Note 6. 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. These classifications are consistent with those utilized in the Quarterly Report of Condition and Income filed with the Federal Deposit Insurance Corporation (FDIC).

The information presented herein for December 31, 2011, has been reclassified from the presentation in our Annual Report on Form 10-K for the year ended December 31, 2011 to conform to the December 31, 2012 presentation in that troubled debt restructurings previously included in accruing loans are now presented separately.

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-impaired or doubtful-impaired. Pinnacle Financial believes that its categories follow those outlined by Pinnacle Bank's primary regulators. At December 31, 2012, approximately 77% 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 policy requires that every risk rated loan of $500,000 or more be subject to a formal credit risk review process. Each loan grade is also subject to review by our independent loan review department. Currently, our independent loan review department targets reviews a significant portion of our 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 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 December 31, 2012 and 2011 (in thousands):

December 31, 2012	Commercial real estate - mortgage		Consumer real estate - mortgage		Construction and land development		Commercial and industrial		Consumer and other		Total
Accruing loans
Pass	$	1,093,628	$	649,571	$	259,878	$	1,390,207	$	93,712	$	3,486,996
Special Mention		12,670		4,242		29,472		23,133		-		69,517
Substandard (1)		42,343		13,896		19,622		29,513		-		105,374
Total		1,148,641		667,709		308,972		1,442,853		93,712		3,661,887
Impaired loans
Nonperforming loans
Substandard-nonaccrual		9,290		5,877		4,509		3,035		79		22,790
Doubtful-nonaccrual		1		29		-		3		-		33
Total nonperforming loans		9,291		5,906		4,509		3,038		79		22,823
Troubled debt restructurings(2)
Pass		4,705		3,623		71		502		119		9,020
Special Mention		-		-		-		-		-		-
Substandard		15,559		2,688		-		185		-		18,432
Total troubled debt restructurings		20,264		6,311		71		687		119		27,452
Total impaired loans		29,555		12,217		4,580		3,725		198		50,275
Total loans	$	1,178,196	$	679,926	$	313,552	$	1,446,578	$	93,910	$	3,712,162

December 31, 2011	Commercial real estate - mortgage		Consumer real estate - mortgage		Construction and land development		Commercial and industrial		Consumer and other		Total
Accruing loans
Pass	$	994,059	$	643,924	$	204,696	$	1,098,898	$	63,218	$	3,004,795
Special Mention		19,403		15,225		27,553		17,029		649		79,859
Substandard (1)		72,160		18,235		28,957		16,073		1		135,426
Total		1,085,622		677,384		261,206		1,132,000		63,868		3,220,080
Impaired loans
Nonperforming loans
Substandard-nonaccrual		9,962		11,990		12,965		11,194		551		46,662
Doubtful-nonaccrual		-		497		-		696		-		1,193
Total nonperforming loans		9,962		12,487		12,965		11,890		551		47,855
Troubled debt restructurings(2)
Pass		193		3,631		77		949		242		5,092
Special Mention		-		-		-		-		-		-
Substandard		15,185		2,243		-		896		-		18,324
Total troubled debt restructurings		15,378		5,874		77		1,845		242		23,416
Total impaired loans		25,340		18,361		13,042		13,735		793		71,271
Total loans	$	1,110,962	$	695,745	$	274,248	$	1,145,735	$	64,661	$	3,291,351

(1)

Potential problem loans represent those loans with a well-defined weakness and where information about possible credit problems of borrowers has caused management to have doubts about the borrower's ability to comply with present repayment terms. This definition is believed to be substantially consistent with the standards established by Pinnacle Bank's primary regulators for loans classified as substandard, excluding the impact of substandard nonperforming loans and substandard troubled debt restructurings. Potential problem loans, which are not included in nonperforming assets, amounted to approximately $105.4 million at December 31, 2012, compared to $135.4 million at December 31, 2011.

