructurings.

At March 31, 2014 and December 31, 2013, there were $15.1 million and $19.6 million, respectively, of troubled debt restructurings that were performing as of their restructure date and which were accruing interest. These troubled debt restructurings are considered impaired loans pursuant to U.S. GAAP. Troubled commercial loans are restructured by specialists within our Special Assets Group, and all restructurings are approved by committees and credit officers separate and apart from the normal loan approval process. These specialists are charged with reducing Pinnacle Financial's overall risk and exposure to loss in the event of a restructuring by obtaining some or all of the following: improved documentation, additional guaranties, increase in curtailments, reduction in collateral release terms, additional collateral or other similar strategies.

The following table outlines the amount of each troubled debt restructuring categorized by loan classification made during the three months ended March 31, 2014 and 2013 (dollars in thousands):

	Three months ended March 31, 2014						Three months ended March 31, 2013
	Number of contracts		Pre Modification Outstanding Recorded Investment		Post Modification Outstanding Recorded Investment, net of related allowance		Number of contracts		Pre Modification Outstanding Recorded Investment		Post Modification Outstanding Recorded Investment, net of related allowance
Commercial real estate – mortgage		-	$	-	$	-		-	$	-	$	-
Consumer real estate – mortgage		-		-		-		1		432		359
Construction and land development		-		-		-		-		-		-
Commercial and industrial		6		2,584		565		-		-		-
Consumer and other		-		-		-		1		200		170
		6	$	2,584	$	565		2	$	632	$	529

During the three months ended March 31, 2014, Pinnacle Financial did not have any troubled debt restructurings that subsequently defaulted within twelve months of the restructuring. During the three months ended March 31, 2013, two consumer real estate loans totaling $1.0 million which were previously classified as a troubled debt restructuring subsequently defaulted, within twelve months of the restructuring. A default of a troubled debt restructuring is defined as an occurrence which violates the terms of the receivable's contract.

Pinnacle Financial analyzes its commercial loan portfolio to determine if a concentration of credit risk exists to any industry. Pinnacle Financial utilizes broadly accepted industry classification systems in order to classify borrowers into various industry classifications. Pinnacle Financial has a credit exposure (loans outstanding plus unfunded lines of credit) exceeding 25 % of Pinnacle Bank's total risk-based capital to borrowers in the following industries at March 31, 2014 with the comparative exposures for December 31, 2013 (in thousands):

	At March 31, 2014:
	Outstanding Principal Balances			Unfunded Commitments			Total exposure			Total Exposure at December 31, 2013

Lessors of nonresidential buildings		$	501,891		$	53,584		$	555,475		$	515,240
Lessors of residential buildings			240,296			27,544			267,840			270,773

The table below presents past due balances at March 31, 2014 and December 31, 2013, by loan classification and segment allocated between accruing and nonaccrual status (in thousands):

March 31, 2014	30-89 days past due and accruing		90 days or more past due and accruing			Total past due and accruing		Nonaccrual⁽¹⁾		Current and accruing		Total Loans
Commercial real estate:
Owner-occupied	$	125	$	-		$	125	$	6,906	$	694,296	$	701,327
All other		844		7,736	⁽²⁾		8,580		239		746,026		754,845
Consumer real estate – mortgage		5,239		-			5,239		5,679		692,674		703,592
Construction and land development		849		147			996		990		292,069		294,055
Commercial and industrial		1,191		52			1,243		1,538		1,566,156		1,568,937
Consumer and other		2,096		8			2,104		254		156,573		158,931
	$	10,344	$	7,943		$	18,287	$	15,606	$	4,147,794	$	4,181,687

December 31, 2013	30-89 days past due and accruing		90 days or more past due and accruing		Total past due and accruing		Nonaccrual⁽¹⁾		Current and accruing		Total Loans
Commercial real estate:
Owner-occupied	$	2,534	$	-	$	2,534	$	7,750	$	669,014	$	679,298
All other		27		2,232		2,259		1,267		700,611		704,137
Consumer real estate – mortgage		2,215		-		2,215		5,289		688,112		695,616
Construction and land development		4,839		-		4,839		1,070		310,282		316,191
Commercial and industrial		1,847		825		2,672		2,565		1,600,310		1,605,547
Consumer and other		1,488		289		1,777		242		141,685		143,704
	$	12,950	$	3,346	$	16,296	$	18,183	$	4,110,014	$	4,144,493

(1) Approximately $10.9 million of nonaccrual loans as of March 31, 2014 and December 31, 2013, respectively, were currently performing pursuant to their contractual terms.

