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 June 30, 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 $500,000 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 June 30, 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
June 30, 2014
Accruing loans
Pass	$	1,417,022	$	672,747	$	253,501	$	1,634,704	$	168,287	$	4,146,261
Special Mention		16,291		2,667		26,739		23,163		146		69,006
Substandard ⁽¹⁾		17,268		12,932		11,550		35,162		154		77,066
Total		1,450,581		688,346		291,790		1,693,029		168,587		4,292,333
Impaired loans
Nonaccrual loans
Substandard-nonaccrual		6,754		6,239		978		1,387		320		15,678
Doubtful-nonaccrual		-		-		-		-		-		-
Total nonaccrual loans		6,754		6,239		978		1,387		320		15,678
Troubled debt restructurings⁽²⁾
Pass		-		66		107		263		83		519
Special Mention		-		820		-		-		200		1,020
Substandard		-		3,057		-		2,955		-		6,012
Total troubled debt restructurings		-		3,943		107		3,218		283		7,551
Total impaired loans		6,754		10,182		1,085		4,605		603		23,229
Total loans	$	1,457,335	$	698,528	$	292,875	$	1,697,634	$	169,190	$	4,315,562

(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 nonaccrual loans and troubled debt restructurings. Potential problem loans, which are not included in nonaccrual loans, amounted to approximately $77.1 million at June 30, 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.

	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)

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

At June 30, 2014 and December 31, 2013, all loans classified as nonaccrual were deemed to be impaired. The principal balances of these nonaccrual loans amounted to $15.7 million and $18.2 million at June 30, 2014 and December 31, 2013, respectively, and are included in the tables above. For the six months ended June 30, 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 $416,000 for the six months ended June 30, 2014 and by $573,000 for the six months ended June 30, 2013.

The following table details the recorded investment, unpaid principal balance and related allowance and average recorded investment of our nonaccrual loans at June 30, 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 June 30, 2014						For the six months ended June 30, 2014
	Recorded investment		Unpaid principal balance		Related allowance⁽¹⁾		Average recorded investment		Interest income recognized
Collateral dependent nonaccrual loans:
Commercial real estate – mortgage	$	4,814	$	5,407	$	-	$	4,913	$	-
Consumer real estate – mortgage		2,336		2,416		-		2,366		-
Construction and land development		545		545		-		545		-
Commercial and industrial		1,018		1,161		-		1,053		-
Consumer and other		-		-		-		-		-
Total	$	8,713	$	9,529	$	-	$	8,877	$	-

Cash flow dependent nonaccrual loans:
Commercial real estate – mortgage	$	1,940	$	2,145	$	190	$	1,967	$	-
Consumer real estate – mortgage		3,903		4,185		1,089		4,045		-
Construction and land development		433		512		16		443		-
Commercial and industrial		369		375		145		469		-
Consumer and other		320		338		126		333		-
Total	$	6,965	$	7,555	$	1,566	$	7,257	$	-
Total nonaccrual loans	$	15,678	$	17,084	$	1,566	$	16,134	$	-

	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 and six months ended June 30, 2014 or during the year ended December 31, 2013.

Impaired loans also include loans that Pinnacle Bank has elected to formally restructure 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 June 30, 2014 and December 31, 2013, there were $7.6 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 and six months ended June 30, 2014 and 2013 (dollars in thousands):

	Three months ended June 30, 2014						Six months ended June 30, 2014
	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		-		-		-		-		-		-
Construction and land development		-		-		-		-		-		-
Commercial and industrial		1		75		59		7		2,955		2,099
Consumer and other		-		-		-		-		-		-
		1	$	75	$	59		7	$	2,955	$	2,099

	Three months ended June 30, 2013						Six months ended June 30, 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		428		355
Construction and land development		1		51		44		1		51		44
Commercial and industrial		1		1,500		1,290		1		1,500		1,290
Consumer and other		-		-		-		1		193		164
		2	$	1,551	$	1,334		4	$	2,172	$	1,853

During the three months ended June 30, 2014 and 2013, Pinnacle Financial did not have any troubled debt restructurings that subsequently defaulted within twelve months of the restructuring. During the six months ended June 30, 2014, Pinnacle Financial did not have any troubled debt restructurings that subsequently defaulted within twelve months of the restructuring. During the six months ended June 30, 2013, two consumer real estate loans totaling $1.0 million which were previously classified as a troubled debt restructuring subsequently defaulted due to their lack of performance, 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 restructured 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 June 30, 2014 with the comparative exposures for December 31, 2013 (in thousands):

