UNITED STATES
SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-Q

(Mark One)

þ		Quarterly Report Pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934

o		Transition Report Pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934

Commission File Number: 000-08185

CHEMICAL FINANCIAL CORPORATION

(Exact Name of Registrant as Specified in Its Charter)

Michigan (State or Other Jurisdiction of Incorporation or Organization)		38-2022454 (I.R.S. Employer Identification No.)
235 E. Main Street Midland, Michigan (Address of Principal Executive Offices)		48640 (Zip Code)

(989) 839-5350
(Registrant’s Telephone Number, Including Area Code)

Indicate by check mark whether the registrant: (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes þ   No o

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Website, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files). Yes þ   No o

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer or a smaller reporting company. See the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act. (Check one):

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes o   No þ

The number of shares outstanding of the registrant’s Common Stock, $1 par value, as of July 22, 2011, was 27,456,907 shares.

 

 

INDEX

Chemical Financial Corporation
Form 10-Q

Index to Form 10-Q

				Page
Forward-Looking Statements					3
Part I.		Financial Information
Item 1.		Financial Statements (unaudited, except Consolidated
		Statement of Financial Position as of December 31, 2010)			4
		Consolidated Statements of Financial Position as of June 30, 2011, December 31, 2010 and June 30, 2010			4
		Consolidated Statements of Income for the Three and Six Months Ended
		June 30, 2011 and June 30, 2010			5
		Consolidated Statements of Changes in Shareholders’ Equity for the Six Months
		Ended June 30, 2011 and June 30, 2010			6
		Consolidated Statements of Cash Flows for the Six Months Ended
		June 30, 2011 and June 30, 2010			7
		Notes to Consolidated Financial Statements (unaudited)			8-44
Item 2.		Management’s Discussion and Analysis of Financial Condition and Results of Operations			45-72
Item 3.		Quantitative and Qualitative Disclosures About Market Risk			73
Item 4.		Controls and Procedures			73
Part II.		Other Information
Item 1A.		Risk Factors			74
Item 6.		Exhibits			75
Signatures					76
Exhibit Index					77
EX-10.1
EX-31.1
EX-31.2
EX-32.1
EX-101 INSTANCE DOCUMENT
EX-101 SCHEMA DOCUMENT
EX-101 CALCULATION LINKBASE DOCUMENT
EX-101 LABELS LINKBASE DOCUMENT
EX-101 PRESENTATION LINKBASE DOCUMENT
EX-101 DEFINITION LINKBASE DOCUMENT

Forward-Looking Statements

This report contains forward-looking statements that are based on management’s beliefs, assumptions, current expectations, estimates and projections about the financial services industry, the economy and Chemical Financial Corporation (Chemical). Words such as “anticipates,” “believes,” “estimates,” “expects,” “forecasts,” “intends,” “is likely,” “judgment,” “plans,” “predicts,” “projects,” “should,” “will,” and variations of such words and similar expressions are intended to identify such forward-looking statements. Such statements are based upon current beliefs and expectations and involve substantial risks and uncertainties which could cause actual results to differ materially from those expressed or implied by such forward-looking statements. These statements include, among others, statements related to real estate valuation, future levels of nonperforming loans, the rate of asset dispositions, future capital levels, future dividends, future growth and funding sources, future liquidity levels, future profitability levels, future deposit insurance premiums, the effects on earnings of future changes in interest rates, the future level of other revenue sources, future economic trends, future initiatives to expand Chemical’s market share, and future opportunities for acquisitions. All statements referencing future time periods are forward-looking. Management’s determination of the provision and allowance for loan losses; the carrying value of acquired loans, goodwill and mortgage servicing rights; the fair value of investment securities (including whether any impairment on any investment security is temporary or other-than-temporary and the amount of any impairment); and management’s assumptions concerning pension and other postretirement benefit plans involve judgments that are inherently forward-looking. There can be no assurance that future loan losses will be limited to the amounts estimated. All of the information concerning interest rate sensitivity is forward-looking. The future effect of changes in the financial and credit markets and the national and regional economy on the banking industry, generally, and on Chemical, specifically, are also inherently uncertain. These statements are not guarantees of future performance and involve certain risks, uncertainties and assumptions (“risk factors”) that are difficult to predict with regard to timing, extent, likelihood and degree of occurrence. Therefore, actual results and outcomes may materially differ from what may be expressed or forecasted in such forward-looking statements. Chemical undertakes no obligation to update, amend or clarify forward-looking statements, whether as a result of new information, future events or otherwise.

Risk factors include, but are not limited to, the risk factors described in Item 1A of Chemical’s Annual Report on Form 10-K for the year ended December 31, 2010. These and other factors are representative of the risk factors that may emerge and could cause a difference between an ultimate actual outcome and a preceding forward-looking statement.

Part I. Financial Information

Item 1.		Financial Statements

Chemical Financial Corporation
Consolidated Statements of Financial Position

		June 30,				December 31,				June 30,
		2011				2010				2010
		(Unaudited)								(Unaudited)
		(In thousands, except share data)
Assets
Cash and cash equivalents:
Cash and cash due from banks		$	129,209			$	91,403			$	126,741
Interest-bearing deposits with unaffiliated banks and others			271,070				444,762				270,217
Total cash and cash equivalents			400,279				536,165				396,958
Investment securities:
Trading securities, at fair value			—				—				1,389
Available-for-sale at fair value			612,466				578,610				644,550
Held-to-maturity (fair value — $187,595 at June 30, 2011, $159,188 at December 31, 2010 and $159,715 at June 30, 2010)			190,029				165,400				165,296
Total investment securities			802,495				744,010				811,235
Other securities			25,572				27,133				27,448
Loans held for sale			6,874				20,479				10,871
Loans			3,748,010				3,681,662				3,647,961
Allowance for loan losses			(89,733	)			(89,530	)			(89,502	)
Net loans			3,658,277				3,592,132				3,558,459
Premises and equipment (net of accumulated depreciation of $84,731 at June 30, 2011, $80,792 at December 31, 2010 and $76,764 at June 30, 2010)			65,252				65,961				68,611
Goodwill			113,414				113,414				109,149
Other intangible assets			12,327				13,521				15,023
Interest receivable and other assets			119,568				133,394				122,762
Total Assets		$	5,204,058			$	5,246,209			$	5,120,516
Liabilities and Shareholders’ Equity
Deposits:
Noninterest-bearing		$	813,863			$	753,553			$	680,751
Interest-bearing			3,437,113				3,578,212				3,518,431
Total deposits			4,250,976				4,331,765				4,199,182
Interest payable and other liabilities			33,919				37,533				36,378
Short-term borrowings			276,600				242,703				242,271
Federal Home Loan Bank (FHLB) advances			71,928				74,130				86,635
Total liabilities			4,633,423				4,686,131				4,564,466
Shareholders’ equity:
Preferred stock, no par value:
Authorized — 200,000 shares, none issued			—				—				—
Common stock, $1 par value per share:
Authorized — 45,000,000 shares at June 30, 2011 and 30,000,000 at both December 31, 2010 and June 30, 2010; issued and outstanding — 27,456,907 shares at June 30, 2011, 27,440,006 shares at December 31, 2010 and 27,434,027 shares at June 30, 2010			27,457				27,440				27,434
Additional paid-in capital			430,134				429,511				429,021
Retained earnings			126,477				117,238				111,804
Accumulated other comprehensive loss			(13,433	)			(14,111	)			(12,209	)
Total shareholders’ equity			570,635				560,078				556,050
Total Liabilities and Shareholders’ Equity		$	5,204,058			$	5,246,209			$	5,120,516

See accompanying notes to consolidated financial statements (unaudited).

