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EX-31.1 - EXHIBIT 31.1 - TCF FINANCIAL CORPchfc2016q1exhibit311.htm
EX-32.1 - EXHIBIT 32.1 - TCF FINANCIAL CORPchfc2016q1exhibit321.htm
EX-31.2 - EXHIBIT 31.2 - TCF FINANCIAL CORPchfc2016q1exhibit312.htm
 
 
 
 
 
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
For the quarterly period ended March 31, 2016
 
¨
Transition Report Pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934
For the transition period from ____________ to ____________            
Commission File Number: 000-08185 
CHEMICAL FINANCIAL CORPORATION
(Exact Name of Registrant as Specified in Its Charter)
 
Michigan
 
38-2022454
(State or Other Jurisdiction of
Incorporation or Organization)
 
(I.R.S. Employer
Identification No.)
 
 
235 E. Main Street
Midland, Michigan
 
48640
(Address of Principal Executive Offices)
 
(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  ¨
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  ¨
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):
Large accelerated filer
 
þ

 
Accelerated filer
 
¨

 
 
 
 
Non-accelerated filer
 
¨ (Do not check if a smaller reporting company)
 
Smaller reporting company
 
¨
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).    Yes  ¨    No  þ
The number of shares outstanding of the registrant’s Common Stock, $1 par value, as of April 15, 2016, was 38,248,768 shares.
 
 
 
 
 



INDEX
Chemical Financial Corporation
Form 10-Q
Index to Form 10-Q
 
 
 
Page
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Consolidated Statements of Financial Position as of March 31, 2016 (unaudited), December 31, 2015 and March 31, 2015 (unaudited)
 
 
 
 
Consolidated Statements of Income for the Three Months Ended March 31, 2016 and 2015 (unaudited)
 
 
 
 
Consolidated Statements of Comprehensive Income for the Three Months Ended March 31, 2016 and 2015 (unaudited)
 
 
 
 
Consolidated Statements of Changes in Shareholders’ Equity for the Three Months Ended March 31, 2016 and 2015 (unaudited)
 
 
 
 
Consolidated Statements of Cash Flows for the Three Months Ended March 31, 2016 and 2015 (unaudited)
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 

2


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 the Corporation. Words and phrases such as "anticipates," "believes," "continue," "estimates," "expects," "forecasts," "future," "intends," "is likely," "judgment," "look ahead," "look forward," "on schedule," "opinion," "opportunity," "plans," "potential," "predicts," "probable," "projects," "should," "strategic," "trend," "will," and variations of such words and phrases or 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 future levels of loan charge-offs, future levels of provisions for loan losses, real estate valuation, future levels of nonperforming assets, 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, future asset levels, the effects on earnings of future changes in interest rates, the future level of other revenue sources, future economic trends and conditions, future initiatives to expand the Corporation’s market share, expected performance and cash flows from acquired loans, future effects of new or changed accounting standards, future opportunities for acquisitions, opportunities to increase top line revenues, the Corporation’s ability to grow its core franchise, future cost savings and the Corporation’s ability to maintain adequate liquidity and capital based on the requirements adopted by the Basel Committee on Banking Supervision and U.S. regulators. 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 economies on the banking industry, generally, and on the Corporation, 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. The Corporation undertakes no obligation to update, amend or clarify forward-looking statements, whether as a result of new information, future events or otherwise.
This report also contains forward-looking statements regarding Chemical's outlook or expectations with respect to its planned merger with Talmer Bancorp, Inc. ("Talmer"), the expected costs to be incurred in connection with the transaction, the expected impact of the transaction on Chemical's future financial performance and consequences of the integration of Talmer into Chemical.
Risk factors relating both to the transaction and the integration of Talmer into Chemical after closing include, without limitation:
Completion of the transaction is dependent on, among other things, receipt of regulatory approvals and receipt of Chemical's and Talmer's shareholder approvals, the timing of which cannot be predicted with precision at this point and which may not be received at all.
The impact of the completion of the transaction on Chemical's financial statements will be affected by the timing of the transaction.
The transaction may be more expensive to complete and the anticipated benefits, including anticipated cost savings and strategic gains, may be significantly harder or take longer to achieve than expected or may not be achieved in their entirety as a result of unexpected factors or events.
The integration of Talmer’s business and operations into Chemical, which will include conversion of Talmer’s operating systems and procedures, may take longer than anticipated or be more costly than anticipated or have unanticipated adverse results relating to Chemical's or Talmer’s existing businesses.
Chemical’s ability to achieve anticipated results from the transaction is dependent on the state of the economic and financial markets going forward. Specifically, Chemical may incur more credit losses than expected and customer attrition may be greater than expected.
In addition, 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, 2015. 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.

3


No Offer or Solicitation
This communication is not intended to and does not constitute an offer to sell or the solicitation of an offer to subscribe for or buy or an invitation to purchase or subscribe for any securities or the solicitation of any vote or approval in any jurisdiction pursuant to any merger agreement associated with the Talmer transaction or otherwise, nor shall there be any sale, issuance or transfer of securities in any jurisdiction in contravention of applicable law. No offer of securities shall be made except by means of a prospectus meeting the requirements of Section 10 of the Securities Act of 1933, as amended.
Additional Information about the Transaction
Chemical has filed a registration statement on Form S-4 with the Securities and Exchange Commission ("SEC") to register the securities that the Talmer shareholders will receive if the transaction is consummated. The registration statement contains a prospectus for Chemical and a joint proxy statement to be used by Chemical and Talmer to solicit the required approvals of their respective shareholders of the merger and other relevant documents concerning the transaction. Chemical and Talmer may also file other documents with the SEC concerning the proposed merger. Before making an investment or voting decision, investors and shareholders of Chemical and Talmer are urged to read the registration statement, the prospectus and joint proxy statement, and any other relevant documents when they become available because they will contain important information about Chemical, Talmer, and the transaction. Investors will be able to obtain these documents free of charge at the SEC’s website at www.sec.gov. Copies of the documents filed with the SEC in connection with the merger can also be obtained, when available, without charge, from Chemical’s website at www.chemicalbankmi.com, or by contacting Chemical Financial Corporation, 235 East Main Street, P.O. Box 569, Midland, MI 48640-0569, Attention: Ms. Lori A. Gwizdala, Investor Relations, telephone 800-867-9757, or at Talmer’s website at www.talmerbank.com, or by contacting Talmer Bancorp, Inc., 2301 West Big Beaver Road, Suite 525, Troy, Michigan 48084, Attention: Mr. Brad Adams, Investor Relations, telephone 248-498-2862.
Participants in the Merger Solicitation
Chemical and Talmer, and their respective directors, executive officers, and certain other members of management and employees, may be soliciting proxies from Chemical and Talmer shareholders in favor of the transaction. Information regarding the persons who may, under the rules of the SEC, be considered participants in the solicitation of Chemical and Talmer shareholders in connection with the proposed transaction are set forth in the prospectus and joint proxy statement filed with the SEC. Free copies of this document may be obtained as described above. Information about Chemical's directors and executive officers can be found in Chemical's definitive proxy statement in connection with its 2016 annual meeting of shareholders, as filed with the SEC on March 4, 2016, and other documents subsequently filed by Chemical with the SEC. Information about Talmer’s directors and executive officers can be found in Talmer’s Annual Report on Form 10-K, Amendment No. 1, as filed with the SEC on March 30, 2016, and other documents subsequently filed by Talmer with the SEC. Additional information regarding the interests of such participants are included in the prospectus and joint proxy statement and other relevant documents regarding the merger filed with the SEC when they become available.

4


Part I. Financial Information
 
Item 1.    Financial Statements
Chemical Financial Corporation
Consolidated Statements of Financial Position
 
 
March 31,
2016
 
December 31,
2015
 
March 31,
2015
 
 
(Unaudited)
 
 
 
(Unaudited)
Assets
 
(In thousands, except share data)
Cash and cash equivalents:
 
 
 
 
 
 
Cash and cash due from banks
 
$
168,739

 
$
194,136

 
$
121,796

Interest-bearing deposits with the Federal Reserve Bank and other banks
 
122,635

 
44,653

 
272,142

Total cash and cash equivalents
 
291,374

 
238,789

 
393,938

Investment securities:
 
 
 
 
 
 
Available-for-sale, at fair value
 
514,015

 
553,731

 
680,644

Held-to-maturity (fair value - $525,593 at March 31, 2016, $512,705 at December 31, 2015 and $380,176 at March 31, 2015)
 
518,300

 
509,971

 
381,450

Total investment securities
 
1,032,315

 
1,063,702

 
1,062,094

Loans held-for-sale, at fair value
 
9,667

 
10,327

 
9,675

Loans
 
7,366,885

 
7,271,147

 
5,702,874

Allowance for loan losses
 
(70,318
)
 
(73,328
)
 
(75,256
)
Net loans
 
7,296,567

 
7,197,819

 
5,627,618

Premises and equipment (net of accumulated depreciation of $121,762 at March 31, 2016, $120,382 at December 31, 2015 and $111,270 at March 31, 2015)
 
105,868

 
106,317

 
96,486

Goodwill
 
286,867

 
287,393

 
180,128

Other intangible assets
 
36,266

 
38,104

 
31,655

Interest receivable and other assets
 
244,708

 
246,346

 
150,041

Total Assets
 
$
9,303,632

 
$
9,188,797

 
$
7,551,635

Liabilities and Shareholders’ Equity
 
 
 