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

At December 31, 2012 and December 31, 2011, all loans classified as nonaccrual were deemed to be impaired. The principal balances of these nonaccrual loans amounted to $22.8 million and $47.9 million at December 31, 2012 and December 31, 2011, respectively, and are included in the table above. For the twelve months ended December 31, 2012, the average balance of nonaccrual loans was $38.4 million as compared to $60.8 million for the twelve months ended December 31, 2011. At the date such loans were placed on nonaccrual status, Pinnacle Financial reversed all previously accrued interest income against current year earnings. Had these nonaccruing loans been on accruing status, interest income would have been higher by $1.4 million, $5.0 million and $7.1 million, respectively, for the years ended December 31, 2012, 2011 and 2010, respectively.

The following tables details the recorded investment, unpaid principal balance and related allowance and average recorded investment of our nonaccrual loans at December 31, 2012, 2011 and 2010 by loan classification and the amount of interest income recognized on a cash basis throughout the quarter and year-to-date period then ended, respectively, on these loans that remain on the balance sheets (in thousands):

	At December 31, 2012						For the year ended December 31, 2012
	Recorded investment		Unpaid principal balance		Related allowance⁽¹⁾		Average recorded investment		Interest income recognized
Collateral dependent nonaccrual loans:
Commercial real estate – mortgage	$	8,740	$	11,187	$	-	$	11,194	$	-
Consumer real estate – mortgage		3,641		6,394		-		6,394		-
Construction and land development		1,546		2,062		-		2,063		-
Commercial and industrial		1,547		1,761		-		1,896		-
Consumer and other		-		-		-		-		-
Total	$	15,474	$	21,404	$	-	$	21,547	$	-

Cash flow dependent nonaccrual loans:
Commercial real estate – mortgage	$	551	$	1,841	$	154	$	3,228	$	-
Consumer real estate – mortgage		2,265		4,473		573		5,828		-
Construction and land development		2,963		4,701		201		5,102		-
Commercial and industrial		1,491		2,459		814		2,528		-
Consumer and other		79		179		22		180		-
Total	$	7,349	$	13,653	$	1,764	$	16,866	$	-

Total Nonaccrual Loans	$	22,823	$	35,057	$	1,764	$	38,413	$	-

	At December 31, 2011						For the year ended December 31, 2011
	Recorded investment		Unpaid principal balance		Related allowance⁽¹⁾		Average recorded investment		Interest income recognized
Collateral dependent nonaccrual loans:
Commercial real estate – mortgage	$	9,345	$	12,099	$	-	$	12,450	$	5
Consumer real estate – mortgage		9,248		9,961		-		10,140		-
Construction and land development		6,917		9,093		-		9,288		37
Commercial and industrial		3,036		3,546		-		3,689		-
Consumer and other		-		-		-		-		-
Total	$	28,546	$	34,699	$	-	$	35,567	$	42

Cash flow dependent nonaccrual loans:
Commercial real estate – mortgage	$	617	$	661	$	57	$	792	$	-
Consumer real estate – mortgage		3,239		4,902		301		5,005		-
Construction and land development		6,048		6,822		1,264		7,074		-
Commercial and industrial		8,854		11,041		2,767		11,497		-
Consumer and other		551		856		51		857		-
Total	$	19,309	$	24,282	$	4,440	$	25,225	$	-

Total Nonaccrual Loans	$	47,855	$	58,981	$	4,440	$	60,792	$	42

	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
Collateral dependent nonaccrual loans:
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

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

Total Nonaccrual 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 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 year ended December 31, 2012 and $42,000 and $1.3 million of interest income during the years ended December 31, 2011 and 2010, respectively.