Chemical Financial Corporation
Consolidated Statements of Income (Unaudited)

		Three Months Ended								Six Months Ended
		June 30,								June 30,
		2011				2010				2011				2010
		(In thousands, except per share data)
Interest Income
Interest and fees on loans		$	49,172			$	48,278			$	98,612			$	89,996
Interest on investment securities:
Taxable			2,225				2,964				4,549				6,088
Tax-exempt			1,393				1,221				2,872				2,203
Dividends on other securities			368				295				491				377
Interest on deposits with unaffiliated banks and others			281				204				590				420
Total interest income			53,439				52,962				107,114				99,084
Interest Expense
Interest on deposits			7,551				9,202				15,429				17,902
Interest on short-term borrowings			151				161				301				321
Interest on FHLB advances			443				708				885				1,582
Total interest expense			8,145				10,071				16,615				19,805
Net Interest Income			45,294				42,891				90,499				79,279
Provision for loan losses			7,000				12,700				14,500				26,700
Net interest income after provision for loan losses			38,294				30,191				75,999				52,579
Noninterest Income
Service charges on deposit accounts			4,628				5,091				8,724				9,482
Wealth management revenue			3,026				2,603				5,792				4,895
Other charges and fees for customer services			2,728				2,333				5,386				4,341
Mortgage banking revenue			499				915				1,563				1,633
Other			21				58				209				89
Total noninterest income			10,902				11,000				21,674				20,440
Operating Expenses
Salaries, wages and employee benefits			18,068				17,214				36,393				31,721
Occupancy			3,099				2,734				6,437				5,571
Equipment and software			3,110				3,698				5,832				6,412
Other			9,136				11,004				20,140				20,135
Total operating expenses			33,413				34,650				68,802				63,839
Income before income taxes			15,783				6,541				28,871				9,180
Federal income tax expense			4,750				2,150				8,650				2,500
Net Income		$	11,033			$	4,391			$	20,221			$	6,680
Net Income Per Common Share:
Basic		$	0.40			$	0.17			$	0.74			$	0.27
Diluted			0.40				0.17				0.74				0.27
Cash Dividends Declared Per Common Share			0.20				0.20				0.40				0.40

See accompanying notes to consolidated financial statements (unaudited).

Chemical Financial Corporation
Consolidated Statements of Changes in Shareholders’ Equity (Unaudited)

														Accumulated
						Additional								Other
		Common				Paid-in				Retained				Comprehensive
		Stock				Capital				Earnings				Loss				Total
		(In thousands, except per share data)
Balances at January 1, 2010		$	23,891			$	347,676			$	115,391			$	(12,647	)		$	474,311
Comprehensive income:
Net income											6,680
Other:
Net unrealized gains on investment securities—available-for-sale, net of tax expense of $207															384
Adjustment for pension and other postretirement benefits, net of tax expense of $29															54
Comprehensive income																			7,118
Shares issued — stock options			1				41												42
Shares and stock options issued in the acquisition of O.A.K. Financial Corporation			3,530				80,167												83,697
Cash dividends declared of $0.40 per share											(10,267	)							(10,267	)
Shares issued — directors’ stock purchase plan			12				238												250
Share-based compensation							899												899
Balances at June 30, 2010		$	27,434			$	429,021			$	111,804			$	(12,209	)		$	556,050
Balances at January 1, 2011		$	27,440			$	429,511			$	117,238			$	(14,111	)		$	560,078
Comprehensive income:
Net income											20,221
Other:
Net unrealized gains on investment securities—available-for-sale, net of tax expense of $239															444
Adjustment for pension and other postretirement benefits, net of tax expense of $126															234
Comprehensive income																			20,899
Cash dividends declared of $0.40 per share											(10,982	)							(10,982	)
Shares issued — directors’ stock plans			12				254												266
Share-based compensation			5				369												374
Balances at June 30, 2011		$	27,457			$	430,134			$	126,477			$	(13,433	)		$	570,635

See accompanying notes to consolidated financial statements (unaudited).

Chemical Financial Corporation
Consolidated Statements of Cash Flows (Unaudited)

		Six Months Ended
		June 30,
		2011				2010
		(In thousands)
Cash Flows From Operating Activities:
Net income		$	20,221			$	6,680
Adjustments to reconcile net income to net cash provided by operating activities:
Provision for loan losses			14,500				26,700
Gains on sales of loans			(2,208	)			(2,173	)
Proceeds from sales of loans			101,586				104,831
Loans originated for sale			(85,773	)			(103,842	)
Proceeds from sale of trading securities			—				1,083
Net gains on sales of other real estate and repossessed assets			(703	)			(915	)
Net losses on disposal of premises and equipment and branch bank property			17				350
Depreciation of premises and equipment			4,076				3,667
Amortization of intangible assets			1,904				1,324
Net amortization of premiums and discounts on investment securities			1,713				1,208
Share-based compensation expense			374				899
Net decrease in interest receivable and other assets			10,477				4,531
Net increase (decrease) in interest payable and other liabilities			(3,166	)			1,217
Net cash provided by operating activities			63,018				45,560
Cash Flows From Investing Activities:
Investment securities—available-for-sale:
Proceeds from maturities, calls and principal reductions			185,803				163,935
Purchases			(220,747	)			(149,449	)
Investment securities—held-to-maturity:
Proceeds from maturities, calls and principal reductions			30,763				21,510
Purchases			(55,334	)			(55,552	)
Other securities:
Proceeds from redemption			1,561				—
Net increase in loans			(86,502	)			(52,817	)
Proceeds from sales of other real estate and repossessed assets			8,767				9,585
Purchases of premises and equipment and branch bank property, net			(3,384	)			(4,016	)
Cash acquired, net of cash paid, in business combination			—				17,177
Net cash used in investing activities			(139,073	)			(49,627	)
Cash Flows From Financing Activities:
Net increase (decrease) in noninterest-bearing and interest-bearing demand deposits and savings accounts			(60,655	)			110,549
Net decrease in time deposits			(20,134	)			(22,733	)
Net increase in securities sold under agreements to repurchase			33,897				1,703
Repayment of FHLB advances			(2,202	)			(39,228	)
Cash dividends paid			(10,982	)			(10,267	)
Proceeds from directors’ stock purchase plan and exercise of stock options			245				292
Net cash provided by (used in) financing activities			(59,831	)			40,316
Net increase (decrease) in cash and cash equivalents			(135,886	)			36,249
Cash and cash equivalents at beginning of period			536,165				360,709
Cash and Cash Equivalents at End of Period		$	400,279			$	396,958
Supplemental Disclosure of Cash Flow Information:
Interest paid		$	17,015			$	20,371
Federal income taxes paid (received)			(849	)			3,900
Loans transferred to other real estate and repossessed assets			5,857				10,550
Business combination:
Fair value of tangible assets acquired (noncash)			—				753,671
Goodwill and identifiable intangible assets acquired			—				49,555
Liabilities assumed			—				736,706
Common stock issued			—				83,697

See accompanying notes to consolidated financial statements (unaudited).

Chemical Financial Corporation
Notes to Consolidated Financial Statements (Unaudited)
June 30, 2011

Note 1: Significant Accounting Policies

Nature of Operations

Chemical Financial Corporation (Chemical or the Corporation) operates in a single operating segment — commercial banking. The Corporation is a financial holding company, headquartered in Midland, Michigan, that operates through one commercial bank, Chemical Bank. Chemical Bank operates within the State of Michigan as a state-chartered commercial bank. Chemical Bank operates through an internal organizational structure of four regional banking units and offers a full range of traditional banking and fiduciary products and services to the residents and business customers in the bank’s geographical market areas. The products and services offered by the regional banking units, through branch banking offices, are generally consistent throughout the Corporation, as is the pricing of those products and services. The marketing of products and services throughout the Corporation’s regional banking units is generally uniform, as many of the markets served by the regional banking units overlap. The distribution of products and services is uniform throughout the Corporation’s regional banking units and is achieved primarily through retail branch banking offices, automated teller machines and electronically accessed banking products.

Basis of Presentation

The accompanying unaudited consolidated financial statements of the Corporation and its subsidiaries have been prepared in accordance with U.S. generally accepted accounting principles (GAAP) for interim financial information and the instructions to Form 10-Q and Rule 10-01 of Regulation S-X. Accordingly, the consolidated financial statements do not include all of the information and footnotes required by GAAP for complete financial statements and should be read in conjunction with the Corporation’s consolidated financial statements and footnotes thereto included in the Corporation’s Annual Report on Form 10-K for the year ended December 31, 2010. In the opinion of management, the accompanying unaudited consolidated financial statements contain all adjustments believed necessary to present fairly the financial condition and results of operations of the Corporation for the periods presented. Operating results for the three and six months ended June 30, 2011 are not necessarily indicative of the results that may be expected for the year ending December 31, 2011.

Use of Estimates

Management makes estimates and assumptions that affect the amounts reported in the consolidated financial statements and accompanying footnotes. Estimates that are particularly susceptible to significant change include the determination of the allowance for loan losses, expected cash flows from acquired loans, fair value amounts related to business combinations, pension expense, income taxes, goodwill and those assets that require fair value measurement. Actual results could differ from these estimates.

