Note 5. 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).

Pinnacle Financial uses five loan categories: commercial real estate mortgage, consumer real estate mortgage, construction and land development, commercial and industrial, and consumer and other.

Commercial real-estate mortgage loans. Commercial real-estate mortgage loans are categorized as such based on investor exposures where repayment is largely dependent upon the operation, refinance, or sale of the underlying real estate. Commercial real-estate mortgage also includes owner occupied commercial real estate which shares a similar risk profile to Pinnacle Financial's commercial and industrial products.

·	Consumer real-estate mortgage loans. Consumer real-estate mortgage consists primarily of loans secured by 1-4 residential properties including home equity lines of credit.

Construction and land development loans. Construction and land development loans include loans where the repayment is dependent on the successful operation of the related real estate project. Construction and land development loans include 1-4 family construction projects and commercial construction endeavors such as warehouses, apartments, office and retail space and land acquisition and development.

·	Commercial and industrial loans. Commercial and industrial loans include loans to business enterprises issued for commercial, industrial and/or other professional purposes.

·	Consumer and other loans. Consumer and other loans include all loans issued to individuals not included in the consumer real-estate mortgage classification. Examples of consumer and other loans are automobile loans, credit cards and loans to finance education, among others.

Commercial loans receive risk ratings assigned by a financial advisor and approved by a senior credit officer 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, 2016, approximately 77.10% of Pinnacle Financial's 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 a financial advisor and a senior credit officer. At least annually, Pinnacle Financial's credit procedures require that every risk rated loan of $500,000 or more be subject to a formal credit risk review process by the assigned financial advisor. Each loan's risk rating is also subject to review by Pinnacle Financial's independent loan review department, which reviews a substantial portion of Pinnacle Financial's risk rated portfolio annually. Included in the coverage are independent loan reviews of loans in targeted higher-risk portfolio segments such as certain commercial and industrial loans, land loans and/or loan types in certain geographies.

The following table presents Pinnacle Financial's 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, 2016 and December 31, 2015 (in thousands):

	Commercial real estate - mortgage		Consumer real estate - mortgage		Construction and land development		Commercial and industrial		Consumer and other		Total
June 30, 2016
Accruing loans
Pass	$	2,423,496	$	1,046,149	$	798,597	$	2,402,831	$	244,199	$	6,915,272
Special Mention		13,781		1,869		3,896		14,835		-		34,381
Substandard ⁽¹⁾		24,538		10,134		7,073		56,291		67		98,103
Total		2,461,815		1,058,152		809,566		2,473,957		244,266		7,047,756
Impaired loans
Nonaccrual loans⁽²⁾
Substandard-nonaccrual		5,184		7,016		7,112		11,827		2,556		33,695
Doubtful-nonaccrual		-		-		-		90		-		90
Total nonaccrual loans		5,184		7,016		7,112		11,917		2,556		33,785
Troubled debt restructurings⁽³⁾
Pass		220		1,377		3		335		44		1,979
Special Mention		-		245		-		-		-		245
Substandard		-		1,830		-		5,807		-		7,637
Total troubled debt restructurings		220		3,452		3		6,142		44		9,861
Total impaired loans		5,404		10,468		7,115		18,059		2,600		43,646
Total loans	$	2,467,219	$	1,068,620	$	816,681	$	2,492,016	$	246,866	$	7,091,402


