The following is a discussion of our financial condition at December 31, 2012 and 2011 and our results of operations for each of the years in the three-year period ended December 31, 2012. The purpose of this discussion is to focus on information about our financial condition and results of operations which is not otherwise apparent from the consolidated financial statements. The following discussion and analysis should be read along with our consolidated financial statements and the related notes included elsewhere herein.

Overview

General. During 2012, our focus was to improve our asset quality and grow the core earnings capacity of the firm. Our fully diluted net income per common share available to common stockholders for the year ended December 31, 2012 was $1.10 compared to fully diluted net income (loss) per common share available to common stockholders of $1.09 and ($0.93) for the years ended December 31, 2011 and 2010, respectively. Results for the year ended December 31, 2011, included a $22.5 million benefit associated with the reversal of the deferred tax valuation allowance which was established during the fiscal year ended December 31, 2010.

Results of operations. Our net interest income increased to $162.9 million for 2012 compared to $151.5 million for 2011 and $144.4 million for 2010. The net interest margin (the ratio of net interest income to average earning assets) for 2012 was 3.77% compared to 3.55% for 2011 and 3.25% for 2010. Our net interest margin was impacted favorably in all three years by an increased effort to reduce our cost of funds and our decreased dependency on higher priced noncore funding.

Our provision for loan losses was $5.6 million for 2012 compared to $21.8 million in 2011 and $53.7 million in 2010. Our net charge-offs were $10.1 million during 2012 compared to $30.4 million in 2011 and $63.1 million in 2010. During 2012, we decreased our allowance for loan losses as a percentage of loans from 2.25% at December 31, 2011 to 1.87% at December 31, 2012 primarily due to the ongoing resolution of non-performing loans, the reduction in our net charge-offs, and overall improvements in the asset quality of our loan portfolio during 2012.

Noninterest income for 2012 compared to 2011 increased by $5.5 million, or 14.4%. This growth was primarily attributable to increased production in our mortgage origination business as well as in our fee-based products such as investments, insurance and trust. Noninterest income for 2011 compared to 2010 increased by $1.6 million, or 4.5%.

Noninterest expense for 2012 compared to 2011 decreased by $942 thousand, or 6.8%, primarily due to decreased other real estate owned expenses, which decreased by $5.9 million over the 2011 levels, and lower FDIC insurance expense, which decreased by $3.5 million offset by higher salaries and employee benefits expense, which increased by $3.6 million. Noninterest expense for 2011 compared to 2010 decreased by $7.8 million, or 5.3%, primarily due to decreased other real estate owned expenses which decreased by $11.8 million from 2010, and lower FDIC insurance expense, which decreased by $2.8 million from 2010, offset by higher salaries and employee benefits expense, which increased by $9.8 million primarily as a result of $9.4 million of cash incentive compensation in 2011compared to no cash incentive compensation paid in 2010. The number of full-time equivalent employees decreased from 769 at December 31, 2010 to 747 at December 31, 2011. There were 730.5 full-time equivalent employees at December 31, 2012.

Income tax expense for 2012 was $20.6 million compared to an income tax benefit of $15.2 million in 2011 and income tax expense of $4.4 million in 2010. The effective income tax expense rate for the year ended December 31, 2012 was approximately 33.0%, compared to an income tax benefit rate of 53.5% for the year ended December 31, 2011 and an effective income tax expense rate of 22.2% for the year ended December 31, 2010. For the year ended December 31, 2012, our effective income tax rate differs from the statutory rates primarily due to our investments in bank qualified municipal securities, our real estate investment trust and bank-owned life insurance offset in part by meals and entertainment expense and executive compensation expense, portions of which are non-deductible. For the years ended December 31, 2011 and 2010, our income tax expense rate was principally impacted by the reversal of the deferred tax valuation allowance in the third quarter of 2011 which had been initially established during the second quarter of 2010.

