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 by Pinnacle Bank 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 loans also includes owner occupied commercial real estate which shares a similar risk profile to Pinnacle Financial's commercial and industrial products.


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

•

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


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


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

Commercial loans receive risk ratings assigned by a financial advisor and approved by a senior credit officer subject to validation by Pinnacle Financial's independent loan review department. Risk ratings are categorized as pass, special mention, substandard, substandard-nonaccrual or doubtful-nonaccrual. Pinnacle Financial believes that its categories follow those used by Pinnacle Bank's primary regulators. At June 30, 2018, approximately 81.4% of Pinnacle Financial's loan portfolio was analyzed as a commercial loan type with a specifically assigned risk rating. 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 $1.0 million 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 net worth and financial 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 could sustain some loss if the deficiencies are not corrected.


•	Substandard-nonaccrual loans are substandard loans that have been placed on nonaccrual status.


•	Doubtful-nonaccrual loans have all the characteristics of substandard-nonaccrual loans with the added characteristic that the weaknesses make collection or liquidation in full, on the basis of currently existing facts, conditions and values, highly questionable and improbable.

The following table outlines the amount of each loan classification categorized into each risk rating category as of June 30, 2018 and December 31, 2017 (in thousands):



	Commercial real estate - mortgage		Consumer real estate - mortgage		Construction and land development		Commercial and industrial		Consumer and other		Total
June 30, 2018
Pass	$	6,849,567	$	2,655,282	$	2,119,011	$	4,689,555	$	362,201	$	16,675,616
Special Mention	64,873		10,049		5,594		40,461		735		121,712
Substandard ⁽¹⁾	79,915		13,175		7,013		74,465		70		174,638
Substandard-nonaccrual	30,284		20,893		2,028		16,818		864		70,887
Doubtful-nonaccrual	—		—		—		—		—		—
Total loans	$	7,024,639	$	2,699,399	$	2,133,646	$	4,821,299	$	363,870	$	17,042,853



December 31, 2017
Pass	$	6,487,368	$	2,503,688	$	1,880,704	$	4,014,656	$	351,359	$	15,237,775
Special Mention	94,134		18,356		8,148		46,898		1,177		168,713
Substandard ⁽¹⁾	72,044		21,053		13,468		62,529		79		169,173
Substandard-nonaccrual	16,064		18,117		5,968		17,258		48		57,455
Doubtful-nonaccrual	—		—		—		—		—		—
Total loans	$	6,669,610	$	2,561,214	$	1,908,288	$	4,141,341	$	352,663	$	15,633,116

(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 $170.8 million at June 30, 2018, compared to $164.0 million at December 31, 2017.

Loans acquired with deteriorated credit quality are recorded pursuant to the provisions of ASC 310-30, and are referred to as purchase credit impaired loans. The following table provides a rollforward of purchase credit impaired loans from December 31, 2017 through June 30, 2018 (in thousands):



	Gross Carrying Value			Accretable Yield			Nonaccretable Yield			Net Carrying Value
December 31, 2017	$	74,324		$	(132	)	$	(31,537	)	$	42,655
Acquisition	—			—			—			—
Year-to-date settlements	(10,356		)	16			3,346			(6,994		)
June 30, 2018	$	63,968		$	(116	)	$	(28,191	)	$	35,661

Certain of 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.

For the three and six months ended June 30, 2018, the average balance of impaired loans was $75.1 million and $69.8 million, respectively, compared to $32.9 million and $33.2 million for the same periods in 2017. Pinnacle Financial's policy is that the accrual of interest income will be discontinued 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 no interest income from cash payments received on nonaccrual loans during the three and six months ended June 30, 2018 compared to approximately $16,000 and $65,000, respectively, during the three and six months ended June 30, 2017. Had these nonaccruing loans been on accruing status, interest income would have been higher by $1.2 million and $2.2 million, respectively, for the three and six months ended June 30, 2018 compared to $1.0 million and $1.5 million, respectively, higher for the three and six months ended June 30, 2017.