December 31, 2015
Accruing loans
Pass	$	2,217,639	$	1,020,239	$	732,662	$	2,143,006	$	239,874	$	6,353,420
Special Mention		18,162		1,894		1,133		26,037		118		47,344
Substandard ⁽¹⁾		33,638		11,346		6,295		53,671		74		105,024
Total		2,269,439		1,033,479		740,090		2,222,714		240,066		6,505,788
Impaired loans
Nonaccrual loans⁽²⁾
Substandard-nonaccrual		5,819		9,344		7,607		1,591		4,902		29,263
Doubtful-nonaccrual		2		2		-		92		-		96
Total nonaccrual loans		5,821		9,346		7,607		1,683		4,902		29,359
Troubled debt restructurings⁽³⁾
Pass		223		409		-		553		28		1,213
Special Mention		-		422		-		-		-		422
Substandard		-		2,861		-		3,592		-		6,453
Total troubled debt restructurings		223		3,692		-		4,145		28		8,088
Total impaired loans		6,044		13,038		7,607		5,828		4,930		37,447
Total loans	$	2,275,483	$	1,046,517	$	747,697	$	2,228,542	$	244,996	$	6,543,235

(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 $98.1 million at June 30, 2016, compared to $105.0 million at December 31, 2015.

(2)	Included in nonaccrual loans at June 30, 2016 and December 31, 2015 are $9.8 million and $12.1 million, respectively, in purchase credit impaired loans acquired with deteriorated credit quality.

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

At June 30, 2016 and December 31, 2015, all loans classified as nonaccrual were deemed to be impaired. The principal balances of these nonaccrual loans amounted to $33.8 million and $29.4 million at June 30, 2016 and December 31, 2015, respectively, and are included in the tables above. For the six months ended June 30, 2016, the average balance of nonaccrual loans was $36.6 million compared to $17.3 million for the same period in 2015. Pinnacle Financial's policy is that the discontinuation of the accrual of interest income will occur when (1) there is a significant deterioration in the financial condition of the borrower and full repayment of principal and interest is not expected or (2) the principal or interest is more than 90 days past due, unless the loan is both well secured and in the process of collection. As such, at the date the above mentioned loans were placed on nonaccrual status, Pinnacle Financial reversed all previously accrued interest income against current year earnings. 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 approximately $41,000 and $88,000, respectively, in interest income from cash payments received on nonaccrual loans during the three and six months ended June 30, 2016, compared to $99,000 and $183,000 during the three and six months ended June 30, 2015. Had these nonaccruing loans been on accruing status, interest income would have been higher by $676,000 and $398,000 for the six months ended June 30, 2016 and 2015, respectively.

The following table details the recorded investment, unpaid principal balance and related allowance of Pinnacle Financial's nonaccrual loans at June 30, 2016 and December 31, 2015 by loan classification (in thousands):

	At June 30, 2016						At December 31, 2015
	Recorded investment		Unpaid principal balances⁽¹⁾		Related allowance⁽²⁾		Recorded investment		Unpaid principal balances ⁽¹⁾		Related allowance⁽²⁾
Collateral dependent nonaccrual loans:
Commercial real estate – mortgage	$	3,848	$	4,571	$	-	$	4,411	$	5,659	$	-
Consumer real estate – mortgage		4,059		4,585		-		5,596		6,242		-
Construction and land development		7,055		7,797		-		7,531		7,883		-
Commercial and industrial		11,408		13,319		-		1,420		3,151		-
Consumer and other		382		406		-		-		-		-
Total	$	26,752	$	30,678	$	-	$	18,958	$	22,935	$	-

Cash flow dependent nonaccrual loans:
Commercial real estate – mortgage	$	1,336	$	1,344	$	172	$	1,410	$	1,661	$	20
Consumer real estate – mortgage		2,957		2,914		249		3,750		4,098		616
Construction and land development		56		63		224		76		125		12
Commercial and industrial		510		515		701		263		281		19
Consumer and other		2,174		2,429		134		4,902		5,341		3,002
Total	$	7,033	$	7,265	$	1,480	$	10,401	$	11,506	$	3,669
Total nonaccrual loans	$	33,785	$	37,943	$	1,480	$	29,359	$	34,441	$	3,669

The following table details the average recorded investment and the amount of interest income recognized on a cash basis throughout the three and six months ended June 30, 2016 and 2015, respectively, on Pinnacle Financial's nonaccrual loans that remain on the balance sheets (in thousands):

