Note 4. Loans and Allowance for Loan Losses

For financial reporting purposes, Pinnacle Financial classifies our 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).

The composition of loans by primary loan classification as well as impaired and performing loan status at June 30, 2011 and December 31, 2010 is summarized in the table below (in thousands):

	Performing Loans				Impaired Loans				Total Loans
	June 30 2011		December 31, 2010		June 30, 2011		December 31, 2010		June 30 2011		December 31, 2010
Commercial real estate – mortgage	$	1,082,786	$	1,082,073	$	8,497	$	12,542	$	1,091,283	$	1,094,615
Consumer real estate – mortgage		697,425		696,452		10,855		9,035		708,280		705,487
Construction and land development		252,549		287,747		29,515		43,514		282,064		331,261
Commercial and industrial		1,048,081		997,351		10,182		14,740		1,058,263		1,012,091
Consumer and other		66,536		67,954		678		1,032		67,214		68,986
	$	3,147,377	$	3,131,577	$	59,727	$	80,863	$	3,207,104	$	3,212,440

The following table shows the allowance allocation by loan classification for impaired and performing loans at June 30, 2011 and December 31, 2010 (in thousands):

	Performing Loans				Impaired Loans				Total Allowance for Loan Losses
	June 30, 2011		December 31, 2010		June 30, 2011		December 31, 2010		June 30, 2011		December 31, 2010
Commercial real estate – mortgage	$	19,680	$	19,076	$	493	$	176	$	20,173	$	19,252
Consumer real estate – mortgage		10,423		9,330		362		568		10,785		9,898
Construction and land development		11,762		15,297		1,945		3,825		13,707		19,122
Commercial and industrial		18,498		17,428		2,187		3,998		20,685		21,426
Consumer and other		1,185		1,484		35		390		1,220		1,874
Unallocated		10,400		11,003		-		-		10,400		11,003
	$	71,948	$	73,618	$	5,022	$	8,957	$	76,970	$	82,575

The following table details the changes in the allowance for loan losses from January 1, 2010 to December 31, 2010 to June 30, 2011 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

Balances, January 1, 2010	$	22,505		$	10,725		$	23,027		$	26,332		$	2,456		$	6,914		$	91,959
Charged-off loans		(9,041	)		(6,769	)		(27,526	)		(23,555	)		(652	)		-			(67,543	)
Recovery of previously charged-off loans		343			377			2,618			874			252			-			4,464
Provision for loan losses		5,445			5,565			21,003			17,775			(182	)		4,089			53,695
Balances, Dec. 31, 2010	$	19,252		$	9,898		$	19,122		$	21,426		$	1,874		$	11,003		$	82,575
Charged-off loans		(2,647	)		(2,006	)		(4,026	)		(11,127	)		(868	)		-			(20,674	)
Recovery of previously charged-off loans		84			260			825			1,088			86			-			2,343
Provision for loan losses		3,484			2,633			(2,214	)		9,298			128			(603	)		12,726
Balances, June 30, 2011	$	20,173		$	10,785		$	13,707		$	20,685		$	1,220		$	10,400		$	76,970

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, past loan loss experience, 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.

Commercial loans receive risk ratings by the assigned financial advisor that are subject to validation by our independent loan review department. Risk ratings are categorized as pass, special mention, substandard, substandard-impaired or doubtful-impaired. Pinnacle Financial believes that our categories follow those outlined by our primary regulator. At June 30, 2011, approximately 75% 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 are generally not assigned an individual risk rating but are evaluated as either accrual or nonaccrual based on the performance of the loan. However, certain consumer real estate-mortgage loans and certain consumer and other loans do 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 and in many cases twice per year, our credit policy requires that each risk-rated loan is subject to a formal credit risk review to be performed by the respective loan officer. Each loan grade is also subject to review by our independent loan review department. Currently, our independent loan review department targets reviews of at least 70% of our risk rated portfolio annually. Included in the 70% coverage are independent loan reviews of loans in targeted portfolio segments such as certain consumer loans, land loans, loans assigned to a particular lending officer and/or loan types in certain geographies.

The following table presents our loan balances by primary loan classification and the amount classified within each risk rating category. Pass rated loans include all credits other than those included in special mention, substandard and doubtful 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-impaired loans are substandard loans that have been placed on nonaccrual.

Doubtful-impaired loans have all the characteristics of substandard 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. Pinnacle Financial considers all doubtful loans to be impaired and places the loan on nonaccrual status.

