Note 4. 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).

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 June 30, 2012 presentation. Troubled debt restructurings previously included in accruing loans are now broken out separately.

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 Pinnacle National's primary regulator. At June 30, 2012, 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 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 loan. 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 is 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 of at least 70% of our risk rated portfolio annually. Included in the 70% coverage are independent loan reviews of loans in targeted higher-risk portfolio segments such as certain commercial and industrial 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, 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.

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. All doubtful-nonaccrual loans are on nonaccrual status.

The following table outlines the amount of each loan classification categorized into each risk rating class as of June 30, 2012 and December 31, 2011 (in thousands):

June 30, 2012	Commercial real estate - mortgage		Consumer real estate - mortgage		Construction and land development		Commercial and industrial		Consumer and other		Total

Accruing loans
Pass	$	1,052,422	$	645,766	$	228,825	$	1,182,567	$	73,695	$	3,183,275
Special Mention		21,228		6,189		27,067		19,524		-		74,008
Substandard (1)		59,142		15,358		26,696		18,757		-		119,953

Impaired Loans
Troubled debt restructurings(2)
Pass	$	333	$	3,833	$	74	$	728	$	124	$	5,092
Special Mention		4,508		-		-		-		-		4,508
Substandard		14,199		2,212		360		255		-		17,026
Total troubled debt restructurings	$	19,040	$	6,045	$	434	$	983	$	124	$	26,626

Nonaccrual loans
Substandard		15,236		13,344		6,039		5,345		459		40,423
Doubtful		-		300		-		98		-		398
Total nonaccrual loans	$	15,236	$	13,644	$	6,039	$	5,443	$	459	$	40,821

Total Impaired loans		34,276		19,689		6,473		6,426		583		67,447
				-		-
Total Loans	$	1,167,068	$	687,002	$	289,061	$	1,227,275	$	74,277	$	3,444,683

December 31, 2011

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

Impaired Loans
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

Nonaccrual loans
Substandard	$	9,962	$	11,990	$	12,965	$	11,194	$	551	$	46,662
Doubtful		-		497		-		696		-		1,193
Total nonaccrual loans	$	9,962	$	12,487	$	12,965	$	11,890	$	551	$	47,855

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 the OCC, Pinnacle National's primary regulator, 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 $120.0 million at June 30, 2012, compared to $135.4 million at December 31, 2011.

(2)

Troubled debt restructurings are accruing. Troubled debt restructurings are presented as an impaired, however, continue to accrue interest at contractual rates.

At June 30, 2012 and December 31, 2011, all loans classified as nonaccrual were deemed to be impaired. The principal balances of these nonaccrual loans amounted to $40.8 million and $47.9 million at June 30, 2012 and December 31, 2011, respectively, and are included in the table above. For the six months ended June 30, 2012, the average balance of nonaccrual loans was $43.8 million as compared to $63.9 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 $618,000 and $1.1 million, respectively, for the three and six months ended June 30, 2012 compared to $1.1 million and $2.7 million, respectively, for the three and six months ended June 30, 2011.

The following table details the recorded investment, unpaid principal balance and related allowance and average recorded investment of our nonaccrual loans at June 30, 2012 and December 31, 2011 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 June 30, 2012						For the six months ended June 30, 2012
	Recorded investment		Unpaid principal balance		Related allowance(1)		Average recorded investment		Interest income recognized

Collateral dependent nonaccrual loans:
Commercial real estate - mortgage	$	14,235	$	14,659	$	-	$	16,763	$	-
Consumer real estate - mortgage		11,220		11,386		-		13,675		-
Construction and land development		2,942		3,048		-		3,320		-
Commercial and industrial		2,239		2,333		-		2,806		-
Consumer and other		-		-		-		-		-
Total	$	30,636	$	31,426	$	-	$	36,564	$	-

Cash flow dependent nonaccrual loans:
Commercial real estate - mortgage	$	1,001	$	1,052	$	209	$	1,101	$	-
Consumer real estate - mortgage		2,424		2,559		507		4,070		-
Construction and land development		3,097		3,180		281		4,360		-
Commercial and industrial		3,204		3,428		1,566		3,769		-
Consumer and other		459		484		96		592		-
Total	$	10,185	$	10,703	$	2,659	$	13,892	$	-

Total Nonaccrual Loans	$	40,821	$	42,129	$	2,659	$	50,456	$	-

	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

(1)

Collateral dependent loans are typically charged-off to their net realizable value pursuant to requirements of our primary regulator 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 six months ended June 30, 2012 and $42,000 of interest income during the year ended December 31, 2011.

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. Loans that have been restructured that were performing as of the restructure date and continue to perform are reported separately as troubled debt restructurings.

At June 30, 2012 and December 31, 2011, there were $26.6 million and $23.4 million, respectively, of troubled debt restructurings that were performing as of the restructure date which are accruing interest, but are considered impaired loans pursuant to U.S. GAAP. Troubled commercial loans are restructured by specialists within our Special Assets Group, and all restructurings are approved by committees and credit officers separate and apart from the normal loan approval process. These specialists are charged with reducing Pinnacle Financial's overall risk and exposure to loss in the event of a restructuring by obtaining some or all of the following: improved documentation, additional guaranties, increase in curtailments, reduction in collateral release terms, additional collateral or other similar strategies.