 
 
 
Deposits:
 
 
 
 
 
 
Noninterest-bearing
 
$
1,951,193

 
$
1,934,583

 
$
1,614,319

Interest-bearing
 
5,698,923

 
5,522,184

 
4,706,034

Total deposits
 
7,650,116

 
7,456,767

 
6,320,353

Interest payable and other liabilities
 
64,120

 
76,466

 
48,545

Securities sold under agreements to repurchase with customers
 
283,383

 
297,199

 
372,236

Short-term borrowings
 

 
100,000

 

Long-term borrowings
 
273,722

 
242,391

 

Total liabilities
 
8,271,341

 
8,172,823

 
6,741,134

Shareholders’ equity:
 
 
 
 
 
 
Preferred stock, no par value:
 
 
 
 
 
 
Authorized – 2,000,000 shares at both March 31, 2016 and December 31, 2015 and 200,000 shares at March 31, 2015, none issued
 

 

 

Common stock, $1 par value per share:
 
 
 
 
 
 
Authorized — 60,000,000 shares at both March 31, 2016 and December 31, 2015 and 45,000,000 shares at March 31, 2015
 
 
 
 
 
 
Issued and outstanding — 38,248,489 shares at March 31, 2016, 38,167,861 shares at December 31, 2015 and 32,847,063 shares at March 31, 2015
 
38,248

 
38,168

 
32,847

Additional paid-in capital
 
725,874

 
725,280

 
565,851

Retained earnings
 
294,859

 
281,558

 
241,582

Accumulated other comprehensive loss
 
(26,690
)
 
(29,032
)
 
(29,779
)
Total shareholders’ equity
 
1,032,291

 
1,015,974

 
810,501

Total Liabilities and Shareholders’ Equity
 
$
9,303,632

 
$
9,188,797

 
$
7,551,635

See accompanying notes to consolidated financial statements (unaudited).

5


Chemical Financial Corporation
Consolidated Statements of Income (Unaudited)
 
 
 
Three Months Ended
 
 
March 31,
 
 
2016
 
2015
 
 
(In thousands, except per share data)
Interest Income
 
 
 
 
Interest and fees on loans
 
$
74,401

 
$
58,097

Interest on investment securities:
 
 
 
 
Taxable
 
1,929

 
2,307

Tax-exempt
 
2,665

 
1,906

Dividends on nonmarketable equity securities
 
256

 
198

Interest on deposits with the Federal Reserve Bank and other banks
 
213

 
122

Total interest income
 
79,464

 
62,630

Interest Expense
 
 
 
 
Interest on deposits
 
4,059

 
3,352

Interest on short-term borrowings
 
100

 
98

Interest on long-term borrowings
 
975

 

Total interest expense
 
5,134

 
3,450

Net Interest Income
 
74,330

 
59,180

Provision for loan losses
 
1,500

 
1,500

Net interest income after provision for loan losses
 
72,830

 
57,680

Noninterest Income
 
 
 
 
Service charges and fees on deposit accounts
 
5,720

 
5,916

Wealth management revenue
 
5,201

 
5,071

Other charges and fees for customer services
 
6,392

 
5,990

Mortgage banking revenue
 
1,405

 
1,403

Gain on sale of investment securities
 
19

 
579

Other
 
682

 
316

Total noninterest income
 
19,419

 
19,275

Operating Expenses
 
 
 
 
Salaries, wages and employee benefits
 
33,890

 
29,253

Occupancy
 
4,905

 
4,426

Equipment and software
 
4,404

 
4,398

Merger and acquisition-related transaction expenses
 
2,594

 
1,362

Other
 
13,094

 
11,581

Total operating expenses
 
58,887

 
51,020

Income before income taxes
 
33,362

 
25,935

Federal income tax expense
 
10,100

 
8,100

Net Income
 
$
23,262

 
$
17,835

Net Income Per Common Share:
 
 
 
 
Basic
 
$
0.61

 
$
0.54

Diluted
 
0.60

 
0.54

Cash Dividends Declared Per Common Share
 
0.26

 
0.24

See accompanying notes to consolidated financial statements (unaudited).

6


Chemical Financial Corporation
Consolidated Statements of Comprehensive Income (Unaudited)
 
 
Three Months Ended
 
March 31,
 
2016
 
2015
 
(In thousands)
Net income
$
23,262

 
$
17,835

Other comprehensive income (loss), net of tax:
 
 
 
Net unrealized gains on investment securities available-for-sale, net of tax expense of $1,470 and $1,262 for the three months ended March 31, 2016 and 2015, respectively
2,729

 
2,344

Reclassification adjustment for realized gain on sale of investment securities available-for-sale included in net income, net of tax expense of $7 and $203 for the three months ended March 31, 2016 and 2015, respectively.
(12
)
 
(376
)
Adjustment for pension and other postretirement benefits, net of tax expense (benefit) of $(202) and $381 for the three months ended March 31, 2016 and 2015, respectively
(375
)
 
706

Total other comprehensive income (loss), net of tax
2,342

 
2,674

Comprehensive income
$
25,604

 
$
20,509


See accompanying notes to consolidated financial statements (unaudited).

7


Chemical Financial Corporation
Consolidated Statements of Changes in Shareholders’ Equity (Unaudited)
 
 
 
Common
Stock
 
Additional
Paid-in
Capital
 
Retained
Earnings
 
Accumulated
Other
Comprehensive
Loss
 
Total
 
 
(In thousands, except per share data)
Balances at December 31, 2014
 
$
32,774

 
$
565,166

 
$
231,646

 
$
(32,453
)
 
$
797,133

Comprehensive income
 
 
 
 
 
17,835

 
2,674

 
20,509

Cash dividends declared and paid of $0.24 per share
 
 
 
 
 
(7,899
)
 
 
 
(7,899
)
Shares issued – stock options
 
13

 
118

 
 
 
 
 
131

Shares issued – directors’ stock plans
 
11

 
305

 
 
 
 
 
316

Shares issued – restricted stock units
 
48

 
(492
)
 
 
 
 
 
(444
)
Share-based compensation
 
1

 
754

 
 
 
 
 
755

Balances at March 31, 2015
 
$
32,847

 
$
565,851

 
$
241,582

 
$
(29,779
)
 
$
810,501

 
 
 
 
 
 
 
 
 
 
 
Balances at December 31, 2015
 
$
38,168

 
$
725,280

 
$
281,558

 
$
(29,032
)
 
$
1,015,974

Comprehensive income
 
 
 
 
 
23,262

 
2,342

 
25,604

Cash dividends declared and paid of $0.26 per share
 
 
 
 
 
(9,961
)
 
 
 
(9,961
)
Shares issued – stock options
 
36

 
346

 
 
 
 
 
382

Shares issued – restricted stock units
 
43

 
(500
)
 
 
 
 
 
(457
)
Share-based compensation
 
1

 
748

 
 
 
 
 
749

Balances at March 31, 2016
 
$
38,248

 
$
725,874

 
$
294,859

 
$
(26,690
)
 
$
1,032,291


See accompanying notes to consolidated financial statements (unaudited).

8


Chemical Financial Corporation
Consolidated Statements of Cash Flows (Unaudited)
 
 
Three Months Ended March 31,
 
 
2016
 
2015
 
 
(In thousands)
Operating Activities
 
 
 
 
Net income
 
$
23,262

 
$
17,835

Adjustments to reconcile net income to net cash provided by operating activities:
 
 
 
 
Provision for loan losses
 
1,500

 
1,500

Gains on sales of loans
 
(1,296
)
 
(1,589
)
Proceeds from sales of loans
 
45,928

 
54,280

Loans originated for sale
 
(43,972
)
 
(53,238
)
Net gains from sales/writedowns of other real estate and repossessed assets
 
(547
)
 
(570
)
Depreciation of premises and equipment
 
2,775

 
2,479

Amortization of intangible assets
 
2,169

 
1,825

Net gains on sale of investment securities
 
(19
)
 
(579
)
Net amortization of premiums and discounts on investment securities
 
1,493

 
1,373

Share-based compensation expense
 
749

 
755

Net increase in interest receivable and other assets
 
(921
)
 
(9,562
)
Net decrease in interest payable and other liabilities
 
(11,875
)
 
(7,038
)
Net cash provided by operating activities
 
19,246

 
7,471

Investing Activities
 
 
 
 
Investment securities – available-for-sale:
 
 
 
 
Proceeds from sales
 

 
13,172

Proceeds from maturities, calls and principal reductions
 
42,925

 
57,449

Investment securities – held-to-maturity:
 
 
 
 
Proceeds from maturities, calls and principal reductions
 
8,133

 
7,542

Purchases
 
(16,965
)
 
(72,748
)
Net increase in loans
 
(101,915
)
 
(20,233
)
Proceeds from sales of other real estate and repossessed assets
 
2,901

 
3,693

Purchases of premises and equipment, net of disposals
 
(2,406
)
 
(1,469
)
Net cash used in investing activities
 
(67,327
)
 
(12,594
)
Financing Activities
 
 
 
 
Net increase in interest- and noninterest-bearing demand deposits and savings accounts
 
234,102

 
247,244

Net decrease in time deposits
 
(40,753
)
 
(5,862
)
Net decrease in securities sold under agreements to repurchase with customers and other short-term borrowings
 
(113,816
)
 
(17,231
)
Proceeds from long-term borrowings
 
50,000

 

Repayment of long-term borrowings
 
(18,558
)
 

Cash dividends paid
 
(9,961
)
 
(7,899
)
Proceeds from directors’ stock plans and exercise of stock options, net of shares withheld
 
382

 
447

Cash paid for payroll taxes upon conversion of share-based awards
 
(730
)
 
(658
)
Net cash provided by financing activities
 
100,666

 
216,041

Net increase in cash and cash equivalents
 
52,585

 
210,918

Cash and cash equivalents at beginning of period
 
238,789

 
183,020

Cash and cash equivalents at end of period
 
$
291,374

 
$
393,938

Supplemental Disclosure of Cash Flow Information:
 
 
 
 
Interest paid
 
$
5,080

 
$
3,426

Loans transferred to other real estate and repossessed assets
 
1,667

 
3,662

Federal income taxes paid
 

 
9,800

See accompanying notes to consolidated financial statements (unaudited).

