Attached files
| file | filename |
|---|---|
| EX-32.1 - EXHIBIT 32.1 - TCF FINANCIAL CORP | chfc2016q2exhibit321.htm |
| EX-31.2 - EXHIBIT 31.2 - TCF FINANCIAL CORP | chfc2016q2exhibit312.htm |
| EX-31.1 - EXHIBIT 31.1 - TCF FINANCIAL CORP | chfc2016q2exhibit311.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 June 30, 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 July 21, 2016, was 38,268,487 shares.
INDEX
Chemical Financial Corporation
Form 10-Q
Index to Form 10-Q
Page | ||
Consolidated Statements of Financial Position as of June 30, 2016 (unaudited), December 31, 2015 and June 30, 2015 (unaudited) | ||
Consolidated Statements of Income for the Three and Six Months Ended June 30, 2016 and 2015 (unaudited) | ||
Consolidated Statements of Comprehensive Income for the Three and Six Months Ended June 30, 2016 and 2015 (unaudited) | ||
Consolidated Statements of Changes in Shareholders’ Equity for the Six Months Ended June 30, 2016 and 2015 (unaudited) | ||
Consolidated Statements of Cash Flows for the Six Months Ended June 30, 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, 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 and employee attrition may be greater than expected. |
• | The outcome of pending or threatened litigation, whether currently existing or commencing in the future, including litigation related to the transaction. |
• | The effect of divestitures that may be required by regulatory authorities in certain markets in which Chemical and Talmer compete. |
• | The challenges of integrating, retaining and hiring key personnel. |
• | Failure to attract new customers and retain existing customers in the manner anticipated. |
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
Part I. Financial Information
Item 1. Financial Statements
Chemical Financial Corporation
Consolidated Statements of Financial Position
June 30, 2016 | December 31, 2015 | June 30, 2015 | ||||||||||
(Unaudited) | (Unaudited) | |||||||||||
Assets | (In thousands, except share data) | |||||||||||
Cash and cash equivalents: | ||||||||||||
Cash and cash due from banks | $ | 179,310 | $ | 194,136 | $ | 167,054 | ||||||
Interest-bearing deposits with the Federal Reserve Bank and other banks | 53,650 | 44,653 | 47,980 | |||||||||
Total cash and cash equivalents | 232,960 | 238,789 | 215,034 | |||||||||
Investment securities: | ||||||||||||
Available-for-sale, at fair value | 458,552 | 553,731 | 685,706 | |||||||||
Held-to-maturity (fair value - $568,415 at June 30, 2016, $512,705 at December 31, 2015 and $466,578 at June 30, 2015) | 552,828 | 509,971 | 469,837 | |||||||||
Total investment securities | 1,011,380 | 1,063,702 | 1,155,543 | |||||||||
Loans held-for-sale, at fair value | 13,990 | 10,327 | 7,798 | |||||||||
Loans | 7,647,269 | 7,271,147 | 7,034,743 | |||||||||
Allowance for loan losses | (71,506 | ) | (73,328 | ) | (74,941 | ) | ||||||
Net loans | 7,575,763 | 7,197,819 | 6,959,802 | |||||||||
Premises and equipment (net of accumulated depreciation of $121,890 at June 30, 2016, $120,382 at December 31, 2015 and $112,530 at June 30, 2015) | 102,709 | 106,317 | 111,968 | |||||||||
Goodwill | 286,867 | 287,393 | 285,512 | |||||||||
Other intangible assets | 34,270 | 38,104 | 41,201 | |||||||||
Interest receivable and other assets | 256,233 | 246,346 | 243,867 | |||||||||
Total Assets | $ | 9,514,172 | $ | 9,188,797 | $ | 9,020,725 | ||||||
Liabilities and Shareholders’ Equity | ||||||||||||
Deposits: | ||||||||||||
Noninterest-bearing | $ | 2,007,629 | $ | 1,934,583 | $ | 1,860,863 | ||||||
Interest-bearing | 5,457,017 | 5,522,184 | 5,432,116 | |||||||||
Total deposits | 7,464,646 | 7,456,767 | 7,292,979 | |||||||||
Interest payable and other liabilities | 71,417 | 76,466 | 66,174 | |||||||||
Securities sold under agreements to repurchase with customers | 256,213 | 297,199 | 305,291 | |||||||||
Short-term borrowings | 300,000 | 100,000 | 227,000 | |||||||||
Long-term borrowings | 371,597 | 242,391 | 148,490 | |||||||||
Total liabilities | 8,463,873 | 8,172,823 | 8,039,934 | |||||||||
Shareholders’ equity: | ||||||||||||
Preferred stock, no par value: | ||||||||||||
Authorized – 2,000,000 shares, none issued | — | — | — | |||||||||
Common stock, $1 par value per share: | ||||||||||||
Authorized — 60,000,000 shares | ||||||||||||
Issued and outstanding — 38,267,118 shares at June 30, 2016, 38,167,861 shares at December 31, 2015 and 38,110,136 shares at June 30, 2015 | 38,267 | 38,168 | 38,110 | |||||||||
Additional paid-in capital | 727,145 | 725,280 | 722,329 | |||||||||
Retained earnings | 310,585 | 281,558 | 251,456 | |||||||||
Accumulated other comprehensive loss | (25,698 | ) | (29,032 | ) | (31,104 | ) | ||||||
Total shareholders’ equity | 1,050,299 | 1,015,974 | 980,791 | |||||||||
Total Liabilities and Shareholders’ Equity | $ | 9,514,172 | $ | 9,188,797 | $ | 9,020,725 | ||||||
See accompanying notes to consolidated financial statements (unaudited).
4
Chemical Financial Corporation
Consolidated Statements of Income (Unaudited)
Three Months Ended | Six Months Ended | |||||||||||||||
June 30, | June 30, | |||||||||||||||
2016 | 2015 | 2016 | 2015 | |||||||||||||
(In thousands, except per share data) | ||||||||||||||||
Interest Income | ||||||||||||||||
Interest and fees on loans | $ | 77,578 | $ | 64,613 | $ | 151,979 | $ | 122,710 | ||||||||
Interest on investment securities: | ||||||||||||||||
Taxable | 1,798 | 2,202 | 3,727 | 4,509 | ||||||||||||
Tax-exempt | 2,640 | 2,185 | 5,305 | 4,091 | ||||||||||||
Dividends on nonmarketable equity securities | 777 | 551 | 1,033 | 749 | ||||||||||||
Interest on deposits with the Federal Reserve Bank and other banks | 144 | 128 | 357 | 250 | ||||||||||||
Total interest income | 82,937 | 69,679 | 162,401 | 132,309 | ||||||||||||
Interest Expense | ||||||||||||||||
Interest on deposits | 4,260 | 3,630 | 8,319 | 6,982 | ||||||||||||
Interest on short-term borrowings | 226 | 101 | 326 | 199 | ||||||||||||
Interest on long-term borrowings | 956 | 213 | 1,931 | 213 | ||||||||||||
Total interest expense | 5,442 | 3,944 | 10,576 | 7,394 | ||||||||||||
Net Interest Income | 77,495 | 65,735 | 151,825 | 124,915 | ||||||||||||
Provision for loan losses | 3,000 | 1,500 | 4,500 | 3,000 | ||||||||||||
Net interest income after provision for loan losses | 74,495 | 64,235 | 147,325 | 121,915 | ||||||||||||
Noninterest Income | ||||||||||||||||
Service charges and fees on deposit accounts | 6,337 | 6,445 | 12,057 | 12,361 | ||||||||||||
Wealth management revenue | 5,782 | 5,605 | 10,983 | 10,676 | ||||||||||||
Other charges and fees for customer services | 6,463 | 6,516 | 12,855 | 12,506 | ||||||||||||
Mortgage banking revenue | 1,595 | 1,688 | 3,000 | 3,091 | ||||||||||||
Gain on sale of investment securities | 18 | 28 | 37 | 607 | ||||||||||||
Other | 702 | 392 | 1,384 | 708 | ||||||||||||
Total noninterest income | 20,897 | 20,674 | 40,316 | 39,949 | ||||||||||||
Operating Expenses | ||||||||||||||||
Salaries, wages and employee benefits | 33,127 | 31,711 | 67,017 | 60,964 | ||||||||||||
Occupancy | 5,514 | 4,386 | 10,419 | 8,812 | ||||||||||||
Equipment and software | 4,875 | 4,480 | 9,279 | 8,878 | ||||||||||||
Merger and acquisition-related transaction expenses | 3,054 | 3,457 | 5,648 | 4,819 | ||||||||||||
Other | 12,515 | 12,751 | 25,609 | 24,332 | ||||||||||||
Total operating expenses | 59,085 | 56,785 | 117,972 | 107,805 | ||||||||||||
Income before income taxes | 36,307 | 28,124 | 69,669 | 54,059 | ||||||||||||
Federal income tax expense | 10,600 | 9,100 | 20,700 | 17,200 | ||||||||||||
Net Income | $ | 25,707 | $ | 19,024 | $ | 48,969 | $ | 36,859 | ||||||||
Net Income Per Common Share: | ||||||||||||||||
Basic | $ | 0.67 | $ | 0.54 | $ | 1.28 | $ | 1.08 | ||||||||
Diluted | 0.67 | 0.54 | 1.27 | 1.08 | ||||||||||||
Cash Dividends Declared Per Common Share | 0.26 | 0.24 | 0.52 | 0.48 | ||||||||||||
See accompanying notes to consolidated financial statements (unaudited).
5
Chemical Financial Corporation
Consolidated Statements of Comprehensive Income (Unaudited)
Three Months Ended | Six Months Ended | ||||||||||||||
June 30, | June 30, | ||||||||||||||
2016 | 2015 | 2016 | 2015 | ||||||||||||
(In thousands) | |||||||||||||||
Net income | $ | 25,707 | $ | 19,024 | $ | 48,969 | $ | 36,859 | |||||||
Other comprehensive income (loss), net of tax: | |||||||||||||||
Net unrealized gains (losses) on investment securities available-for-sale, net of tax expense (benefit) of $742 and $(1,084) for the three months ended June 30, 2016 and 2015, respectively, and $2,212 and $177 for the six months ended June 30, 2016 and 2015, respectively | 1,379 | (2,014 | ) | 4,108 | 331 | ||||||||||
Reclassification adjustment for realized gain on sale of investment securities available-for-sale included in net income, net of tax expense of $6 and $10 for the three months ended June 30, 2016 and 2015, respectively, and $13 and $212 for the six months ended June 30, 2016 and 2015, respectively | (12 | ) | (18 | ) | (24 | ) | (395 | ) | |||||||
Adjustment for pension and other postretirement benefits, net of tax expense (benefit) of $(202) and $380 for the three months ended June 30, 2016 and 2015, respectively, and $(404) and $761 for the six months ended June 30, 2016 and 2015, respectively | (375 | ) | 707 | (750 | ) | 1,413 | |||||||||
Total other comprehensive income (loss), net of tax | 992 | (1,325 | ) | 3,334 | 1,349 | ||||||||||
Comprehensive income | $ | 26,699 | $ | 17,699 | $ | 52,303 | $ | 38,208 | |||||||
See accompanying notes to consolidated financial statements (unaudited).
6
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 | 36,859 | 1,349 | 38,208 | |||||||||||||||||
Cash dividends declared and paid of $0.48 per share | (17,049 | ) | (17,049 | ) | ||||||||||||||||
Issuance of common stock in business acquisitions | 5,183 | 154,721 | 159,904 | |||||||||||||||||
Shares issued – stock options | 88 | 1,058 | 1,146 | |||||||||||||||||
Shares issued – directors’ stock plans | 11 | 305 | 316 | |||||||||||||||||
Shares issued – restricted stock units | 53 | (381 | ) | (328 | ) | |||||||||||||||
Share-based compensation | 1 | 1,460 | 1,461 | |||||||||||||||||
Balances at June 30, 2015 | $ | 38,110 | $ | 722,329 | $ | 251,456 | $ | (31,104 | ) | $ | 980,791 | |||||||||
Balances at December 31, 2015 | $ | 38,168 | $ | 725,280 | $ | 281,558 | $ | (29,032 | ) | $ | 1,015,974 | |||||||||
Comprehensive income | 48,969 | 3,334 | 52,303 | |||||||||||||||||
Cash dividends declared and paid of $0.52 per share | (19,942 | ) | (19,942 | ) | ||||||||||||||||
Shares issued – stock options | 48 | 480 | 528 | |||||||||||||||||
Shares issued – directors’ stock plans | 5 | 120 | 125 | |||||||||||||||||
Shares issued – restricted stock units | 45 | (514 | ) | (469 | ) | |||||||||||||||
Share-based compensation | 1 | 1,779 | 1,780 | |||||||||||||||||
Balances at June 30, 2016 | $ | 38,267 | $ | 727,145 | $ | 310,585 | $ | (25,698 | ) | $ | 1,050,299 | |||||||||
See accompanying notes to consolidated financial statements (unaudited).
