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 March 31, 2017, approximately 78% 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 March 31, 2017 and December 31, 2016 (in thousands):

	Commercial real estate - mortgage		Consumer real estate - mortgage		Construction and land development		Commercial and industrial		Consumer and other		Total
March 31, 2017
Accruing loans
Pass	$	3,111,795	$	1,171,131	$	1,000,453	$	2,858,856	$	266,341	$	8,408,576
Special Mention		39,448		1,620		4,800		37,387		783		84,038
Substandard ⁽¹⁾		26,081		11,867		5,762		65,946		121		109,777
Total		3,177,324		1,184,618		1,011,015		2,962,189		267,245		8,602,391
Impaired loans
Nonaccrual loans⁽²⁾
Substandard-nonaccrual		4,050		8,809		4,112		7,255		822		25,048
Doubtful-nonaccrual		-		-		-		2		-		2
Total nonaccrual loans		4,050		8,809		4,112		7,257		822		25,050
Troubled debt restructurings⁽³⁾
Pass		210		1,349		-		720		39		2,318
Special Mention		-		233		-		-		-		233
Substandard		-		1,366		-		10,674		-		12,040
Total troubled debt restructurings		210		2,948		-		11,394		39		14,591
Total impaired loans		4,260		11,757		4,112		18,651		861		39,641
Total loans	$	3,181,584	$	1,196,375	$	1,015,127	$	2,980,840	$	268,106	$	8,642,032

December 31, 2016
Accruing loans
Pass	$	3,137,239	$	1,159,003	$	897,549	$	2,782,000	$	264,682	$	8,240,473
Special Mention		21,449		1,620		2,716		25,641		802		52,228
Substandard ⁽¹⁾		29,674		13,833		5,788		65,215		129		114,639
Total		3,188,362		1,174,456		906,053		2,872,856		265,613		8,407,340
Impaired loans
Nonaccrual loans⁽²⁾
Substandard-nonaccrual		4,921		8,073		6,613		7,492		475		27,574
Doubtful-nonaccrual		-		-		-		3		-		3
Total nonaccrual loans		4,921		8,073		6,613		7,495		475		27,577
Troubled debt restructurings⁽³⁾
Pass		213		1,358		7		713		41		2,332
Special Mention		-		236		-		-		-		236
Substandard		-		1,794		-		10,646		-		12,440
Total troubled debt restructurings		213		3,388		7		11,359		41		15,008
Total impaired loans		5,134		11,461		6,620		18,854		516		42,585
Total loans	$	3,193,496	$	1,185,917	$	912,673	$	2,891,710	$	266,129	$	8,449,925

(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 $109.8 million at March 31, 2017, compared to $114.6 million at December 31, 2016.

(2)	Included in nonaccrual loans at March 31, 2017 and December 31, 2016 are $7.3 million and $8.8 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.

For the three months ended March 31, 2017, the average balance of nonaccrual loans was $26.3 million compared to $43.7 million for the same period in 2016. 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 $49,000 in interest income from cash payments received on nonaccrual loans during the three months ended March 31, 2017, compared to $31,000 during the three months ended March 31, 2016. Had these nonaccruing loans been on accruing status, interest income would have been higher by $640,000 for the three months ended March 31, 2017 compared to $280,000 for the three months ended March 31, 2016, respectively.

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, 2016 through March 31, 2017 (in thousands):

	Gross Contractual Receivable			Accretable Yield		Nonaccretable Yield			Carrying Value

December 31, 2016	$	12,468		$	-	$	(3,633	)	$	8,835
Acquisitions		-			-		-			-
Year-to-date settlements		(1,814	)		-		252			(1,562	)
Additional fundings		5			-		-			5
March 31, 2017	$	10,659		$	-	$	(3,381	)	$	7,278

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.

The following table details the recorded investment, unpaid principal balance and related allowance of Pinnacle Financial's nonaccrual loans at March 31, 2017 and December 31, 2016 by loan classification (in thousands):

	At March 31, 2017						At December 31, 2016
	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	$	2,283	$	2,280	$	-	$	2,308	$	2,312	$	-
Consumer real estate – mortgage		2,513		2,544		-		2,880		2,915		-
Construction and land development		1,028		1,035		-		3,128		3,135		-
Commercial and industrial		6,252		6,266		-		6,373		6,407		-
Consumer and other		-		-		-		-		-		-
Total	$	12,076	$	12,125	$	-	$	14,689	$	14,769	$	-

Cash flow dependent nonaccrual loans:
Commercial real estate – mortgage	$	1,767	$	2,465	$	63	$	2,613	$	3,349	$	59
Consumer real estate – mortgage		6,296		6,883		1,085		5,193		5,775		688
Construction and land development		3,083		3,756		19		3,485		4,154		20
Commercial and industrial		1,006		2,379		220		1,122		2,714		77
Consumer and other		822		942		465		475		851		227
Total	$	12,974	$	16,425	$	1,852	$	12,888	$	16,843	$	1,071

Total nonaccrual loans	$	25,050	$	28,550	$	1,852	$	27,577	$	31,612	$	1,071

(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.