9


Chemical Financial Corporation
Notes to Consolidated Financial Statements (Unaudited)
March 31, 2016




Note 1: Significant Accounting Policies
Nature of Operations
Chemical Financial Corporation ("Corporation" or "Chemical") 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.
The Corporation’s primary sources of revenue are interest from its loan products and investment securities, service charges and fees from customer deposit accounts and wealth management revenue.
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 interim 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, 2015. In the opinion of management, the accompanying unaudited interim 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 months ended March 31, 2016 are not necessarily indicative of the results that may be expected for the year ending December 31, 2016.
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 impairment and those assets that require fair value measurement. Actual results could differ from these estimates.
Business Combinations
Pursuant to the guidance of Accounting Standards Codification ("ASC") Topic 805, Business Combinations ("ASC 805"), the Corporation recognizes assets acquired, including identified intangible assets, and the liabilities assumed in acquisitions at their fair values as of the acquisition date, with the acquisition-related transaction and restructuring costs expensed in the period incurred.
ASC 805 affords a measurement period beyond the acquisition date that allows the Corporation the opportunity to finalize the acquisition accounting in the event that new information is identified that existed as of the acquisition date but was not known by the Corporation at that time. The Corporation anticipates that measurement period adjustments may arise from adjustments to the fair values of assets and liabilities recognized at the acquisition date for its May 31, 2015 acquisition of Lake Michigan Financial Corporation ("Lake Michigan"), as additional information is obtained, such as appraisals of collateral securing loans and other borrower information. In the event that a measurement period adjustment is identified, the Corporation will recognize the adjustment as part of its acquisition accounting, which may result in an adjustment to goodwill being recorded in the period the adjustment was identified.
See Note 2 for further information regarding the Corporation's mergers and acquisitions, including its pending merger with Talmer Bancorp, Inc. ("Talmer").

10


Chemical Financial Corporation
Notes to Consolidated Financial Statements (Unaudited)
March 31, 2016



Originated Loans
Originated loans include all of the Corporation's portfolio loans, excluding loans acquired in business combinations, as further discussed below. Originated loans are stated at their principal amount outstanding, net of unearned income, charge-offs and unamortized deferred fees and costs. Loan interest income is recognized on the accrual basis. Deferred loan fees and costs are amortized over the loan term based on the level-yield method. Net loan commitment fees are deferred and amortized into fee income on a straight-line basis over the commitment period.
The past due status of a loan is based on the loan’s contractual terms. A loan is placed in nonaccrual status (accrual of interest is discontinued) when principal or interest is past due 90 days or more (except for a loan that is secured by residential real estate, which is transferred to nonaccrual status 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. Subsequent receipts of interest while a loan is in nonaccrual status are recorded as a reduction of principal. Loans are returned to accrual status when principal and interest payments are brought current, payments have been received consistently for a period of time (generally six months) 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 on May 31, 2015 in the acquisition of Lake Michigan, on April 1, 2015 in the acquisition of Monarch Community Bancorp, Inc. ("Monarch"), on October 31, 2014 in the acquisition of Northwestern Bancorp, Inc. ("Northwestern"), and on April 30, 2010 in the acquisition of O.A.K. Financial Corporation ("OAK"). Acquired loans were recorded at fair value at the date of acquisition, without a carryover of the 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 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. 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.
The Corporation accounts for acquired loans, which are recorded at fair value at acquisition, in accordance with ASC Topic 310-30, Loans and Debt Securities Acquired with Deteriorated Credit Quality ("ASC 310-30"). 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 2 pools in the acquisition of Lake Michigan, 2 pools in the acquisition of Monarch, 4 pools in the acquisition of Northwestern and 14 pools in the acquisition of OAK 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 prescribed in ASC 310-30. 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 expected cash flows quarterly thereafter, based on a set of assumptions including expectations as to default rates, prepayment rates and loss severities. 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.
The calculation of the fair value of the acquired loan pools entails estimating the amount and timing of cash flows attributable to both principal and interest expected to be collected on such loan pools and then discounting those cash flows at market interest rates. The excess of a loan pool'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 estimated remaining life of the loan pool on a level-yield basis. The difference between a loan pool'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 estimated life of the loan pool and interest payments that are not expected to be collected. Decreases to the expected cash flows in each loan pool in subsequent periods will require the Corporation to record a provision for loan losses. Improvements in expected cash flows in each loan pool 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 estimated remaining life of the loan pool.

11


Chemical Financial Corporation
Notes to Consolidated Financial Statements (Unaudited)
March 31, 2016



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 TDRs include performing and nonperforming TDRs, which consist of originated loans that continue to accrue interest at the loan's original interest rate as the Corporation expects to collect the remaining principal and interest on the loan, and nonaccrual TDRs, which include originated loans that are in a nonaccrual status and are no longer accruing interest, as the Corporation does not expect to collect the full amount of principal and interest owed from the borrower on these loans. In accordance with ASC Topic 310-30, acquired loans are excluded from TDRs as these loans are accounted for in pools at net realizable value based on the principal and interest the Corporation expects to collect on such loans. At the time of modification (except for loans on nonaccrual status), a TDR is reported as a nonperforming TDR until a six-month payment history of principal and interest payments, in accordance with the terms of the loan modification, is sustained, at which time the Corporation moves the loan to a performing status ("performing TDR"). If the Corporation does not expect to collect all principal and interest on the loan, the modified loan is classified as a nonaccrual TDR. All TDRs are accounted for as impaired loans and are included in the Corporation’s analysis of the allowance for loan losses. A TDR that has been renewed by a borrower who is no longer experiencing financial difficulty and which yields a market rate of interest at the time of a renewal is no longer reported as a TDR.
Loans in the Corporation’s commercial loan portfolio (comprised of commercial, commercial real estate, real estate construction and land development loans) that meet the definition of a TDR generally consist of loans where the Corporation has allowed 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 reduced payments due to a moderate extension of the loan’s contractual term. If the Corporation does not expect to collect all principal and interest on the loan, the modified loan is classified as a nonaccrual TDR. If the Corporation does not expect to incur a loss on the loan based on its assessment of the borrowers’ expected cash flows, as the pre- and post-modification effective yields are approximately the same, the loan is classified as a nonperforming TDR until a six-month payment history is sustained, at which time the loan is classified as a performing TDR. Since no loss is expected to be incurred on these loans, no additional provision for loan losses has been recognized related to these loans, and these loans accrue interest at their contractual interest rate. These loans are individually evaluated for impairment and transferred to nonaccrual status if they become 90 days past due as to principal or interest payments or 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.
Loans in the Corporation’s consumer loan portfolio (comprised of residential mortgage, consumer installment and home equity loans) that meet the definition of a performing or nonperforming TDR generally consist of residential mortgage loans that include a concession that reduces a borrower’s monthly payments by decreasing the interest rate charged on the loan for a specified period of time (generally 24 months) under a formal modification agreement. The Corporation recognizes an additional provision for loan losses related to impairment on these loans on an individual basis based on the present value of expected future cash flows discounted at the loan’s original effective interest rate. These loans continue to accrue interest at their effective interest rate, which consists of contractual interest under the terms of the modification agreement in addition to an adjustment for the accretion of computed impairment. These loans are moved to nonaccrual status if they become 90 days past due as to principal or interest payments, or sooner if conditions warrant.
Impaired Loans
A loan is defined to be impaired when it is probable that payment of principal and interest will not be paid in accordance with the original contractual terms of the loan agreement. Impaired loans include nonaccrual loans (including nonaccrual TDRs), performing and nonperforming TDRs and acquired loans that were not performing in accordance with original contractual terms. Impaired loans are accounted for at the lower of the present value of expected cash flows discounted at the loan's original effective interest rate or the estimated fair value of the collateral, if the loan is collateral dependent. When the present value of expected cash flows or the fair value of collateral of an impaired loan in the originated loan portfolio is less than the amount of unpaid principal outstanding on the loan, the principal balance of the loan is reduced to its carrying value through either an allocation of the allowance for loan losses or a partial charge-off of the loan balance.
Nonperforming Loans
Nonperforming loans are comprised of loans for which the accrual of interest has been discontinued (nonaccrual loans, including nonaccrual TDRs), accruing originated loans contractually past due 90 days or more as to interest or principal payments and nonperforming TDRs.
Acquired loans that were classified as nonperforming loans prior to being acquired and acquired loans that are not performing in accordance with contractual terms subsequent to acquisition are not classified as nonperforming loans subsequent to acquisition