Net income available to common stockholders for 2012 was $38.1 million compared to $37.1 million in net income in 2011 and $30.4 million in net loss available to common stockholders in 2010. Fully-diluted net income per common share available to common stockholders was $1.10 for 2012 compared to fully-diluted net income per common share available to common stockholders of $1.09 for 2011 and fully-diluted net loss per common share available to common stockholders of $0.93 for 2010. Included in net income available to common stockholders for the year ended December 31, 2012 was approximately $3.8 million of charges related to preferred stock dividends and accretion of the preferred stock discount related to our participation in the U.S. Treasury's CPP, as compared to $6.7 million for the year ended December 31, 2011 and $6.1 million for the year ended December 31, 2010. The charges associated with the preferred stock in fiscal 2012 and 2011 included the acceleration of the preferred stock discount associated with the early redemption of 23,750 shares of Series A preferred stock during the fourth quarter of 2011 and the remaining 71,250 shares during the second quarter of 2012.

Financial Condition. Our loan balances increased by $420.8 million during 2012 compared to an increase of $78.9 million in 2011. The increase in our outstanding loan balances represents a renewed focus on our organic growth model. Loan growth in 2011 was offset by the continued resolution of non-performing loans, specifically loans within the construction and development portfolio.

Total deposits increased from $3.654 billion at December 31, 2011 to $4.015 billion at December 31, 2012. Within our deposits, the ratio of core funding to total deposits increased from 83.8% at December 31, 2011 to 89.9% at December 31, 2012. The increase in our core funding percentage contributed to our improved cost of funds during 2012.

We believe we have hired experienced relationship managers that have significant client portfolios and longstanding reputations within the communities we serve. As such, we believe they will attract additional loans and deposits from new and existing small-and middle-market clients as the economies in our principal markets continue to strengthen.

Capital and Liquidity. At December 31, 2012 and 2011, our capital ratios, including our bank's capital ratios, exceeded regulatory minimum capital requirements. From time to time we may be required to support the capital needs of Pinnacle Bank. At December 31, 2012, we had approximately $13.7 million of cash at the holding company which could be used to support our bank. Although we do not anticipate our bank needing any additional capital from us currently, we believe we have various capital raising techniques available to us to provide for the capital needs of our bank, if necessary.

During the fourth quarter of 2008, we issued 95,000 shares of Series A preferred stock for $95 million to the U.S. Treasury as part of the U.S. Treasury's TARP Capital Purchase Program (CPP). Concurrently, we issued warrants to acquire 534,910 shares of our common stock to the U.S. Treasury. The warrants had an exercise price of $26.64 each, were immediately exercisable and expired 10 years from the date of issuance. Subsequently, the number of warrants outstanding was reduced by half as a result of our 2009 public stock offering. During the fourth quarter of 2011, we repurchased 25% of the shares of Series A preferred stock originally issued to the U.S. Treasury under the CPP in a transaction totaling approximately $23.9 million. During the second quarter of 2012, we completed the redemption of the remaining 71,250 outstanding preferred shares owned by the U.S. Treasury in a transaction totaling $71.6 million. We accelerated the accretion of the remaining preferred stock discount of approximately $1.7 million during the second quarter of 2012. Subsequent to the redemption of the preferred shares, we repurchased all of the remaining outstanding warrants held by the U.S. Treasury for $755,000 during the third quarter of 2012.

Critical Accounting Estimates

The accounting principles we follow and our methods of applying these principles conform with U.S. generally accepted accounting principles and with general practices within the banking industry. In connection with the application of those principles, we have made judgments and estimates which, in the case of the determination of our allowance for loan losses, the valuation of other real estate owned, the assessment of the valuation of deferred tax assets and the assessment of impairment of intangibles, has been critical to the determination of our financial position and results of operations.

Allowance for Loan Losses (allowance). Our management assesses the adequacy of the allowance prior to the end of each calendar quarter. This assessment includes procedures to estimate the allowance and test the adequacy and appropriateness of the resulting balance. The level of the allowance is based upon management's 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 the loan (including the timing of future payment), the estimated value of any underlying collateral, composition of the loan portfolio, economic conditions, industry and peer bank loan quality indications and other pertinent factors, including regulatory recommendations. The level of allowance maintained is believed by management to be adequate to absorb probable losses inherent in the loan portfolio at the balance sheet date. The allowance is increased by provisions charged to expense and decreased by charge-offs, net of recoveries of amounts previously charged-off. Allocation of the allowance may be made for specific loans, but the entire allowance is available for any loan that, in management's judgment, is deemed to be uncollectible.