Business Combinations

On April 30, 2010, the Corporation acquired 100% of O.A.K. Financial Corporation (OAK) for total consideration of $83.7 million. Pursuant to the guidance of Accounting Standards Codification (ASC) Topic 805, Business Combinations (ASC 805) effective for all acquisitions with closing dates after January 1, 2009, the Corporation recognized the assets acquired and the liabilities assumed in the OAK acquisition at their fair values as of the acquisition date with the related acquisition and restructuring costs expensed in the period incurred. The Corporation recorded $43.5 million of goodwill in conjunction with the acquisition, which represented the purchase price over the fair values of the identifiable net assets acquired. Additionally, the Corporation recorded $9.8 million of other intangible assets as a result of the OAK acquisition attributable to core deposits, mortgage servicing rights and non-compete agreements acquired.

See Note 2 for further information regarding the OAK acquisition.

Chemical Financial Corporation
Notes to Consolidated Financial Statements (Unaudited)
June 30, 2011

Originated Loans

Originated loans include all of the Corporation’s portfolio loans, excluding loans acquired in the OAK transaction.

Originated loans are stated at their principal amount outstanding, net of unearned income, charge-offs and unamortized deferred fees and costs. Interest income on loans is reported based on the level-yield method and includes amortization of deferred loan fees and costs over the loan term. Net loan commitment fees for commitment periods greater than one year are deferred and amortized into fee income on a straight-line basis over the commitment period.

Loan interest income is recognized on the accrual basis. The past due status of a loan is based on the loan’s contractual terms. A loan is placed in the nonaccrual category when principal or interest is past due 90 days or more (except for real estate residential loans that are transferred at 120 days past due), unless the loan is both well-secured and in the process of collection, or earlier when, in the opinion of management, there is sufficient reason to doubt the collectibility of principal or interest. Interest previously accrued, but not collected, is reversed and charged against interest income at the time the loan is placed in nonaccrual status. The subsequent recognition of interest income on a nonaccrual loan is then recognized only to the extent cash is received and where future collection of principal is probable. Loans are returned to accrual status when principal and interest payments are brought current, payments have been received consistently for a period of time and collectibility is no longer in doubt.

Loans Acquired in a Business Combination

Loans acquired in a business combination (acquired loans) consist of loans acquired in the acquisition of OAK. Acquired loans were recorded at fair value, without a carryover of OAK’s associated allowance for loan losses related to these loans, through a fair value discount that was, in part, attributable to deterioration in credit quality. The fair value discount was recorded as a reduction of the acquired loans’ outstanding principal balances in the consolidated statement of financial position at the acquisition date.

Those loans that qualify under ASC Topic 310-30, Loans and Debt Securities Acquired with Deteriorated Credit Quality (ASC 310-30), are recorded at fair value at acquisition. The calculation of the fair value of the acquired loans entailed estimating the amount and timing of both principal and interest cash flows expected to be collected on such loans and then discounting those cash flows at market interest rates. The excess of a loan’s expected cash flows at the acquisition date over its estimated fair value is referred to as the “accretable yield,” which is recognized into interest income over the remaining life of the loan on a level-yield basis. The difference between a loan’s contractually required principal and interest payments at the acquisition date and the cash flows expected to be collected at the acquisition date is referred to as the “nonaccretable difference,” which includes an estimate of future credit losses expected to be incurred over the life of the loan and interest payments that are not expected to be collected. The estimate of expected credit losses was determined based on due diligence performed by executive and senior officers of the Corporation, with assistance from third-party consultants. Decreases to the expected cash flows in subsequent periods will require the Corporation to record a provision for loan losses. Improvements in expected cash flows in subsequent periods will result in reversing a portion of the nonaccretable difference, which is then classified as part of the accretable yield and subsequently recognized into interest income over the remaining life of the loan.

The Corporation must make numerous assumptions, interpretations and judgments using internal and third-party credit quality information to determine whether it is probable that the Corporation will be able to collect all contractually required payments. This is a point in time assessment and inherently subjective due to the nature of the available information and judgment involved. Evidence of credit quality deterioration as of the purchase date may include credit metrics such as past due and nonaccrual status, deterioration in borrower credit scores and negative changes to loan-to-value percentages.

Acquired loans with an outstanding principal balance of $105 million at the acquisition date were determined to be loans with deteriorated credit quality and, therefore, met the scope criteria set forth in ASC 310-30. Further, the

Chemical Financial Corporation
Notes to Consolidated Financial Statements (Unaudited)
June 30, 2011

Corporation understands, as outlined in the American Institute of Certified Public Accountants’ open letter to the Office of the Chief Accountant of the Securities and Exchange Commission (SEC) dated December 18, 2009 and pending further standard setting, that for acquired loans that do not meet the scope criteria of ASC 310-30, a company may elect to account for such acquired loans pursuant to the provisions of either ASC 310-20, Nonrefundable Fees and Other Costs, or ASC 310-30. The Corporation elected to apply ASC 310-30 by analogy to acquired loans that were determined not to have deteriorated credit quality with an outstanding principal balance of $578 million at the acquisition date and will follow the accounting and disclosure guidance of ASC 310-30 for these loans. Accordingly, the Corporation applied ASC 310-30 to the entire loan portfolio acquired in the acquisition of OAK with an outstanding principal balance of $683 million at the acquisition date. None of the acquired loans were classified as debt securities.

ASC 310-30 allows investors to aggregate loans acquired into loan pools that have common risk characteristics and thereby use a composite interest rate and expectation of cash flows expected to be collected for the loan pools. Under the provisions of ASC 310-30, the Corporation aggregated acquired loans into 14 pools based upon common risk characteristics, including types of loans, commercial type loans with similar risk grades and whether loans were performing or nonperforming. A pool is considered a single unit of accounting for the purposes of applying the guidance as described above. A loan will be removed from a pool of acquired loans only if the loan is sold, foreclosed, paid off or written off, and will be removed from the pool at the carrying value. If an individual loan is removed from a pool of loans, the difference between its relative carrying amount and the cash, fair value of the collateral, or other assets received would not affect the effective yield used to recognize the accretable difference on the remaining pool. The Corporation estimated the cash flows expected to be collected over the life of the pools of loans at acquisition, and estimates quarterly thereafter, based on a set of assumptions including expectations as to default rates, prepayment rates and loss severities. In the event that the updated expected cash flows increase in a pool from those originally projected at acquisition date, the Corporation will adjust the accretable yield amount with a resulting change in the amount recognized in interest income in subsequent periods. In the event that the updated expected cash flows in a pool decrease from those originally projected at the acquisition date, the Corporation will consider that loan pool impaired, which results in the Corporation recording a charge to the provision for loan losses.

Loans Modified Under Troubled Debt Restructurings

Loans modified under troubled debt restructurings (TDRs) involve granting a concession to a borrower who is experiencing financial difficulty. Concessions generally include modifications to original loan terms, including changes to a loan’s payment schedule or interest rate, which generally would not otherwise be considered. The Corporation’s loans reported as TDRs continue to accrue interest at the loan’s effective interest rate. TDRs are reported as nonperforming TDRs until a six-month payment history of principal and interest payments, in accordance with the loan modification, is sustained, at which time the Corporation moves them to a performing TDR status.

The Corporation’s TDRs to commercial borrowers generally consist of allowing borrowers to defer scheduled principal payments and make interest only payments for a specified period of time at the stated interest rate of the original loan agreement or lower payments due to a modification of the loan’s contractual term. The Corporation does not expect to incur a loss on these loans based on its assessment of the borrowers’ expected cash flows, and accordingly, no additional provision for loan losses has been recognized related to these loans. These loans are individually evaluated for impairment and transferred to nonaccrual status if it is probable that any remaining principal and interest payments due on the loan will not be collected in accordance with the modified terms of the loan.

The Corporation’s real estate residential TDRs generally consist of reducing a borrower’s monthly payments by decreasing the interest rate charged on the loan for a specified period of time (generally 24 months). The Corporation recognizes additional provision for loan losses related to impairment on these loans based on the present value of expected future cash flows discounted at the loan’s original effective interest rate. These loans are moved to nonaccrual status if they become 90 days past due as to principal or interest, or sooner if conditions warrant.

Chemical Financial Corporation
Notes to Consolidated Financial Statements (Unaudited)
June 30, 2011

Impaired Loans

A loan is defined to be impaired when it is probable that payment of principal and interest will not be made in accordance with the original contractual terms of the loan agreement. Impaired loans include all classes of nonaccrual loans, all reported TDRs and acquired loans that were not performing in accordance with original contractual terms. Impaired loans are carried at the present value of expected cash flows discounted at the loan’s effective interest rate or, if lower, at the estimated fair value of the collateral, if the loan is collateral dependent.