12


Chemical Financial Corporation
Notes to Consolidated Financial Statements (Unaudited)
March 31, 2016



because the loans are recorded in pools at net realizable value based on the principal and interest the Corporation expects to collect on such loans.
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 appropriate 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 incurred 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 loan in the commercial loan portfolio (commercial, commercial real estate, real estate construction and land development loans) at the time of origination 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 charge-off experience, trends with respect to adversely risk-rated loans in the commercial loan portfolio, 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 loans in the commercial loan portfolio, (ii) reserves established for adversely-rated loans in the commercial loan portfolio and nonaccrual residential mortgage, consumer installment and home equity loans based on loan loss experience of other adversely-rated loans, (iii) reserves, by loan classes, on all other loans based principally on a five-year historical loan loss experience, with equal weighting placed on all of the years, loan loss trends giving consideration to estimated loss emergence periods and (iv) a reserve for qualitative factors that take into consideration risks inherent in the originated loan portfolio that differ from historical loan loss experience.
Although the Corporation allocates portions of the allowance to specific loans and loan types, the entire allowance attributable to originated loans is available for any loan losses that occur in the originated portfolio. Loans that are deemed not collectible are charged off and reduce the allowance. The provision for loan losses and recoveries on loans previously charged off increase the allowance. Collection efforts may continue and recoveries may occur after a loan is charged off.
Acquired loans are aggregated into pools based upon common risk characteristics. An allowance may be recorded related to an acquired loan pool if it 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 in a reduction in the allowance allocated to acquired loans for the particular pool, if applicable, and then 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.
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.

13


Chemical Financial Corporation
Notes to Consolidated Financial Statements (Unaudited)
March 31, 2016



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 March 31, 2016, December 31, 2015 and March 31, 2015, the Corporation had elected the fair value option on all of its residential mortgage loans held-for-sale. The Corporation has not elected the fair value option for any other financial assets or liabilities.
Share-Based Compensation
The Corporation grants stock options, stock awards, restricted stock performance units and restricted stock service-based 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 stock options based on the estimated grant date fair value as computed using the Black-Scholes option pricing model and the probability of issuance. The Corporation accounts for stock awards based on the closing stock price of the Corporation's common stock on the date of the award. The fair values of both stock options and stock awards are recognized as compensation expense on a straight-line basis over the requisite service period. The Corporation accounts for restricted stock performance units based on the closing stock price of the Corporation's common stock on the date of grant, discounted by the present value of estimated future dividends to be declared over the requisite performance or service period. The fair value of restricted stock performance units is recognized as compensation expense over the expected requisite performance period, or requisite service period for awards with multiple performance and service conditions. The Corporation accounts for restricted stock service-based units based on the closing stock price of the Corporation's common stock on the date of grant, as these awards accrue dividend equivalents equal to the amount of any cash dividends that would have been payable to a shareholder owning the number of shares of the Corporation's common stock represented by the restricted stock service-based units. The fair value of the restricted stock service-based units is recognized as compensation expense over the requisite service 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.
Bank-Owned Life Insurance
The Corporation has life insurance policies on certain key officers of Chemical Bank. The majority of the bank-owned life insurance policies of the Corporation were obtained through its acquisition of Lake Michigan. Bank-owned life insurance is recorded at the cash surrender value, net of surrender charges, and is included within other assets on the consolidated statements of financial position and changes in the cash surrender values are recorded as other noninterest income on the consolidated statements of income.
Income and Other Taxes
The Corporation is subject to the income and other tax laws of the United States, the State of Michigan and any other states where nexus has been created. 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 enacted 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.
On a quarterly basis, management assesses the reasonableness of its effective federal tax rate based upon its estimate of taxable income and the applicable taxes expected for the full year. Deferred tax assets and liabilities are reassessed on a quarterly basis, including the need for a valuation allowance for deferred tax assets.
Uncertain 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 income 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 contingent income tax liabilities recorded at March 31, 2016December 31, 2015 or March 31, 2015.

14


Chemical Financial Corporation
Notes to Consolidated Financial Statements (Unaudited)
March 31, 2016



Investments in Qualified Affordable Housing Projects, Federal Historic Projects and New Market Tax Credits
The Corporation invests in qualified affordable housing projects, federal historic projects, and new market projects for the purpose of community reinvestment and obtaining tax credits. Return on the Corporation's investment in these projects comes in the form of the tax credits and tax losses that pass through to the Corporation. The carrying value of the investments are reflected in other assets on the consolidated statements of financial position. The Corporation utilizes the proportional amortization method to account for investments in qualified affordable housing projects and the equity method to account for investments in other tax credit projects.
Under the proportional amortization method, the Corporation amortizes the initial cost of the investment in proportion to the tax credits and other tax benefits allocated. The Corporation recognized additional income tax expense attributable to the amortization of investments in qualified affordable housing projects of $0.6 million and $0.1 million during the three months ended March 31, 2016, and 2015, respectively. The Corporation's remaining investment in qualified affordable housing projects accounted for under the proportional amortization method totaled $21.1 million at March 31, 2016, $21.7 million at December 31, 2015 and $4.8 million at March 31, 2015. The increase in qualified affordable housing project investments at March 31, 2016, compared to March 31, 2015, was attributable to investments acquired as part of the Lake Michigan transaction.
Under the equity method, the Corporation's share of the earnings or losses are included in other operating expenses on the consolidated statements of income. The Corporation's remaining investment in new market projects accounted for under the equity method totaled $1.5 million and $1.7 million at March 31, 2016 and December 31, 2015, respectively. There were no investments in such projects accounted for under the equity method as of March 31, 2015.
The Corporation's unfunded equity contributions relating to investments in qualified affordable housing projects, federal historic tax projects and new market projects is recorded in other liabilities on the consolidated statements of financial position. The Corporation's remaining unfunded equity contributions totaled $4.2 million and $8.0 million at March 31, 2016 and December 31, 2015.
Management analyzes these investments for potential impairment when events or changes in circumstances indicate that it is more-likely-than-not that the carrying amount of the investment will not be realized. An impairment loss is measured as the amount by which the carrying amount of an investment exceeds its fair value. There were no impairment losses recognized as of March 31, 2016, December 31, 2015 or March 31, 2015.
The Corporation consolidates variable interest entities ("VIEs") in which it is the primary beneficiary. In general, a VIE is an entity that either (i) has an insufficient amount of equity to carry out its principal activities without additional subordinated financial support, (ii) has a group of equity owners that are unable to make significant decisions about its activities or (iii) has a group of equity owners that do not have the obligation to absorb losses or the right to receive returns as generated by its operations. If any of these characteristics are present, the entity is subject to a variable interests consolidation model, and consolidation is based on variable interests, not on ownership of the entity's outstanding voting stock. Variable interests are defined as contractual, ownership, or other monetary interests in an entity that change with fluctuations in the entity's net asset value. The primary beneficiary consolidates the VIE. The primary beneficiary is defined as the enterprise that has the power to direct the activities and absorb losses or the right to receive benefits. The Corporation is a significant limited partner in the qualified affordable housing, federal historic and new market projects it has invested in. These projects meet the definition of VIEs. However, the Corporation is not the primary beneficiary of any of the VIEs in which it holds a limited partnership interest; therefore, the VIEs are not consolidated in the Corporation's consolidated financial statements.
Shareholders’ Equity
Common Stock Repurchase Programs
From time to time, the board of directors of the Corporation 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.

15


Chemical Financial Corporation
Notes to Consolidated Financial Statements (Unaudited)
March 31, 2016