	At June 30, 2014:
	Outstanding Principal Balances			Unfunded Commitments			Total exposure			Total Exposure at December 31, 2013

Lessors of nonresidential buildings		$	477,902		$	73,210		$	551,112		$	515,240
Lessors of residential buildings			245,782			33,609			279,391			270,773

The table below presents past due balances at June 30, 2014 and December 31, 2013, by loan classification and segment allocated between accruing and nonaccrual status (in thousands):

June 30, 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	$	914	$	280	$	1,194	$	6,754	$	694,903	$	702,851
All other		21		-		21		-		754,463		754,484
Consumer real estate – mortgage		5,402		-		5,402		6,239		686,887		698,528
Construction and land development		5,083		-		5,083		978		286,814		292,875
Commercial and industrial		3,581		51		3,632		1,387		1,692,615		1,697,634
Consumer and other		3,561		318		3,879		320		164,991		169,190
	$	18,562	$	649	$	19,211	$	15,678	$	4,280,673	$	4,315,562

December 31, 2013
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 $10.7 million and $10.9 million of nonaccrual loans as of June 30, 2014 and December 31, 2013, respectively, were performing pursuant to their contractual terms at those dates.

The following table shows the allowance allocation by loan classification and accrual status at June 30, 2014 and December 31, 2013 (in thousands):

					Impaired Loans
	Accruing Loans				Nonaccrual Loans				Troubled Debt Restructurings⁽¹⁾				Total Allowance for Loan Losses
	June 30, 2014		December 31, 2013		June 30, 2014		December 31, 2013		June 30, 2014		December 31, 2013		June 30, 2014		December 31, 2013
Commercial real estate –mortgage	$	19,149	$	19,298	$	190	$	142	$	-	$	1,932	$	19,339	$	21,372
Consumer real estate – mortgage		6,292		7,090		1,089		722		827		543		8,208		8,355
Construction and land development		6,376		7,186		16		33		22		16		6,414		7,235
Commercial and industrial		26,663		24,660		145		218		675		256		27,483		25,134
Consumer and other		1,751		1,521		126		72		59		39		1,936		1,632
Unallocated		-		-		-		-		-		-		3,508		4,242
	$	60,231	$	59,755	$	1,566	$	1,187	$	1,583	$	2,786	$	66,888	$	67,970

(1)	Troubled debt restructurings of $7.6 million and $19.6 million as of June 30, 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 June 30, 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					$	4,144,493

	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		(393	)		(418	)		(7	)		(1,777	)		(674	)		-			(3,269	)
Recovery of previously charged-off loans		216			126			240			624			239			-			1,445
Provision for loan losses		(1,856	)		145			(1,054	)		3,502			739			(734	)		742
Balance at June 30, 2014	$	19,339		$	8,208		$	6,414		$	27,483		$	1,936		$	3,508		$	66,888

Collectively evaluated for impairment	$	19,149		$	6,292		$	6,376		$	26,663		$	1,751					$	63,739
Individually evaluated for impairment		190		$	1,916			38			820			185						3,149
Loans acquired with deteriorated credit quality		-		$	-			-			-			-						-
Balance at June 30, 2014	$	19,339		$	8,208		$	6,414		$	27,483		$	1,936					$	66,888

Loans:
Collectively evaluated for impairment	$	1,450,581		$	688,346		$	291,790		$	1,693,029		$	168,587					$	4,292,333
Individually evaluated for impairment	$	6,754		$	10,182		$	1,085		$	4,605		$	603					$	23,229
Loans acquired with deteriorated credit quality	$	-		$	-		$	-		$	-		$	-					$	-
Balance at June 30, 2014	$	1,457,335		$	698,528		$	292,875		$	1,697,634		$	169,190					$	4,315,562

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 June 30, 2014, Pinnacle Financial had granted loans and other extensions of credit amounting to approximately $8.7 million to current directors, executive officers, and their related entities, of which $6.2 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 than 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 June 30, 2014 or December 31, 2013.

Residential Lending

At June 30, 2014, Pinnacle Financial had approximately $24.6 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 requires that Pinnacle Financial deliver an individual loan contract to the investor or compensate the investor in the event the loan does not ultimately close. Mandatory delivery exposes Pinnacle Financial to interest rate risk between the initial rate-lock and the ultimate sale of the loan to its approved investors. Pinnacle Financial enters into a short-term economic hedging relationship on a loan-by-loan basis to mitigate this interest rate exposure. Pinnacle Financial 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 six months ended June 30, 2014, Pinnacle Financial recognized $2.9 million in gains on the sale of these loans, net of commissions paid, compared to $3.8 million during the six months ended June 30, 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.