(2) Represents one commercial real estate loan which, subsequent to March 31, 2014, was brought current with a principal curtailment of $7.6 million.

The following table shows the allowance allocation by loan classification and accrual status at March 31, 2014 and December 31, 2013 (in thousands):

					Impaired Loans
	Accruing Loans				Nonaccrual Loans				Troubled Debt Restructurings⁽¹⁾				Total Allowance for Loan Losses
	March 31, 2014		December 31, 2013		March 31, 2014		December 31, 2013		March 31, 2014		December 31, 2013		March 31, 2014		December 31, 2013
Commercial real estate –mortgage	$	19,636	$	19,298	$	161	$	142	$	753	$	1,932	$	20,550	$	21,372
Consumer real estate – mortgage		6,426		7,090		875		722		521		543		7,822		8,355
Construction and land development		6,737		7,186		14		33		14		16		6,765		7,235
Commercial and industrial		25,951		24,660		162		218		597		256		26,710		25,134
Consumer and other		1,764		1,521		86		72		36		39		1,886		1,632
Unallocated		-		-		-		-		-		-		3,791		4,242
	$	60,514	$	59,755	$	1,298	$	1,187	$	1,921	$	2,786	$	67,524	$	67,970

(1)	Troubled debt restructurings of $15.1 million and $19.6 million as of March 31, 2014 and December 31, 2013, respectively, are classified as impaired loans pursuant to U.S. GAAP; however, these loans continue to accrue interest at contractual rates.

The following table details the changes in the allowance for loan losses from December 31, 2012 to December 31, 2013 to March 31, 2014 by loan classification and the allocation of the allowance for loan losses (in thousands):

	Commercial real estate – mortgage			Consumer real estate – mortgage			Construction and land development			Commercial and industrial			Consumer and other			Unallocated			Total
Allowance for Loan Losses:
Balance at December 31, 2012	$	19,634		$	8,762		$	9,164		$	24,738		$	1,094		$	6,025		$	69,417
Charged-off loans		(4,123	)		(2,250	)		(1,351	)		(8,159	)		(1,369	)		-			(17,252	)
Recovery of previously charged-off loans		500			1,209			1,464			4,531			244			-			7,948
Provision for loan losses		5,361			634			(2,042	)		4,024			1,663			(1,783	)		7,857
Balance at December 31, 2013	$	21,372		$	8,355		$	7,235		$	25,134		$	1,632		$	4,242		$	67,970

Collectively evaluated for impairment	$	19,298		$	7,090		$	7,186		$	24,660		$	1,521					$	59,755
Individually evaluated for impairment		2,074			1,265			49			474			111						3,973
Loans acquired with deteriorated credit quality		-			-			-			-			-						-
Balance at December 31, 2013	$	21,372		$	8,355		$	7,235		$	25,134		$	1,632					$	67,970

Loans:
Collectively evaluated for impairment	$	1,360,965		$	686,343		$	315,008		$	1,601,162		$	143,186					$	4,106,664
Individually evaluated for impairment		22,470			9,273			1,183			4,385			518						37,829
Loans acquired with deteriorated credit quality		-			-			-			-			-						-
Balance at December 31, 2013	$	1,383,435		$	695,616		$	316,191		$	1,605,547		$	143,704					$	4,144

	Commercial real estate - mortgage			Consumer real estate - mortgage			Construction and land development			Commercial and industrial			Consumer and other			Unallocated			Total
Allowance for Loan Losses:
Balance at December 31, 2013	$	21,372		$	8,355		$	7,235		$	25,134		$	1,632		$	4,242		$	67,970
Charged-off loans		(123	)		(334	)		(7	)		(824	)		(214	)		-			(1,502	)
Recovery of previously charged-off loans		1			72			31			398			66			-			568
Provision for loan losses		(700	)		(271	)		(494	)		2,002			402			(451	)		488
Balance at March 31, 2014	$	20,550		$	7,822		$	6,765		$	26,710		$	1,886		$	3,791		$	67,524