In January 2008, the board of directors of the Corporation authorized the repurchase of up to 500,000 shares of the Corporation’s common stock under a stock repurchase program. In November 2011, the board of directors of the Corporation reaffirmed the stock buy-back authorization with the qualification that the shares may only be repurchased if the share price is below the tangible book value per share of the Corporation’s common stock at the time of the repurchase. Since the January 2008 authorization, no shares have been repurchased. At March 31, 2016, there were 500,000 remaining shares available for repurchase under the Corporation’s stock repurchase program.
Shelf Registration
On June 12, 2014, the Corporation filed an automatic shelf registration statement on Form S-3 with the Securities and Exchange Commission ("SEC") for an indeterminate amount of securities, which became immediately effective. The shelf registration statement provides the Corporation with the ability to raise capital, subject to SEC rules and limitations, if the board of directors of the Corporation decides to do so.
Preferred Stock
On April 20, 2015, the shareholders of the Corporation approved an amendment to the restated articles of incorporation which eliminated and replaced the previous class of 200,000 shares of preferred stock, that had been approved by shareholders on April 20, 2009, with a new class of 2,000,000 shares of preferred stock. At March 31, 2016, no shares of preferred stock were issued and outstanding.
Common Stock
On April 20, 2015, 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 45,000,000 to 60,000,000.
Legal Matters
On February 22, 2016, two putative class action and derivative complaints were filed in the Circuit Court for Oakland County, Michigan by individuals purporting to be a shareholder of Talmer. The actions are styled Regina Gertel Lee v. Chemical Financial Corporation, et. al., Case No. 2016-151642-CB and City of Livonia Employees’ Retirement System v. Chemical Financial Corporation et. al., Case No. 2016-151641-CB. These complaints purport to be brought derivatively on behalf of Talmer against the individual defendants, and individually and on behalf of all others similarly situated against Talmer and Chemical. The complaints allege, among other things, that the directors of Talmer breached their fiduciary duties to Talmer’s shareholders in connection with the merger by approving a transaction pursuant to an allegedly inadequate process that undervalues Talmer and includes preclusive deal protection provisions, and that Chemical allegedly aided and abetted the Talmer directors in breaching their duties to Talmer’s shareholders. The complaints also allege that the individual defendants have been unjustly enriched. Both complaints seek various remedies on behalf of the putative class (consisting of all shareholders of Talmer who are not related to or affiliated with any defendant). They request, among other things, that the Court enjoin the merger from being consummated in accordance with its agreed-upon terms, direct the Talmer directors to exercise their fiduciary duties, rescind the merger agreement to the extent that it is already implemented, award the plaintiff all costs and disbursements in each respective action (including reasonable attorneys’ and experts’ fees), and grant such further relief as the court deems just and proper. The City of Livonia plaintiff amended its complaint on April 21, 2016 to add additional factual allegations, including but not limited to allegations that Keefe Bruyette & Woods, Inc. served as a financial advisor for the proposed merger despite an alleged conflict of interest, that Talmer’s board acted under actual or potential conflicts of interest, and that the defendants omitted and/or misrepresented material information about the proposed merger in the Form S-4 Registration Statement relating to the proposed merger. Talmer, Chemical and the individual defendants all believe that the claims asserted against each of them in the above-described lawsuits are without merit and intend to vigorously defend against these lawsuits.
On March 22, 2016, an additional putative class action and derivative complaint was filed in the Circuit Court for Oakland County, Michigan, by an individual purporting to be a shareholder of Talmer, styled Stephen Bushansky v. Gary Torgow et. al. Case No. 2016-152112-CB. This action contained similar allegations, claims, and requests for relief as the complaints filed in the Lee and City of Livonia lawsuits discussed above. The Bushansky lawsuit was voluntarily dismissed by the plaintiff as to all defendants, without prejudice, on April 18, 2016.
On April 6, 2016, a complaint was filed in the United States District Court for the Eastern District of Michigan by another purported shareholder of Talmer, styled Matthew Sciabacucchi v. Chemical Financial Corporation et. al., Docket No. 1:16-cv-11261. Mr. Sciabacucchi purports to bring this action “on behalf of himself and all others similarly situated.” This lawsuit alleges violations of Sections 14(a) and 20(a) of the Securities Exchange Act of 1934, naming Talmer, Chemical, and several individuals as defendants.  The complaint alleges, among other things, that the Defendants issued materially incomplete and misleading disclosures in the

16


Chemical Financial Corporation
Notes to Consolidated Financial Statements (Unaudited)
March 31, 2016



Form S-4 Registration Statement relating to the proposed merger. The Complaint contains requests for relief that include, among other things, that the Court enjoin the proposed transaction, rescind the transaction if it is consummated or award rescissory damages, order the Talmer directors to file a revised Registration Statement, declare that the Defendants violated Sections 14(a) and/or Section 20(a) of the Securities Exchange Act, as well as Rule 14a-9 promulgated thereunder, award the plaintiff all costs associated with bringing the action (including reasonable attorneys’ and experts’ fees), and grant such further relief as the court deems just and proper. Talmer, Chemical and the individual defendants all believe that the claims asserted against each of them in this lawsuit are without merit and intend to vigorously defend against this lawsuit.
On April 25, 2016, a complaint was filed in the United States District Court for the Eastern District of Michigan by another purported shareholder of Talmer, styled Kevin Nicholl v. Chemical Financial Corporation et. al., Docket No. 1:16-cv-11482. The plaintiff names Talmer, Chemical, and several individuals as defendants. This lawsuit is styled as a class action and derivative action, and alleges breach of fiduciary duties as well as violations of Sections 14(a) and 20(a) of the Securities Exchange Act of 1934. The complaint alleges, among other things, that the individual defendants breached their fiduciary duties as directors of Talmer by, among other things, entering into the proposed merger under various alleged conflicts of interest without regard to the fairness of the transaction to Talmer’s shareholders, using a flawed process in entering into the proposed merger that failed to maximize value for Talmer shareholders, and knowingly or recklessly attempting to unfairly deprive the Talmer shareholders of the true value of their investment in Talmer. The Complaint further alleges that the individual defendants issued materially incomplete and misleading disclosures in the Form S-4 Registration Statement relating to the proposed merger, in violation of Section 14(a) of the Securities Exchange Act, and/or were control persons liable for these alleged violations under Section 20(a) of the Securities Exchange Act. The Complaint alleges that Chemical aided and abetted the alleged wrongdoing of the individual defendants, as described in the Complaint. The Complaint contains requests for relief that include, among other things, that the Court certify the action as a class and derivative action, declare that the individual defendants breached their fiduciary duties in entering into the transaction, direct the individual defendants to comply with their fiduciary duties to obtain a transaction in the best interest of Talmer’s shareholders, enjoin the proposed transaction unless an appropriate procedure or process is implemented to provide the best terms to Talmer’s shareholders, rescind the transaction if it is consummated, award the plaintiff the costs and disbursements of the action (including reasonable attorneys’ and experts’ fees), and grant such further equitable relief as the court deems just and proper. Talmer, Chemical and the individual defendants all believe that the claims asserted against each of them in this lawsuit are without merit and intend to vigorously defend against this lawsuit.
In addition, 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.
Reclassifications
Certain amounts appearing in the consolidated financial statements and notes thereto for prior periods have been reclassified to conform with the current presentation. The reclassification had no effect on net income or shareholders’ equity as previously reported.
Adopted Accounting Pronouncements
Consolidation of Variable Interest Entities
In February 2015, the FASB issued ASU No. 2015-02, Consolidation (Topic 810): Amendments to the Consolidation Analysis ("ASU 2015-02"). ASU 2015-02 is applicable to reporting entities that are required to evaluate whether they should consolidate certain legal entities. Specifically, ASU 2015-02 (i) modifies the evaluation of whether limited partnerships and similar legal entities are VIEs, (ii) eliminates the presumption that a general partner should consolidate a limited partnership, (iii) affects the consolidation analysis of reporting entities that are involved with VIEs, particularly those that have fee arrangements and related party relationships and (iv) provides a scope exception from consolidation guidance for reporting entities with interests in legal entities that are required to comply with or operate in accordance with requirements that are similar to those in Rule 2a-7 of the Investment Company Act of 1940 for registered money market funds. The adoption of ASU 2015-02 effective January 1, 2016 did not have a material impact on the Corporation's consolidated financial condition or results of operations.
Customer's Accounting for Cloud Computing Fees
In April 2015, the FASB issued ASU No. 2015-05, Intangibles - Goodwill and Other - Internal Use Software (Subtopic 350-40): Customer’s Accounting for Fees Paid in a Cloud Computing Arrangement ("ASU 2015-05"). ASU 2015-05 provides guidance to customers about whether a cloud computing arrangement includes a software license. If a cloud computing arrangement includes a software license, the customer should account for the software license element of the arrangement consistent with the acquisition of other software licenses. If a cloud computing arrangement does not include a software license, the customer should account for

17


Chemical Financial Corporation
Notes to Consolidated Financial Statements (Unaudited)
March 31, 2016



the arrangement as a service contract. ASU 2015-05 does not change the accounting for a customer’s accounting for service contracts. The purpose of ASU 2015-05 is to clarify which fees paid in a cloud computing arrangement should be capitalized and which fees should be expensed as incurred. The adoption of ASU 2015-05 prospectively effective January 1, 2016 did not have a material impact on the Corporation's consolidated financial condition or results of operations.
Pending Accounting Pronouncements
Recognition and Measurement
In January 2016, the FASB issued ASU No. 2016-01, Financial Instruments - Overall (Subtopic 825-10): Recognition and Measurement of Financial Assets and Financial Liabilities ("ASU 2016-01"). ASU 2016-01 amends current guidance by: (i) requiring equity investments with readily determinable fair values to be measured at fair value with changes in fair value recognized in net income, (ii) allowing an entity to measure equity investments that do not have readily determinable fair values at either fair value or cost minus impairment, if any, plus or minus changes in observable prices, with changes in measurement recognized in net income, (iii) simplifying the impairment assessment of equity investments without readily determinable fair values by requiring a qualitative assessment to identify impairment, (iv) eliminating the requirement to disclose the methods and significant assumptions used to estimate the fair value for financial instruments measured at amortized cost on the balance sheet; (v) requiring use the of exit price notion when measuring the fair value of financial instruments for disclosure purposes; (vi) requiring recognition of changes in the fair value related to instrument-specific credit risk in other comprehensive income if the fair value option for financial liabilities is elected, (vii) requiring separate presentation in the financial statements of financial assets and financial liabilities by measurement category, and (8) clarifying that an entity should evaluate the need for a valuation allowance on deferred tax assets related to available-for-sale securities in combination with the entity’s other deferred tax assets. ASU 2016-01 is effective for interim and annual reporting periods beginning after December 15, 2017. Early application is permitted as of the beginning of the fiscal year of adoption only for items (iv) and (vi) above. Early adoption of the other items mentioned above is not permitted. The adoption of ASU 2016-01 is not expected to have a material impact on the Corporation's consolidated financial condition or results of operations.
Leases
In February 2016, the FASB issued ASU No. 2016-02, Leases (Topic 842) ("ASU 2016-02"). Under ASU 2016-02, the Corporation will be required to recognize the following for all leases (with the exception of short-term leases): (i) a right to use asset, which is an asset that represents the lessee's right to use, or control the use of, a specified asset for the lease term and (ii) a lease liability, which is a liability that represents lessee's obligation to make lease payments arising from a lease, measured on a discounted basis. ASU 2016-02 requires a modified retrospective transition approach for leases existing at, or entered into after, the beginning of the earliest comparative period presented in the financial statements. ASU 2016-02 is effective for public companies for interim and annual periods beginning after December 15, 2018. The adoption of ASU 2016-02 is not expected to have a material impact on the Corporation's consolidated financial condition or results of operations.
Stock Compensation
In March 2016, the FASB issued ASU No. 2016-09, Compensation - Stock Compensation (Topic 718): Improvements to Employee Share-Based Payment Accounting ("ASU 2016-09"). ASU 2016-09 allows for simplification of several aspects of the accounting for share-based payment transactions including the income tax consequences, classification of awards as either equity or liabilities, and classification on the statement of cash flows. Under ASU 2016-09, all excess tax benefits and tax deficiencies (including tax benefits of dividends on share-based payment awards) should be recognized as income tax expense or benefit in the income statement. ASU 2016-09 also requires recognition of excess tax benefits regardless of whether the benefit reduces taxes payable in the current period. ASU 2016-09 further permits the withholding of an amount up to employees' maximum individual tax rate in the relevant jurisdiction without resulting in a liability classification. ASU 2016-09 also requires any excess tax benefits be classified along with other income tax cash flows as an operating activity and cash paid by an employer when directly withholding shares for tax-withholding purposes to be classified as a financing activity. ASU 2016-09 is effective for public companies for interim and annual periods beginning after December 15, 2016. The Corporation is currently evaluating the impact of ASU 2016-09 on the Corporation's consolidated financial condition and results of operations.