At December 31, 2012 and 2011, there were $27.5 million and $23.4 million, respectively, of troubled debt restructurings that were performing as of their restructure date and which are accruing interest. These troubled debt restructurings are considered impaired loans pursuant to U.S. GAAP. Troubled commercial loans are restructured by specialists within Pinnacle Bank's 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 by loan classification made during the year ended December 31, 2012 and 2011 (in thousands):

	December 31, 2012						December 31, 2011
	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		4	$	11,539	$	10,022		9	$	15,378	$	12,619
Consumer real estate – mortgage		4		834		718		16		5,874		5,358
Construction and land development		-		-		-		2		77		65
Commercial and industrial		-		-		-		26		1,845		1,563
Consumer and other		1		36		31		4		242		205
		9	$	12,409	$	10,771		57	$	23,416	$	19,810

During the year ended December 31, 2012, two commercial real estate loans totaling $3.2 million, eight commercial and industrial loans totaling $476,000 and two consumer loans totaling $153,000 which were previously classified as troubled debt restructurings subsequently defaulted. For the year ended December 31, 2011, Pinnacle Financial did not have any troubled debt restructurings that subsequently defaulted, within twelve months of the restructuring. A default is defined as an occurrence which violates the terms of the receivable's contract.

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 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 Bank's total risk-based capital to borrowers in the following industries at December 31, 2012 with the comparative exposures for December 31, 2011 (in thousands):

	At December 31, 2012
	Outstanding Principal Balances		Unfunded Commitments		Total exposure		Total Exposure at December 31, 2011

Lessors of nonresidential buildings	$	382,238	$	57,999	$	440,237	$	509,003
Lessors of residential buildings		191,693		24,206		215,899		177,414
Land subdividers		92,613		15,670		108,283		119,106

The table below presents past due balances at December 31, 2012 and 2011, by loan classification and segment allocated between performing and nonperforming status (in thousands):

December 31, 2012	30-89 days past due and performing			90 days or more past due and performing			Total past due and performing			Nonperforming(1)			Current and performing			Total Loans
Commercial real estate:
Owner-occupied		$	462		$	-		$	462		$	8,091		$	585,848		$	594,401
All other			41			-			41			1,200			582,554			583,795
Consumer real estate – mortgage			3,870			-			3,870			5,906			670,150			679,926
Construction and land development			3,511			-			3,511			4,509			305,532			313,552
Commercial and industrial			2,549			-			2,549			3,038			1,440,991			1,446,578
Consumer and other			444			-			444			79			93,387			93,910
		$	10,877		$	-		$	10,877		$	22,823		$	3,678,462		$	3,712,162
December 31, 2011
Commercial real estate:
Owner-occupied		$	2,489		$	-		$	2,489		$	6,735		$	572,746		$	581,970
All other			3,260			-			3,260			3,227			522,505			528,992
Consumer real estate – mortgage			2,589			254			2,843			12,487			680,415			695,745
Construction and land development			1,572			-			1,572			12,965			259,711			274,248
Commercial and industrial			648			604			1,252			11,890			1,132,593			1,145,735
Consumer and other			526			-			526			551			63,584			64,661
		$	11,084		$	858		$	11,942		$	47,855		$	3,231,554		$	3,291,351

(1)	Approximately $9.4 million and $25.5 million of nonaccrual loans as of December 31, 2012 and 2011, respectively, are currently performing pursuant to their contractual terms.

The following table shows the allowance allocation by loan classification for accruing and nonperforming loans at December 31, 2012 and 2011 (in thousands):

					Impaired Loans
	Accruing Loans				Nonaccrual Loans				Troubled Debt Restructurings(1)				Total Allowance for Loan Losses
	December 31, 2012		December 31, 2011		December 31, 2012		December 31, 2011		December 31, 2012		December 31, 2011		December 31, 2012		December 31, 2011
Commercial real estate –mortgage	$	16,642	$	20,581	$	154	$	57	$	2,838	$	2,759	$	19,634	$	23,397
Consumer real estate – mortgage		7,336		9,485		573		301		853		516		8,762		10,302
Construction and land development		8,953		10,764		201		1,264		10		12		9,164		12,040
Commercial and industrial		23,829		17,740		814		2,767		95		282		24,738		20,789
Consumer and other		1,055		1,037		22		51		17		37		1,094		1,125
Unallocated		-		-		-		-		-		-		6,025		6,322
	$	57,815	$	59,607	$	1,764	$	4,440	$	3,813	$	3,606	$	69,417	$	73,975