The following table outlines the amount of each troubled debt restructuring categorized by loan classification as of June 30, 2012 and December 31, 2011 (in thousands):

	June 30, 2012								December 31, 2011
	Number of contracts		Pre Modification Outstanding Recorded Investment		Related Allowance		Post Modification Outstanding Recorded Investment, net of related allowance		Number of contracts		Pre Modification Outstanding Recorded Investment		Related Allowance		Post Modification Outstanding Recorded Investment, net of related allowance
Commercial real estate - mortgage		9	$	19,040	$	2,757	$	16,283		9	$	15,378	$	2,759	$	12,619
Consumer real estate - mortgage		15		6,045		787		5,258		16		5,874		516		5,358
Construction and land development		2		434		27		407		2		77		12		65
Commercial and industrial		13		983		137		846		26		1,845		282		1,563
Consumer and other		3		124		17		107		4		242		37		205
		42	$	26,626	$	3,725	$	22,901		57	$	23,416	$	3,606	$	19,810

During the six months ended June 30, 2012, Pinnacle Financial reclassified four commercial loans totaling $194,000 and two consumer loans totaling $154,000 which were previously classified as troubled debt restructurings to nonperforming status due to their lack of performance.

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 National's total risk-based capital to borrowers in the following industries at June 30, 2012 with the comparative exposures for December 31, 2011 (in thousands):

	At June 30, 2012
	Outstanding Principal Balances		Unfunded Commitments		Total exposure		Total Exposure at December 31, 2011

Lessors of nonresidential buildings	$	373,153	$	44,653	$	417,806	$	509,003
Lessors of residential buildings		174,526		17,732		192,258		177,414
Land subdividers		108,189		16,989		125,178		119,106

The table below presents past due balances at June 30, 2012 and December 31, 2011, by loan classification and segment allocated between performing and nonperforming status (in thousands):

	At June 30, 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	$	1,254	$	-	$	1,254	$	11,039	$	589,238	$	601,531
All other		108		-		108		4,197		561,232		565,537
Consumer real estate - mortgage		2,979		-		2,979		13,644		670,379		687,002
Construction and land development		516		-		516		6,039		282,506		289,061
Commercial and industrial		2,244		-		2,244		5,443		1,219,587		1,227,274
Consumer and other		208		-		208		460		73,610		74,278
	$	7,309	$	-	$	7,309	$	40,822	$	3,396,552	$	3,444,683

	At December 31, 2011
	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	$	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 $18.4 million and $25.5 million of nonaccrual loans as of June 30, 2012 and December 31, 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 June 30, 2012 and December 31, 2011 (in thousands):

					Impaired Loans
	Accruing Loans				Nonaccrual Loans				Troubled Debt Restructurings(1)				Total Allowance for Loan Losses
	June 30, 2012		December 31, 2011		June 30, 2012		December 31, 2011		June 30, 2012		December 31, 2011		June 30, 2012		December 31, 2011
Commercial real estate -mortgage	$	18,126	$	20,581	$	209	$	57	$	2,757	$	2,759	$	21,092	$	23,397
Consumer real estate - mortgage		8,327		9,485		507		301		787		516		9,621		10,302
Construction and land development		9,935		10,764		281		1,264		27		12		10,243		12,040
Commercial and industrial		19,833		17,740		1,566		2,767		137		282		21,536		20,789
Consumer and other		1,056		1,037		96		51		17		37		1,169		1,125
Unallocated		5,953		6,322		-		-		-		-		5,953		6,322
	$	57,277	$	59,607	$	2,659	$	4,440	$	3,725	$	3,606	$	69,614	$	73,975

(1)

Troubled debt restructurings of $26.6 million and $23.4 million as of June 30, 2012 and December 31, 2011, respectively, are shown as impaired loans, however, 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 June 30, 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, 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		(624	)		(3,219	)		(1,437	)		(2,929	)		(566	)		-			(8,775	)
Recovery of previously charged-off loans		212			721			701			1,065			47			-			2,746
Provision for loan losses		(1,893	)		1,817			(1,061	)		2,611			563			(369	)		1,668
Balances, June 30, 2012	$	21,092		$	9,621		$	10,243		$	21,536		$	1,169		$	5,953		$	69,614

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 June 30, 2012, Pinnacle Financial had granted loans and other extensions of credit amounting to approximately $10.8 million to current directors, executive officers, and their related entities, of which $9.5 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 June 30, 2012 or December 31, 2011. At June 30, 2012 and December 31, 2011, Pinnacle National had $3.6 million of loans to a director and his affiliated entities which have been classified as potential problem loans.

Residential Lending

At June 30, 2012, Pinnacle Financial had approximately $36.3 million of mortgage loans held-for-sale compared to approximately $35.4 million at December 31, 2011. 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 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 and six months ended June 30, 2012, Pinnacle Financial recognized $1.5 million and $3.0 million, respectively, in gains on the sale of these loans compared to $0.8 million and $1.4 million, respectively, during the three and six months ended June 30, 2011.

These mortgage loans held-for-sale are originated internally and are primarily to borrowers in Pinnacle National'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 National 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 National 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 National 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 National's mortgage department in January 2003 through June 30, 2012, Pinnacle National originated and sold approximately 11,900 mortgage loans totaling $2.5 billion to third-party purchasers. Of the approximately 11,900 mortgage loans, Pinnacle underwrote approximately 2,800 conventional loans at a 80% or less loan-to-value that were sold to other investors and underwrote 2,400 loans that were sold to the HUD/VA. To date, repurchase activity pursuant to the terms of these representations and warranties has been insignificant and has resulted in insignificant losses to Pinnacle National. The remaining mortgage loans were underwritten by the purchasers of those loans, but funded by Pinnacle 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 National evaluated its foreclosure process related to home equity and consumer mortgage loans within its loan portfolio. At June 30, 2012, Pinnacle National has $653.6 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 National personnel and external legal counsel, as appropriate, following established policies regarding legal and regulatory requirements. Pinnacle National 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.