The following table outlines the amount of each loan classification categorized into each risk rating class as of June 30, 2011 and December 31, 2010 (in thousands):

	June 30, 2011
	Pass		Special Mention		Substandard		Substandard- Impaired		Doubtful- Impaired		Total Loans
Commercial real estate – mortgage	$	973,979	$	41,914	$	66,893	$	8,497	$	-	$	1,091,283
Consumer real estate – mortgage		658,529		15,812		23,084		7,403		3,452		708,280
Construction and land development		187,594		24,299		40,656		28,908		607		282,064
Commercial and industrial		996,839		24,818		26,424		8,965		1,217		1,058,263
Consumer and other		65,756		743		37		557		121		67,214
	$	2,882,697	$	107,586	$	157,094	$	54,330	$	5,397	$	3,207,104

	December 31, 2010
		Pass		Special Mention		Substandard		Substandard- Impaired		Doubtful- Impaired		Total Loans
Commercial real estate – mortgage	$	947,593	$	46,520	$	87,960	$	11,351	$	1,191	$	1,094,615
Consumer real estate – mortgage		661,234		12,384		22,834		4,622		4,413		705,487
Construction and land development		188,470		29,670		69,607		43,203		311		331,261
Commercial and industrial		918,414		13,511		65,426		13,347		1,393		1,012,091
Consumer and other		66,916		65		973		879		153		68,986
	$	2,782,627	$	102,150	$	246,800	$	73,402	$	7,461	$	3,212,440

The information presented above for December 31, 2010 has been reclassified from the presentation in our Annual Report on Form 10-K for the year ended December 31, 2010 to conform to the June 30, 2011 presentation. Consumer loans previously classified as performing have been further classified into special mention and substandard.

At June 30, 2011 and December 31, 2010, there were no loans classified as nonaccrual that were not deemed to be impaired. At June 30, 2011 and December 31, 2010, all impaired loans were on nonaccruing interest status. The principal balances of these nonaccrual loans amounted to $59,727,000 and $80,863,000 at June 30, 2011 and December 31, 2010, respectively, and are included in the table above. For the three months ended June 30, 2011 the average balance of impaired loans was $68,048,000 as compared to $108,426,000 for the twelve months ended December 31, 2010. At the date such loans were placed on nonaccrual status, Pinnacle Financial reversed all previously accrued interest income against current year earnings. Had nonaccruing loans been on accruing status, interest income would have been higher by $2,714,000 and $5,546,000 for the six months ended June 30, 2011 and June 30, 2010, respectively. Had nonaccruing loans been on accruing status, interest income would have been higher by $1,075,000 and $2,920,000 for the three months ended June 30, 2011 and 2010, respectively.

The following table details the recorded investment, unpaid principal balance and related allowance and average recorded investment of our impaired loans at June 30, 2011 and December 31, 2010 by loan category and the amount of interest income recognized on a cash basis throughout the quarter and year then ended, respectively, on these loans that remain on our balance sheet (in thousands):

	At June 30, 2011						For the six months ended June 30, 2011
	Recorded investment		Unpaid principal balance		Related allowance(1)		Average recorded investment		Interest income recognized

Impaired loans with no recorded allowance:
Commercial real estate – mortgage	$	6,609	$	7,901	$	-	$	6,316	$	5
Consumer real estate – mortgage		6,906		9,334		-		9,323		-
Construction and land development		22,392		26,630		-		26,675		37
Commercial and industrial		3,923		5,244		-		5,248		-
Consumer and other		251		347		-		347		-
Total	$	40,081	$	49,456	$	-	$	47,909	$	42


Impaired loans with a recorded allowance:
Commercial real estate – mortgage	$	1,888	$	4,092	$	493	$	4,097	$	-
Consumer real estate – mortgage		3,949		5,807		362		5,859		1
Construction and land development		7,123		7,487		1,945		7,487		7
Commercial and industrial		6,259		9,626		2,187		9,565		-
Consumer and other		427		723		35		723		-
Total	$	19,646	$	27,735	$	5,022		27,731	$	8

Total Impaired Loans	$	59,727	$	77,191	$	5,022	$	75,640	$	50

	At December 31, 2010						For the year ended December 31, 2010
	Recorded investment		Unpaid principal balance		Related allowance(1)		Average recorded investment		Interest income recognized

Impaired loans with no recorded allowance:
Commercial real estate – mortgage	$	10,585	$	12,468	$	-	$	12,478	$	278
Consumer real estate – mortgage		4,063		5,041		-		5,041		83
Construction and land development		31,106		35,525		-		35,631		188
Commercial and industrial		2,865		5,501		-		5,501		9
Consumer and other		272		368		-		368		-
Total	$	48,891	$	58,903	$	-	$	59,019	$	558

Impaired loans with a recorded allowance:
Commercial real estate – mortgage	$	1,957	$	2,328	$	176	$	2,328	$	55
Consumer real estate – mortgage		4,972		5,869		568		5,875		143
Construction and land development		12,408		12,619		3,825		12,623		234
Commercial and industrial		11,875		13,005		3,998		12,996		324
Consumer and other		760		846		390		846		17
Total	$	31,972	$	34,667	$	8,957	$	34,668	$	773

Total Impaired Loans	$	80,863	$	93,570	$	8,957	$	93,687	$	1,331

(1)

Collateral dependent loans are typically charged-off to their net realizable value pursuant to regulatory requirements and no specific allowance is carried related to those loans.