Nonperforming Loans

Nonperforming loans are comprised of originated loans for which the accrual of interest has been discontinued (nonaccrual loans), accruing loans contractually past due 90 days or more as to interest or principal payments and nonperforming TDRs.

Allowance for Loan Losses

The allowance for loan losses (allowance) is presented as a reserve against loans. The allowance represents management’s assessment of probable loan losses inherent in the Corporation’s loan portfolio.

Management’s evaluation of the adequacy of the allowance is based on a continuing review of the loan portfolio, actual loan loss experience, the underlying value of the collateral, risk characteristics of the loan portfolio, the level and composition of nonperforming loans, the financial condition of the borrowers, the balance of the loan portfolio, loan growth, economic conditions, employment levels in the Corporation’s local markets, and special factors affecting specific business sectors. The Corporation maintains formal policies and procedures to monitor and control credit risk. Management evaluates the allowance on a quarterly basis in an effort to ensure the level is adequate to absorb probable losses inherent in the loan portfolio.

The allowance provides for probable losses that have been identified with specific customer relationships and for probable losses believed to be inherent in the remainder of the originated loan portfolio, but that have not been specifically identified. The Corporation utilizes its own loss experience to estimate inherent losses on loans. Internal risk ratings are assigned to each commercial, real estate commercial, real estate construction and land development loan at the time of approval and are subject to subsequent periodic reviews by senior management. The Corporation performs a detailed credit quality review quarterly on all loans greater than $0.25 million that have deteriorated below certain levels of credit risk, and may allocate a specific portion of the allowance to such loans based upon this review. A portion of the allowance is allocated to the remaining loans by applying projected loss ratios, based on numerous factors. Projected loss ratios incorporate factors such as recent charge-off experience, trends with respect to adversely risk-rated commercial, real estate commercial, real estate construction and land development loans, trends with respect to past due and nonaccrual loans, changes in economic conditions and trends, changes in the value of underlying collateral and other credit risk factors. This evaluation involves a high degree of uncertainty.

In determining the allowance and the related provision for loan losses, the Corporation considers four principal elements: (i) valuation allowances based upon probable losses identified during the review of impaired commercial, real estate commercial, real estate construction and land development loans, (ii) allocations established for adversely-rated commercial, real estate commercial, real estate construction and land development loans and nonaccrual real estate residential, consumer installment and home equity loans, (iii) allocations, by loan classes, on all other loans based principally on the most recent three years of historical loan loss experience and loan loss trends and (iv) an unallocated allowance based on the imprecision in the overall allowance methodology.

The first element reflects the Corporation’s estimate of probable losses based upon the systematic review of individually impaired commercial, real estate commercial, real estate construction and land development loans in the originated loan portfolio. These estimates are based upon a number of objective factors, such as payment history, financial condition of the borrower and discounted collateral exposure. The Corporation measures the investment in an impaired loan based on one of three methods: the loan’s observable market price; the fair value of the collateral; or, the present value of expected future cash flows discounted at the loan’s effective interest rate. At June 30, 2011, loans in the commercial loan portfolio that were in nonaccrual status were valued based on the fair value of the collateral securing the loan, while TDRs in the commercial loan portfolio were valued based on the present value of

Chemical Financial Corporation
Notes to Consolidated Financial Statements (Unaudited)
June 30, 2011

expected future cash flows discounted at the loan’s effective interest rate. It is the Corporation’s general policy to, at least annually, obtain new appraisals on impaired loans that are primarily secured by real estate. When the Corporation determines that the fair value of the collateral is less than the carrying value of an impaired loan on nonaccrual status and a portion is deemed not collectible, the portion of the impairment that is deemed not collectible is charged off (confirmed loss) and deducted from the allowance. The remaining carrying value of the impaired loan is classified as a nonperforming loan. When the Corporation determines that the fair value of the collateral is less than the carrying value of an impaired loan but believes it is probable it will recover this impairment, the Corporation establishes a valuation allowance for such impairment.

The second element reflects the application of the Corporation’s loan grade risk rating system. This risk rating system is similar to those employed by state and federal banking regulators. Loans in the commercial loan portfolio that are risk rated below a certain predetermined risk grade and nonaccrual real estate residential and nonaccrual consumer installment and home equity loans are assigned a loss allocation factor that is based upon a historical analysis of actual loan losses incurred and a valuation of the type of collateral securing the loans.

The third element is determined by assigning allocations based principally upon the three-year average of loss experience for each class of loan. Average losses may be adjusted based on current loan loss experience and delinquency trends. This component considers the lagging impact of historical charge-off ratios in periods where future loan charge-offs are expected to increase or decrease, trends in delinquencies and nonaccrual loans, the changing portfolio mix in terms of collateral, average loan balance, loan growth and the degree of seasoning in the various loan portfolios. Loan loss analyses are performed quarterly.

The fourth element is based on factors that cannot be associated with a specific credit or loan class and reflects an attempt to ensure that the overall allowance appropriately reflects a margin for the imprecision necessarily inherent in the estimates of loan losses. Management maintains an unallocated allowance to recognize the uncertainty and imprecision underlying the process of estimating inherent loan losses in the loan portfolio. Determination of the probable losses inherent in the portfolio, which are not necessarily captured by the allocation methodology discussed above, involves the exercise of judgment. The unallocated allowance associated with the imprecision in the risk rating system is based on a historical evaluation of the accuracy of the risk ratings associated with loans. This unallocated portion of the allowance is judgmentally determined and generally serves to compensate for the uncertainty in estimating inherent losses, particularly in times of changing economic conditions, and also considers the possibility of improper risk ratings. The unallocated portion of the allowance also takes into consideration economic conditions within the State of Michigan and nationwide, including unemployment levels, industry-wide loan delinquency rates, and declining commercial and residential real estate values and historically high inventory levels of residential lots, condominiums and single family houses held for sale.

Although the Corporation allocates portions of the allowance to specific loans and loan types, the entire allowance is available for any loan losses that occur. Loans that are deemed not collectible are charged off and deducted from the allowance. The provision for loan losses and recoveries on loans previously charged off are added to the allowance. Collection efforts may continue and recoveries may occur after a loan is charged off against the allowance.

Acquired loans are aggregated into pools based upon common risk characteristics. An allowance may be recorded related to acquired loans, if an acquired loan pool experiences a decrease in expected cash flows as compared to those projected at the acquisition date. On a quarterly basis, the expected future cash flow of each pool is estimated based on various factors including changes in property values of collateral dependent loans, default rates, loss severities and prepayment speeds. Decreases in estimates of expected cash flows within a pool generally result in a charge to the provision for loan losses and a corresponding increase in the allowance allocated to acquired loans for the particular pool. Increases in estimates of expected cash flows within a pool generally result first in a reduction in the allowance allocated to acquired loans for the particular pool, and second in an adjustment to the accretable yield for the pool, which will increase amounts recognized in interest income in subsequent periods.

Various regulatory agencies, as an integral part of their examination process, periodically review the allowance. Such agencies may require additions to the allowance based on their judgment reflecting information available to them at the time of their examinations.

Chemical Financial Corporation
Notes to Consolidated Financial Statements (Unaudited)
June 30, 2011

Fair Value Measurements

Fair value for assets and liabilities measured at fair value on a recurring or nonrecurring basis refers to the price that would be received to sell an asset or paid to transfer a liability (an exit price) in an orderly transaction between market participants in the market in which the reporting entity transacts such sales or transfers based on the assumptions market participants would use when pricing an asset or liability. Assumptions are developed based on prioritizing information within a fair value hierarchy that gives the highest priority to quoted prices in active markets and the lowest priority to unobservable data, such as the reporting entity’s own data.

The Corporation may choose to measure eligible items at fair value at specified election dates. Unrealized gains and losses on items for which the fair value measurement option has been elected are reported in earnings at each subsequent reporting date. The fair value option (i) may be applied instrument by instrument, with certain exceptions, allowing the Corporation to record identical financial assets and liabilities at fair value or by another measurement basis permitted under GAAP, (ii) is irrevocable (unless a new election date occurs) and (iii) is applied only to entire instruments and not to portions of instruments. At June 30, 2011, December 31, 2010 and June 30, 2010, the Corporation had not elected the fair value option for any financial assets or liabilities.