Impaired loans, as disclosed in the table below, include troubled debt restructurings, nonaccrual loans, and loans deemed to be impaired but that continue to accrue interest. The following tables detail the recorded investment, unpaid principal balance and related allowance of Pinnacle Financial's impaired loans at June 30, 2018 and December 31, 2017 by loan classification (in thousands):



	At June 30, 2018						At December 31, 2017
	Recorded investment		Unpaid principal balances		Related allowance		Recorded investment		Unpaid principal balances		Related allowance
Impaired loans with an allowance:
Commercial real estate – mortgage	$	16,667	$	16,698	$	1,092	$	1,850	$	1,863	$	95
Consumer real estate – mortgage	12,577		12,624		433		8,028		8,079		410
Construction and land development	1,737		1,738		33		2,522		2,528		66
Commercial and industrial	6,032		6,086		588		12,521		12,644		1,627
Consumer and other	863		886		182		—		—		—
Total	$	37,876	$	38,032	$	2,328	$	24,921	$	25,114	$	2,198

Impaired loans without an allowance:
Commercial real estate – mortgage	$	22,601	$	22,684	$	—	$	16,364	$	16,514	$	—
Consumer real estate – mortgage	5,016		5,036		—		4,144		4,174		—
Construction and land development	—		—		—		2,645		2,650		—
Commercial and industrial	15,339		15,324		—		10,905		10,902		—
Consumer and other	—		—		—		—		—		—
Total	$	42,956	$	43,044	$	—	$	34,058	$	34,240	$	—

Total impaired loans	$	80,832	$	81,076	$	2,328	$	58,979	$	59,354	$	2,198

The following table details the average recorded investment and the amount of interest income recognized on a cash basis for the three and six months ended June 30, 2018 and 2017, respectively, of impaired loans by loan classification (in thousands):



	For the three months ended June 30,								For the six months ended June 30,
	2018				2017				2018				2017
	Average recorded investment		Interest income recognized		Average recorded investment		Interest income recognized		Average recorded investment		Interest income recognized		Average recorded investment		Interest income recognized
Impaired loans with an allowance:
Commercial real estate – mortgage	$	12,527	$	—	$	395	$	—	$	8,968	$	—	$	410	$	—
Consumer real estate – mortgage	11,066		—		4,437		—		10,053		—		4,058		—
Construction and land development	1,059		—		77		—		1,547		—		79		—
Commercial and industrial	7,976		—		11,778		—		9,491		—		9,203		—
Consumer and other	822		—		677		—		548		—		628		—
Total	$	33,450	$	—	$	17,364	$	—	$	30,607	$	—	$	14,378	$	—

Impaired loans without an allowance:
Commercial real estate – mortgage	$	18,493	$	—	$	2,599	$	—	$	17,783	$	—	$	2,502	$	—
Consumer real estate – mortgage	4,805		—		5,722		—		4,585		—		5,695		—
Construction and land development	—		—		1,031		16		882		—		1,730		65
Commercial and industrial	18,401		—		6,199		—		15,902		—		8,892		—
Consumer and other	—		—		—		—		—		—		—		—
Total	$	41,699	$	—	$	15,551	$	16	$	39,152	$	—	$	18,819	$	65

Total impaired loans	$	75,149	$	—	$	32,915	$	16	$	69,759	$	—	$	33,197	$	65

At June 30, 2018 and December 31, 2017, there were $5.6 million and $6.6 million, respectively, of troubled debt restructurings that were performing as of their restructure date and which were accruing interest. 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 loan category where troubled debt restructurings were made during the three and six months ended June 30, 2018 and 2017 (dollars in thousands):