7
Chemical Financial Corporation
Consolidated Statements of Cash Flows (Unaudited)
Six Months Ended June 30, | ||||||||
2016 | 2015 | |||||||
(In thousands) | ||||||||
Operating Activities | ||||||||
Net income | $ | 48,969 | $ | 36,859 | ||||
Adjustments to reconcile net income to net cash provided by operating activities: | ||||||||
Provision for loan losses | 4,500 | 3,000 | ||||||
Gains on sales of loans | (3,431 | ) | (3,375 | ) | ||||
Proceeds from sales of loans | 119,845 | 119,683 | ||||||
Loans originated for sale | (120,077 | ) | (111,903 | ) | ||||
Net gains from sales/writedowns of other real estate and repossessed assets | (2,512 | ) | (1,578 | ) | ||||
Depreciation of premises and equipment | 5,562 | 5,239 | ||||||
Amortization of intangible assets | 4,751 | 3,787 | ||||||
Net gains on sale of investment securities | (37 | ) | (607 | ) | ||||
Net amortization of premiums and discounts on investment securities | 2,891 | 2,759 | ||||||
Share-based compensation expense | 1,780 | 1,461 | ||||||
Net increase in interest receivable and other assets | (13,642 | ) | (11,695 | ) | ||||
Net decrease in interest payable and other liabilities | (4,139 | ) | (15,727 | ) | ||||
Net cash provided by operating activities | 44,460 | 27,903 | ||||||
Investing Activities | ||||||||
Investment securities – available-for-sale: | ||||||||
Proceeds from sales | — | 13,173 | ||||||
Proceeds from maturities, calls and principal reductions | 99,528 | 113,973 | ||||||
Investment securities – held-to-maturity: | ||||||||
Proceeds from maturities, calls and principal reductions | 57,518 | 54,481 | ||||||
Purchases | (101,295 | ) | (205,286 | ) | ||||
Net increase in loans | (385,814 | ) | (250,997 | ) | ||||
Proceeds from sales of other real estate and repossessed assets | 7,377 | 7,934 | ||||||
Purchases of premises and equipment, net of disposals | (3,897 | ) | (3,333 | ) | ||||
Cash acquired, net of cash paid, in business combinations | — | 16,551 | ||||||
Net cash used in investing activities | (326,583 | ) | (253,504 | ) | ||||
Financing Activities | ||||||||
Net increase in interest- and noninterest-bearing demand deposits and savings accounts | 95,263 | 217,719 | ||||||
Net decrease in time deposits | (87,384 | ) | (72,795 | ) | ||||
Net increase in securities sold under agreements to repurchase with customers and other short-term borrowings | 159,014 | 103,824 | ||||||
Proceeds from long-term borrowings | 150,000 | 25,000 | ||||||
Repayment of long-term borrowings | (20,558 | ) | — | |||||
Cash dividends paid | (19,942 | ) | (17,049 | ) | ||||
Proceeds from directors’ stock plans and exercise of stock options, net of shares withheld | 653 | 1,462 | ||||||
Cash paid for payroll taxes upon conversion of share-based awards | (752 | ) | (546 | ) | ||||
Net cash provided by financing activities | 276,294 | 257,615 | ||||||
Net increase (decrease) in cash and cash equivalents | (5,829 | ) | 32,014 | |||||
Cash and cash equivalents at beginning of period | 238,789 | 183,020 | ||||||
Cash and cash equivalents at end of period | $ | 232,960 | $ | 215,034 | ||||
Supplemental Disclosure of Cash Flow Information: | ||||||||
Interest paid | $ | 10,764 | $ | 6,592 | ||||
Loans transferred to other real estate and repossessed assets | 3,370 | 5,908 | ||||||
Closed branch offices transferred to other real estate | 1,863 | 359 | ||||||
Federal income taxes paid | 11,700 | 20,800 | ||||||
Business combinations: | ||||||||
Fair value of tangible assets acquired (non-cash) | — | 1,284,552 | ||||||
Goodwill and identifiable intangible assets acquired | — | 116,478 | ||||||
Liabilities assumed | — | 1,257,917 | ||||||
Common stock issued | — | 159,904 | ||||||
See accompanying notes to consolidated financial statements (unaudited).
8
Chemical Financial Corporation
Notes to Consolidated Financial Statements (Unaudited)
June 30, 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 six months ended June 30, 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").
9
Chemical Financial Corporation
Notes to Consolidated Financial Statements (Unaudited)
June 30, 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.
10
Chemical Financial Corporation
Notes to Consolidated Financial Statements (Unaudited)
June 30, 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 nonperforming TDRs, no additional provision for loan losses has been recognized for these loans and they continue to accrue interest at their contractual interest rate. Nonperforming TDRs 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
11
Chemical Financial Corporation
Notes to Consolidated Financial Statements (Unaudited)
June 30, 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 and 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.
12
Chemical Financial Corporation
Notes to Consolidated Financial Statements (Unaudited)
June 30, 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 June 30, 2016, December 31, 2015 and June 30, 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 June 30, 2016, December 31, 2015 or June 30, 2015.
13
Chemical Financial Corporation
Notes to Consolidated Financial Statements (Unaudited)
June 30, 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 $1.2 million during the three and six months ended June 30, 2016, respectively, and $0.2 million and $0.3 million during the three and six months ended June 30, 2015, respectively. The Corporation's remaining investment in qualified affordable housing projects accounted for under the proportional amortization method totaled $24.3 million at June 30, 2016, $21.7 million at December 31, 2015 and $21.4 million at June 30, 2015.
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 $7.5 million, $1.7 million and $3.3 million at June 30, 2016, December 31, 2015 and June 30, 2015, respectively.
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 $11.5 million, $8.0 million and $9.7 million at June 30, 2016, December 31, 2015 and June 30, 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 June 30, 2016, December 31, 2015 or June 30, 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.
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 June 30, 2016, there were 500,000 remaining shares available for repurchase under the Corporation’s stock repurchase program.
14
Chemical Financial Corporation
Notes to Consolidated Financial Statements (Unaudited)
June 30, 2016
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 June 30, 2016, no shares of preferred stock were issued and outstanding.
Common Stock
On July 19, 2016, 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 60,000,000 to 100,000,000 in connection with the pending merger with Talmer.
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. These two cases ere consolidated as In re Talmer Bancorp Shareholder Litigation, case number 2016-151641-CB, per an order entered on May 12, 2016.
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 27, 2016, Stephen Bushansky filed a new putative class action complaint in the United State District Court for Eastern District of Michigan, styled Stephen Bushansky v. Talmer Bancorp In. et.al., Docket No. 1:16-cv-11511. This lawsuit alleged violations of Sections 14(a) and 20(a) of the Securities Exchange Act of 1934, and named Talmer, Chemical, and several individuals as defendants. The complaint alleged, among other things, that the Defendants issued materially incomplete and misleading disclosures in the preliminary Form S-4 Registration Statement relating to the proposed merger. The Federal Bushansky lawsuit was voluntarily dismissed by the plaintiff as to all defendants, without prejudice, on June 20, 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.
15
Chemical Financial Corporation
Notes to Consolidated Financial Statements (Unaudited)
June 30, 2016
The complaint alleges, among other things, that the Defendants issued materially incomplete and misleading disclosures in the 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 was styled as a class action and derivative action, and alleged breach of fiduciary duties as well as violations of Sections 14(a) and 20(a) of the Securities Exchange Act of 1934. The Nicholl lawsuit was voluntarily dismissed by the plaintiff as to all defendants, with prejudice, on June 20, 2016.
On June 16, 2016, a complaint was filed in the United States District Court for the Eastern District of Michigan by a purported Talmer shareholder, styled City of Livonia Employees’ Retirement System v. Chemical Financial Corporation, et. al., Docket No. 2:16-cv-12229. The plaintiff purports to bring the action “individually and on behalf of all others similarly situated,” and requests certification as a class action. This lawsuit alleges violations of Section 14(a) and 20(a) of the Securities Exchange Act of 1934. The Complaint alleges, among other things, that the Defendants issued materially incomplete and misleading disclosures in the 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 unless and until additional information is provided to Talmer’s shareholders, declare that the Defendants violated the securities laws in connection with the proposed merger, award compensatory damages, interest, attorneys’ and experts’ fees, and that the Court grant such other relief as it 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 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
16
Chemical Financial Corporation
Notes to Consolidated Financial Statements (Unaudited)
June 30, 2016
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.
Credit Losses
In June, the FASB issued ASU No. 2016-13, Financial Instruments - Credit Losses (Topic 326): Measurement of Credit Losses on Financial Instruments ("ASU 2016-13"). ASU 2016-13 changes how entities will measure credit losses for most financial assets and certain other instruments that are not measured at fair value through net income.
ASU 2016-13 requires an entity measure expected credit losses for financial assets over the estimated lifetime of expected credit loss and record an allowance that, when deducted from the amortized cost basis of the financial asset, presents the net amount expected to be collected on the financial asset. The standard includes the following core concepts in determining the expected credit loss estimate: (a) be based on an asset’s amortized cost (including premiums or discounts, net deferred fees and costs, foreign
17
Chemical Financial Corporation
Notes to Consolidated Financial Statements (Unaudited)
June 30, 2016
exchange and fair value hedge accounting adjustments), (b) reflect losses expected over the remaining contractual life of an asset (considering the effect of voluntary prepayments), (c) consider available relevant information about the estimated collectability of cash flows (including information about past events, current conditions, and reasonable and supportable forecasts), and (d) reflect the risk of loss, even when that risk is remote.
ASU 2016-13 also amends the recording of purchased credit-deteriorated assets. Under the new guidance, an allowance will be recognized at acquisition through a gross-up approach whereby an entity will record as the initial amortized cost the sum of (a) the purchase price and (b) an estimate of credit losses as of the date of acquisition. In addition, the guidance also requires immediate recognition in earnings any subsequent changes, both favorable and unfavorable, in expected cash flows by adjusting this allowance.
ASU 2016-13 amends the impairment model for available-for-sale debt securities and requires entities to determine whether all or a portion of the unrealized loss on an available-for-sale debt security is a credit loss. Management may not use the length of time a security has been in an unrealized loss position as a factor in concluding whether a credit loss exists, as is currently permitted. In addition, an entity will recognize an allowance for credit losses on available-for-sale debt securities as a contra-account to the amortized cost basis rather than as a direct reduction of the amortized cost basis of the investment, as is currently required. As a result, entities will recognize improvements to credit losses on available-for-sale debt securities immediately in earnings rather than as interest income over time under current practice.
New disclosures required by ASU 2016-13 include: (a) for financial assets measured at amortized cost, an entity will be required to disclose information about how it developed its allowance, including changes in the factors that influenced management’s estimate of expected credit losses and the reasons for those changes, (b) for financial receivables and net investments in leases measured at amortized cost, an entity will be required to further disaggregate the information it currently discloses about the credit quality of these assets by year or the asset’s origination or vintage for as many as five annual periods, and (c) for available-for-sale debt securities, an entity will be required to provide a roll-forward of the allowance for credit losses and an aging analysis for securities that are past due.
Upon adoption of ASU 2016-13, a cumulative-effect adjustment to retained earnings will be recorded as of the beginning of the first reporting period in which the guidance is effective. ASU 2016-13 is effective for public companies for interim and annual periods beginning after December 15, 2019, with early adoption permitted for annual periods beginning after December 15, 2018. The Corporation is currently evaluating the provisions of ASU 2016-13 to determine the potential impact on the Corporation's consolidated financial condition and results of operations.
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 June 30, 2016, Talmer had total assets of $6.9 billion, total loans of $5.0 billion and total deposits of $5.3 billion, including brokered deposits of $389 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. At a special meeting of Talmer shareholders, held on July 14, 2016, Talmer shareholders approved the merger. And at a special meeting of Chemical shareholders, held on July 19, 2016, Chemical shareholders approved the merger. Completion of the merger is subject to regulatory approval, 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.
18
Chemical Financial Corporation
Notes to Consolidated Financial Statements (Unaudited)
June 30, 2016
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 $756 million and $734 million, respectively, at June 30, 2016, compared to $864 million and $842 million, respectively, at December 31, 2015 and $990 million and $967 million, respectively, at June 30, 2015. 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.
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 $101 million and $94 million, respectively, at June 30, 2016, compared to $115 million and $108 million, respectively, at December 31, 2015 and $126 million and $119 million, respectively, at June 30, 2015. 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.
19
Chemical Financial Corporation
Notes to Consolidated Financial Statements (Unaudited)
June 30, 2016
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 $305 million and $275 million, respectively, at June 30, 2016, compared to $361 million and $330 million, respectively, at December 31, 2015 and $415 million and $382 million, respectively, at June 30, 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 $182 million and $166 million, respectively, at June 30, 2016, compared to $204 million and $183 million, respectively, at December 31, 2015 and $236 million and $215 million, respectively, at June 30, 2015.