The following table details the average recorded investment and the amount of interest income recognized on a cash basis for the three months ended March 31, 2017 and 2016, respectively, on Pinnacle Financial's nonaccrual loans that remain on the balance sheets as of such date (in thousands):

	For the three months ended March 31,
	2017				2016
	Average recorded investment		Interest income recognized		Average recorded investment		Interest income recognized
Collateral dependent nonaccrual loans:
Commercial real estate – mortgage	$	2,100	$	-	$	3,854	$	-
Consumer real estate – mortgage		2,216		-		4,462		-
Construction and land development		2,078		49		7,320		31
Commercial and industrial		6,312		-		15,451		-
Consumer and other		-		-		386		-
Total	$	12,706	$	49	$	31,473	$	31

Cash flow dependent nonaccrual loans:
Commercial real estate – mortgage	$	2,386	$	-	$	1,548	$	-
Consumer real estate – mortgage		6,225		-		5,815		-
Construction and land development		3,284		-		74		-
Commercial and industrial		1,064		-		1,128		-
Consumer and other		649		-		3,702		-
Total	$	13,608	$	-	$	12,267	$	-

Total nonaccrual loans	$	26,314	$	49	$	43,740	$	31

At March 31, 2017 and December 31, 2016, there were $14.6 million and $15.0 million, respectively, of troubled debt restructurings that were performing as of their restructure date and which were accruing interest.

The following table outlines the amount of each loan category where troubled debt restructurings were made during the three months ended March 31, 2017 and 2016 (dollars in thousands):

	Three months ended March 31,
2017	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		3,457		3,457
Consumer and other		-		-		-
		1	$	3,457	$	3,457

2016
Commercial real estate – mortgage		-	$	-	$	-
Consumer real estate – mortgage		-		-		-
Construction and land development		-		-		-
Commercial and industrial		1		2,333		1,536
Consumer and other		-		-		-
		1	$	2,333	$	1,536

During the three months ended March 31, 2017 and 2016, Pinnacle Financial did not have any troubled debt restructurings that subsequently defaulted within twelve months of the restructuring.

To monitor concentration risk, 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, 2017 with the comparative exposures for December 31, 2016 (in thousands):

	March 31, 2017
	Outstanding Principal Balances			Unfunded Commitments			Total exposure			Total Exposure at December 31, 2016

Lessors of nonresidential buildings		$	1,302,962		$	359,869		$	1,662,831		$	1,701,853
Lessors of residential buildings			487,960			291,045			779,005			874,234

The table below presents past due balances by loan classification and segment at March 31, 2017 and December 31, 2016, allocated between accruing and nonaccrual status (in thousands):

March 31, 2017	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	$	1,056	$	-	$	1,056	$	3,401	$	1,395,055	$	1,399,512
All other		30		-		30		649		1,781,393		1,782,072
Consumer real estate – mortgage		1,917		49		1,966		8,809		1,185,600		1,196,375
Construction and land development		1,350		-		1,350		4,112		1,009,665		1,015,127
Commercial and industrial		3,514		-		3,514		7,258		2,970,068		2,980,840
Consumer and other		5,706		1,062		6,768		821		260,517		268,106
	$	13,573	$	1,111	$	14,684	$	25,050	$	8,602,298	$	8,642,032

December 31, 2016
Commercial real estate:
Owner-occupied	$	3,505	$	-	$	3,505	$	4,254	$	1,347,134	$	1,354,893
All other		-		-		-		667		1,837,936		1,838,603
Consumer real estate – mortgage		3,838		53		3,891		8,073		1,173,953		1,185,917
Construction and land development		2,210		-		2,210		6,613		903,850		912,673
Commercial and industrial		4,475		-		4,475		7,495		2,879,740		2,891,710
Consumer and other		7,168		1,081		8,249		475		257,405		266,129
	$	21,196	$	1,134	$	22,330	$	27,577	$	8,400,018	$	8,449,925

(1)	Approximately $15.0 million and $16.7 million of nonaccrual loans as of March 31, 2017 and December 31, 2016, 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 March 31, 2017 and December 31, 2016 (in thousands):

					Impaired Loans
	Accruing Loans				Nonaccrual Loans				Troubled Debt Restructurings⁽¹⁾				Total Allowance for Loan Losses
	March 31, 2017		December 31, 2016		March 31, 2017		December 31, 2016		March 31, 2017		December 31, 2016		March 31, 2017		December 31, 2016
Commercial real estate –mortgage	$	14,105	$	13,595	$	63	$	59	$	-	$	1	$	14,168	$	13,655
Consumer real estate – mortgage		6,132		5,874		1,085		688		2		2		7,219		6,564
Construction and land development		4,422		3,604		19		20		-		-		4,441		3,624
Commercial and industrial		22,650		24,648		220		77		42		18		22,912		24,743
Consumer and other		8,012		9,293		465		227		-		-		8,477		9,520
Unallocated		-		-		-		-		-		-		1,133		874
	$	55,321	$	57,014	$	1,852	$	1,071	$	44	$	21	$	58,350	$	58,980