Pinnacle Financial's policy is that once a loan is classified as impaired and placed on nonaccrual status, interest income is subsequently recognized to the extent cash payments are received while the loan is classified as nonaccrual, but is reviewed on a case-by-case basis. Pinnacle Financial recognized $50,000 and $1,340,000 of interest income from cash payments received during the six months ended June 30, 2011 and the year ended December 31, 2010 while the underlying loans were placed on impaired status.

Impaired loans also include loans that Pinnacle National 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 National may have to otherwise incur. If on nonaccruing status as of the date of restructuring, the loans are included in nonperforming loans and are classified as impaired loans. In accordance with industry practice, once a relationship is classified as a restructured loan, the relationship will remain classified as a restructured loan until the borrower can demonstrate adherence to the restructured terms for at least six months. Loans that have been restructured that were performing as of the restructure date are not included in nonperforming loans. At June 30, 2011 and December 31, 2010, there were $13.0 million and $20.5 million, respectively, of accruing restructured loans that were performing as of the restructure date.

In addition to the loan metrics above, Pinnacle Financial analyzes its commercial loan portfolio to determine if a concentration of credit risk exists to any one or more industries. 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 National's total risk-based capital to borrowers in the following industries at June 30, 2011 with the comparative exposures for December 31, 2010:

	(dollars in thousands)
	June 30, 2011		December 31, 2010
Lessors of nonresidential buildings	$	492,377	$	502,268
Lessors of residential buildings		153,049		132,668
Land subdividers		134,089		144,550

The table below presents past due balances at June 30, 2011 and December 31, 2010, by loan classification allocated between performing and impaired status (in thousands):

	At June 30, 2011
	30-89 days past due		90 days or more past due and performing		Total past due and performing		Impaired (1)		Current and performing		Total Loans

Commercial real estate:
Owner-occupied	$	1,103	$	-	$	1,103	$	7,420	$	533,912	$	542,435
All other		4,717		-		4,717		1,077		543,054		548,848
Consumer real estate – mortgage		2,501		122		2,623		10,855		694,802		708,280
Construction and land development		1,163		-		1,163		29,515		251,386		282,064
Commercial and industrial		2,559		755		3,314		10,182		1,044,767		1,058,263
Consumer and other		292		-		292		678		66,244		67,214
	$	12,335	$	877	$	13,212	$	59,727	$	3,134,165	$	3,207,104

	At December 31, 2010
	30-89 days past due		90 days or more past due and performing		Total past due and performing		Impaired (1)		Current and performing		Total Loans

Commercial real estate:
Owner-occupied	$	1,602	$	-	$	1,602	$	10,037	$	520,260	$	531,899
All other		362		-		362		2,505		559,849		562,716
Consumer real estate – mortgage		3,544		-		3,544		9,035		692,908		705,487
Construction and land development		2,157		38		2,195		43,514		285,552		331,261
Commercial and industrial		1,636		100		1,736		14,740		995,615		1,012,091
Consumer and other		152		-		152		1,032		67,802		68,986
	$	9,453	$	138	$	9,591	$	80,863	$	3,121,986	$	3,212,440

(1)

Approximately $24.6 million and $33.2 million of impaired loans as of June 30, 2011 and December 31, 2010, respectively, are currently performing pursuant to their contractual terms. All impaired loans as of these dates are on nonaccrual status.

Potential problem loans, which are not included in nonperforming assets, amounted to approximately $148.5 million at June 30, 2011, compared to $223.1 million at December 31, 2010. 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 serious 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 the Office of the Comptroller of the Currency, or OCC, Pinnacle National's primary regulator, for loans classified as substandard, excluding the impact of substandard nonperforming loans and substandard restructured accruing loans.

At June 30, 2011, Pinnacle Financial had granted loans and other extensions of credit amounting to approximately $12,059,000 to current directors, executive officers, and their related entities, of which $8,927,000 had been drawn upon. At December 31, 2010, Pinnacle Financial had granted loans and other extensions of credit amounting to approximately $22,543,000 to directors, executive officers, and their related entities, of which approximately $18,103,000 had been drawn upon. The terms on these loans and extensions are on substantially the same terms customary for other persons similarly situated for the type of loan involved. None of these loans to directors, executive officers, and their related entities were impaired at June 30, 2011.

At June 30, 2011, Pinnacle Financial had approximately $14.2 million of mortgage loans held-for-sale compared to approximately $16.2 million at December 31, 2010. These loans are marketed to potential investors prior to closing the loan with the borrower such that there is an agreement for the subsequent sale of the loan between the eventual investor and Pinnacle Financial prior to the loan being closed with the borrower. Pinnacle Financial sells loans to investors on a loan-by-loan basis 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 and six months ended June 30, 2011, Pinnacle Financial recognized $789,000 and $1,399,000, respectively, in gains on the sale of these loans compared to $909,000 and $1,424,000, respectively, during the three and six months ended June 30, 2010.