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 | |||||||||||||||||
Six Months Ended June 30, 2016 | (In thousands) | ||||||||||||||||||||
Balance at beginning of period | $ | 152,999 | $ | 34,558 | $ | 82,623 | $ | 28,077 | $ | 298,257 | |||||||||||
Additions (reductions)* | (10,365 | ) | (863 | ) | (5,848 | ) | (201 | ) | (17,277 | ) | |||||||||||
Accretion recognized in interest income | (17,291 | ) | (2,836 | ) | (8,029 | ) | (6,284 | ) | (34,440 | ) | |||||||||||
Reclassification from nonaccretable difference | — | — | 5,000 | 5,000 | 10,000 | ||||||||||||||||
Balance at end of period | $ | 125,343 | $ | 30,859 | $ | 73,746 | $ | 26,592 | $ | 256,540 | |||||||||||
Six Months Ended June 30, 2015 | |||||||||||||||||||||
Balance at beginning of period | $ | — | $ | — | $ | 104,675 | $ | 33,286 | $ | 137,961 | |||||||||||
Additions attributable to acquisitions | 190,246 | 37,914 | — | — | 228,160 | ||||||||||||||||
Additions (reductions)* | 1,550 | (1,141 | ) | (2,859 | ) | 5,215 | 2,765 | ||||||||||||||
Accretion recognized in interest income | (3,486 | ) | (968 | ) | (10,058 | ) | (6,326 | ) | (20,838 | ) | |||||||||||
Balance at end of period | $ | 188,310 | $ | 35,805 | $ | 91,758 | $ | 32,175 | $ | 348,048 | |||||||||||
*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.
As part of its ongoing assessment of the acquired loan portfolios, management has determined that the overall credit quality of the Northwestern and OAK acquired loan portfolios has improved, which has resulted in an improvement in expected cash flows of certain loan pools in these acquired loan portfolios. Accordingly, management reclassified $5.0 million during the three months ended June 30, 2016 from the nonaccretable difference to the accretable yield for each of these acquired loan portfolios, which will increase amounts recognized into interest income over the estimated remaining lives of the loan pools within these portfolios.
20
Chemical Financial Corporation
Notes to Consolidated Financial Statements (Unaudited)
June 30, 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 June 30, 2016, December 31, 2015 and June 30, 2015:
Investment Securities Available-for-Sale | ||||||||||||||||
Amortized Cost | Unrealized Gains | Unrealized Losses | Fair Value | |||||||||||||
(In thousands) | ||||||||||||||||
June 30, 2016 | ||||||||||||||||
U.S. Treasury securities | $ | 5,781 | $ | 29 | $ | — | $ | 5,810 | ||||||||
Government sponsored agencies | 156,843 | 715 | 536 | 157,022 | ||||||||||||
State and political subdivisions | 12,901 | 319 | — | 13,220 | ||||||||||||
Residential mortgage-backed securities | 166,582 | 2,034 | — | 168,616 | ||||||||||||
Collateralized mortgage obligations | 100,433 | 611 | 195 | 100,849 | ||||||||||||
Corporate bonds | 9,746 | 30 | 64 | 9,712 | ||||||||||||
Preferred stock and trust preferred securities | 2,888 | 436 | 1 | 3,323 | ||||||||||||
Total | $ | 455,174 | $ | 4,174 | $ | 796 | $ | 458,552 | ||||||||
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 | ||||||||
June 30, 2015 | ||||||||||||||||
U.S. Treasury securities | $ | 8,270 | $ | 24 | $ | — | $ | 8,294 | ||||||||
Government sponsored agencies | 227,424 | 683 | 200 | 227,907 | ||||||||||||
State and political subdivisions | 26,476 | 503 | 14 | 26,965 | ||||||||||||
Residential mortgage-backed securities | 213,621 | 742 | 1,694 | 212,669 | ||||||||||||
Collateralized mortgage obligations | 167,768 | 245 | 981 | 167,032 | ||||||||||||
Corporate bonds | 39,680 | 76 | 78 | 39,678 | ||||||||||||
Preferred stock and trust preferred securities | 2,889 | 272 | — | 3,161 | ||||||||||||
Total | $ | 686,128 | $ | 2,545 | $ | 2,967 | $ | 685,706 | ||||||||
21
Chemical Financial Corporation
Notes to Consolidated Financial Statements (Unaudited)
June 30, 2016
Investment Securities Held-to-Maturity | ||||||||||||||||
Amortized Cost | Unrealized Gains | Unrealized Losses | Fair Value | |||||||||||||
(In thousands) | ||||||||||||||||
June 30, 2016 | ||||||||||||||||
State and political subdivisions | $ | 552,328 | $ | 16,123 | $ | 321 | $ | 568,130 | ||||||||
Trust preferred securities | 500 | — | 215 | 285 | ||||||||||||
Total | $ | 552,828 | $ | 16,123 | $ | 536 | $ | 568,415 | ||||||||
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 | ||||||||
June 30, 2015 | ||||||||||||||||
State and political subdivisions | $ | 469,337 | $ | 4,853 | $ | 7,912 | $ | 466,278 | ||||||||
Trust preferred securities | 500 | — | 200 | 300 | ||||||||||||
Total | $ | 469,837 | $ | 4,853 | $ | 8,112 | $ | 466,578 | ||||||||
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).
The following is a summary of the amortized cost and fair value of investment securities at June 30, 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.
June 30, 2016 | ||||||||
Amortized Cost | Fair Value | |||||||
(In thousands) | ||||||||
Investment Securities Available-for-Sale: | ||||||||
Due in one year or less | $ | 154,820 | $ | 155,386 | ||||
Due after one year through five years | 257,040 | 258,856 | ||||||
Due after five years through ten years | 37,877 | 38,374 | ||||||
Due after ten years | 4,049 | 4,112 | ||||||
Preferred stock | 1,388 | 1,824 | ||||||
Total | $ | 455,174 | $ | 458,552 | ||||
Investment Securities Held-to-Maturity: | ||||||||
Due in one year or less | $ | 59,330 | $ | 59,633 | ||||
Due after one year through five years | 275,988 | 280,491 | ||||||
Due after five years through ten years | 130,304 | 136,879 | ||||||
Due after ten years | 87,206 | 91,412 | ||||||
Total | $ | 552,828 | $ | 568,415 | ||||
22
Chemical Financial Corporation
Notes to Consolidated Financial Statements (Unaudited)
June 30, 2016
The following schedule summarizes information for both available-for-sale and held-to-maturity investment securities with gross unrealized losses at June 30, 2016, December 31, 2015 and June 30, 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) | ||||||||||||||||||||||||
June 30, 2016 | ||||||||||||||||||||||||
Government sponsored agencies | $ | 14,110 | $ | 19 | $ | 18,787 | $ | 517 | $ | 32,897 | $ | 536 | ||||||||||||
State and political subdivisions | 73,532 | 237 | 25,713 | 84 | 99,245 | 321 | ||||||||||||||||||
Collateralized mortgage obligations | 8,461 | 13 | 22,955 | 182 | 31,416 | 195 | ||||||||||||||||||
Corporate bonds | — | — | 4,936 | 64 | 4,936 | 64 | ||||||||||||||||||
Preferred stock and trust preferred securities | 1,499 | 1 | 285 | 215 | 1,784 | 216 | ||||||||||||||||||
Total | $ | 97,602 | $ | 270 | $ | 72,676 | $ | 1,062 | $ | 170,278 | $ | 1,332 | ||||||||||||
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 | ||||||||||||
June 30, 2015 | ||||||||||||||||||||||||
Government sponsored agencies | $ | 24,789 | $ | 163 | $ | 14,715 | $ | 37 | $ | 39,504 | $ | 200 | ||||||||||||
State and political subdivisions | 258,503 | 5,433 | 63,584 | 2,493 | 322,087 | 7,926 | ||||||||||||||||||
Residential mortgage-backed securities | 187,858 | 1,592 | 3,643 | 102 | 191,501 | 1,694 | ||||||||||||||||||
Collateralized mortgage obligations | 49,845 | 155 | 48,881 | 826 | 98,726 | 981 | ||||||||||||||||||
Corporate bonds | 9,670 | 49 | 14,971 | 29 | 24,641 | 78 | ||||||||||||||||||
Trust preferred securities | — | — | 300 | 200 | 300 | 200 | ||||||||||||||||||
Total | $ | 530,665 | $ | 7,392 | $ | 146,094 | $ | 3,687 | $ | 676,759 | $ | 11,079 | ||||||||||||
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 reasonably 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 June 30, 2016, represented an other-than-temporary impairment (OTTI). Management believed that the unrealized losses on investment securities at June 30, 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 June 30, 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 June 30, 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.
23
Chemical Financial Corporation
Notes to Consolidated Financial Statements (Unaudited)
June 30, 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 are 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:
June 30, 2016 | December 31, 2015 | June 30, 2015 | ||||||||||
(In thousands) | ||||||||||||
Commercial loan portfolio: | ||||||||||||
Commercial | $ | 1,953,301 | $ | 1,905,879 | $ | 1,754,873 | ||||||
Commercial real estate | 2,157,733 | 2,112,162 | 2,243,513 | |||||||||
Real estate construction and land development | 285,848 | 232,076 | 112,312 | |||||||||
Subtotal | 4,396,882 | 4,250,117 | 4,110,698 | |||||||||
Consumer loan portfolio: | ||||||||||||
Residential mortgage | 1,494,192 | 1,429,636 | 1,310,167 | |||||||||
Consumer installment | 1,048,622 | 877,457 | 887,907 | |||||||||
Home equity | 707,573 | 713,937 | 725,971 | |||||||||
Subtotal | 3,250,387 | 3,021,030 | 2,924,045 | |||||||||
Total loans | $ | 7,647,269 | $ | 7,271,147 | $ | 7,034,743 | ||||||
24
Chemical Financial Corporation
Notes to Consolidated Financial Statements (Unaudited)
June 30, 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).
25
Chemical Financial Corporation
Notes to Consolidated Financial Statements (Unaudited)
June 30, 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 June 30, 2016, December 31, 2015 and June 30, 2015:
26
Chemical Financial Corporation
Notes to Consolidated Financial Statements (Unaudited)
June 30, 2016
Commercial | Commercial Real Estate | Real Estate Construction and Land Development | Total | |||||||||||||
(In thousands) | ||||||||||||||||
June 30, 2016 | ||||||||||||||||
Originated Portfolio: | ||||||||||||||||
Risk Grades 1-5 | $ | 1,537,612 | $ | 1,479,365 | $ | 239,194 | $ | 3,256,171 | ||||||||
Risk Grade 6 | 46,202 | 36,814 | 843 | 83,859 | ||||||||||||
Risk Grade 7 | 35,602 | 15,434 | 517 | 51,553 | ||||||||||||
Risk Grade 8 | 14,577 | 21,324 | 496 | 36,397 | ||||||||||||
Risk Grade 9 | — | 1 | — | 1 | ||||||||||||
Subtotal | 1,633,993 | 1,552,938 | 241,050 | 3,427,981 | ||||||||||||
Acquired Portfolio: | ||||||||||||||||
Risk Grades 1-5 | 292,492 | 554,352 | 40,671 | 887,515 | ||||||||||||
Risk Grade 6 | 15,352 | 20,746 | 1,500 | 37,598 | ||||||||||||
Risk Grade 7 | 8,448 | 23,879 | 1,229 | 33,556 | ||||||||||||
Risk Grade 8 | 3,016 | 5,818 | 1,398 | 10,232 | ||||||||||||
Risk Grade 9 | — | — | — | — | ||||||||||||
Subtotal | 319,308 | 604,795 | 44,798 | 968,901 | ||||||||||||
Total | $ | 1,953,301 | $ | 2,157,733 | $ | 285,848 | $ | 4,396,882 | ||||||||
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 | ||||||||
June 30, 2015 | ||||||||||||||||
Originated Portfolio: | ||||||||||||||||
Risk Grades 1-5 | $ | 1,269,091 | $ | 1,273,725 | $ | 97,364 | $ | 2,640,180 | ||||||||
Risk Grade 6 | 32,189 | 34,677 | 433 | 67,299 | ||||||||||||
Risk Grade 7 | 41,316 | 29,737 | 2,127 | 73,180 | ||||||||||||
Risk Grade 8 | 17,260 | 25,283 | 502 | 43,045 | ||||||||||||
Risk Grade 9 | — | 4 | — | 4 | ||||||||||||
Subtotal | 1,359,856 | 1,363,426 | 100,426 | 2,823,708 | ||||||||||||
Acquired Portfolio: | ||||||||||||||||
Risk Grades 1-5 | 347,914 | 820,400 | 10,139 | 1,178,453 | ||||||||||||
Risk Grade 6 | 29,412 | 22,796 | 71 | 52,279 | ||||||||||||
Risk Grade 7 | 13,910 | 30,288 | 119 | 44,317 | ||||||||||||
Risk Grade 8 | 3,781 | 6,603 | 1,557 | 11,941 | ||||||||||||
Risk Grade 9 | — | — | — | — | ||||||||||||
Subtotal | 395,017 | 880,087 | 11,886 | 1,286,990 | ||||||||||||
Total | $ | 1,754,873 | $ | 2,243,513 | $ | 112,312 | $ | 4,110,698 | ||||||||
27
Chemical Financial Corporation
Notes to Consolidated Financial Statements (Unaudited)
June 30, 2016
Consumer Loan Portfolio
The Corporation evaluates the credit quality of loans in the consumer loan portfolio based on the performing or nonperforming status of the loan. Loans in the consumer loan portfolio that are performing in accordance with original contractual terms and are less than 90 days past due and accruing interest are considered to be in a performing status, while those that are in nonaccrual status, contractually past due 90 days or more as to interest or principal payments or classified as a nonperforming TDR are considered to be in a nonperforming status. Nonaccrual TDRs in the consumer loan portfolio are included with nonaccrual loans, while other TDRs in the consumer loan portfolio are considered to be in a nonperforming status until they meet the Corporation’s definition of a performing TDR, at which time they are considered to be in a performing status.