	Three months ended June 30,					Six months ended June 30,
2018	Number of contracts	Pre Modification Outstanding Recorded Investment		Post Modification Outstanding Recorded Investment, net of related allowance		Number of contracts	Pre Modification Outstanding Recorded Investment		Post Modification Outstanding Recorded Investment, net of related allowance
Commercial real estate – mortgage	—	$	—	$	—	—	$	—	$	—
Consumer real estate – mortgage	1	38		38		1	38		38
Construction and land development	—	—		—		—	—		—
Commercial and industrial	—	—		—		—	—		—
Consumer and other	—	—		—		—	—		—
	1	$	38	$	38	1	$	38	$	38

2017
Commercial real estate – mortgage	—	$	—	$	—	—	$	—	$	—
Consumer real estate – mortgage	1	9		6		1	9		6
Construction and land development	—	—		—		—	—		—
Commercial and industrial	—	—		—		2	2,033		2,033
Consumer and other	—	—		—		—	—		—
	1	$	9	$	6	3	$	2,042	$	2,039

During the six months ended June 30, 2018 and 2017, Pinnacle Financial did not have any troubled debt restructurings that subsequently defaulted within twelve months of the restructuring.

At both June 30, 2018 and December 31, 2017, the allowance for loan losses included no allowance specifically related to accruing troubled debt restructurings, which are classified as impaired loans pursuant to U.S. GAAP, but which loans continued to accrue interest at contractual rates at those dates.

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 June 30, 2018 with the comparative exposures for December 31, 2017 (in thousands):



	June 30, 2018
	Outstanding Principal Balances		Unfunded Commitments		Total exposure		Total Exposure at December 31, 2017
Lessors of nonresidential buildings	$	3,096,519	$	668,891	$	3,765,410	$	3,483,597
Lessors of residential buildings	981,328		283,888		1,265,216		1,151,676
Hotels (except Casino Hotels) and Motels	723,347		167,577		890,924		836,320
New Housing For-Sale Builders	374,653		593,400		968,053		780,137

Additionally, Pinnacle Financial monitors two ratios regarding construction and commercial real estate lending as part of its concentration management processes. Both ratios are calculated by dividing certain types of loan balances for each of the two categories by Pinnacle Bank’s total risk-based capital. At June 30, 2018 and December 31, 2017, Pinnacle Bank’s construction and land development loans as a percentage of total risk-based capital were 94.6% and 89.4%, respectively. Non-owner occupied commercial real estate and multifamily loans (including construction and land development loans) as a percentage of total risk-based capital were 304.3% and 297.1% as of June 30, 2018 and December 31, 2017, respectively. Banking regulations have established guidelines for the construction ratio of less than 100% of total risk-based capital and for the non-owner occupied ratio of less than 300% of total risk-based capital. When a bank’s ratios are in excess of one or both of these guidelines, banking regulations generally require an increased level of monitoring in these lending areas by bank management. At June 30, 2018, Pinnacle Bank slightly exceeded the 300% guideline and has established what it believes to be appropriate controls to monitor Pinnacle Bank's lending in this area.

The table below presents past due balances by loan classification and segment at June 30, 2018 and December 31, 2017, allocated between accruing and nonaccrual status (in thousands):



	Accruing										Nonaccruing
June 30, 2018	30-89 days past due and accruing		90 days or more past due and accruing		Total past due and accruing		Current and accruing		Purchase credit impaired		Nonaccrual ⁽¹⁾		Nonaccruing purchase credit impaired		Total loans
Commercial real estate:
Owner-occupied	$	2,132	$	—	$	2,132	$	2,474,296	$	3,424	$	22,874	$	2,164	$	2,504,890
All other	7,017		—		7,017		4,495,948		11,539		2,274		2,971		4,519,749
Consumer real estate – mortgage	14,093		—		14,093		2,660,129		4,285		14,776		6,116		2,699,399
Construction and land development	2,725		—		2,725		2,125,629		3,264		662		1,366		2,133,646
Commercial and industrial	5,755		875		6,630		4,797,371		480		16,767		51		4,821,299
Consumer and other	5,088		697		5,785		357,221		—		863		1		363,870
Total	$	36,810	$	1,572	$	38,382	$	16,910,594	$	22,992	$	58,216	$	12,669	$	17,042,853