Collectively evaluated for impairment	$	19,636		$	6,426		$	6,737		$	25,951		$	1,764					$	60,514
Individually evaluated for impairment		914		$	1,396			28			759			122						7,010
Loans acquired with deteriorated credit quality		-		$	-			-			-			-						-
Balance at March 31, 2014	$	20,550		$	7,822		$	6,765		$	26,710		$	1,886					$	67,524

Loans:
Collectively evaluated for impairment	$	1,441,148		$	693,943		$	292,954		$	1,564,538		$	158,391					$	4,150,974
Individually evaluated for impairment	$	15,024		$	9,649		$	1,101		$	4,399		$	540					$	30,713
Loans acquired with deteriorated credit quality	$	-		$	-		$	-		$	-		$	-					$	-
Balance at March 31, 2014	$	1,456,172		$	703,592		$	294,055		$	1,568,937		$	158,931					$	4,182

The adequacy of the allowance for loan losses is assessed at the end of each calendar quarter. The level of the allowance is based upon evaluation of the loan portfolio, current asset quality trends, known and inherent risks in the portfolio, adverse situations that may affect the borrowers' ability to repay (including the timing of future payment), the estimated value of any underlying collateral, composition of the loan portfolio, economic conditions, historical loss experience, industry and peer bank loan quality indications and other pertinent factors, including regulatory recommendations.

At March 31, 2014, Pinnacle Financial had granted loans and other extensions of credit amounting to approximately $10.2 million to current directors, executive officers, and their related entities, of which $7.7 million had been drawn upon. At December 31, 2013, Pinnacle Financial had granted loans and other extensions of credit amounting to approximately $11.2 million to directors, executive officers, and their related entities, of which approximately $8.9 million had been drawn upon. These loans and extensions of credit were made in the ordinary course of business on substantially the same terms, including interest rates and collateral, as those prevailing at the time for comparable loans to persons not related to Pinnacle Bank and did not involve more that the normal risk of collectability or present other unfavorable features. None of these loans to directors, executive officers, and their related entities were impaired at March 31, 2014 or December 31, 2013.

Residential Lending

At March 31, 2014, Pinnacle Financial had approximately $14.0 million of mortgage loans held-for-sale compared to approximately $12.9 million at December 31, 2013. During the first quarter of 2014, Pinnacle Financial began delivering loans on a mandatory basis to its approved investors. Mandatory delivery exposes Pinnacle to interest rate risk between the initial rate-lock and the ultimate sale of the loan to a third-party. Pinnacle Financial sells loans to third-party investors and has not entered into any forward commitments with investors for future bulk loan sales. All of these loan sales transfer servicing rights to the buyer. During the three months ended March 31, 2014, Pinnacle Financial recognized $952,200 in gains on the sale of these loans, net of commissions paid, compared to $1.8 million during the three months ended March 31, 2013.

These mortgage loans held-for-sale are originated internally and are primarily to borrowers in Pinnacle Bank's geographic markets. These sales are typically on a mandatory basis to investors that follow conventional government sponsored entities (GSE) and the Department of Housing and Urban Development/U.S. Department of Veterans Affairs (HUD/VA) guidelines.

Each purchaser has specific guidelines and criteria for sellers of loans, and the risk of credit loss with regard to the principal amount of the loans sold is generally transferred to the purchasers upon sale. While the loans are sold without recourse, the purchase agreements require Pinnacle Bank to make certain representations and warranties regarding the existence and sufficiency of file documentation and the absence of fraud by borrowers or other third parties such as appraisers in connection with obtaining the loan. If it is determined that the loans sold were in breach of these representations or warranties, Pinnacle Bank has obligations to either repurchase the loan for the unpaid principal balance and related investor fees or make the purchaser whole for the economic benefits of the loan. To date, repurchase activity pursuant to the terms of these representations and warranties has been insignificant to Pinnacle Bank.