18


Chemical Financial Corporation
Notes to Consolidated Financial Statements (Unaudited)
March 31, 2016



Note 2: Mergers and Acquisitions
Pending Merger with Talmer Bancorp, Inc.
On January 25, 2016, the Corporation entered into an Agreement and Plan of Merger with Talmer. Under the terms of the merger agreement, each Talmer shareholder will receive $1.61 in cash and 0.4725 shares of the Corporation's common stock for each share of Talmer common stock, subject to adjustment in limited circumstances. Based on the 30-day volume weighted price per share of the Corporation's common stock as of January 25, 2016, the merger had a transaction value of approximately $1.1 billion. Following the completion of the merger, the Corporation intends to consolidate Talmer's wholly-owned subsidiary bank, Talmer Bank and Trust, with and into Chemical Bank. At December 31, 2015, Talmer had total assets of $6.6 billion, total loans of $4.8 billion and total deposits of $5.0 billion, including brokered deposits of $229 million. Talmer Bank and Trust is a full service community bank offering a full suite of commercial banking, retail banking, mortgage banking, wealth management and trust services to small and medium-sized businesses and individuals through 80 full service banking offices located primarily within southeast Michigan and northeast Ohio, as well as in west Michigan, northeast Michigan, Chicago, Illinois, northern Indiana, and Las Vegas, Nevada. Completion of the merger is subject to regulatory approval and the approval of the Corporation's and Talmer's shareholders, in addition to satisfaction of other customary closing conditions.
Acquisition of Lake Michigan Financial Corporation
On May 31, 2015, the Corporation acquired all the outstanding stock of Lake Michigan for total consideration of $187.4 million, which included stock consideration of $132.9 million and cash consideration of $54.5 million. As a result of the acquisition, the Corporation issued approximately 4.3 million shares of its common stock, based on an exchange ratio of 1.326 shares of its common stock, and paid $16.64 in cash, for each share of Lake Michigan common stock outstanding. Lake Michigan, a bank holding company which owned The Bank of Holland and The Bank of Northern Michigan, provided traditional banking services and products with five banking offices in Holland, Grand Haven, Grand Rapids, Petoskey and Traverse City, Michigan. The Bank of Holland and The Bank of Northern Michigan were consolidated with and into Chemical Bank on November 13, 2015.
At the acquisition date, Lake Michigan added total assets of $1.24 billion, including total loans of $986 million, and total deposits of $925 million to the Corporation's consolidated statement of financial position. The Corporation recorded $101 million of goodwill, which was primarily attributable to the synergies and economies of scale expected from combining the operations of the Corporation and Lake Michigan. In addition, the Corporation recorded $8.6 million of core deposit and other intangible assets in conjunction with the acquisition. During the first quarter 2016, the Corporation obtained additional information regarding the valuation of deferred tax assets, which resulted in a decrease to goodwill recognized in the transaction of $0.5 million. In accordance with ASU 2015-16, no amounts were recorded in the consolidated statements of income during 2016 for these adjustments that would have been recorded in a previous reporting period had these adjustments been recognized as of the acquisition date.
Upon acquisition, the Lake Michigan loan portfolio had contractually required principal and interest payments receivable of $1.01 billion and $190.2 million, respectively, expected principal and interest cash flows of $986.1 million and $189.6 million, respectively, and a fair value of $985.5 million. The difference between the contractually required payments receivable and the expected cash flows represents the nonaccretable difference, which totaled $22.6 million at the acquisition date, with $22.0 million attributable to expected credit losses. The difference between the expected cash flows and fair value represents the accretable yield, which totaled $190.2 million at the date of acquisition. The outstanding contractual principal balance and the carrying amount of the Lake Michigan acquired loan portfolio were $804 million and $782 million, respectively, at March 31, 2016, compared to $864 million and $842 million, respectively, at December 31, 2015 and there was no related allowance for loan losses at those dates.
Acquisition of Monarch Community Bancorp, Inc.
On April 1, 2015, the Corporation acquired all of the outstanding stock of Monarch in an all-stock transaction valued at $27.2 million. As a result of the acquisition, the Corporation issued 860,575 shares of its common stock based on an exchange ratio of 0.0982 shares of its common stock for each share of Monarch common stock outstanding. Monarch, a bank holding company, owned Monarch Community Bank, which operated five full service branch offices in Coldwater, Marshall, Hillsdale and Union City, Michigan. Monarch Community Bank was consolidated with and into Chemical Bank on May 8, 2015.
As of the April 1, 2015 acquisition date, Monarch added total assets of $183 million, including total loans of $122 million, and total deposits of $144 million to the Corporation's consolidated statement of financial position. In connection with the acquisition of Monarch, the Corporation recorded $5.3 million of goodwill, which was primarily attributable to the synergies and economies of scale expected from combining the operations of the Corporation and Monarch. In addition, the Corporation recorded $1.9 million of core deposit intangible assets in conjunction with the acquisition.

19


Chemical Financial Corporation
Notes to Consolidated Financial Statements (Unaudited)
March 31, 2016



Upon acquisition, the Monarch loan portfolio had contractually required principal and interest payments receivable of $128.9 million and $37.8 million, respectively, expected principal and interest cash flows of $122.6 million and $37.1 million, respectively, and a fair value of $121.8 million. The difference between the contractually required payments receivable and the expected cash flows represents the nonaccretable difference, which totaled $7.1 million at the acquisition date, with $6.3 million attributable to expected credit losses. The difference between the expected cash flows and fair value represents the accretable yield, which totaled $37.9 million at the date of acquisition. The outstanding contractual principal balance and the carrying amount of the Monarch acquired loan portfolio were $107 million and $101 million, respectively, at March 31, 2016, compared to $115 million and $108 million, respectively as of December 31, 2015 and there was no related allowance for loan losses at those dates.
Acquisition of Northwestern Bancorp, Inc.
On October 31, 2014, the Corporation acquired all of the outstanding stock of Northwestern Bancorp, Inc. (Northwestern) for total cash consideration of $121 million. Northwestern, a bank holding company which owned Northwestern Bank, provided traditional banking services and products through 25 banking offices serving communities in the northwestern lower peninsula of Michigan. At the acquisition date, Northwestern added total assets of $815 million, including total loans of $475 million, and total deposits of $794 million to the Corporation. Northwestern Bank was consolidated with and into Chemical Bank as of the acquisition date. In connection with the acquisition of Northwestern, the Corporation recorded $60.3 million of goodwill, which was primarily attributable to the synergies and economies of scale expected from combining the operations of the Corporation and Northwestern. In addition, the Corporation recorded $12.9 million of core deposit intangible assets in conjunction with the acquisition.
Upon acquisition, the Northwestern loan portfolio had contractually required principal and interest payments receivable of $507 million and $112 million, respectively, expected principal and interest cash flows of $481 million and $104 million, respectively, and a fair value of $475 million. The difference between the contractually required payments receivable and the expected cash flows represents the nonaccretable difference, which totaled $34 million at the acquisition date, with $26 million attributable to expected credit losses. The difference between the expected cash flows and fair value represents the accretable yield, which totaled $110 million at the acquisition date. The outstanding contractual principal balance and the carrying amount of the Northwestern acquired loan portfolio were $336 million and $305 million, respectively, at March 31, 2016, compared to $361 million and $330 million, respectively, at December 31, 2015 and $453 million and $421 million, respectively, at March 31, 2015.
Acquisition of 21 Branches
On December 7, 2012, Chemical Bank acquired 21 branches from Independent Bank, a subsidiary of Independent Bank Corporation, located in the Northeast and Battle Creek regions of Michigan, including $404 million in deposits and $44 million in loans (branch acquisition transaction). The purchase price of the branch offices, including equipment, was $8.1 million and the Corporation paid a premium on deposits of $11.5 million, or approximately 2.85% of total deposits. The loans were purchased at a discount of 1.75%. In connection with the branch acquisition transaction, the Corporation recorded goodwill of $6.8 million and other intangible assets attributable to customer core deposits of $5.6 million.
Acquisition of O.A.K. Financial Corporation
On April 30, 2010, the Corporation acquired OAK in an all-stock transaction for total consideration of $83.7 million. OAK provided traditional banking services and products through 14 banking offices serving communities in Ottawa, Allegan and Kent counties in west Michigan. At the acquisition date, OAK added 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 payments receivable of $683 million and a fair value of $627 million. The outstanding contractual principal balance and the carrying amount of the OAK acquired loan portfolio were $196 million and $178 million, respectively, at March 31, 2016, compared to $204 million and $183 million, respectively, at December 31, 2015 and $255 million and $234 million, respectively, at March 31, 2015.