	For the three months ended June 30,								For the six months ended June 30,
	2016				2015				2016				2015
	Average recorded investment		Interest income recognized		Average recorded investment		Interest income recognized		Average recorded investment		Interest income recognized		Average recorded investment		Interest income recognized
Collateral dependent nonaccrual loans:
Commercial real estate – mortgage	$	3,845	$	-	$	3,205	$	53	$	3,474	$	-	$	3,148	$	53
Consumer real estate – mortgage		4,125		-		611		-		4,140		-		617		-
Construction and land development		7,125		41		3,219		46		7,293		88		3,277		130
Commercial and industrial		12,107		-		918		-		11,928		-		932		-
Consumer and other		383		-		-		-		385		-		-		-
Total	$	27,585	$	41	$	7,953	$	99	$	27,220	$	88	$	7,974	$	183

Cash flow dependent nonaccrual loans:
Commercial real estate – mortgage	$	1,352	$	-	$	1,804	$	-	$	725	$	-	$	1,824	$	-
Consumer real estate – mortgage		3,163		-		3,982		-		3,181		-		4,037		-
Construction and land development		130		-		296		-		134		-		299		-
Commercial and industrial		1,838		-		193		-		2,396		-		204		-
Consumer and other		2,936		-		3,020		-		2,973		-		3,003		-
Total	$	9,419	$	-	$	9,295	$	-	$	9,409	$	-	$	9,367	$	-
Total nonaccrual loans	$	37,004	$	41	$	17,248	$	99	$	36,629	$	88	$	17,341	$	183

(1)	Unpaid principal balance presented net of fair value adjustments recorded in conjunction with purchase accounting.

(2)	Collateral dependent loans are typically charged-off to their net realizable value and no specific allowance is carried related to those loans.

Loans acquired with deteriorated credit quality are recorded pursuant to the provisions of ASC 310-30, Loans and Debt Securities Acquired with Deteriorated Credit Quality, and are referred to as purchase credit impaired loans.

The following table provides a rollforward of purchase credit impaired loans from December 31, 2015 through June 30, 2016 (in thousands):

	Gross Contractual Receivable			Accretable Yield		Nonaccretable Yield			Carrying Value

December 31, 2015	$	16,274		$	-	$	(4,143	)	$	12,131
Year-to-date settlements		(3,063	)		-		668			(2,395	)
Additional fundings		122			-		-			122
June 30, 2016	$	13,333		$	-	$	(3,475	)	$	9,858

These loans have been deemed to be collateral dependent and as such, no accretable yield has been recorded for these loans. The carrying value is adjusted for additional draws, pursuant to contractual arrangements, offset by loan paydowns. Year-to-date settlements include both loans that were charged-off as well as loans that were paid off, typically as a result of refinancings at other institutions.

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, 2016 and December 31, 2015, there were $9.9 million and $8.1 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 loan category where troubled debt restructurings were made during the three and six months ended June 30, 2016 and 2015 (dollars in thousands):

	Three months ended June 30,						Six months ended June 30,
2016	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		2,321		1,536
Consumer and other		-		-		-		-		-		-
		-	$	-	$	-		1	$	2,321	$	1,536

2015
Commercial real estate – mortgage		-	$	-	$	-		-	$	-	$	-
Consumer real estate – mortgage		-		-		-		-		-		-
Construction and land development		-		-		-		-		-		-
Commercial and industrial		-		-		-		1		434		337
Consumer and other		-		-		-		-		-		-
		-	$	-	$	-		1	$	434	$	337

During the three and six months ended June 30, 2016 and 2015, Pinnacle Financial did not have any troubled debt restructurings that subsequently defaulted within twelve months of the restructuring.