The following schedule presents the recorded investment of loans in the consumer loan portfolio based on loans in a performing status and loans in a nonperforming status at June 30, 2016, December 31, 2015 and June 30, 2015:
Residential Mortgage | Consumer Installment | Home Equity | Total Consumer | |||||||||||||
(In thousands) | ||||||||||||||||
June 30, 2016 | ||||||||||||||||
Originated Loans: | ||||||||||||||||
Performing | $ | 1,299,382 | $ | 1,041,978 | $ | 598,283 | $ | 2,939,643 | ||||||||
Nonperforming | 7,983 | 285 | 3,042 | 11,310 | ||||||||||||
Subtotal | 1,307,365 | 1,042,263 | 601,325 | 2,950,953 | ||||||||||||
Acquired Loans: | ||||||||||||||||
Performing | 185,492 | 6,298 | 105,360 | 297,150 | ||||||||||||
Nonperforming | 1,335 | 61 | 888 | 2,284 | ||||||||||||
Subtotal | 186,827 | 6,359 | 106,248 | 299,434 | ||||||||||||
Total | $ | 1,494,192 | $ | 1,048,622 | $ | 707,573 | $ | 3,250,387 | ||||||||
December 31, 2015 | ||||||||||||||||
Originated Loans: | ||||||||||||||||
Performing | $ | 1,207,945 | $ | 868,975 | $ | 587,566 | $ | 2,664,486 | ||||||||
Nonperforming | 9,030 | 451 | 3,246 | 12,727 | ||||||||||||
Subtotal | 1,216,975 | 869,426 | 590,812 | 2,677,213 | ||||||||||||
Acquired Loans: | ||||||||||||||||
Performing | 210,580 | 7,984 | 122,118 | 340,682 | ||||||||||||
Nonperforming | 2,081 | 47 | 1,007 | 3,135 | ||||||||||||
Subtotal | 212,661 | 8,031 | 123,125 | 343,817 | ||||||||||||
Total | $ | 1,429,636 | $ | 877,457 | $ | 713,937 | $ | 3,021,030 | ||||||||
June 30, 2015 | ||||||||||||||||
Originated Loans: | ||||||||||||||||
Performing | $ | 1,058,696 | $ | 871,543 | $ | 584,520 | $ | 2,514,759 | ||||||||
Nonperforming | 9,793 | 393 | 2,357 | 12,543 | ||||||||||||
Subtotal | 1,068,489 | 871,936 | 586,877 | 2,527,302 | ||||||||||||
Acquired Loans: | ||||||||||||||||
Performing | 238,698 | 15,966 | 138,086 | 392,750 | ||||||||||||
Nonperforming | 2,980 | 5 | 1,008 | 3,993 | ||||||||||||
Subtotal | 241,678 | 15,971 | 139,094 | 396,743 | ||||||||||||
Total | $ | 1,310,167 | $ | 887,907 | $ | 725,971 | $ | 2,924,045 | ||||||||
28
Chemical Financial Corporation
Notes to Consolidated Financial Statements (Unaudited)
June 30, 2016
Nonperforming Loans
A summary of nonperforming loans follows:
June 30, 2016 | December 31, 2015 | June 30, 2015 | ||||||||||
(In thousands) | ||||||||||||
Nonaccrual loans: | ||||||||||||
Commercial | $ | 14,577 | $ | 28,554 | $ | 17,260 | ||||||
Commercial real estate | 21,325 | 25,163 | 25,287 | |||||||||
Real estate construction and land development | 496 | 521 | 502 | |||||||||
Residential mortgage | 5,343 | 5,557 | 6,004 | |||||||||
Consumer installment | 285 | 451 | 393 | |||||||||
Home equity | 1,971 | 1,979 | 1,769 | |||||||||
Total nonaccrual loans | 43,997 | 62,225 | 51,215 | |||||||||
Accruing loans contractually past due 90 days or more as to interest or principal payments: | ||||||||||||
Commercial | 3 | 364 | 711 | |||||||||
Commercial real estate | 3 | 254 | 56 | |||||||||
Residential mortgage | 407 | 402 | 424 | |||||||||
Home equity | 1,071 | 1,267 | 588 | |||||||||
Total accruing loans contractually past due 90 days or more as to interest or principal payments | 1,484 | 2,287 | 1,779 | |||||||||
Nonperforming TDRs: | ||||||||||||
Commercial loan portfolio | 14,240 | 16,297 | 14,547 | |||||||||
Consumer loan portfolio | 2,233 | 3,071 | 3,365 | |||||||||
Total nonperforming TDRs | 16,473 | 19,368 | 17,912 | |||||||||
Total nonperforming loans | $ | 61,954 | $ | 83,880 | $ | 70,906 | ||||||
The Corporation’s nonaccrual loans at June 30, 2016, December 31, 2015 and June 30, 2015 included $32.4 million, $35.9 million and $35.7 million, respectively, of nonaccrual TDRs.
The Corporation had $0.9 million of residential mortgage loans that were in the process of foreclosure at June 30, 2016, compared to $2.9 million and $2.0 million at December 31, 2015 and June 30, 2015, respectively.
29
Chemical Financial Corporation
Notes to Consolidated Financial Statements (Unaudited)
June 30, 2016
Impaired Loans
The following schedule presents impaired loans by classes of loans at June 30, 2016, December 31, 2015 and June 30, 2015:
Recorded Investment | Unpaid Principal Balance | Related Valuation Allowance | ||||||||||
(In thousands) | ||||||||||||
June 30, 2016 | ||||||||||||
Impaired loans with a valuation allowance: | ||||||||||||
Commercial | $ | 3,764 | $ | 3,769 | $ | 2,582 | ||||||
Commercial real estate | 3,270 | 3,438 | 472 | |||||||||
Residential mortgage | 20,745 | 20,745 | 163 | |||||||||
Subtotal | 27,779 | 27,952 | 3,217 | |||||||||
Impaired loans with no related valuation allowance: | ||||||||||||
Commercial | 34,633 | 43,576 | — | |||||||||
Commercial real estate | 47,894 | 58,312 | — | |||||||||
Real estate construction and land development | 2,196 | 3,770 | — | |||||||||
Residential mortgage | 6,678 | 7,365 | — | |||||||||
Consumer installment | 347 | 365 | — | |||||||||
Home equity | 2,859 | 3,084 | — | |||||||||
Subtotal | 94,607 | 116,472 | — | |||||||||
Total impaired loans: | ||||||||||||
Commercial | 38,397 | 47,345 | 2,582 | |||||||||
Commercial real estate | 51,164 | 61,750 | 472 | |||||||||
Real estate construction and land development | 2,196 | 3,770 | — | |||||||||
Residential mortgage | 27,423 | 28,110 | 163 | |||||||||
Consumer installment | 347 | 365 | — | |||||||||
Home equity | 2,859 | 3,084 | — | |||||||||
Total | $ | 122,386 | $ | 144,424 | $ | 3,217 | ||||||
December 31, 2015 | ||||||||||||
Impaired loans with a valuation allowance: | ||||||||||||
Commercial | $ | 18,898 | $ | 19,426 | $ | 5,700 | ||||||
Commercial real estate | 4,448 | 4,688 | 497 | |||||||||
Residential mortgage | 21,037 | 21,037 | 192 | |||||||||
Subtotal | 44,383 | 45,151 | 6,389 | |||||||||
Impaired loans with no related valuation allowance: | ||||||||||||
Commercial | 31,039 | 37,703 | — | |||||||||
Commercial real estate | 53,518 | 69,130 | — | |||||||||
Real estate construction and land development | 2,136 | 3,108 | — | |||||||||
Residential mortgage | 7,638 | 8,644 | — | |||||||||
Consumer installment | 498 | 512 | — | |||||||||
Home equity | 2,986 | 3,270 | — | |||||||||
Subtotal | 97,815 | 122,367 | — | |||||||||
Total impaired loans: | ||||||||||||
Commercial | 49,937 | 57,129 | 5,700 | |||||||||
Commercial real estate | 57,966 | 73,818 | 497 | |||||||||
Real estate construction and land development | 2,136 | 3,108 | — | |||||||||
Residential mortgage | 28,675 | 29,681 | 192 | |||||||||
Consumer installment | 498 | 512 | — | |||||||||
Home equity | 2,986 | 3,270 | — | |||||||||
Total | $ | 142,198 | $ | 167,518 | $ | 6,389 | ||||||
30
Chemical Financial Corporation
Notes to Consolidated Financial Statements (Unaudited)
June 30, 2016
Recorded Investment | Unpaid Principal Balance | Related Valuation Allowance | ||||||||||
(In thousands) | ||||||||||||
June 30, 2015 | ||||||||||||
Impaired loans with a valuation allowance: | ||||||||||||
Commercial | $ | 4,044 | $ | 4,137 | $ | 718 | ||||||
Commercial real estate | 2,789 | 2,948 | 603 | |||||||||
Residential mortgage | 20,970 | 20,970 | 260 | |||||||||
Subtotal | 27,803 | 28,055 | 1,581 | |||||||||
Impaired loans with no related valuation allowance: | ||||||||||||
Commercial | 32,461 | 38,160 | — | |||||||||
Commercial real estate | 56,052 | 78,490 | — | |||||||||
Real estate construction and land development | 2,393 | 4,175 | — | |||||||||
Residential mortgage | 8,984 | 8,984 | — | |||||||||
Consumer installment | 398 | 398 | — | |||||||||
Home equity | 2,778 | 2,778 | — | |||||||||
Subtotal | 103,066 | 132,985 | — | |||||||||
Total impaired loans: | ||||||||||||
Commercial | 36,505 | 42,297 | 718 | |||||||||
Commercial real estate | 58,841 | 81,438 | 603 | |||||||||
Real estate construction and land development | 2,393 | 4,175 | — | |||||||||
Residential mortgage | 29,954 | 29,954 | 260 | |||||||||
Consumer installment | 398 | 398 | — | |||||||||
Home equity | 2,778 | 2,778 | — | |||||||||
Total | $ | 130,869 | $ | 161,040 | $ | 1,581 | ||||||
The difference between an impaired loan’s recorded investment and the unpaid principal balance for originated loans represents a partial charge-off resulting from a confirmed loss due to the value of the collateral securing the loan being below the loan balance and management’s assessment that full collection of the loan balance is not likely, and for acquired loans that meet the definition of an impaired loan represents fair value adjustments recognized at the acquisition date attributable to expected credit losses and the discounting of expected cash flows at market interest rates. The difference between the recorded investment and the unpaid principal balance of $22.0 million, $25.3 million and $30.2 million at June 30, 2016, December 31, 2015 and June 30, 2015, respectively, includes confirmed losses (partial charge-offs) of $16.3 million, $17.1 million and $15.2 million, respectively, and fair value discount adjustments of $5.7 million, $8.2 million and $15.0 million, respectively.
Impaired loans included $12.5 million, $12.8 million and $15.9 million at June 30, 2016, December 31, 2015 and June 30, 2015, respectively, of acquired loans that were not performing in accordance with original contractual terms. Acquired loans that are not performing in accordance with contractual terms are not reported as nonperforming loans because these loans are recorded in pools at their net realizable value based on the principal and interest the Corporation expects to collect on these loans. Impaired loans also included $49.4 million, $47.8 million and $45.8 million at June 30, 2016, December 31, 2015 and June 30, 2015, respectively, of performing TDRs.