Share-Based Compensation

The Corporation has granted stock options, stock awards and restricted stock performance units to certain executive and senior management employees. The Corporation accounts for share-based compensation expense using the modified-prospective transition method. Under that method, compensation expense is recognized for share-based awards granted after December 31, 2005, based on the estimated grant date fair value as computed using the Black-Scholes option pricing model and the probability of issuance for performance-based awards. The fair value of stock options is recognized as compensation expense on a straight-line basis over the requisite service period. The fair value of restricted stock performance units is recognized as compensation expense over the requisite performance period.

Cash flows realized from the tax benefits of exercised stock option awards that result from actual tax deductions that are in excess of the recorded tax benefits related to the compensation expense recognized for those options (excess tax benefits) are classified as financing activities on the consolidated statements of cash flows.

Income and Other Taxes

The Corporation is subject to the income and other tax laws of the United States and the State of Michigan. These laws are complex and are subject to different interpretations by the taxpayer and the various taxing authorities. In determining the provision for income and other taxes, management must make judgments and estimates about the application of these inherently complex laws, related regulations and case law. In the process of preparing the Corporation’s tax returns, management attempts to make reasonable interpretations of the tax laws. These interpretations are subject to challenge by the tax authorities upon audit or to reinterpretation based on management’s ongoing assessment of facts and evolving case law.

The Corporation and its subsidiaries file a consolidated federal income tax return. The provision for federal income taxes is based on income and expenses, as reported in the consolidated financial statements, rather than amounts reported on the Corporation’s federal income tax return. The difference between the federal statutory income tax rate and the Corporation’s effective federal income tax rate is primarily a function of the proportion of the Corporation’s interest income exempt from federal taxation, nondeductible interest expense and other nondeductible expenses relative to pretax income and tax credits. When income and expenses are recognized in different periods for tax purposes than for book purposes, deferred tax assets and liabilities are recognized for the future tax consequences attributable to the temporary differences between the financial statement carrying amounts of existing assets and liabilities and their respective tax bases. Deferred tax assets and liabilities are measured using enacted tax rates expected to apply to taxable income in the years in which those temporary differences are expected to be recovered or settled. The effect on deferred tax assets and liabilities of a change in tax rates is recognized as income or expense in the period that includes the enactment date of the change.

Chemical Financial Corporation
Notes to Consolidated Financial Statements (Unaudited)
June 30, 2011

On a quarterly basis, management assesses the reasonableness of its effective federal tax rate based upon its current best estimate of taxable income and the applicable taxes expected for the full year. Deferred tax assets and liabilities are reassessed on an annual basis, or sooner, if business events or circumstances warrant. Management also assesses the need for a valuation allowance for deferred tax assets on a quarterly basis using information about the Corporation’s current and historical financial position and results of operations.

Income tax positions are evaluated to determine whether it is more-likely-than-not that a tax position will be sustained upon examination based on the technical merits of the tax position. If a tax position is more-likely-than-not to be sustained, a tax benefit is recognized for the amount that is greater than 50% likely to be realized. Reserves for contingent tax liabilities attributable to unrecognized tax benefits associated with uncertain tax positions are reviewed quarterly for adequacy based upon developments in tax law and the status of audits or examinations. The Corporation had no reserve for contingent income tax liabilities recorded at June 30, 2011, December 31, 2010 or June 30, 2010.

The tax periods open to examination by the Internal Revenue Service include the calendar years ended December 31, 2010, 2009, 2008 and 2007. The calendar years ended December 31, 2010, 2009 and 2008 are open to examination for the Corporation’s Michigan Business Tax and the calendar years ended December 31, 2007 and 2006 are open to examination for the Michigan Single Business Tax of the Corporation and certain subsidiaries of the Corporation.

Shareholders’ Equity

Common Stock Repurchase Programs

From time to time, the board of directors approves common stock repurchase programs allowing management to repurchase shares of the Corporation’s common stock in the open market. The repurchased shares are available for later reissuance in connection with potential future stock dividends, the Corporation’s dividend reinvestment plan, employee benefit plans and other general corporate purposes. Under these programs, the timing and actual number of shares subject to repurchase are at the discretion of management and are contingent on a number of factors, including the projected parent company cash flow requirements and the Corporation’s market price per share.

In January 2008, the board of directors of the Corporation authorized management to repurchase up to 500,000 shares of the Corporation’s common stock under a stock repurchase program. Since the January 2008 authorization, no shares have been repurchased. At June 30, 2011, there were 500,000 remaining shares available for repurchase under the Corporation’s stock repurchase programs.

Preferred Stock

On April 20, 2009, the shareholders of the Corporation authorized the board of directors of the Corporation to issue up to 200,000 shares of preferred stock in connection with either an acquisition by the Corporation of an entity that has shares of preferred stock issued and outstanding pursuant to any program established by the United States government or participation by the Corporation in any program established by the United States government. At June 30, 2011, no shares of preferred stock were issued and outstanding.

Common Stock

On April 18, 2011, the shareholders of the Corporation approved an amendment to the restated articles of incorporation to increase the number of authorized shares of common stock from 30,000,000 to 45,000,000.

Chemical Financial Corporation
Notes to Consolidated Financial Statements (Unaudited)
June 30, 2011

Legal Matters

The Corporation and Chemical Bank are subject to certain legal actions arising in the ordinary course of business. In the opinion of management, after consultation with legal counsel, the ultimate disposition of these matters is not expected to have a material adverse effect on the consolidated financial condition or results of operations of the Corporation.

Pending Accounting Pronouncements

Determination of Troubled Debt Restructurings and Related Disclosures: In April 2011, the Financial Accounting Standards Board (FASB) issued ASU No. 2011-02, Receivables (Topic 310): A Creditor’s Determination of Whether a Restructuring is a Troubled Debt Restructuring (ASU 2011-02). ASU 2011-02 provides additional clarifying guidance for creditors in determining whether modifications to a receivable constitute a concession granted by the creditor; evaluating whether a restructuring results in a delay in payment that is insignificant; and determining whether a debtor is experiencing financial difficulties. ASU 2011-02 also establishes the effective date for certain disclosures about loans modified under troubled debt restructurings that had been delayed by the FASB’s issuance of ASU No. 2011-01, Receivables (Topic 310): Deferral of the Effective Date of Disclosures about Troubled Debt Restructurings in Update No. 2010-20. For public entities, ASU 2011-02 (including related disclosures) is effective for the first interim or annual period beginning on or after June 15, 2011, with early adoption permitted. The adoption of ASU 2011-02 is not expected to have a material impact on the Corporation’s consolidated financial condition or results of operations.

Transfers and Servicing of Financial Assets: In April 2011, the FASB issued ASU No. 2011-03, Transfers and Servicing (Topic 860): Reconsideration of Effective Control for Repurchase Agreements (ASU 2011-03). ASU 2011-03 modifies current guidance by eliminating (i) from the assessment of effective control over transferred financial assets in connection with a repurchase agreement the criterion requiring the transferor to have the ability to repurchase or redeem the financial assets on substantially the agreed terms, even in the event of the transferee’s default, and (ii) the condition requiring the transferor to have obtained sufficient collateral to demonstrate that ability. ASU 2011-03 is effective for interim and annual periods beginning on or after December 15, 2011, with early adoption prohibited. The adoption of ASU 2011-03 is not expected to have a material impact on the Corporation’s consolidated financial condition or results of operations.

Fair Value Measurement and Disclosure Requirements: In May 2011, the FASB issued ASU No. 2011-04, Fair Value Measurement (Topic 820): Amendments to Achieve Common Fair Value Measurement and Disclosure Requirements in U.S. GAAP and IFRSs (ASU 2011-04). The amended guidance of ASU 2011-04 (i) clarifies how a principal market is determined, (ii) establishes the valuation premise for the highest and best use of nonfinancial assets, (iii) addresses the fair value measurement of instruments with offsetting market or counterparty credit risks, (iv) extends the prohibition on blockage factors to all three levels of the fair value hierarchy, and (v) requires additional disclosures including transfers between Level 1 and Level 2 of the fair value hierarchy, quantitative and qualitative information and a description of an entity’s valuation process for Level 3 fair value measurements, and fair value hierarchy disclosures for financial instruments not measured at fair value. ASU 2011-04 is effective for interim and annual periods beginning on or after December 15, 2011, with early adoption prohibited. The adoption of ASU 2011-04 is not expected to have a material impact on the Corporation’s consolidated financial condition or results of operations.