The table below presents past due balances by loan classification and segment at June 30, 2016 and December 31, 2015, allocated between accruing and nonaccrual status (in thousands):

June 30, 2016	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	$	629	$	-	$	629	$	4,663	$	1,114,819	$	1,120,111
All other		386		-		386		521		1,346,201		1,347,108
Consumer real estate – mortgage		5,476		1,046		6,522		7,016		1,055,082		1,068,620
Construction and land development		8,199		-		8,199		7,112		801,370		816,681
Commercial and industrial		1,166		-		1,166		11,917		2,478,933		2,492,016
Consumer and other		6,252		577		6,829		2,556		237,481		246,866
	$	22,108	$	1,623	$	23,731	$	33,785	$	7,033,886	$	7,091,402

December 31, 2015	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	$	-	$	-	$	-	$	5,103	$	1,078,394	$	1,083,497
All other		-		-		-		718		1,191,268		1,191,986
Consumer real estate – mortgage		6,380		1,396		7,776		9,346		1,029,395		1,046,517
Construction and land development		309		-		309		7,607		739,781		747,697
Commercial and industrial		4,798		-		4,798		1,683		2,222,061		2,228,542
Consumer and other		6,721		373		7,094		4,902		233,000		244,996
	$	18,208	$	1,769	$	19,977	$	29,359	$	6,493,899	$	6,543,235

(1)	Approximately $23.7 million and $19.0 million of nonaccrual loans as of June 30, 2016 and December 31, 2015, 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, 2016 and December 31, 2015 (in thousands):

					Impaired Loans
	Accruing Loans				Nonaccrual Loans				Troubled Debt Restructurings⁽¹⁾				Total Allowance for Loan Losses
	June 30, 2016		December 31, 2015		June 30, 2016		December 31, 2015		June 30, 2016		December 31, 2015		June 30, 2016		December 31, 2015
Commercial real estate –mortgage	$	13,613	$	15,452	$	4	$	20	$	48	$	41	$	13,665	$	15,513
Consumer real estate – mortgage		6,012		6,109		131		616		397		495		6,540		7,220
Construction and land development		3,920		2,891		2		12		1		-		3,923		2,903
Commercial and industrial		23,268		22,669		138		19		1,684		955		25,090		23,643
Consumer and other		9,923		12,609		1,205		3,002		10		5		11,138		15,616
Unallocated		-		-		-		-		-		-		1,056		537
	$	56,736	$	59,730	$	1,480	$	3,669	$	2,140	$	1,496	$	61,412	$	65,432

(1)	Troubled debt restructurings of $9.9 million and $8.1 million as of both June 30, 2016 and December 31, 2015, 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, 2014 to December 31, 2015 to June 30, 2016 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, 2014	$	22,202		$	5,424		$	5,724		$	29,167		$	1,570		$	3,272		$	67,359
Charged-off loans		(384	)		(365	)		(190	)		(2,207	)		(18,002	)		-			(21,148	)
Recovery of previously charged-off loans		85			874			1,479			1,730			5,865			-			10,033
Provision for loan losses		(6,390	)		1,287			(4,110	)		(5,047	)		26,183			(2,735	)		9,188
Balance at December 31, 2015	$	15,513		$	7,220		$	2,903		$	23,643		$	15,616		$	537		$	65,432

Collectively evaluated for impairment	$	15,452		$	6,109		$	2,891		$	22,669		$	12,609					$	59,730
Individually evaluated for impairment		61			1,111			12			974			3,007						5,165
Loans acquired with deteriorated credit quality		-			-			-			-			-						-
Balance at December 31, 2015	$	15,513		$	7,220		$	2,903		$	23,643		$	15,616					$	65,432

Loans:
Collectively evaluated for impairment	$	2,269,439		$	1,033,479		$	740,090		$	2,222,714		$	240,066					$	6,505,788
Individually evaluated for impairment		2,420			8,986			3,689			5,288			4,930						25,313
Loans acquired with deteriorated credit quality		3,624			4,052			3,918			540			-						12,134
Balance at December 31, 2015	$	2,275,483		$	1,046,517		$	747,697		$	2,228,542		$	244,996					$	6,543,235