31
Chemical Financial Corporation
Notes to Consolidated Financial Statements (Unaudited)
June 30, 2016
The following schedule presents information related to impaired loans for the three and six months ended June 30, 2016 and 2015:
Three Months Ended June 30, 2016 | Six Months Ended June 30, 2016 | |||||||||||||||
Average Recorded Investment | Interest Income Recognized While on Impaired Status | Average Recorded Investment | Interest Income Recognized While on Impaired Status | |||||||||||||
(In thousands) | ||||||||||||||||
Commercial | $ | 38,606 | $ | 348 | $ | 41,811 | $ | 677 | ||||||||
Commercial real estate | 53,723 | 391 | 55,839 | 849 | ||||||||||||
Real estate construction and land development | 2,265 | 26 | 2,166 | 51 | ||||||||||||
Residential mortgage | 27,418 | 356 | 27,755 | 722 | ||||||||||||
Consumer installment | 330 | 1 | 359 | 2 | ||||||||||||
Home equity | 2,791 | 13 | 3,022 | 28 | ||||||||||||
Total | $ | 125,133 | $ | 1,135 | $ | 130,952 | $ | 2,329 | ||||||||
Three Months Ended June 30, 2015 | Six Months Ended June 30, 2015 | |||||||||||||||
Average Recorded Investment | Interest Income Recognized While on Impaired Status | Average Recorded Investment | Interest Income Recognized While on Impaired Status | |||||||||||||
(In thousands) | ||||||||||||||||
Commercial | $ | 36,735 | $ | 263 | $ | 37,655 | $ | 552 | ||||||||
Commercial real estate | 60,393 | 458 | 60,317 | 983 | ||||||||||||
Real estate construction and land development | 2,290 | 36 | 2,403 | 63 | ||||||||||||
Residential mortgage | 29,432 | 380 | 28,392 | 711 | ||||||||||||
Consumer installment | 426 | 1 | 463 | 1 | ||||||||||||
Home equity | 2,529 | 14 | 2,440 | 22 | ||||||||||||
Total | $ | 131,805 | $ | 1,152 | $ | 131,670 | $ | 2,332 | ||||||||
The following schedule presents the aging status of the recorded investment in loans by classes of loans at June 30, 2016, December 31, 2015 and June 30, 2015:
31-60 Days Past Due | 61-89 Days Past Due | Accruing Loans Past Due 90 Days or More | Non-accrual Loans | Total Past Due | Current | Total Loans | ||||||||||||||||||||||
(In thousands) | ||||||||||||||||||||||||||||
June 30, 2016 | ||||||||||||||||||||||||||||
Originated Portfolio: | ||||||||||||||||||||||||||||
Commercial | $ | 4,522 | $ | 822 | $ | 3 | $ | 14,577 | $ | 19,924 | $ | 1,614,069 | $ | 1,633,993 | ||||||||||||||
Commercial real estate | 8,842 | 343 | 3 | 21,325 | 30,513 | 1,522,425 | 1,552,938 | |||||||||||||||||||||
Real estate construction and land development | 62 | — | — | 496 | 558 | 240,492 | 241,050 | |||||||||||||||||||||
Residential mortgage | 1,955 | — | 407 | 5,343 | 7,705 | 1,299,660 | 1,307,365 | |||||||||||||||||||||
Consumer installment | 2,856 | 554 | — | 285 | 3,695 | 1,038,568 | 1,042,263 | |||||||||||||||||||||
Home equity | 2,594 | 366 | 1,071 | 1,971 | 6,002 | 595,323 | 601,325 | |||||||||||||||||||||
Total | $ | 20,831 | $ | 2,085 | $ | 1,484 | $ | 43,997 | $ | 68,397 | $ | 6,310,537 | $ | 6,378,934 | ||||||||||||||
Acquired Portfolio: | ||||||||||||||||||||||||||||
Commercial | $ | 547 | $ | — | $ | 3,038 | $ | — | $ | 3,585 | $ | 315,723 | $ | 319,308 | ||||||||||||||
Commercial real estate | 90 | — | 5,817 | — | 5,907 | 598,888 | 604,795 | |||||||||||||||||||||
Real estate construction and land development | 389 | — | 1,398 | — | 1,787 | 43,011 | 44,798 | |||||||||||||||||||||
Residential mortgage | 407 | — | 1,335 | — | 1,742 | 185,085 | 186,827 | |||||||||||||||||||||
Consumer installment | 58 | 25 | 62 | — | 145 | 6,214 | 6,359 | |||||||||||||||||||||
Home equity | 416 | 38 | 888 | — | 1,342 | 104,906 | 106,248 | |||||||||||||||||||||
Total | $ | 1,907 | $ | 63 | $ | 12,538 | $ | — | $ | 14,508 | $ | 1,253,827 | $ | 1,268,335 | ||||||||||||||
32
Chemical Financial Corporation
Notes to Consolidated Financial Statements (Unaudited)
June 30, 2016
31-60 Days Past Due | 61-89 Days Past Due | Accruing Loans Past Due 90 Days or More | Non-accrual Loans | Total Past Due | Current | Total Loans | ||||||||||||||||||||||
(In thousands) | ||||||||||||||||||||||||||||
December 31, 2015 | ||||||||||||||||||||||||||||
Originated Portfolio: | ||||||||||||||||||||||||||||
Commercial | $ | 3,685 | $ | 1,230 | $ | 364 | $ | 28,554 | $ | 33,833 | $ | 1,487,682 | $ | 1,521,515 | ||||||||||||||
Commercial real estate | 4,168 | 1,603 | 254 | 25,163 | 31,188 | 1,392,871 | 1,424,059 | |||||||||||||||||||||
Real estate construction and land development | — | — | — | 521 | 521 | 184,626 | 185,147 | |||||||||||||||||||||
Residential mortgage | 1,737 | — | 402 | 5,557 | 7,696 | 1,209,279 | 1,216,975 | |||||||||||||||||||||
Consumer installment | 3,145 | 644 | — | 451 | 4,240 | 865,186 | 869,426 | |||||||||||||||||||||
Home equity | 1,767 | 788 | 1,267 | 1,979 | 5,801 | 585,011 | 590,812 | |||||||||||||||||||||
Total | $ | 14,502 | $ | 4,265 | $ | 2,287 | $ | 62,225 | $ | 83,279 | $ | 5,724,655 | $ | 5,807,934 | ||||||||||||||
Acquired Portfolio: | ||||||||||||||||||||||||||||
Commercial | $ | 490 | $ | 532 | $ | 3,735 | $ | — | $ | 4,757 | $ | 379,607 | $ | 384,364 | ||||||||||||||
Commercial real estate | 3,557 | 691 | 4,771 | — | 9,019 | 679,084 | 688,103 | |||||||||||||||||||||
Real estate construction and land development | — | — | 1,154 | — | 1,154 | 45,775 | 46,929 | |||||||||||||||||||||
Residential mortgage | 1,370 | — | 2,081 | — | 3,451 | 209,210 | 212,661 | |||||||||||||||||||||
Consumer installment | 55 | — | 47 | — | 102 | 7,929 | 8,031 | |||||||||||||||||||||
Home equity | 847 | 78 | 1,007 | — | 1,932 | 121,193 | 123,125 | |||||||||||||||||||||
Total | $ | 6,319 | $ | 1,301 | $ | 12,795 | $ | — | $ | 20,415 | $ | 1,442,798 | $ | 1,463,213 | ||||||||||||||
June 30, 2015 | ||||||||||||||||||||||||||||
Originated Portfolio: | ||||||||||||||||||||||||||||
Commercial | $ | 4,055 | $ | 2,317 | $ | 711 | $ | 17,260 | $ | 24,343 | $ | 1,335,513 | $ | 1,359,856 | ||||||||||||||
Commercial real estate | 2,754 | 1,117 | 56 | 25,287 | 29,214 | 1,334,212 | 1,363,426 | |||||||||||||||||||||
Real estate construction and land development | 413 | — | — | 502 | 915 | 99,511 | 100,426 | |||||||||||||||||||||
Residential mortgage | 1,536 | — | 424 | 6,004 | 7,964 | 1,060,525 | 1,068,489 | |||||||||||||||||||||
Consumer installment | 2,526 | 302 | — | 393 | 3,221 | 868,715 | 871,936 | |||||||||||||||||||||
Home equity | 2,334 | 204 | 588 | 1,769 | 4,895 | 581,982 | 586,877 | |||||||||||||||||||||
Total | $ | 13,618 | $ | 3,940 | $ | 1,779 | $ | 51,215 | $ | 70,552 | $ | 5,280,458 | $ | 5,351,010 | ||||||||||||||
Acquired Portfolio: | ||||||||||||||||||||||||||||
Commercial | $ | 690 | $ | — | $ | 3,781 | $ | — | $ | 4,471 | $ | 390,546 | $ | 395,017 | ||||||||||||||
Commercial real estate | 969 | 291 | 6,603 | — | 7,863 | 872,224 | 880,087 | |||||||||||||||||||||
Real estate construction and land development | — | — | 1,557 | — | 1,557 | 10,329 | 11,886 | |||||||||||||||||||||
Residential mortgage | 1,077 | 138 | 2,980 | — | 4,195 | 237,483 | 241,678 | |||||||||||||||||||||
Consumer installment | — | 56 | 5 | — | 61 | 15,910 | 15,971 | |||||||||||||||||||||
Home equity | 1,153 | 210 | 1,008 | — | 2,371 | 136,723 | 139,094 | |||||||||||||||||||||
Total | $ | 3,889 | $ | 695 | $ | 15,934 | $ | — | $ | 20,518 | $ | 1,663,215 | $ | 1,683,733 | ||||||||||||||
33
Chemical Financial Corporation
Notes to Consolidated Financial Statements (Unaudited)
June 30, 2016
Loans Modified Under Troubled Debt Restructurings (TDRs)
The following schedule presents the Corporation’s TDRs at June 30, 2016, December 31, 2015 and June 30, 2015:
Performing TDRs | Non-Performing TDRs | Nonaccrual TDRs | Total | |||||||||||||
(In thousands) | ||||||||||||||||
June 30, 2016 | ||||||||||||||||
Commercial loan portfolio | $ | 30,866 | $ | 14,240 | $ | 28,979 | $ | 74,085 | ||||||||
Consumer loan portfolio | 18,512 | 2,233 | 3,402 | 24,147 | ||||||||||||
Total | $ | 49,378 | $ | 16,473 | $ | 32,381 | $ | 98,232 | ||||||||
December 31, 2015 | ||||||||||||||||
Commercial loan portfolio | $ | 29,844 | $ | 16,297 | $ | 32,682 | $ | 78,823 | ||||||||
Consumer loan portfolio | 17,966 | 3,071 | 3,251 | 24,288 | ||||||||||||
Total | $ | 47,810 | $ | 19,368 | $ | 35,933 | $ | 103,111 | ||||||||
June 30, 2015 | ||||||||||||||||
Commercial loan portfolio | $ | 28,203 | $ | 14,547 | $ | 32,001 | $ | 74,751 | ||||||||
Consumer loan portfolio | 17,605 | 3,365 | 3,707 | 24,677 | ||||||||||||
Total | $ | 45,808 | $ | 17,912 | $ | 35,708 | $ | 99,428 | ||||||||
The following schedule provides information on the Corporation's TDRs that were modified during the three and six months ended June 30, 2016 and 2015:
Three Months Ended June 30, 2016 | Six Months Ended June 30, 2016 | ||||||||||||||||||||
Number of Loans | Pre- Modification Recorded Investment | Post- Modification Recorded Investment | Number of Loans | Pre- Modification Recorded Investment | Post- Modification Recorded Investment | ||||||||||||||||
(Dollars in thousands) | |||||||||||||||||||||
Commercial loan portfolio: | |||||||||||||||||||||
Commercial | 21 | $ | 4,149 | $ | 4,149 | 28 | $ | 7,981 | $ | 7,981 | |||||||||||
Commercial real estate | 2 | 1,454 | 1,454 | 6 | 2,441 | 2,441 | |||||||||||||||
Subtotal – commercial loan portfolio | 23 | 5,603 | 5,603 | 34 | 10,422 | 10,422 | |||||||||||||||
Consumer loan portfolio | 14 | 490 | 490 | 21 | 694 | 694 | |||||||||||||||
Total | 37 | $ | 6,093 | $ | 6,093 | 55 | $ | 11,116 | $ | 11,116 | |||||||||||
Three Months Ended June 30, 2015 | Six Months Ended June 30, 2015 | ||||||||||||||||||||
Number of Loans | Pre- Modification Recorded Investment | Post- Modification Recorded Investment | Number of Loans | Pre- Modification Recorded Investment | Post- Modification Recorded Investment | ||||||||||||||||
(Dollars in thousands) | |||||||||||||||||||||
Commercial loan portfolio: | |||||||||||||||||||||
Commercial | 13 | $ | 2,332 | $ | 2,332 | 18 | $ | 4,264 | $ | 4,264 | |||||||||||
Commercial real estate | 4 | 527 | 527 | 9 | 3,061 | 3,061 | |||||||||||||||
Real estate construction and land development | 1 | 305 | 305 | 1 | 305 | 305 | |||||||||||||||
Subtotal – commercial loan portfolio | 18 | 3,164 | 3,164 | 28 | 7,630 | 7,630 | |||||||||||||||
Consumer loan portfolio | 29 | 1,633 | 1,631 | 39 | 1,969 | 1,967 | |||||||||||||||
Total | 47 | $ | 4,797 | $ | 4,795 | 67 | $ | 9,599 | $ | 9,597 | |||||||||||
The pre-modification and post-modification recorded investment represents amounts as of the date of loan modification. The difference between the pre-modification and post-modification recorded investment of residential mortgage TDRs represents impairment recognized by the Corporation through the provision for loan losses computed based on a loan's post-modification present value of expected future cash flows discounted at the loan's original effective interest rate.