(1)	Troubled debt restructurings of $14.6 million and $15.0 million as of both March 31, 2017 and December 31, 2016, 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 for the three months ended March 31, 2017 and 2016, respectively, by loan classification (in thousands):

	Commercial real estate - mortgage			Consumer real estate - mortgage			Construction and land development		Commercial and industrial			Consumer and other			Unallocated		Total
Three months ended March 31, 2017:
Balance at December 31, 2016	$	13,655		$	6,564		$	3,624	$	24,743		$	9,520		$	874	$	58,980
Charged-off loans		-			(61	)		-		(1,158	)		(3,943	)		-		(5,162	)
Recovery of previously charged-off loans		6			170			33		140			532			-		881
Provision for loan losses		507			546			784		(813	)		2,368			259		3,651
Balance at March 31, 2017	$	14,168		$	7,219		$	4,441	$	22,912		$	8,477		$	1,133	$	58,350

Three months ended March 31, 2016:
Balance at December 31, 2015	$	15,513		$	7,220		$	2,903	$	23,643		$	15,616		$	537	$	65,432
Charged-off loans		-			(199	)		-		(1,624	)		(7,404	)		-		(9,227	)
Recovery of previously charged-off loans		58			85			25		1,433			540			-		2,141
Provision for loan losses		(2,020	)		63			1,014		692			3,106			1,038		3,893
Balance at March 31, 2016	$	13,551		$	7,169		$	3,942	$	24,144		$	11,858		$	1,575	$	62,239

The following table details the allowance for loan losses and recorded investment in loans by loan classification and by impairment evaluation method as of March 31, 2017 and December 31, 2016, respectively (in thousands):

	Commercial real estate - mortgage		Consumer real estate - mortgage		Construction and land development		Commercial and industrial		Consumer and other		Unallocated		Total
March 31, 2017
Allowance for Loan Losses:
Collectively evaluated for impairment	$	14,105	$	6,132	$	4,422	$	22,650	$	8,012	$	1,133	$	56,454
Individually evaluated for impairment		63		1,087		19		262		465		-		1,896
Loans acquired with deteriorated credit quality		-		-		-		-		-		-		-
Total allowance for loan losses	$	14,168	$	7,219	$	4,441	$	22,912	$	8,477	$	1,133	$	58,350

Loans:
Collectively evaluated for impairment	$	3,177,324	$	1,184,618	$	1,011,015	$	2,962,189	$	267,245			$	8,602,391
Individually evaluated for impairment		2,714		9,276		1,094		18,418		861				32,363
Loans acquired with deteriorated credit quality		1,546		2,481		3,018		233		-				7,278
Total loans	$	3,181,584	$	1,196,375	$	1,015,127	$	2,980,840	$	268,106			$	8,642,032

December 31, 2016
Allowance for Loan Losses:
Collectively evaluated for impairment	$	13,595	$	5,874	$	3,604	$	24,648	$	9,293	$	874	$	57,888
Individually evaluated for impairment		60		690		20		95		227		-		1,092
Loans acquired with deteriorated credit quality		-		-		-		-		-		-		-
Total allowance for loan losses	$	13,655	$	6,564	$	3,624	$	24,743	$	9,520	$	874	$	58,980

Loans:
Collectively evaluated for impairment	$	3,188,362	$	1,174,456	$	906,053	$	2,872,856	$	265,613			$	8,407,340
Individually evaluated for impairment		2,750		8,941		3,212		18,331		516				33,750
Loans acquired with deteriorated credit quality		2,384		2,520		3,408		523		-				8,835
Total loans	$	3,193,496	$	1,185,917	$	912,673	$	2,891,710	$	266,129			$	8,449,925

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. 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 on a loan-by-loan basis 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.

At March 31, 2017, Pinnacle Bank had granted loans and other extensions of credit amounting to approximately $21.8 million to current directors, executive officers, and their related entities, of which $15.0 million had been drawn upon. At December 31, 2016, Pinnacle Bank had granted loans and other extensions of credit amounting to approximately $22.6 million to directors, executive officers, and their related entities, of which approximately $14.8 million had been drawn upon. None of these loans to directors, executive officers, and their related entities were impaired at March 31, 2017 or December 31, 2016.

At March 31, 2017, Pinnacle Financial had approximately $15.4 million in commercial loans held for sale, which included loans previously held in Pinnacle Bank's commercial loan portfolio that it has elected to sell as well 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 March 31, 2017, Pinnacle Financial had approximately $70.6 million of mortgage loans held-for-sale compared to approximately $47.7 million at December 31, 2016. Total loan volumes sold during the three months ended March 31, 2017 were approximately $160.7 million compared to approximately $163.9 million for the three months ended March 31, 2016. During the three months ended March 31, 2017, Pinnacle Financial recognized $4.2 million in gains on the sale of these loans, net of commissions paid, compared to $3.6 million during the three months ended March 31, 2016.

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 of a mortgage loan held-for-sale 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.