Allowance for Loan Losses:
Balance at December 31, 2015	$	15,513		$	7,220		$	2,903	$	23,643		$	15,616		$	537	$	65,432
Charged-off loans		(196	)		(379	)		-		(2,243	)		(13,555	)		-		(16,373	)
Recovery of previously charged-off loans		193			156			106		1,615			1,109			-		3,179
Provision for loan losses		(1,845	)		(457	)		914		2,075			7,968			519		9,174
Balance at June 30, 2016	$	13,665		$	6,540		$	3,923	$	25,090		$	11,138		$	1,056	$	61,412

Collectively evaluated for impairment	$	13,613		$	6,012		$	3,920	$	23,268		$	9,923				$	56,736
Individually evaluated for impairment		52			528			3		1,822			1,215					3,620
Loans acquired with deteriorated credit quality		-			-			-		-			-					-
Balance at June 30, 2016	$	13,665		$	6,540		$	3,923	$	25,090		$	11,138				$	61,412

Loans:
Collectively evaluated for impairment	$	2,461,815		$	1,058,152		$	809,566	$	2,473,957		$	244,266				$	7,047,756
Individually evaluated for impairment		1,922			8,068			4,129		17,483			2,219					33,821
Loans acquired with deteriorated credit quality		3,482			2,400			2,986		576			381					9,825
Balance at June 30, 2016	$	2,467,219		$	1,068,620		$	816,681	$	2,492,016		$	246,866				$	7,091,402

The adequacy of the allowance for loan losses is assessed at the end of each calendar quarter using a migration analysis compiled using loss data over the previous 24 quarters. 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. The allowance for loan losses for purchased loans is calculated similarly to the method utilized for legacy Pinnacle Bank loans. Pinnacle Financial's accounting policy is to compare the computed allowance for loan losses for purchased loans to any remaining fair value adjustment. If the computed allowance is greater than the remaining fair value adjustment, the excess is added to the allowance for loan losses by a charge to the provision for loan losses.

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, 2016 with the comparative exposures for December 31, 2015 (in thousands):

	at June 30, 2016
	Outstanding Principal Balances			Unfunded Commitments			Total exposure			Total Exposure at December 31, 2015

Lessors of nonresidential buildings		$	945,924		$	274,357		$	1,220,281		$	1,078,211
Lessors of residential buildings			432,711			189,627			622,338			500,266

At June 30, 2016, Pinnacle Bank had granted loans and other extensions of credit amounting to approximately $8.8 million to current directors, executive officers, and their related entities, of which $5.9 million had been drawn upon. At December 31, 2015, Pinnacle Bank had granted loans and other extensions of credit amounting to approximately $14.5 million to directors, executive officers, and their related entities, of which approximately $11.4 million had been drawn upon. None of these loans to directors, executive officers, and their related entities were impaired at June 30, 2016 or December 31, 2015.

At June 30, 2016, Pinnacle Financial had approximately $9.3 million in commercial loans held for sale. These loans held for sale consist solely of apartment loans originated for sale to a third-party as part of a multi-family loan program. Such loans are closed under a pass-through commitment structure wherein Pinnacle Bank's loan commitment to the borrower is the same as the third party's take-out commitment to Pinnacle Bank, and the third party purchase typically occurs within thirty days of Pinnacle Bank closing with the borrowers.

Residential Lending

At June 30, 2016, Pinnacle Financial had approximately $53.1 million of mortgage loans held-for-sale compared to approximately $47.9 million at December 31, 2015. Total loan volumes sold during the six months ended June 30, 2016 were approximately $198.2 million compared to approximately $208.4 million for the six months ended June 30, 2015. During the six months ended June 30, 2016, Pinnacle Financial recognized $7.8 million in gains on the sale of these loans, net of commissions paid, compared to $3.6 million during the six months ended June 30, 2015.

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.