In assessing the adequacy of the allowance, we also consider the results of our ongoing independent loan review process. We undertake this process both to ascertain those loans in the portfolio with elevated credit risk and to assist in our overall evaluation of the risk characteristics of the entire loan portfolio. Our loan review process includes the judgment of management, independent internal loan reviewers, and reviews that may have been conducted by third-party reviewers including regulatory examiners. We incorporate relevant loan review results in the loan impairment determination.

Our allowance for loan losses is composed of the result of two independent analyses pursuant to the provisions of ASC 450-20, Loss Contingencies and ASC 310-10-35, Receivables. The ASC 450-20 analysis is intended to quantify the inherent risk in our performing loan portfolio. The component of the allowance generated by ASC 310-10-35 is the result of a loan-by-loan analysis of loans that have been specifically identified as impaired.

The ASC 450-20 component of the allowance for loan losses begins with a process of estimating the probable losses based on our internal system of risk ratings and historical loss data for our risk rated portfolio. Prior to 2010, because of our limited loss history, loss estimates were primarily derived from historical loss data by loan categories for comparable peer institutions. During 2010, we incorporated the results of our own historical migration analysis of all loans that were charged-off during the prior eight quarters. The look-back period in our migration analysis was extended in 2011 to eleven quarters to continue to include the losses incurred in the second quarter of 2009. Subsequently, we have increased our look-back period each quarter to include the most recent quarters' loss history for a total of 15 quarters as of December 31, 2012. We will likely continue to increase our look-back period to eventually incorporate twenty quarters of loss history. In this current economic environment, we believe the extension of our look-back period in our migration analysis is appropriate due to the risks inherent in our loan portfolio. Absent the extension, the early cycle periods in which we experienced significant losses would be excluded from the determination of the allowance and its balance would decrease. This migration analysis assists in evaluating loan loss allocation rates for the various risk grades assigned to loans in our portfolio. The results of the migration analysis are then compared to other industry factors to determine the loss allocation rates for the risk rated loan portfolios. The loss allocation rates from our migration analysis and the industry loss factors are weighted 75%
- 25% respectively to determine a weighted average loss allocation rate for these portfolios.

The allowance allocation for non risk-rated portfolios is based on consideration of our actual historical loss rates and industry loss rates for those particular segments. Non risk-rated loans are evaluated as a group by category rather than on a individual loan basis because these loans are smaller and homogeneous. We weight the allocation methodologies for the non risk-rated loan portfolio and determine a weighted average allocation for these portfolios.

The estimated loan loss allocation for all loan segments is then adjusted for management's estimate of probable losses for a number of environmental factors. The allocation for environmental factors is particularly subjective and does not lend itself to exact mathematical calculation. This amount represents estimated probable inherent credit losses which exist, but have not yet been identified, as of the balance sheet date, and is based upon quarterly trend assessments in delinquent and nonaccrual loans, unanticipated charge-offs, credit concentration changes, prevailing economic conditions, changes in lending personnel experience, changes in lending policies or procedures and other influencing factors. These environmental factors are considered for each of the five loan segments, and the allowance allocation, as determined by the processes noted above for each segment, is increased or decreased based on the incremental assessment of these various environmental factors.

The ASC 450-20 portion of the allowance also includes an unallocated component. We believe that the unallocated amount is warranted for inherent factors that cannot be practically assigned to individual loan categories, such as the imprecision in the overall loss allocation measurement process, the volatility of the local economies in the markets we serve and imprecision in our credit risk ratings process.

The second component of the allowance for loan losses is determined pursuant to ASC 310-10-35. Loans are impaired when, based on current information and events, it is probable that we will be unable to collect all amounts due according to the contractual terms of the loan agreement. Collection of all amounts due according to the contractual terms means that both the interest and principal payments of a loan will be collected as scheduled in the loan agreement. This evaluation is inherently subjective as it requires material estimates including the amounts and timing of future cash flows expected to be received on impaired loans that may be susceptible to significant change. Loan losses are charged off when management believes that the full collectability of the loan is unlikely. A loan may be partially charged-off after a "confirming event" has occurred which serves to validate that full repayment pursuant to the terms of the loan is unlikely.