20


Chemical Financial Corporation
Notes to Consolidated Financial Statements (Unaudited)
March 31, 2016



Accretable Yield
Activity for the accretable yield, which includes contractually due interest for acquired loans that have been renewed or extended since the date of acquisition and continue to be accounted for in loan pools in accordance with ASC 310-30, follows:
 
 
Lake Michigan
 
Monarch
 
North-western
 
OAK
 
Total
 
Three Months Ended March 31, 2016
 
(In thousands)
Balance at beginning of period
 
$
152,999

 
$
34,558

 
$
82,623

 
$
28,077

 
$
298,257

 
Additions (reductions)*
 
(6,071
)
 
128

 
(2,254
)
 
1,516

 
(6,681
)
 
Accretion recognized in interest income
 
(8,953
)
 
(1,451
)
 
(4,001
)
 
(2,557
)
 
(16,962
)
 
Balance at end of period
 
$
137,975

 
$
33,235

 
$
76,368

 
$
27,036

 
$
274,614

 
 
 
 
 
 
 
 
 
 
 
 
 
Three Months Ended March 31, 2015
 
 
 
 
 
 
 
 
 
 
 
Balance at beginning of period
 
 
 
 
 
$
104,675

 
$
33,286

 
$
137,961

 
Additions (reductions)*
 
 
 
 
 
(1,410
)
 
714

 
(696
)
 
Accretion recognized in interest income
 
 
 
 
 
(4,998
)
 
(3,207
)
 
(8,205
)
 
Balance at end of period
 


 


 
$
98,267

 
$
30,793

 
$
129,060

 
*Represents additions of estimated contractual interest expected to be collected from acquired loans being renewed or extended, less reductions in contractual interest resulting from the early payoff of acquired loans.

21


Chemical Financial Corporation
Notes to Consolidated Financial Statements (Unaudited)
March 31, 2016



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 March 31, 2016December 31, 2015 and March 31, 2015:
 
 
Investment Securities Available-for-Sale
 
 
Amortized
Cost
 
Unrealized
Gains
 
Unrealized
Losses
 
Fair
Value
 
 
(In thousands)
March 31, 2016
 
 
 
 
 
 
 
 
U.S. Treasury securities
 
$
5,777

 
$
20

 
$

 
$
5,797

Government sponsored agencies
 
177,537

 
591

 
491

 
177,637

State and political subdivisions
 
14,707

 
356

 
2

 
15,061

Residential mortgage-backed securities
 
178,498

 
899

 
248

 
179,149

Collateralized mortgage obligations
 
118,501

 
338

 
441

 
118,398

Corporate bonds
 
14,832

 

 
124

 
14,708

Preferred stock and trust preferred securities
 
2,888

 
377

 

 
3,265

Total
 
$
512,740

 
$
2,581

 
$
1,306

 
$
514,015

December 31, 2015
 
 
 
 
 
 
 
 
U.S. Treasury securities
 
$
5,773

 
$

 
$
8

 
$
5,765

Government sponsored agencies
 
195,711

 
78

 
800

 
194,989

State and political subdivisions
 
14,731

 
395

 
6

 
15,120

Residential mortgage-backed securities
 
189,452

 
538

 
2,222

 
187,768

Collateralized mortgage obligations
 
133,256

 
111

 
1,137

 
132,230

Corporate bonds
 
14,825

 
2

 
200

 
14,627

Preferred stock and trust preferred securities
 
2,888

 
344

 

 
3,232

Total
 
$
556,636

 
$
1,468

 
$
4,373

 
$
553,731

March 31, 2015
 
 
 
 
 
 
 
 
U.S. Treasury securities
 
$
8,271

 
$
31

 
$

 
$
8,302

Government sponsored agencies
 
249,642

 
889

 
101

 
250,430

State and political subdivisions
 
31,701

 
624

 
3

 
32,322

Residential mortgage-backed securities
 
218,299

 
1,358

 
56

 
219,601

Collateralized mortgage obligations
 
133,713

 
305

 
718

 
133,300

Corporate bonds
 
34,925

 
136

 
64

 
34,997

Preferred stock
 
1,389

 
303

 

 
1,692

Total
 
$
677,940

 
$
3,646

 
$
942

 
$
680,644



22


Chemical Financial Corporation
Notes to Consolidated Financial Statements (Unaudited)
March 31, 2016



 
 
Investment Securities Held-to-Maturity
 
 
Amortized
Cost
 
Unrealized
Gains
 
Unrealized
Losses
 
Fair
Value
 
 
(In thousands)
March 31, 2016
 
 
 
 
 
 
 
 
State and political subdivisions
 
$
517,800

 
$
9,493

 
$
1,985

 
$
525,308

Trust preferred securities
 
500

 

 
215

 
285

Total
 
$
518,300

 
$
9,493

 
$
2,200

 
$
525,593

December 31, 2015
 
 
 
 
 
 
 
 
State and political subdivisions
 
$
509,471

 
$
7,446

 
$
4,512

 
$
512,405

Trust preferred securities
 
500

 

 
200

 
300

Total
 
$
509,971

 
$
7,446

 
$
4,712

 
$
512,705

March 31, 2015
 
 
 
 
 
 
 
 
State and political subdivisions
 
$
370,950

 
$
6,852

 
$
4,926

 
$
372,876

Trust preferred securities
 
10,500

 

 
3,200

 
7,300

Total
 
$
381,450

 
$
6,852

 
$
8,126

 
$
380,176

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).
As of March 31, 2015, the Corporation held a $10.0 million trust preferred investment security of Lake Michigan. With the acquisition of Lake Michigan, this investment was settled as of the acquisition date at par.
The following is a summary of the amortized cost and fair value of investment securities at March 31, 2016, 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.
 
 
March 31, 2016
 
 
Amortized
Cost
 
Fair Value
 
 
(In thousands)
Investment Securities Available-for-Sale:
 
 
 
 
Due in one year or less
 
$
167,082

 
$
167,114

Due after one year through five years
 
293,731

 
294,443

Due after five years through ten years
 
45,820

 
45,935

Due after ten years
 
4,719

 
4,757

Preferred stock
 
1,388

 
1,766

Total
 
$
512,740

 
$
514,015

Investment Securities Held-to-Maturity:
 
 
 
 
Due in one year or less
 
$
57,074

 
$
57,148

Due after one year through five years
 
239,496

 
241,445

Due after five years through ten years
 
142,968

 
145,988

Due after ten years
 
78,762

 
81,012

Total
 
$
518,300

 
$
525,593


23


Chemical Financial Corporation
Notes to Consolidated Financial Statements (Unaudited)
March 31, 2016



The following schedule summarizes information for both available-for-sale and held-to-maturity investment securities with gross unrealized losses at March 31, 2016December 31, 2015 and March 31, 2015, 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
 
 
Fair
Value
 
Gross
Unrealized
Losses
 
Fair
Value
 
Gross
Unrealized
Losses
 
Fair
Value
 
Gross
Unrealized
Losses
 
 
(In thousands)
March 31, 2016
 
 
 
 
 
 
 
 
 
 
 
 
Government sponsored agencies
 
$
2,501

 
$
1

 
$
20,275

 
$
490

 
$
22,776

 
$
491

State and political subdivisions
 
83,997

 
1,067

 
96,143

 
920

 
180,140

 
1,987

Residential mortgage-backed securities
 
54,163

 
63

 
63,869

 
185

 
118,032

 
248

Collateralized mortgage obligations
 
29,973

 
34

 
35,489

 
407

 
65,462

 
441

Corporate bonds
 
4,666

 
73

 
4,950

 
51

 
9,616

 
124

Trust preferred securities
 

 

 
285

 
215

 
285

 
215

Total
 
$
175,300


$
1,238

 
$
221,011

 
$
2,268

 
$
396,311

 
$
3,506

December 31, 2015
 
 
 
 
 
 
 
 
 
 
 
 
U.S. Treasury securities
 
$
5,765

 
$
8

 
$

 
$

 
$
5,765

 
$
8

Government sponsored agencies
 
114,640

 
292

 
21,681

 
508

 
136,321

 
800

State and political subdivisions
 
195,285

 
2,891

 
68,361

 
1,627

 
263,646

 
4,518

Residential mortgage-backed securities
 
169,226

 
2,146

 
3,435

 
76

 
172,661

 
2,222

Collateralized mortgage obligations
 
60,459

 
408

 
39,382

 
729

 
99,841

 
1,137

Corporate bonds
 
9,532

 
200

 