Presentation of Comprehensive Income: In June 2011, the FASB issued ASU No. 2011-05, Comprehensive Income (Topic 220): Presentation of Comprehensive Income (ASU 2011-05). ASU 2011-05 amends current guidance by (i) eliminating the option to present components of other comprehensive income (OCI) as part of the statement of changes in shareholders’ equity, (ii) requiring the presentation of each component of net income and each component of OCI either in a single continuous statement or in two separate but consecutive statements, and (iii) requiring the presentation of reclassification adjustments on the face of the statement. The amendments of ASU 2011-05 do not change the option to present components of OCI either before or after related income tax effects, the items that must be reported in OCI, when an item of OCI should be reclassified to net income, or the computation of earnings per share (which continues to be based on net income). ASU 2011-05 is effective for interim and annual

Chemical Financial Corporation
Notes to Consolidated Financial Statements (Unaudited)
June 30, 2011

periods beginning on or after December 15, 2011 for public companies, with early adoption permitted and retrospective application required. The adoption of ASU 2011-05 is not expected to have a material impact on the Corporation’s consolidated financial condition or results of operations.

Note 2: Acquisition

On April 30, 2010, the Corporation acquired 100% of OAK for total consideration of $83.7 million. The total consideration consisted of the issuance of 3,529,772 shares of Chemical common stock with a total value of $83.7 million based upon a price per share of the Corporation’s common stock of $23.70 at the acquisition date, the exchange of 26,425 vested stock options for the outstanding vested stock options of OAK with a value of the exchange at the acquisition date of approximately $41,000 and approximately $8,000 of cash in lieu of fractional shares. The issuance of 3,529,772 shares of Chemical common stock was based on an exchange rate of 1.306 times the 2,703,009 outstanding shares of OAK at the acquisition date. There were no contingencies resulting from the acquisition.

OAK, a bank holding company, owned Byron Bank, which provided traditional commercial banking services and products through 14 banking offices serving communities in Ottawa, Allegan and Kent counties in west Michigan. Byron Bank was consolidated with and into Chemical Bank on July 23, 2010. At the acquisition date, OAK had total assets of $820 million, including total loans of $627 million, and total deposits of $693 million, including brokered deposits of $193 million.

Upon acquisition, the OAK loan portfolio had contractually required principal and interest payments receivable of $683 million and $97 million, respectively, expected principal and interest cash flows of $636 million and $88 million, respectively, and a fair value of $627 million. The difference between the contractually required payments receivable and the expected cash flows represents the nonaccretable difference, which totaled $56 million at the acquisition date, with $47 million attributable to expected credit losses. The difference between the expected cash flows and fair value represents the accretable yield, which totaled $97 million at the acquisition date. The outstanding contractual principal balance and the carrying amount of the acquired loan portfolio were $565 million and $523 million, respectively, at June 30, 2011, compared to $597 million and $552 million, respectively, at December 31, 2010 and $665 million and $613 million, respectively, at June 30, 2010, and there was no related allowance for loan losses at those dates.

Activity for the accretable yield, which includes contractually due interest, of acquired loans follows:

		Accretable Yield
		(In thousands)
Balance at January 1, 2011		$	72,863
Additions			—
Reductions			—
Accretion recognized in interest income			(17,098	)
Reclassification from (to) nonaccretable difference			—
Balance at June 30, 2011		$	55,765

Chemical Financial Corporation
Notes to Consolidated Financial Statements (Unaudited)
June 30, 2011

Note 3: Investment Securities

The following is a summary of the amortized cost and fair value of investment securities available-for-sale and investment securities held-to-maturity at June 30, 2011, December 31, 2010 and June 30, 2010:

		Investment Securities Available-for-Sale
		Amortized				Unrealized				Unrealized				Fair
		Cost				Gains				Losses				Value
		(In thousands)
June 30, 2011
Government sponsored agencies		$	108,957			$	283			$	36			$	109,204
State and political subdivisions			43,793				1,163				6				44,950
Residential mortgage-backed securities			111,760				4,036				191				115,605
Collateralized mortgage obligations			283,840				775				371				284,244
Corporate bonds			56,941				138				175				56,904
Preferred stock			1,389				170				—				1,559
Total		$	606,680			$	6,565			$	779			$	612,466
December 31, 2010
Government sponsored agencies		$	117,167			$	394			$	40			$	117,521
State and political subdivisions			45,951				326				231				46,046
Residential mortgage-backed securities			132,683				4,439				187				136,935
Collateralized mortgage obligations			233,202				911				192				233,921
Corporate bonds			43,115				99				467				42,747
Preferred stock			1,389				51				—				1,440
Total		$	573,507			$	6,220			$	1,117			$	578,610
June 30, 2010
Government sponsored agencies		$	163,194			$	730			$	82			$	163,842
State and political subdivisions			47,312				561				—				47,873
Residential mortgage-backed securities			152,112				4,582				335				156,359
Collateralized mortgage obligations			247,407				661				711				247,357
Corporate bonds			29,230				135				246				29,119
Total		$	639,255			$	6,669			$	1,374			$	644,550

Chemical Financial Corporation
Notes to Consolidated Financial Statements (Unaudited)
June 30, 2011

		Investment Securities Held-to-Maturity
		Amortized				Unrealized				Unrealized				Fair
		Cost				Gains				Losses				Value
		(In thousands)
June 30, 2011
State and political subdivisions		$	179,529			$	4,614			$	1,223			$	182,920
Trust preferred securities			10,500				—				5,825				4,675
Total		$	190,029			$	4,614			$	7,048			$	187,595
December 31, 2010
State and political subdivisions		$	154,900			$	2,106			$	1,758			$	155,248
Trust preferred securities			10,500				—				6,560				3,940
Total		$	165,400			$	2,106			$	8,318			$	159,188
June 30, 2010
State and political subdivisions		$	154,796			$	2,400			$	1,106			$	156,090
Trust preferred securities			10,500				—				6,875				3,625
Total		$	165,296			$	2,400			$	7,981			$	159,715

The majority of the Corporation’s residential mortgage-backed securities and collateralized mortgage obligations are backed by a U.S. government agency (Government National Mortgage Association) or a government sponsored enterprise (Federal Home Loan Mortgage Corporation or Federal National Mortgage Association).

At June 30, 2011, the Corporation held $10.5 million of trust preferred investment securities that were recorded as held-to-maturity, with $10.0 million of these securities representing a 100% interest in a trust preferred investment security of a non-public bank holding company in Michigan that has been assessed by the Corporation as financially strong. The remaining $0.5 million represents a 10% interest in another trust preferred investment security of a non-public bank holding company located in Michigan that incurred net losses in both 2010 and 2009, although remained well-capitalized under regulatory guidelines during that time.

At June 30, 2011, it was the Corporation’s opinion that the market for trust preferred investment securities was not active, and thus, in accordance with GAAP, when there is a significant decrease in the volume and activity for an asset or liability in relation to normal market activity, adjustments to transaction or quoted prices may be necessary or a change in valuation technique or multiple valuation techniques may be appropriate. The fair values of the trust preferred investment securities were based upon a calculation of discounted cash flows. The cash flows were discounted based upon both observable inputs and appropriate risk adjustments that market participants would make for nonperformance, illiquidity and issuer specifics. An independent third party provided the Corporation with observable inputs based on the existing market and insight into appropriate rate of return adjustments that market participants would require for the additional risk associated with a single issue investment security of this nature. Using a model that incorporated the average current yield of publicly traded performing trust preferred securities of large financial institutions with no known material financial difficulties at June 30, 2011, and adjusted for both illiquidity and the specific characteristics of the issuer, such as size, leverage position and location, the Corporation calculated an implied yield of 45% on its $10.0 million trust preferred investment security and 35% for its $0.5 million trust preferred investment security. Based upon these implied yields, the fair values of the trust preferred investment securities were calculated by the Corporation at $4.5 million and $0.2 million, respectively, resulting in a combined impairment of $5.8 million. At June 30, 2011, the Corporation concluded that the $5.8 million of combined impairment on the trust preferred investment securities was temporary in nature.

The following is a summary of the amortized cost and fair value of investment securities at June 30, 2011, by maturity, for both available-for-sale and held-to-maturity investment securities. The maturities of residential mortgage-backed securities and collateralized mortgage obligations are based on scheduled principal payments. The maturities of all other debt securities are based on final contractual maturity.