An impairment allowance is recognized if the fair value of the loan is less than the recorded investment in the loan (recorded investment in the loan is the principal balance plus any accrued interest, net of deferred loan fees or costs and unamortized premium or discount). The impairment is recognized through the provision for loan losses and is a component of the allowance. Loans that are impaired are recorded at the present value of expected future cash flows discounted at the loan's effective interest rate or if the loan is collateral dependent, the fair value of the collateral, less estimated disposal costs. If the loan is collateral dependent, the principal balance of the loan is charged-off in an amount equal to the impairment measurement. The fair value of collateral dependent loans is derived primarily from collateral appraisals performed by independent third-party appraisers. Management believes it follows appropriate accounting and regulatory guidance in determining impairment and accrual status of impaired loans.

Pursuant to the guidance set forth in ASU No. 2011-02, A Creditor's Determination of Whether a Restructuring is a Troubled Debt Restructuring, the above impairment methodology is also applied to those loans identified as troubled debt restructurings.

We then test the resulting allowance by comparing the balance in the allowance to historical trends and industry and peer information. Our management then evaluates the result of the procedures performed, including the results of our testing, and decides on the appropriateness of the balance of the allowance in its entirety. The audit committee of our board of directors reviews and approves the assessment prior to the filing of quarterly and annual financial information.

While our policies and procedures used to estimate the allowance for loan losses, as well as the resultant provision for loan losses charged to operations, are considered adequate by management and are reviewed from time to time by our regulators, they are necessarily approximate and imprecise. There are factors beyond our control, such as conditions in the local and national economy, a local real estate market or particular industry conditions which may negatively impact, materially, our asset quality and the adequacy of our allowance for loan losses and, thus, the resulting provision for loan losses.

Other Real Estate Owned. Other real estate owned (OREO), consists of properties obtained through foreclosure or through deed in lieu of foreclosure in satisfaction of loans, is reported at the lower of cost or fair value based on appraised value less selling costs, estimated as of the date acquired, with any loss recognized as a charge-off through the allowance for loan losses. Additional OREO losses for subsequent downward valuation adjustments are determined on a specific property basis and are included as a component of other noninterest expense along with holding costs. The fair value of other real estate owned is derived primarily from independent appraisers. Our internal policies generally require OREO properties to be appraised every nine months. At December 31, 2012, the average age of our OREO appraisals was 7.2 months. Any net gains or losses on disposal realized at the time of disposal are reflected in noninterest income or noninterest expense, as applicable. Significant judgments and complex estimates are required in estimating the fair value of other real estate owned, and the period of time within which such estimates can be considered current is significantly shortened during periods of market volatility, as experienced during the last few years. As a result, the net proceeds realized from sales transactions could differ significantly from appraisals, comparable sales, and other estimates used to determine the fair value of other real estate owned.

Deferred Tax Asset Valuation. A valuation allowance is recognized for a deferred tax asset if, based on the weight of available evidence, it is more-likely-than-not that some portion or the deferred tax asset will not be realized. The ultimate realization of deferred tax assets is dependent upon the generation of future taxable income during the periods in which those temporary differences become deductible. In making such judgments, significant weight is given to evidence that can be objectively determined. Primarily as a result of credit losses, we entered into a three-year cumulative pre-tax loss position as of June 30, 2010. A three-year cumulative loss position is considered significant negative evidence in assessing the realizability of a deferred tax asset which is difficult to overcome and accordingly, we established a valuation allowance against the net deferred tax asset at June 30, 2010. Subsequently, we reported several linked-quarters with increasing profitability, demonstrated an improved ability to produce reliable projections, and realized an improvement in overall asset quality and related credit metrics. Due to these factors, other positive trends, and the relatively short period of time in which we forecast we will be able to exit a three-year cumulative tax loss position and utilize our net deferred tax asset, we determined during the quarter ended September 30, 2011 that we had sufficient objective positive evidence to reverse the beginning of the year deferred tax valuation allowance at September 30, 2011. At December 31, 2012 and 2011, we did not have a deferred tax valuation allowance.

Impairment of Intangible Assets. Long-lived assets, including purchased intangible assets subject to amortization, such as our core deposit intangible asset, are reviewed for impairment whenever events or changes in circumstances indicate that the carrying amount of an asset may not be recoverable. Recoverability of assets to be held and used is measured by a comparison of the carrying amount of an asset to estimated undiscounted future cash flows expected to be generated by the asset. If the carrying amount of an asset exceeds its estimated future cash flows, an impairment charge is recognized by the amount by which the carrying amount of the asset exceeds the fair value of the asset. Assets to be disposed of would be separately presented in the balance sheet and reported at the lower of the carrying amount or fair value less costs to sell, and are no longer depreciated. There are no such assets to be disposed of at December 31, 2012.