(1)	Troubled debt restructurings of $27.5 million and $23.4 million as of December 31, 2012 and 2011, 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, 2010 to December 31, 2011 to December 31, 2012 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, December 31, 2009	$	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, December 31, 2010	$	19,252		$	9,898		$	19,122		$	21,426		$	1,874		$	11,003		$	82,575
Charged-off loans		(3,044	)		(5,076	)		(10,157	)		(15,360	)		(1,213	)		-			(34,850	)
Recovery of previously charged-off loans		116			495			1,530			2,167			144			-			4,452
Provision for loan losses		7,073			4,985			1,545			12,556			320			(4,681	)		21,798
Balances, December 31, 2011	$	23,397		$	10,302		$	12,040		$	20,789		$	1,125		$	6,322		$	73,975
Charged-off loans		(4,667	)		(6,731	)		(2,530	)		(4,612	)		(1,117	)		-			(19,657	)
Recovery of previously charged-off loans		285			818			1,155			7,175	⁽¹⁾		97			-			9,530
Provision for loan losses		619			4,373			(1,501	)		1,386			989			(297	)		5,569
Balances, December 31, 2012	$	19,634		$	8,762		$	9,164		$	24,738		$	1,094		$	6,025		$	69,417

(1)	Includes the 2012 $5.6 million recovery of a loan previously charged off in 2009.

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.

At December 31, 2012, Pinnacle Financial 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 $8.1 million had been drawn upon. At December 31, 2011, Pinnacle Financial had granted loans and other extensions of credit amounting to approximately $10.8 million to directors, executive officers, and their related entities, of which approximately $9.6 million had been drawn upon. These loans and extensions of credit were made 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 December 31, 2012 or 2011.

Residential Lending

At December 31, 2012, Pinnacle Financial had approximately $41.2 million of mortgage loans held-for-sale compared to approximately $35.4 million at December 31, 2011. Pinnacle Financial generally has an agreement for the subsequent sale of the mortgage loan prior to the loan being closed with the borrower. Pinnacle Financial sells loans to third-party 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 years ended December 31, 2012, Pinnacle Financial recognized $6.7 million, $4.1 million and $4.1 million, respectively, in gains on the sale of these loans, net of commissions paid.

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 best efforts 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. Generally, loans sold to the HUD/VA are underwritten by Pinnacle Bank while the majority of the loans sold to other investors are underwritten by the purchaser of the loans.

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.

From inception of Pinnacle Bank's mortgage department in January 2003 through December 31, 2012, Pinnacle Bank originated and sold approximately 13,000 mortgage loans totaling $2.821 billion to third-party purchasers. Of the approximately 13,000 mortgage loans, Pinnacle Bank underwrote approximately 3,300 conventional loans at an 80% or less loan-to-value that were sold to other investors and underwrote 2,800 loans that were sold to the HUD/VA. To date, repurchase activity pursuant to the terms of these representations and warranties has been insignificant to Pinnacle Bank. The remaining mortgage loans were underwritten by the purchasers of those loans, but funded by Pinnacle Bank until settlement with the purchaser.

Based on information currently available, management believes that it does not have material exposure to losses that may arise relating to the representations and warranties that it has made in connection with its mortgage loan sales.

Due to the current focus on foreclosure practices of financial institutions nationwide, Pinnacle Bank evaluated its foreclosure process related to home equity and consumer mortgage loans within its loan portfolio. At December 31, 2012, Pinnacle Bank has $679.9 million of home equity and consumer mortgage loans which are secured by first or second liens on residential properties. Foreclosure activity in this portfolio has been minimal. Any foreclosures on these loans are handled by designated Pinnacle Bank personnel and external legal counsel, as appropriate, following established policies regarding legal and regulatory requirements. Pinnacle Bank has not imposed any freezes on foreclosures. Based on information currently available, management believes that it does not have material exposure to faulty foreclosure practices.