December 31, 2017
Commercial real estate:
Owner-occupied	$	6,772	$	104	$	6,876	$	2,435,819	$	4,820	$	11,395	$	1,105	$	2,460,015
All other	16,559		—		16,559		4,177,454		12,018		704		2,860		4,209,595
Consumer real estate – mortgage	14,835		1,265		16,100		2,521,748		5,249		9,320		8,797		2,561,214
Construction and land development	4,136		146		4,282		1,894,560		3,478		2,878		3,090		1,908,288
Commercial and industrial	7,406		1,348		8,754		4,114,127		1,154		17,222		84		4,141,341
Consumer and other	6,311		1,276		7,587		345,076		—		—		—		352,663
Total	$	56,019	$	4,139	$	60,158	$	15,488,784	$	26,719	$	41,519	$	15,936	$	15,633,116


(1)	Approximately $54.4 million and $45.8 million of nonaccrual loans as of June 30, 2018 and December 31, 2017, respectively, were performing pursuant to their contractual terms at those dates.

The following table details the changes in the allowance for loan losses for the three and six months ended June 30, 2018 and 2017, 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 June 30, 2018:
Balance at March 31, 2018	$	22,688		$	5,100		$	10,116		$	26,648		$	5,476		$	176	$	70,204
Charged-off loans	(234		)	(935		)	(10		)	(1,724		)	(3,795		)	—		(6,698		)
Recovery of previously charged-off loans	58			537			1,010			567			590			—		2,762
Provision for loan losses	2,336			1,151			(132		)	2,847			2,901			299		9,402
Balance at June 30, 2018	$	24,848		$	5,853		$	10,984		$	28,338		$	5,172		$	475	$	75,670



	Commercial real estate - mortgage			Consumer real estate - mortgage			Construction and land development			Commercial and industrial			Consumer and other			Unallocated			Total
Three months ended June 30, 2017:
Balance at March 31, 2017	$	14,168		$	7,219		$	4,441		$	22,912		$	8,477		$	1,133		$	58,350
Charged-off loans	(8		)	(206		)	—			(495		)	(4,448		)	—			(5,157		)
Recovery of previously charged-off loans	9			412			96			560			862			—			1,939
Provision for loan losses	1,833			410			589			1,258			2,658			64			6,812
Balance at June 30, 2017	$	16,002		$	7,835		$	5,126		$	24,235		$	7,549		$	1,197		$	61,944

Six months ended June 30, 2018:
Balance at December 31, 2017	$	21,188		$	5,031		$	8,962		$	24,863		$	5,874		$	1,322		$	67,240
Charged-off loans	(962		)	(1,271		)	(12		)	(4,264		)	(8,858		)	—			(15,367		)
Recovery of previously charged-off loans	1,454			1,203			1,575			1,455			1,777			—			7,464
Provision for loan losses	3,168			890			459			6,284			6,379			(847		)	16,333
Balance at June 30, 2018	$	24,848		$	5,853		$	10,984		$	28,338		$	5,172		$	475		$	75,670

Six months ended June 30, 2017:
Balance at December 31, 2016	$	13,655		$	6,564		$	3,624		$	24,743		$	9,520		$	874		$	58,980
Charged-off loans	(9		)	(268		)	—			(1,653		)	(8,391		)	—			(10,321		)
Recovery of previously charged-off loans	15			582			129			702			1,394			—			2,822
Provision for loan losses	2,341			957			1,373			443			5,026			323			10,463
Balance at June 30, 2017	$	16,002		$	7,835		$	5,126		$	24,235		$	7,549		$	1,197		$	61,944

The following table details the allowance for loan losses and recorded investment in loans by loan classification and by impairment evaluation method as of June 30, 2018 and December 31, 2017, respectively (in thousands):