34
Chemical Financial Corporation
Notes to Consolidated Financial Statements (Unaudited)
June 30, 2016
The following schedule includes TDRs for which there was a payment default during the three and six months ended June 30, 2016 and 2015, whereby the borrower was past due with respect to principal and/or interest for 90 days or more, and the loan became a TDR during the twelve-month period prior to the default:
Three Months Ended June 30, 2016 | Six Months Ended June 30, 2016 | |||||||||||||
Number of Loans | Principal Balance at End of Period | Number of Loans | Principal Balance at End of Period | |||||||||||
(Dollars in thousands) | ||||||||||||||
Commercial loan portfolio: | ||||||||||||||
Commercial | — | $ | — | — | $ | — | ||||||||
Commercial real estate | 1 | 788 | 2 | 1,721 | ||||||||||
Subtotal – commercial loan portfolio | 1 | 788 | 2 | 1,721 | ||||||||||
Consumer loan portfolio | 1 | — | 2 | — | ||||||||||
Total | 2 | $ | 788 | 4 | $ | 1,721 | ||||||||
Three Months Ended June 30, 2015 | Six Months Ended June 30, 2015 | |||||||||||||
Number of Loans | Principal Balance at End of Period | Number of Loans | Principal Balance at End of Period | |||||||||||
(Dollars in thousands) | ||||||||||||||
Commercial loan portfolio: | ||||||||||||||
Commercial | — | $ | — | — | $ | — | ||||||||
Commercial real estate | 1 | 183 | 4 | 942 | ||||||||||
Subtotal – commercial loan portfolio | 1 | 183 | 4 | 942 | ||||||||||
Consumer loan portfolio | — | — | 1 | 33 | ||||||||||
Total | 1 | $ | 183 | 5 | $ | 975 | ||||||||
35
Chemical Financial Corporation
Notes to Consolidated Financial Statements (Unaudited)
June 30, 2016
Allowance for Loan Losses
The following schedule presents, by loan portfolio segment, the changes in the allowance for the three and six months ended June 30, 2016 and details regarding the balance in the allowance and the recorded investment in loans at June 30, 2016 by impairment evaluation method.
Commercial Loan Portfolio | Consumer Loan Portfolio | Unallocated | Total | |||||||||||||
(In thousands) | ||||||||||||||||
Changes in allowance for loan losses for the three months ended June 30, 2016: | ||||||||||||||||
Beginning balance | $ | 44,668 | $ | 25,650 | $ | — | $ | 70,318 | ||||||||
Provision for loan losses | 900 | 2,100 | — | 3,000 | ||||||||||||
Charge-offs | (2,542 | ) | (1,078 | ) | — | (3,620 | ) | |||||||||
Recoveries | 1,202 | 606 | — | 1,808 | ||||||||||||
Ending balance | $ | 44,228 | $ | 27,278 | $ | — | $ | 71,506 | ||||||||
Changes in allowance for loan losses for the six months ended June 30, 2016: | ||||||||||||||||
Beginning balance | $ | 47,234 | $ | 26,094 | $ | — | $ | 73,328 | ||||||||
Provision for loan losses | 1,900 | 2,600 | — | 4,500 | ||||||||||||
Charge-offs | (6,438 | ) | (2,640 | ) | — | (9,078 | ) | |||||||||
Recoveries | 1,532 | 1,224 | — | 2,756 | ||||||||||||
Ending balance | $ | 44,228 | $ | 27,278 | $ | — | $ | 71,506 | ||||||||
Allowance for loan losses balance at June 30, 2016 attributable to: | ||||||||||||||||
Loans individually evaluated for impairment | $ | 3,054 | $ | 163 | $ | — | $ | 3,217 | ||||||||
Loans collectively evaluated for impairment | 41,174 | 27,115 | — | 68,289 | ||||||||||||
Loans acquired with deteriorated credit quality | — | — | — | — | ||||||||||||
Total | $ | 44,228 | $ | 27,278 | $ | — | $ | 71,506 | ||||||||
Recorded investment (loan balance) at June 30, 2016: | ||||||||||||||||
Loans individually evaluated for impairment | $ | 81,504 | $ | 20,745 | $ | — | $ | 102,249 | ||||||||
Loans collectively evaluated for impairment | 3,346,477 | 2,930,208 | — | 6,276,685 | ||||||||||||
Loans acquired with deteriorated credit quality | 968,901 | 299,434 | — | 1,268,335 | ||||||||||||
Total | $ | 4,396,882 | $ | 3,250,387 | $ | — | $ | 7,647,269 | ||||||||
The following schedule presents, by loan portfolio segment, details regarding the balance in the allowance and the recorded investment in loans at December 31, 2015 by impairment evaluation method.
Commercial Loan Portfolio | Consumer Loan Portfolio | Unallocated | Total | |||||||||||||
(In thousands) | ||||||||||||||||
Allowance for loan losses balance at December 31, 2015 attributable to: | ||||||||||||||||
Loans individually evaluated for impairment | $ | 6,197 | $ | 192 | $ | — | $ | 6,389 | ||||||||
Loans collectively evaluated for impairment | 41,037 | 25,902 | — | 66,939 | ||||||||||||
Loans acquired with deteriorated credit quality | — | — | — | — | ||||||||||||
Total | $ | 47,234 | $ | 26,094 | $ | — | $ | 73,328 | ||||||||
Recorded investment (loan balance) at December 31, 2015: | ||||||||||||||||
Loans individually evaluated for impairment | $ | 100,379 | $ | 21,037 | $ | — | $ | 121,416 | ||||||||
Loans collectively evaluated for impairment | 3,030,342 | 2,656,176 | — | 5,686,518 | ||||||||||||
Loans acquired with deteriorated credit quality | 1,119,396 | 343,817 | — | 1,463,213 | ||||||||||||
Total | $ | 4,250,117 | $ | 3,021,030 | $ | — | $ | 7,271,147 | ||||||||
36
Chemical Financial Corporation
Notes to Consolidated Financial Statements (Unaudited)
June 30, 2016
The following schedule presents, by loan portfolio segment, the changes in the allowance for the three and six months ended June 30, 2015 and details regarding the balance in the allowance and the recorded investment in loans at June 30, 2015 by impairment evaluation method.
Commercial Loan Portfolio | Consumer Loan Portfolio | Unallocated | Total | |||||||||||||
(In thousands) | ||||||||||||||||
Changes in allowance for loan losses for the three months ended June 30, 2015: | ||||||||||||||||
Beginning balance | $ | 46,819 | $ | 24,579 | $ | 3,858 | $ | 75,256 | ||||||||
Provision for loan losses | (626 | ) | (109 | ) | 2,235 | 1,500 | ||||||||||
Charge-offs | (915 | ) | (1,809 | ) | — | (2,724 | ) | |||||||||
Recoveries | 249 | 660 | — | 909 | ||||||||||||
Ending balance | $ | 45,527 | $ | 23,321 | $ | 6,093 | $ | 74,941 | ||||||||
Changes in allowance for loan losses for the six months ended June 30, 2015: | ||||||||||||||||
Beginning balance | $ | 44,156 | $ | 28,803 | $ | 2,724 | $ | 75,683 | ||||||||
Provision for loan losses | 2,967 | (3,336 | ) | 3,369 | 3,000 | |||||||||||
Charge-offs | (2,419 | ) | (3,448 | ) | — | (5,867 | ) | |||||||||
Recoveries | 823 | 1,302 | — | 2,125 | ||||||||||||
Ending balance | $ | 45,527 | $ | 23,321 | $ | 6,093 | $ | 74,941 | ||||||||
Allowance for loan losses balance at June 30, 2015 attributable to: | ||||||||||||||||
Loans individually evaluated for impairment | $ | 1,321 | $ | 260 | $ | — | $ | 1,581 | ||||||||
Loans collectively evaluated for impairment | 44,206 | 23,061 | 6,093 | 73,360 | ||||||||||||
Loans acquired with deteriorated credit quality | — | — | — | — | ||||||||||||
Total | $ | 45,527 | $ | 23,321 | $ | 6,093 | $ | 74,941 | ||||||||
Recorded investment (loan balance) at June 30, 2015: | ||||||||||||||||
Loans individually evaluated for impairment | $ | 85,799 | $ | 20,970 | $ | — | $ | 106,769 | ||||||||
Loans collectively evaluated for impairment | 2,737,909 | 2,506,332 | — | 5,244,241 | ||||||||||||
Loans acquired with deteriorated credit quality | 1,286,990 | 396,743 | — | 1,683,733 | ||||||||||||
Total | $ | 4,110,698 | $ | 2,924,045 | $ | — | $ | 7,034,743 | ||||||||
Note 5: Intangible Assets
The Corporation has the following types of intangible assets: goodwill, core deposit intangible assets, non-compete intangible assets and mortgage servicing rights (MSRs). Goodwill, core deposit intangible assets, and non-compete intangible assets arose as a result of business combinations or other acquisitions. MSRs arose as a result of selling residential mortgage loans in the secondary market while retaining the right to service these loans and receive servicing income over the life of the loan and from acquisitions of other banks that had MSRs. Amortization is recorded on the core deposit intangible assets, non-compete intangible assets and MSRs.
Goodwill recorded is primarily attributable to the synergies and economies of scale expected from combining the operations of the Corporation and other acquisitions. The Corporation recorded additional goodwill in the first quarter of 2016 of $0.5 million related to the 2015 acquisition of Lake Michigan resulting from adjustments to the original acquisition date valuation of acquired assets and liabilities. Goodwill is not amortized but is evaluated at least annually for impairment. The Corporation’s most recent annual goodwill impairment test performed as of October 31, 2015 did not indicate that an impairment of goodwill existed. The Corporation also determined that no triggering events have occurred that indicated impairment from the most recent valuation date through June 30, 2016 and that the Corporation's goodwill was not impaired at June 30, 2016.
37
Chemical Financial Corporation
Notes to Consolidated Financial Statements (Unaudited)
June 30, 2016
The following table shows the net carrying value of the Corporation’s intangible assets:
June 30, 2016 | December 31, 2015 | June 30, 2015 | ||||||||||
(In thousands) | ||||||||||||
Goodwill | $ | 286,867 | $ | 287,393 | $ | 285,512 | ||||||
Other intangible assets: | ||||||||||||
Core deposit intangible assets | $ | 24,429 | $ | 26,654 | $ | 28,353 | ||||||
Non-compete intangible assets | 164 | 328 | 541 | |||||||||
Mortgage servicing rights | 9,677 | 11,122 | 12,307 | |||||||||
Total other intangible assets | $ | 34,270 | $ | 38,104 | $ | 41,201 | ||||||
The following table sets forth the carrying amount, accumulated amortization and amortization expense of core deposit intangible assets that are amortizable and arose from business combinations or other acquisitions:
June 30, 2016 | December 31, 2015 | June 30, 2015 | ||||||||||
(In thousands) | ||||||||||||
Gross original amount | $ | 40,055 | $ | 40,055 | $ | 39,355 | ||||||
Accumulated amortization | 15,626 | 13,401 | 11,002 | |||||||||
Carrying amount | $ | 24,429 | $ | 26,654 | $ | 28,353 | ||||||
Amortization expense for the three months ended June 30 | $ | 1,113 | $ | 952 | ||||||||
Amortization expense for the six months ended June 30 | $ | 2,225 | $ | 1,743 | ||||||||
The estimated future amortization expense on core deposit intangible assets for periods ending after June 30, 2016 is as follows: 2016 — $2.1 million; 2017 — $3.8 million; 2018 — $3.6 million; 2019 — $3.4 million; 2020 — $2.9 million; 2021 and thereafter — $8.6 million. The non-compete intangible assets will be fully amortized during 2016.