Goodwill is evaluated for impairment annually and more frequently if events and circumstances indicate that the asset might be impaired. Our annual assessment date is September 30. An impairment loss is recognized to the extent that the carrying amount exceeds the asset's fair value.

In September 2011, the FASB issued ASU No. 2011-08, Intangibles - Goodwill and Other, regarding testing goodwill for impairment. The new guidance provides an entity the option to first perform a qualitative assessment to determine whether it is more likely than not that the fair value of a reporting unit is less than its carrying amount. If an entity does a qualitative assessment and determines that this is the case, or if a qualitative assessment is not performed, it is required to perform a two step goodwill impairment test to identify potential goodwill impairment and measure the amount of goodwill impairment loss to be recognized for that reporting unit (if any). Based on a qualitative assessment, if an entity determines that the fair value of a reporting unit is more than its carrying amount, the two-step goodwill impairment test is not required. We adopted the new guidance beginning January 1, 2012 and applied this guidance used in our annual assessment as of September 30, 2012. The results of our qualitative assessment indicated that the fair value of our reporting unit was more than its carrying value, and accordingly, the two-step goodwill impairment test was not performed.

Should our common stock price decline or other impairment indicators become known, additional impairment testing of goodwill may be required. Should it be determined in a future period that the goodwill has become impaired, then a charge to earnings will be recorded in the period such determination is made. While we believe that the assumptions utilized in our testing were appropriate, they may not reflect actual outcomes that could occur. Specific factors that could negatively impact the assumptions used include the following: a change in the control premiums being realized in the market or a meaningful change in the number of mergers and acquisitions occurring; the amount of expense savings that may be realized in an acquisition scenario; significant fluctuations in our asset/liability balances or the composition of our balance sheet; a change in the overall valuation of the stock market, specifically bank stocks; performance of Southeast U.S. Banks; and Pinnacle Financial's performance relative to peers. Changing these assumptions, or any other key assumptions, could have a material impact on the amount of goodwill impairment, if any.

Results of Operations

The following is a summary of our results of operations for 2012, 2011 and 2010 (in thousands except per share data):

                                        Years ended              2012-2011       Year ended          2011-2010
                                       December 31,             Percent         December 31,        Percent
                                                                Increase                            Increase
                                    2012          2011         (Decrease)                2010      (Decrease)

Interest income                   $ 185,422     $ 188,346             (1.6 %)   $     203,348             (1.2 %)
Interest expense                     22,558        36,882            (38.8 %)          58,975            (21.3 %)
Net interest income                 162,864       151,464              7.5 %          144,373             10.4 %
Provision for loan losses             5,569        21,798            (74.5 %)          53,695            (54.0 %
Net interest income after
provision for loan losses           157,295       129,666             21.3 %           90,678            546.2 %
Noninterest income                   43,397        37,940             14.4 %           36,315             (8.4 %)
Noninterest expense                 138,165       139,107             (0.7 %)         146,883             23.9 %
Net income (loss) before income
taxes                                62,527        28,499            119.4 %          (19,890 )          (69.3 %)
Income tax expense (benefit)         20,643       (15,238 )         (235.5 %)           4,410           (115.0 %)
Net income (loss)                    41,884        43,737             (4.2 %)         (24,300 )          (31.5 %)
Preferred dividends and
preferred stock discount
accretion                             3,814         6,665            (42.8 %)           6,142              3.6 %
Net income (loss) available to
common stockholders               $  38,070     $  37,072              2.7 %    $     (30,442 )          (26.5 %)
Basic net income (loss) per
common share available to
common stockholders               $    1.12     $    1.11              0.9 %    $       (0.93 )          (36.4 %)
Diluted net income (loss) per
common share available to
common stockholders               $    1.10     $    1.09              0.9 %    $       (0.93 )          (36.4 %)

Net Interest Income. Net interest income represents the amount by which interest earned on various earning assets exceeds interest paid on deposits and other interest bearing liabilities and is the most significant component of our revenues. For the year ended December 31, 2012, we recorded net interest income . . .