	Commercial real estate - mortgage		Consumer real estate - mortgage		Construction and land development		Commercial and industrial		Consumer and other		Unallocated		Total
June 30, 2018
Allowance for Loan Losses:
Collectively evaluated for impairment	$	23,394	$	5,323	$	10,944	$	27,748	$	4,990			$	72,399
Individually evaluated for impairment	1,092		433		33		588		182				2,328
Loans acquired with deteriorated credit quality ⁽¹⁾	362		97		7		2		—				468
Total allowance for loan losses	$	24,848	$	5,853	$	10,984	$	28,338	$	5,172	$	475	$	75,670

Loans:
Collectively evaluated for impairment	$	6,965,272	$	2,671,404	$	2,127,279	$	4,799,396	$	363,007			$	16,926,358
Individually evaluated for impairment	39,268		17,593		1,737		21,371		863				80,832
Loans acquired with deteriorated credit quality	20,099		10,402		4,630		532		—				35,663
Total loans	$	7,024,639	$	2,699,399	$	2,133,646	$	4,821,299	$	363,870			$	17,042,853

December 31, 2017
Allowance for Loan Losses:
Collectively evaluated for impairment	$	20,753	$	4,460	$	8,879	$	23,181	$	5,874			$	63,147
Individually evaluated for impairment	95		410		66		1,627		—				2,198
Loans acquired with deteriorated credit quality⁽¹⁾	340		161		17		55		—				573
Total allowance for loan losses	$	21,188	$	5,031	$	8,962	$	24,863	$	5,874	$	1,322	$	67,240

Loans:
Collectively evaluated for impairment	$	6,630,593	$	2,534,996	$	1,896,553	$	4,116,677	$	352,663			$	15,531,482
Individually evaluated for impairment	18,214		12,172		5,167		23,426		—				58,979
Loans acquired with deteriorated credit quality	20,803		14,046		6,568		1,238		—				42,655
Total loans	$	6,669,610	$	2,561,214	$	1,908,288	$	4,141,341	$	352,663			$	15,633,116

⁽¹⁾ Loans acquired with deteriorated credit quality are recorded at fair value at the time of acquisition. An allowance for loan losses is recorded resulting from subsequent credit deterioration.

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 June 30, 2018, Pinnacle Bank had granted loans and other extensions of credit amounting to approximately $24.4 million to current directors, executive officers, and their related entities, of which $13.4 million had been drawn upon. At December 31, 2017, Pinnacle Bank had granted loans and other extensions of credit amounting to approximately $26.4 million to directors, executive officers, and their related entities, of which approximately $16.1 million had been drawn upon. None of these loans to directors, executive officers, and their related entities were impaired at June 30, 2018 or December 31, 2017.

At June 30, 2018, Pinnacle Financial had approximately $21.3 million in commercial loans held for sale compared to $25.5 million at December 31, 2017, which primarily included commercial real estate and apartment loans originated for sale to a third-party as part of a multi-family loan program. Such loans are closed under a pass-through commitment structure wherein Pinnacle Bank's loan commitment to the borrower is the same as the third party's take-out commitment to Pinnacle Bank and the third party purchase typically occurs within thirty days of Pinnacle Bank closing with the borrowers.

Residential Lending

At June 30, 2018, Pinnacle Financial had approximately $106.8 million of mortgage loans held-for-sale compared to approximately $102.7 million at December 31, 2017. Total loan volumes sold during the six months ended June 30, 2018 were approximately $636.7 million compared to approximately $422.7 million for the six months ended June 30, 2017. During the three and six months ended June 30, 2018, Pinnacle Financial recognized $3.8 million and $7.5 million, respectively, in gains on the sale of these loans, net of commissions paid, compared to $4.7 million and $8.8 million, respectively, net of commissions paid, during the three and six months ended June 30, 2017.

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, Pinnacle Bank's liability pursuant to the terms of these representations and warranties has been insignificant to Pinnacle Bank.