The following shows the net carrying value and fair value of MSRs and the total loans that the Corporation is servicing for others:
June 30, 2016 | December 31, 2015 | June 30, 2015 | ||||||||||
(In thousands) | ||||||||||||
Net carrying value of MSRs | $ | 9,677 | $ | 11,122 | $ | 12,307 | ||||||
Fair value of MSRs | $ | 12,493 | $ | 15,542 | $ | 16,602 | ||||||
Valuation allowance | $ | 412 | $ | — | $ | — | ||||||
Loans serviced for others that have servicing rights capitalized | $ | 2,014,986 | $ | 2,082,899 | $ | 2,193,067 | ||||||
MSRs are stratified into servicing assets originated by the Corporation and those acquired in acquisitions of other institutions and further stratified into relatively homogeneous pools based on products with similar characteristics. There was a valuation allowance of $0.4 million as of June 30, 2016 related to impairment within certain pools attributable to the Corporation's servicing portfolios that were acquired in the Northwestern and Monarch transactions. There was no impairment valuation allowance recorded on the Corporation's MSRs at and December 31, 2015 and June 30, 2015.
The following table shows the activity for capitalized MSRs:
Three Months Ended June 30, | Six Months Ended June 30, | |||||||||||||||
2016 | 2015 | 2016 | 2015 | |||||||||||||
(In thousands) | ||||||||||||||||
Balance at beginning of period | $ | 10,478 | $ | 11,583 | $ | 11,122 | $ | 12,217 | ||||||||
Acquired in Monarch acquisition | — | 1,284 | — | 1,284 | ||||||||||||
Additions | 586 | 415 | 917 | 815 | ||||||||||||
Amortization | (975 | ) | (1,175 | ) | (1,950 | ) | (2,209 | ) | ||||||||
Change in valuation allowance | (412 | ) | 200 | (412 | ) | 200 | ||||||||||
Balance at end of period | $ | 9,677 | $ | 12,307 | $ | 9,677 | $ | 12,307 | ||||||||
38
Chemical Financial Corporation
Notes to Consolidated Financial Statements (Unaudited)
June 30, 2016
Note 6: Accumulated Other Comprehensive Loss
The components of accumulated other comprehensive loss, net of related tax benefit/expense, were as follows:
June 30, 2016 | December 31, 2015 | June 30, 2015 | ||||||||||
(In thousands) | ||||||||||||
Net unrealized gains (losses) on investment securities – available-for-sale, net of related tax expense (benefit) of $1,182 at June 30, 2016, $(1,017) at December 31, 2015 and $(148) at June 30, 2015 | $ | 2,196 | $ | (1,888 | ) | $ | (274 | ) | ||||
Pension and other postretirement benefits adjustment, net of related tax benefit of $15,020 at June 30, 2016, $14,616 at December 31, 2015 and $16,601 at June 30, 2015 | (27,894 | ) | (27,144 | ) | (30,830 | ) | ||||||
Accumulated other comprehensive loss | $ | (25,698 | ) | $ | (29,032 | ) | $ | (31,104 | ) | |||
Note 7: Borrowings
Short-term Borrowings
The Corporation's short-term borrowings, which generally have an original term to maturity of 30 days or less, consisted of short-term FHLB advances outstanding of $300 million at June 30, 2016, $100 million at December 31, 2015 and $205 million at June 30, 2015, and federal funds purchased of $22 million at June 30, 2015. There were no federal funds purchased at June 30, 2016 and December 31, 2015.
Long-term Borrowings
A summary of the Corporation's long-term borrowings follows:
June 30, 2016 | December 31, 2015 | June 30, 2015 | ||||||||||
(In thousands) | ||||||||||||
Long-term borrowings: | ||||||||||||
Long-term FHLB advances | $ | 329,320 | $ | 181,394 | $ | 81,469 | ||||||
Securities sold under agreements to repurchase | 17,277 | 17,453 | 23,649 | |||||||||
Non-revolving line-of-credit | 25,000 | 25,000 | 25,000 | |||||||||
Subordinated debt obligations | — | 18,544 | 18,372 | |||||||||
Total long-term borrowings | $ | 371,597 | $ | 242,391 | $ | 148,490 | ||||||
During the second quarter of 2016, the Corporation borrowed $100 million of long-term FHLB advances which have a three-year term at a fixed-rate of 1.00%. During the first quarter of 2016, the Corporation borrowed $50 million of long-term FHLB advances which have a four-year term at a fixed-rate of 1.30%. The Corporation's long-term FHLB advances have a combined weighted-average interest rate of 1.27% as of June 30, 2016. The Corporation's FHLB advances, including both short-term and long-term, require monthly interest payments and are collateralized by eligible loans totaling $2.98 billion as of June 30, 2016. The scheduled reductions of long-term FHLB advances as of June 30, 2016 were as follows: 2016 - $5.1 million; 2017 - $47.1 million; 2018 - $67.1 million; 2019; - $100.0 million; and 2020 - $110.0 million.
Securities sold under agreements to repurchase are with an unaffiliated financial institution and are secured by available for-sale-securities. As of June 30, 2016, these agreements had scheduled maturities of $8.1 million in 2016 and $9.2 million in 2017.
The Corporation has a $25 million secured non-revolving line-of-credit with an unaffiliated third-party financial institution. The line-of-credit originally matured in May 2016 and was extended for a period of three months. The Corporation is fully drawn on the entire amount of the line-of-credit. This line-of-credit bears a variable rate of interest which is based on the one-, two- or three-month LIBOR, as periodically selected by the Corporation, plus a fixed stated rate (effective interest rate of 2.41% at June 30, 2016). The line-of-credit agreement contains certain restrictive covenants. The Corporation was in compliance with all of the covenants at June 30, 2016.
As a result of the Lake Michigan transaction on May 31, 2015, the Corporation acquired subordinated debt obligations in the amount of $18.6 million. The Corporation fully repaid these debt obligations during the first quarter of 2016.
39
Chemical Financial Corporation
Notes to Consolidated Financial Statements (Unaudited)
June 30, 2016
Note 8: Regulatory Capital
Federal and state banking regulations place certain restrictions on the transfer of assets, in the form of dividends, loans, or advances, from Chemical Bank to the Corporation. As of June 30, 2016, substantially all of the assets of Chemical Bank were restricted from transfer to the Corporation in the form of loans or advances. Dividends from Chemical Bank are the principal source of funds for the Corporation. In addition to the statutory limits, the Corporation considers the overall financial and capital position of Chemical Bank prior to making any cash dividend decisions.
The Corporation and Chemical Bank are subject to various regulatory capital requirements administered by federal banking agencies. Under these capital requirements, Chemical Bank must meet specific capital guidelines that involve quantitative measures of assets and certain off-balance sheet items as calculated under regulatory accounting practices. In addition, capital amounts and classifications are subject to qualitative judgments by regulators. Failure to meet minimum capital requirements can initiate certain mandatory and possibly additional discretionary actions by regulators that, if undertaken, could have a direct material effect on the Corporation’s consolidated financial statements.
Quantitative measures established by regulation to ensure capital adequacy require minimum ratios of Tier 1 capital to average assets (Leverage Ratio) and common equity Tier 1, Tier 1 and Total capital to risk-weighted assets. These capital guidelines assign risk weights to on- and off-balance sheet items in arriving at total risk-weighted assets. Minimum capital levels are based upon the perceived risk of various asset categories and certain off-balance sheet instruments. Risk weighted assets of the Corporation totaled $7.50 billion, $7.14 billion and $6.99 billion at June 30, 2016, December 31, 2015 and June 30, 2015, respectively.
In July 2013, the Board of Governors of the Federal Reserve System ("Reserve Board") and FDIC approved final rules implementing the Basel Committee on Banking Supervision's ("BCBS") capital guidelines for U.S. banks (commonly referred to as "Basel III"). Beginning January 1, 2015, the Basel III capital rules include a new minimum common equity Tier 1 capital to risk-weighted assets ("CET Tier 1") ratio of 4.5%, in addition to raising the minimum ratio of Tier 1 capital to risk-weighted assets from 4.0% to 6.0% and requiring a minimum leverage ratio of 4.0%. The Basel III capital rules also establish a new capital conservation buffer of 2.5% of risk-weighted assets, which is phased-in over a four-year period beginning January 1, 2016.
At June 30, 2016, December 31, 2015 and June 30, 2015, Chemical Bank’s capital ratios exceeded the quantitative capital ratios required for an institution to be considered “well-capitalized.” Significant factors that may affect capital adequacy include, but are not limited to, a disproportionate growth in assets versus capital and a change in mix or credit quality of assets.
The summary below compares the actual capital amounts and ratios with the quantitative measures established by regulation to ensure capital adequacy:
Actual | Minimum Required for Capital Adequacy Purposes | Required to be Well Capitalized Under Prompt Corrective Action Regulations | |||||||||||||||||||
Capital Amount | Ratio | Capital Amount | Ratio | Capital Amount | Ratio | ||||||||||||||||
(Dollars in thousands) | |||||||||||||||||||||
June 30, 2016 | |||||||||||||||||||||
Total Capital to Risk-Weighted Assets: | |||||||||||||||||||||
Corporation | $ | 851,114 | 11.4 | % | $ | 599,743 | 8.0 | % | N/A | N/A | |||||||||||
Chemical Bank | 854,189 | 11.4 | 598,142 | 8.0 | $ | 747,677 | 10.0 | % | |||||||||||||
Tier 1 Capital to Risk-Weighted Assets: | |||||||||||||||||||||
Corporation | 779,608 | 10.4 | 449,807 | 6.0 | N/A | N/A | |||||||||||||||
Chemical Bank | 782,683 | 10.5 | 448,606 | 6.0 | 598,142 | 8.0 | |||||||||||||||
Common Equity Tier 1 Capital to Risk-Weighted Assets: | |||||||||||||||||||||
Corporation | 779,608 | 10.4 | 337,355 | 4.5 | N/A | N/A | |||||||||||||||
Chemical Bank | 782,683 | 10.5 | 336,455 | 4.5 | 485,990 | 6.5 | |||||||||||||||
Leverage Ratio: | |||||||||||||||||||||
Corporation | 779,608 | 8.6 | 361,408 | 4.0 | N/A | N/A | |||||||||||||||
Chemical Bank | 782,683 | 8.7 | 360,746 | 4.0 | 450,932 | 5.0 | |||||||||||||||
40
Chemical Financial Corporation
Notes to Consolidated Financial Statements (Unaudited)
June 30, 2016
Actual | Minimum Required for Capital Adequacy Purposes | Required to be Well Capitalized Under Prompt Corrective Action Regulations | |||||||||||||||||||
Capital Amount | Ratio | Capital Amount | Ratio | Capital Amount | Ratio | ||||||||||||||||
(Dollars in thousands) | |||||||||||||||||||||
December 31, 2015 | |||||||||||||||||||||
Total Capital to Risk-Weighted Assets: | |||||||||||||||||||||
Corporation | $ | 841,257 | 11.8 | % | $ | 571,509 | 8.0 | % | N/A | N/A | |||||||||||
Chemical Bank | 830,294 | 11.7 | 570,073 | 8.0 | $ | 712,591 | 10.0 | % | |||||||||||||
Tier 1 Capital to Risk-Weighted Assets: | |||||||||||||||||||||
Corporation | 767,929 | 10.7 | 428,631 | 6.0 | N/A | N/A | |||||||||||||||
Chemical Bank | 756,966 | 10.6 | 427,555 | 6.0 | 570,073 | 8.0 | |||||||||||||||
Common Equity Tier 1 Capital to Risk-Weighted Assets: | |||||||||||||||||||||
Corporation | 753,815 | 10.6 | 321,474 | 4.5 | N/A | N/A | |||||||||||||||
Chemical Bank | 756,966 | 10.6 | 320,666 | 4.5 | 463,184 | 6.5 | |||||||||||||||
Leverage Ratio: | |||||||||||||||||||||
Corporation | 767,929 | 8.6 | 356,396 | 4.0 | N/A | N/A | |||||||||||||||
Chemical Bank | 756,966 | 8.5 | 355,911 | 4.0 | 444,888 | 5.0 | |||||||||||||||
June 30, 2015 | |||||||||||||||||||||
Total Capital to Risk-Weighted Assets: | |||||||||||||||||||||
Corporation | $ | 816,595 | 11.6 | % | $ | 559,273 | 8.0 | % | N/A | N/A | |||||||||||
Chemical Bank | 713,999 | 12.0 | 471,422 | 8.0 | $ | 589,277 | 10.0 | % | |||||||||||||
The Bank of Holland | 77,648 | 10.2 | 61,028 | 8.0 | 76,285 | 10.0 | |||||||||||||||
The Bank of Northern Michigan | 32,779 | 10.1 | 25,878 | 8.0 | 32,347 | 10.0 | |||||||||||||||
Tier 1 Capital to Risk-Weighted Assets: | |||||||||||||||||||||
Corporation | 741,654 | 10.6 | 419,455 | 6.0 | N/A | N/A | |||||||||||||||
Chemical Bank | 640,324 | 10.9 | 353,566 | 6.0 | 471,422 | 8.0 | |||||||||||||||
The Bank of Holland | 76,312 | 10.0 | 45,771 | 6.0 | 61,028 | 8.0 | |||||||||||||||
The Bank of Northern Michigan | 32,779 | 10.1 | 19,408 | 6.0 | 25,878 | 8.0 | |||||||||||||||
Common Equity Tier 1 Capital to Risk-Weighted Assets: | |||||||||||||||||||||
Corporation | 723,654 | 10.4 | 314,591 | 4.5 | N/A | N/A | |||||||||||||||
Chemical Bank | 640,324 | 10.9 | 265,175 | 4.5 | 383,030 | 6.5 | |||||||||||||||
The Bank of Holland | 76,312 | 10.0 | 34,328 | 4.5 | 49,585 | 6.5 | |||||||||||||||
The Bank of Northern Michigan | 32,779 | 10.1 | 14,556 | 4.5 | 21,025 | 6.5 | |||||||||||||||
Leverage Ratio: | |||||||||||||||||||||
Corporation | 741,654 | 9.4 | 314,344 | 4.0 | N/A | N/A | |||||||||||||||
Chemical Bank | 640,324 | 8.5 | 300,703 | 4.0 | 375,878 | 5.0 | |||||||||||||||
The Bank of Holland | 76,312 | 9.9 | 30,710 | 4.0 | 38,388 | 5.0 | |||||||||||||||
The Bank of Northern Michigan | 32,779 | 9.1 | 14,421 | 4.0 | 18,026 | 5.0 | |||||||||||||||
Note 9: Fair Value Measurements
Fair value, as defined by GAAP, is the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants. A fair value measurement assumes that the transaction to sell the asset or transfer the liability occurs in the principal market for the asset or liability or, in the absence of a principal market, the most advantageous market for the asset or liability. The price in the principal (or most advantageous) market used to measure the fair value of the asset or liability is not adjusted for transaction costs. An orderly transaction is a transaction that assumes exposure to the market for a period prior to the measurement date to allow for market activities that are usual and customary for transactions involving such assets and liabilities; it is not a forced transaction. Market participants are buyers and sellers in the principal market that are (i) independent, (ii) knowledgeable, (iii) able to transact and (iv) willing to transact.
