We use the suite of utilities that make up the Source SDK (you can get this for free through steam if you have half-life 2).
More useful utiltites are listed at the
Source SDK wiki.
Using the utilities above and just about any paint program you can make meterials/textures.
A variety of programs can be used to make models for modding, our team members use a variety including :
Milkshape 3D
3D Studio Max
and the XSI Mod Tool