Chemical Financial Corporation
Notes to Consolidated Financial Statements (Unaudited)
June 30, 2011

		June 30, 2011
		Amortized Cost				Fair Value
		(In thousands)
Investment Securities Available-for-Sale:
Due in one year or less		$	102,789			$	103,451
Due after one year through five years			365,277				367,800
Due after five years through ten years			82,693				83,886
Due after ten years			54,532				55,770
Preferred stock			1,389				1,559
Total		$	606,680			$	612,466
Investment Securities Held-to-Maturity:
Due in one year or less		$	27,053			$	27,108
Due after one year through five years			82,904				83,729
Due after five years through ten years			50,426				51,995
Due after ten years			29,646				24,763
Total		$	190,029			$	187,595

The following schedule summarizes information for both available-for-sale and held-to-maturity investment securities with gross unrealized losses at June 30, 2011, December 31, 2010 and June 30, 2010, aggregated by category and length of time that individual securities have been in a continuous unrealized loss position.

		Less Than 12 Months								12 Months or More								Total
						Gross								Gross								Gross
		Fair				Unrealized				Fair				Unrealized				Fair				Unrealized
		Value				Losses				Value				Losses				Value				Losses
		(In thousands)
June 30, 2011
Government sponsored agencies		$	29,311			$	34			$	2,860			$	2			$	32,171			$	36
State and political subdivisions			48,011				1,046				12,173				183				60,184				1,229
Residential mortgage-backed securities			25,538				185				1,240				6				26,778				191
Collateralized mortgage obligations			94,073				300				27,617				71				121,690				371
Corporate bonds			24,853				147				2,468				28				27,321				175
Trust preferred securities			—				—				4,675				5,825				4,675				5,825
Total		$	221,786			$	1,712			$	51,033			$	6,115			$	272,819			$	7,827
December 31, 2010
Government sponsored agencies		$	20,117			$	40			$	—			$	—			$	20,117			$	40
State and political subdivisions			71,900				1,863				3,800				126				75,700				1,989
Residential mortgage-backed securities			26,117				187				—				—				26,117				187
Collateralized mortgage obligations			57,556				170				9,616				22				67,172				192
Corporate bonds			24,683				317				2,341				150				27,024				467
Trust preferred securities			—				—				3,940				6,560				3,940				6,560
Total		$	200,373			$	2,577			$	19,697			$	6,858			$	220,070			$	9,435
June 30, 2010
Government sponsored agencies		$	21,237			$	82			$	—			$	—			$	21,237			$	82
State and political subdivisions			34,383				844				10,427				262				44,810				1,106
Residential mortgage-backed securities			46,896				335				—				—				46,896				335
Collateralized mortgage obligations			98,813				689				13,126				22				111,939				711
Corporate bonds			—				—				2,241				246				2,241				246
Trust preferred securities			—				—				3,625				6,875				3,625				6,875
Total		$	201,329			$	1,950			$	29,419			$	7,405			$	230,748			$	9,355

An assessment is performed quarterly by the Corporation to determine whether unrealized losses in its investment securities portfolio are temporary or other-than-temporary by carefully considering all available information. The Corporation reviews factors such as financial statements, credit ratings, news releases and other pertinent

Chemical Financial Corporation
Notes to Consolidated Financial Statements (Unaudited)
June 30, 2011

information of the underlying issuer or company to make its determination. Management did not believe any individual unrealized loss on any investment security, as of June 30, 2011, represented an other-than-temporary impairment (OTTI). Management believed that the unrealized losses on investment securities at June 30, 2011 were temporary in nature and due primarily to changes in interest rates, increased credit spreads and reduced market liquidity and not as a result of credit-related issues. Unrealized losses of $5.8 million in the trust preferred securities portfolio, related to trust preferred securities of two well-capitalized bank holding companies in Michigan, were attributable to illiquidity in certain financial markets. The Corporation performed an analysis of the creditworthiness of these issuers and concluded that, at June 30, 2011, the Corporation expected to recover the entire amortized cost basis of these investment securities.

At June 30, 2011, the Corporation did not have the intent to sell any of its impaired investment securities and believed that it was more-likely-than-not that the Corporation will not have to sell any such investment securities before a full recovery of amortized cost. Accordingly, at June 30, 2011, the Corporation believed the impairments in its investment securities portfolio were temporary in nature. Additionally, no impairment loss was realized in the Corporation’s consolidated statement of income for the six months ended June 30, 2011. However, there is no assurance that OTTI may not occur in the future.

Note 4: Loans

Loan portfolio segments are defined as the level at which an entity develops and documents a systematic methodology to determine its allowance. The Corporation has two loan portfolio segments (commercial loans and consumer loans) which it uses in determining the allowance. Both quantitative and qualitative factors are used by management at the loan portfolio segment level in determining the adequacy of the allowance for the Corporation. Classes of loans are a disaggregation of an entity’s loan portfolio segments. Classes of loans are defined as a group of loans which share similar initial measurement attributes, risk characteristics, and methods for monitoring and assessing credit risk. The Corporation has seven classes of loans, which are set forth below.

Commercial — Loans to varying types of businesses, including municipalities, school districts and nonprofit organizations, for the purpose of supporting working capital, operational needs and term financing of equipment. Repayment of such loans is generally provided through operating cash flows of the business. Commercial loans are predominately secured by equipment, inventory, accounts receivable, personal guarantees of the owner and other sources of repayment, although the Corporation may also secure commercial loans with real estate.

Real estate commercial — Loans secured by real estate occupied by the borrower for ongoing operations, non-owner occupied real estate leased to one or more tenants and vacant land that has been acquired for investment or future land development.

Real estate construction — Secured loans for the construction of business properties. Real estate construction loans often convert to a real estate commercial loan at the completion of the construction period.

Land development — Secured development loans are made to borrowers for the purpose of infrastructure improvements to vacant land to create finished marketable residential and commercial lots/land. Most land development loans are originated with the intention that the loans will be paid through the sale of developed lots/land by the developers within twelve months of the completion date. Land development loans at June 30, 2011 were primarily comprised of loans to develop residential properties.

Real estate residential — Loans secured by one- to four-family residential properties generally with fixed interest rates of fifteen years or less. The loan-to-value ratio at the time of origination is generally 80% or less. Real estate residential loans with a loan-to-value ratio of more than 80% generally require private mortgage insurance.

Consumer installment — Loans to consumers primarily for the purpose of home improvements and acquiring automobiles, recreational vehicles and boats. These loans consist of relatively small amounts that are spread across many individual borrowers.

Chemical Financial Corporation
Notes to Consolidated Financial Statements (Unaudited)
June 30, 2011

Home equity — Loans whereby consumers utilize equity in their personal residence, generally through a second mortgage, as collateral to secure the loan.

Commercial, real estate commercial, real estate construction and land development loans are referred to as the Corporation’s commercial loan portfolio, while real estate residential, consumer installment and home equity loans are referred to as the Corporation’s consumer loan portfolio.

A summary of loans follows:

		June 30,				December 31,				June 30,
		2011				2010				2010
		(In thousands)
Commercial loan portfolio:
Commercial		$	842,404			$	818,997			$	769,287
Real estate commercial			1,065,606				1,076,971				1,081,860
Real estate construction			91,152				89,234				119,449
Land development			51,199				53,386				59,555
Subtotal			2,050,361				2,038,588				2,030,151
Consumer loan portfolio:
Real estate residential			825,860				798,046				768,156
Consumer installment			517,405				503,132				509,508
Home equity			354,384				341,896				340,146
Subtotal			1,697,649				1,643,074				1,617,810
Total loans		$	3,748,010			$	3,681,662			$	3,647,961

Credit Quality Monitoring

The Corporation maintains loan policies and credit underwriting standards as part of the process of managing credit risk. These standards include making loans generally only within the Corporation’s market areas. The Corporation’s lending markets generally consist of communities across the middle to southern and western sections of the lower peninsula of Michigan. The Corporation’s lending market areas do not include the southeastern portion of Michigan. The Corporation has no foreign loans.

The Corporation has a loan approval process involving underwriting and individual and group loan approval authorities to consider credit quality and loss exposure at loan origination. The loans in the Corporation’s commercial loan portfolio are risk rated at origination based on the grading system set forth below. The approval authority of relationship managers is established based on experience levels, with credit decisions greater than $1.0 million requiring group loan authority approval, except for four executive and senior officers who have varying limits exceeding $1.0 million and up to $2.5 million. With respect to the group loan authorities, the Corporation has a loan committee, consisting of certain executive and senior officers, that meets weekly to consider loans in the amount of $1.0 million to $2.5 million. A directors’ loan committee, consisting of ten members of the board of directors, including the chief executive officer, and the senior credit officer, meets regularly to consider loans in the amount of $2.5 million to $10 million. Loans over $10 million require the approval of the board of directors.