 

 
9,532

 
200

Trust preferred securities
 

 

 
300

 
200

 
300

 
200

Total
 
$
554,907

 
$
5,945

 
$
133,159

 
$
3,140

 
$
688,066

 
$
9,085

March 31, 2015
 
 
 
 
 
 
 
 
 
 
 
 
Government sponsored agencies
 
$
27,889

 
$
64

 
$
18,896

 
$
37

 
$
46,785

 
$
101

State and political subdivisions
 
156,010

 
1,989

 
49,839

 
2,940

 
205,849

 
4,929

Residential mortgage-backed securities
 
82,303

 
28

 
3,847

 
28

 
86,150

 
56

Collateralized mortgage obligations
 
22,694

 
22

 
41,061

 
696

 
63,755

 
718

Corporate bonds
 
4,989

 
11

 
14,946

 
53

 
19,935

 
64

Trust preferred securities
 

 

 
7,300

 
3,200

 
7,300

 
3,200

Total
 
$
293,885

 
$
2,114

 
$
135,889

 
$
6,954

 
$
429,774

 
$
9,068

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 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 March 31, 2016, represented an other-than-temporary impairment (OTTI). Management believed that the unrealized losses on investment securities at March 31, 2016 were temporary in nature and due primarily to changes in interest rates and reduced market liquidity and not as a result of credit-related issues.
At March 31, 2016, 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 March 31, 2016, the Corporation believed the impairments in its investment securities portfolio were temporary in nature. However, there is no assurance that OTTI may not occur in the future.

24


Chemical Financial Corporation
Notes to Consolidated Financial Statements (Unaudited)
March 31, 2016



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) that 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 six classes of loans, which are set forth below.
Commercial — Loans and lines of credit 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.
Commercial real estate — 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 and land development — Real estate construction loans represent secured loans for the construction of business properties. Real estate construction loans often convert to a commercial real estate loan at the completion of the construction period. Land development loans represent secured development loans 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 March 31, 2016, December 31, 2015 and March 31, 2015 were primarily comprised of loans to develop residential properties.
Residential mortgage — Loans secured by one- to four-family residential properties, generally with fixed interest rates for periods of fifteen years or less. The loan-to-value ratio at the time of origination is generally 80% or less. Residential mortgage 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 acquiring automobiles, recreational vehicles and personal watercraft and comprised primarily of indirect loans purchased from dealers. These loans consist of relatively small amounts that are spread across many individual borrowers.
Home equity — Loans and lines of credit whereby consumers utilize equity in their personal residence, generally through a second mortgage, as collateral to secure the loan.
Commercial, commercial real estate, real estate construction and land development loans are referred to as the Corporation’s commercial loan portfolio, while residential mortgage, consumer installment and home equity loans are referred to as the Corporation’s consumer loan portfolio. A summary of loans follows:
 
 
March 31,
2016
 
December 31,
2015
 
March 31,
2015
 
 
(In thousands)
Commercial loan portfolio:
 
 
 
 
 
 
Commercial
 
$
1,922,259

 
$
1,905,879

 
$
1,356,169

Commercial real estate
 
2,143,051

 
2,112,162

 
1,616,923

Real estate construction and land development
 
242,899

 
232,076

 
108,839

Subtotal
 
4,308,209

 
4,250,117

 
3,081,931

Consumer loan portfolio:
 
 
 
 
 
 
Residential mortgage
 
1,461,120

 
1,429,636

 
1,117,445

Consumer installment
 
897,078

 
877,457

 
844,066

Home equity
 
700,478

 
713,937

 
659,432

Subtotal
 
3,058,676

 
3,021,030

 
2,620,943

Total loans
 
$
7,366,885

 
$
7,271,147

 
$
5,702,874


25


Chemical Financial Corporation
Notes to Consolidated Financial Statements (Unaudited)
March 31, 2016



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 lower peninsula of Michigan, except for the southeastern portion of Michigan. The Corporation has no foreign loans.
The Corporation, through Chemical Bank, has a commercial loan portfolio 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 six executive and senior officers who have varying loan limits exceeding $1.5 million and up to $3.5 million. With respect to the group loan authorities, Chemical Bank has a loan committee, consisting of certain executive and senior officers, that meets weekly to consider loans ranging in amounts from $1.0 million to $10.0 million, depending on risk rating and credit action required. A directors’ loan committee of Chemical Bank, consisting of eight independent members of the board of directors of Chemical Bank, the chief executive officer of Chemical Bank and the senior credit officer of Chemical Bank, meets bi-weekly to consider loans in amounts over $10.0 million, and certain loans under $10.0 million depending on a loan’s risk rating and credit action required. Loans over $15.0 million require the approval of the board of directors of Chemical Bank.
The majority of the Corporation’s consumer loan portfolio is comprised of secured loans that are relatively small. The Corporation’s consumer loan portfolio has a centralized approval process which utilizes 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, resulting in repossession or foreclosure if payments are not brought current. 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 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 ongoing 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 for loans in the commercial loan portfolio. 
Credit Quality Indicators
Commercial Loan Portfolio
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 through 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 through 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).

26


Chemical Financial Corporation
Notes to Consolidated Financial Statements (Unaudited)
March 31, 2016



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 not available; 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.
The Corporation considers all loans graded 1 through 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 graded 6 and 7 are considered higher-risk credits than loans graded 1 through 5 and the frequency of loan officer contact and receipt of financial data is increased to stay abreast of borrower performance. Loans graded 8 and 9 are considered problematic and require special care. Further, loans graded 6 through 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, and include 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 March 31, 2016December 31, 2015 and March 31, 2015:

27


Chemical Financial Corporation
Notes to Consolidated Financial Statements (Unaudited)
March 31, 2016



 
 
Commercial
 
Commercial Real Estate
 
Real Estate
Construction and Land Development
 
Total
 
 
(In thousands)
March 31, 2016
 
 
 
 
 
 
 
 
Originated Portfolio:
 
 
 
 
 
 
 
 
Risk Grades 1-5
 
$
1,466,094

 
$
1,409,991

 
$
196,982

 
$
3,073,067

Risk Grade 6
 
43,129

 
44,210

 
1,163

 
88,502

Risk Grade 7
 
35,437

 
20,250

 
977

 
56,664

Risk Grade 8
 
17,595

 
25,858

 
546

 
43,999

Risk Grade 9
 
1,669

 
1

 

 
1,670

Subtotal
 
1,563,924

 
1,500,310

 
199,668

 
3,263,902

Acquired Portfolio:
 
 
 
 
 
 
 
 
Risk Grades 1-5
 
319,672

 
590,151

 
39,260

 
949,083

Risk Grade 6
 
25,978

 
17,692

 
1,539

 
45,209

Risk Grade 7
 
11,103

 
30,679

 
1,273

 
43,055

Risk Grade 8
 
1,582

 
4,219

 
1,159

 
6,960

Risk Grade 9
 

 

 

 

Subtotal
 
358,335

 
642,741

 
43,231

 
1,044,307

Total
 
$
1,922,259

 
$
2,143,051

 
$
242,899

 
$
4,308,209

December 31, 2015
 
 
 
 
 
 
 
 
Originated Portfolio:
 
 
 
 
 
 
 
 
Risk Grades 1-5
 
$
1,418,301

 
$
1,341,202

 
$
183,323

 
$
2,942,826

Risk Grade 6
 
34,727

 
31,036

 
180

 
65,943

Risk Grade 7
 
39,933

 
26,658

 
1,123

 
67,714

Risk Grade 8
 
26,459

 
25,163

 
521

 
52,143

Risk Grade 9
 
2,095

 

 

 
2,095

Subtotal
 
1,521,515

 
1,424,059

 
185,147

 
3,130,721

Acquired Portfolio:
 
 
 
 
 
 
 
 
Risk Grades 1-5
 
340,782

 
629,430

 
41,683

 
1,011,895

Risk Grade 6
 
28,321

 
23,926

 
2,556

 
54,803

Risk Grade 7
 
11,607

 
29,975

 
1,537

 
43,119

Risk Grade 8
 
3,654

 
4,772

 
1,153

 
9,579

Risk Grade 9
 

 

 

 

Subtotal
 
384,364

 
688,103

 
46,929

 
1,119,396

Total
 
$
1,905,879

 
$
2,112,162

 
$
232,076

 
$
4,250,117

March 31, 2015
 
 
 
 
 
 
 
 
Originated Portfolio:
 
 
 
 
 
 
 
 
Risk Grades 1-5
 
$
1,176,021

 
$
1,175,373

 
$
96,497

 
$
2,447,891

Risk Grade 6
 
40,999

 
44,248

 
738

 
85,985

Risk Grade 7
 
28,983

 
27,961

 
1,997

 
58,941

Risk Grade 8
 
18,904

 
24,760

 
953

 
44,617

Risk Grade 9
 

 
6

 

 
6

Subtotal
 
1,264,907

 
1,272,348

 
100,185

 
2,637,440

Acquired Portfolio:
 
 
 
 
 
 
 
 
Risk Grades 1-5
 
71,422

 
318,113

 
6,724

 
396,259

Risk Grade 6
 
11,299

 
7,786

 
253

 
19,338

Risk Grade 7
 
6,509

 
12,735

 
140

 
19,384

Risk Grade 8
 
2,032

 
5,941

 
1,537

 
9,510

Risk Grade 9