The majority of the Corporation’s consumer loan portfolio is comprised of secured loans that are relatively small and are evaluated at origination on a centralized basis against standardized underwriting criteria. The ongoing measurement of credit quality of the consumer loan portfolio is largely done on an exception basis. If payments are made on schedule, as agreed, then no further monitoring is performed. However, if delinquency occurs, the delinquent loans are turned over to the Corporation’s collection department for resolution, which generally occurs fairly rapidly and often through repossession and foreclosure. Credit quality for the entire consumer loan portfolio is measured by the periodic delinquency rate, nonaccrual amounts and actual losses incurred.

Loans in the commercial loan portfolio tend to be larger and more complex than those in the consumer loan portfolio, and therefore, are subject to more intensive monitoring. All loans in the commercial loan portfolio have an assigned relationship manager, and most borrowers provide periodic financial and operating information that allows the relationship managers to stay abreast of credit quality during the life of the loans. The risk ratings of loans in the

Chemical Financial Corporation
Notes to Consolidated Financial Statements (Unaudited)
June 30, 2011

commercial loan portfolio are reassessed at least annually, with loans below an acceptable risk rating reassessed more frequently and reviewed by various loan committees within the Corporation at least quarterly.

The Corporation maintains a centralized independent loan review function that monitors the approval process and on-going asset quality of the loan portfolio, including the accuracy of loan grades. The Corporation also maintains an independent appraisal review function that participates in the review of all appraisals obtained by the Corporation.

Credit Quality Indicators

The Corporation uses a nine grade risk rating system to monitor the ongoing credit quality of its commercial loan portfolio. These loan grades rank the credit quality of a borrower by measuring liquidity, debt capacity, coverage and payment behavior as shown in the borrower’s financial statements. The loan grades also measure the quality of the borrower’s management and the repayment support offered by any guarantors. A summary of the Corporation’s loan grades (or, characteristics of the loans within each grade) follows:

Risk Grades 1-5 (Acceptable Credit Quality) — All loans in risk grades 1-5 are considered to be acceptable credit risks by the Corporation and are grouped for purposes of allowance for loan loss considerations and financial reporting. The five grades essentially represent a ranking of loans that are all viewed to be of acceptable credit quality, taking into consideration the various factors mentioned above, but with varying degrees of financial strength, debt coverage, management and factors that could impact credit quality. Business credits within risk grades 1 — 5 range from Risk Grade 1: Prime Quality (factors include: excellent business credit; excellent debt capacity and coverage; outstanding management; strong guarantors; superior liquidity and net worth; favorable loan-to-value ratios; debt secured by cash or equivalents, or backed by the full faith and credit of the U.S. Government) to Risk Grade 5: Acceptable Quality With Care (factors include: acceptable business credit, but with added risk due to specific industry or internal situations).

Risk Grade 6 (Watch) — A business credit that is not acceptable within the Corporation’s loan origination criteria; cash flow may not be adequate or is continually inconsistent to service current debt; financial condition has deteriorated as company trends/management have become inconsistent; the company is slow in furnishing quality financial information; working capital needs of the company are reliant on short-term borrowings; personal guarantees are weak and/or with little or no liquidity; the net worth of the company has deteriorated after recent or continued losses; the loan requires constant monitoring and attention from the Corporation; payment delinquencies becoming more serious; if left uncorrected, these potential weaknesses may, at some future date, result in deterioration of repayment prospects.

Risk Grade 7 (Substandard — Accrual) — A business credit that is inadequately protected by the current financial net worth and paying capacity of the obligor or of the collateral pledged, if any; management has deteriorated or has become non-existent; quality financial information is unattainable; a high level of maintenance is required by the Corporation; cash flow can no longer support debt requirements; loan payments are continually and/or severely delinquent; negative net worth; personal guaranty has become insignificant; a credit that has a well-defined weakness or weaknesses that jeopardize the liquidation of the debt. The Corporation still expects a full recovery of all contractual principal and interest payments; however, a possibility exists that the Corporation will sustain some loss if deficiencies are not corrected.

Risk Grade 8 (Substandard — Nonaccrual) — A business credit accounted for on a nonaccrual basis that has all the weaknesses inherent in a loan classified as risk grade 7 with the added characteristic that the weaknesses are so pronounced that, on the basis of current financial information, conditions, and values, collection in full is highly questionable; a partial loss is possible and interest is no longer being accrued. This loan meets the definition of an impaired loan. The risk of loss requires analysis to determine whether a valuation allowance needs to be established.

Risk Grade 9 (Substandard — Doubtful) — A business credit that has all the weaknesses inherent in a loan classified as risk grade 8 and interest is no longer being accrued, but additional deficiencies make it highly probable that liquidation will not satisfy the majority of the obligation; the primary source of repayment is nonexistent and there is doubt as to the value of the secondary source of repayment; the possibility of loss is likely, but current pending factors could strengthen the credit. This loan meets the definition of an impaired loan. A loan charge-off is recorded when management deems an amount uncollectible; however, the Corporation will establish a valuation allowance for probable losses, if required.

Chemical Financial Corporation
Notes to Consolidated Financial Statements (Unaudited)
June 30, 2011

The Corporation considers all loans graded 1-5 as acceptable credit risks and structures and manages such relationships accordingly. Periodic financial and operating data combined with regular loan officer interactions are deemed adequate to monitor borrower performance. Loans with risk grades of 6 and 7 are considered “watch credits” and the frequency of loan officer contact and receipt of financial data is increased to stay abreast of borrower performance. Loans with risk grades of 8 and 9 are considered problematic and require special care. Further, loans with risk grades of 6-9 are managed and monitored regularly through a number of processes, procedures and committees, including oversight by a loan administration committee comprised of executive and senior management of the Corporation, which includes highly structured reporting of financial and operating data, intensive loan officer intervention and strategies to exit, as well as potential management by the Corporation’s special assets group.

The following schedule presents the recorded investment of loans in the commercial loan portfolio by risk rating categories at June 30, 2011 and December 31, 2010:

		Commercial Loan Portfolio Credit Exposure
		Credit Risk Profile by Creditworthiness Category
						Real Estate				Real Estate				Land
		Commercial				Commercial				Construction				Development				Total
		(In thousands)
June 30, 2011:
Originated Portfolio:
Risk Grades 1-5		$	637,709			$	673,117			$	69,609			$	15,684			$	1,396,119
Risk Grade 6			26,240				22,354				290				7,842				56,726
Risk Grade 7			20,766				49,993				182				651				71,592
Risk Grade 8			12,955				53,494				—				6,844				73,293
Risk Grade 9			1,431				3,830				—				2,089				7,350
Subtotal			699,101				802,788				70,081				33,110				1,605,080
Acquired Portfolio:
Risk Grades 1-5			121,952				236,604				20,918				11,405				390,879
Risk Grade 6			7,127				11,126				—				1,749				20,002
Risk Grade 7			7,904				10,881				—				653				19,438
Risk Grade 8			6,285				4,207				153				4,282				14,927
Risk Grade 9			35				—				—				—				35
Subtotal			143,303				262,818				21,071				18,089				445,281
Total		$	842,404			$	1,065,606			$	91,152			$	51,199			$	2,050,361
December 31, 2010:
Originated Portfolio:
Risk Grades 1-5		$	619,150			$	656,471			$	67,907			$	15,797			$	1,359,325
Risk Grade 6			22,173				39,653				737				8,935				71,498
Risk Grade 7			16,480				35,471				551				983				53,485
Risk Grade 8			16,061				57,287				—				6,537				79,885
Risk Grade 9			607				3,271				—				2,430				6,308
Subtotal			674,471				792,153				69,195				34,682				1,570,501
Acquired Portfolio:
Risk Grades 1-5			119,943				249,495				19,796				12,667				401,901
Risk Grade 6			10,236				18,202				—				—				28,438
Risk Grade 7			6,050				14,896				—				457				21,403
Risk Grade 8			8,282				2,225				243				5,580				16,330
Risk Grade 9			15				—				—				—				15
Subtotal			144,526				284,818				20,039				18,704				468,087
Total		$	818,997			$	1,076,971			$	89,234			$	53,386			$	2,038,588