41
Chemical Financial Corporation
Notes to Consolidated Financial Statements (Unaudited)
June 30, 2016
The Corporation utilizes fair value measurements to record fair value adjustments to certain assets and to determine fair value disclosures. Investment securities — available-for-sale and loans held-for-sale are recorded at fair value on a recurring basis. Additionally, the Corporation may be required to record other assets, such as impaired loans, goodwill, other intangible assets, other real estate and repossessed assets, at fair value on a nonrecurring basis. These nonrecurring fair value adjustments typically involve the application of lower of cost or market accounting or write-downs of individual assets.
The Corporation determines the fair value of its financial instruments based on a three-level hierarchy established by GAAP. The classification and disclosure of assets and liabilities within the hierarchy is based on whether the inputs to the valuation methodology used for measurement are observable or unobservable. Observable inputs reflect market-derived or market-based information obtained from independent sources, while unobservable inputs reflect management’s estimates about market data. The three levels of inputs that may be used to measure fair value within the GAAP hierarchy are as follows:
Level 1 | Valuation is based upon quoted prices for identical instruments traded in active markets. Level 1 valuations for the Corporation would include U.S. Treasury securities that are traded by dealers or brokers in active over-the-counter markets. Valuations are obtained from a third-party pricing service for these investment securities. |
Level 2 | Valuation is based upon quoted prices for similar instruments in active markets, quoted prices for identical or similar instruments in markets that are not active, and model-based valuation techniques for which all significant assumptions are observable in the market. Level 2 valuations for the Corporation include government sponsored agency securities, including securities issued by the Federal Home Loan Bank, Federal Home Loan Mortgage Corporation, Federal National Mortgage Association, Federal Farm Credit Bank, Student Loan Marketing Corporation and the Small Business Administration, securities issued by certain state and political subdivisions, residential mortgage-backed securities, collateralized mortgage obligations, corporate bonds, preferred stock and available-for-sale trust preferred securities. Valuations are obtained from a third-party pricing service for these investment securities. |
Level 3 | Valuation is generated from model-based techniques that use at least one significant assumption not observable in the market. These unobservable assumptions reflect estimates of assumptions that market participants would use in pricing the asset or liability. Valuation techniques include use of option pricing models, discounted cash flow models, yield curves and similar techniques. The determination of fair value requires management judgment or estimation and generally is corroborated by external data, which includes third-party pricing services. Level 3 valuations for the Corporation include securities issued by certain state and political subdivisions, held-to-maturity trust preferred investment securities, impaired loans, goodwill, core deposit intangible assets, non-compete intangible assets, MSRs and other real estate and repossessed assets. |
A description of the valuation methodologies used for instruments measured at fair value, as well as the general classification of such instruments pursuant to the valuation hierarchy, is set forth below. These valuation methodologies were applied to all of the Corporation’s financial assets and financial liabilities carried at fair value and all financial instruments disclosed at fair value. In general, fair value is based upon quoted market prices, where available. If quoted market prices are not available, fair value is based upon third-party pricing services when available. Fair value may also be based on internally developed models that primarily use, as inputs, observable market-based parameters. Valuation adjustments may be required to record financial instruments at fair value. Any such valuation adjustments are applied consistently over time. The Corporation’s valuation methodologies may produce a fair value calculation that may not be indicative of net realizable value or reflective of future fair values.
While management believes the Corporation’s valuation methodologies are appropriate and consistent with other market participants, the use of different methodologies or assumptions to determine the fair value of certain financial instruments could result in a different estimate of fair value at the reporting date. Furthermore, the fair value amounts may change significantly after the date of the statement of financial position from the amounts reported in the consolidated financial statements and related notes.
Assets and Liabilities Recorded at Fair Value on a Recurring Basis
Investment securities — available-for-sale are recorded at fair value on a recurring basis. Fair value measurement is based upon quoted prices, if available. If quoted prices are not available, fair values are generally measured using independent pricing models or other model-based valuation techniques that include market inputs, such as benchmark yields, reported trades, broker/dealer quotes, issuer spreads, two-sided markets, benchmark securities, bids, offers, reference data and industry and economic events.
The Corporation elected the fair value option for all residential mortgage loans held-for-sale originated on or after July 1, 2012. Accordingly, loans held-for-sale are recorded at fair value on a recurring basis. The fair values of loans held-for-sale are based on the market price for similar loans sold in the secondary market, and therefore, are classified as Level 2 valuations.
42
Chemical Financial Corporation
Notes to Consolidated Financial Statements (Unaudited)
June 30, 2016
Disclosure of Recurring Basis Fair Value Measurements
For assets measured at fair value on a recurring basis, quantitative disclosures about the fair value measurements for each major category of assets were as follows:
Quoted Prices In Active Markets for Identical Assets (Level 1) | Significant Other Observable Inputs (Level 2) | Significant Unobservable Inputs (Level 3) | Total | |||||||||||||
(In thousands) | ||||||||||||||||
June 30, 2016 | ||||||||||||||||
Investment securities – available-for-sale: | ||||||||||||||||
U.S. Treasury securities | $ | 5,810 | $ | — | $ | — | $ | 5,810 | ||||||||
Government sponsored agencies | — | 157,022 | — | 157,022 | ||||||||||||
State and political subdivisions | — | 13,220 | — | 13,220 | ||||||||||||
Residential mortgage-backed securities | — | 168,616 | — | 168,616 | ||||||||||||
Collateralized mortgage obligations | — | 100,849 | — | 100,849 | ||||||||||||
Corporate bonds | — | 9,712 | — | 9,712 | ||||||||||||
Preferred stock and trust preferred securities | — | 3,323 | — | 3,323 | ||||||||||||
Total investment securities – available-for-sale | 5,810 | 452,742 | — | 458,552 | ||||||||||||
Loans held-for-sale | — | 13,990 | — | 13,990 | ||||||||||||
Total assets measured at fair value on a recurring basis | $ | 5,810 | $ | 466,732 | $ | — | $ | 472,542 | ||||||||
December 31, 2015 | ||||||||||||||||
Investment securities – available-for-sale: | ||||||||||||||||
U.S. Treasury securities | $ | 5,765 | $ | — | $ | — | $ | 5,765 | ||||||||
Government sponsored agencies | — | 194,989 | — | 194,989 | ||||||||||||
State and political subdivisions | — | 15,120 | — | 15,120 | ||||||||||||
Residential mortgage-backed securities | — | 187,768 | — | 187,768 | ||||||||||||
Collateralized mortgage obligations | — | 132,230 | — | 132,230 | ||||||||||||
Corporate bonds | — | 14,627 | — | 14,627 | ||||||||||||
Preferred stock and trust preferred securities | — | 3,232 | — | 3,232 | ||||||||||||
Total investment securities – available-for-sale | 5,765 | 547,966 | — | 553,731 | ||||||||||||
Loans held-for-sale | — | 10,327 | — | 10,327 | ||||||||||||
Total assets measured at fair value on a recurring basis | $ | 5,765 | $ | 558,293 | $ | — | $ | 564,058 | ||||||||
June 30, 2015 | ||||||||||||||||
Investment securities – available-for-sale: | ||||||||||||||||
U.S. Treasury securities | $ | 8,294 | $ | — | $ | — | $ | 8,294 | ||||||||
Government sponsored agencies | — | 227,907 | — | 227,907 | ||||||||||||
State and political subdivisions | — | 26,965 | — | 26,965 | ||||||||||||
Residential mortgage-backed securities | — | 212,669 | — | 212,669 | ||||||||||||
Collateralized mortgage obligations | — | 167,032 | — | 167,032 | ||||||||||||
Corporate bonds | — | 39,678 | — | 39,678 | ||||||||||||
Preferred stock | — | 3,161 | — | 3,161 | ||||||||||||
Total investment securities – available-for-sale | 8,294 | 677,412 | — | 685,706 | ||||||||||||
Loans held-for-sale | — | 7,798 | — | 7,798 | ||||||||||||
Total assets measured at fair value on a recurring basis | $ | 8,294 | $ | 685,210 | $ | — | $ | 693,504 | ||||||||
There were no liabilities recorded at fair value on a recurring basis at June 30, 2016, December 31, 2015 or June 30, 2015.
43
Chemical Financial Corporation
Notes to Consolidated Financial Statements (Unaudited)
June 30, 2016
Assets and Liabilities Recorded at Fair Value on a Nonrecurring Basis
The Corporation does not record loans held for investment at fair value on a recurring basis. However, from time to time, a loan is considered impaired and an allocation of the allowance (valuation allowance) may be established or a portion of the loan is charged off. Loans for which it is probable that payment of interest and principal will not be made in accordance with the contractual terms of the loan agreement are considered impaired. The fair value of impaired loans is estimated using one of several methods, including the loan’s observable market price, the fair value of the collateral or the present value of the expected future cash flows discounted at the loan’s effective interest rate. Those impaired loans not requiring a valuation allowance represent loans for which the fair value of the expected repayments or collateral exceed the remaining carrying amount of such loans. Impaired loans where a valuation allowance is established or a portion of the loan is charged off based on the fair value of collateral are subject to nonrecurring fair value measurement and require classification in the fair value hierarchy. The Corporation records impaired loans as Level 3 valuations as there is generally no observable market price or independent appraised value, or management determines the fair value of the collateral is further impaired below the appraised value. When management determines the fair value of the collateral is further impaired below appraised value, discount factors ranging between 70% and 80% of the appraised value are used depending on the nature of the collateral and the age of the most recent appraisal.
Goodwill is subject to impairment testing on an annual basis. The assessment of goodwill for impairment requires a significant degree of judgment. In the event the assessment indicates that it is more-likely-than-not that the fair value is less than the carrying value, the asset is considered impaired and recorded at fair value. Goodwill that is impaired and subject to nonrecurring fair value measurements is a Level 3 valuation. At June 30, 2016, December 31, 2015 and June 30, 2015, no goodwill was impaired, and therefore, goodwill was not recorded at fair value on a nonrecurring basis.
Other intangible assets consist of core deposit intangible assets, non-compete intangible assets, and MSRs. These items are recorded at fair value when initially recorded. Subsequently, core deposit intangible assets and non-compete intangible assets are amortized primarily on an accelerated basis over periods ranging from ten to fifteen years and are subject to impairment testing whenever events or changes in circumstances indicate that the carrying amount exceeds the fair value of the asset. If core deposit intangible asset or non-compete intangible asset impairment is identified, the Corporation classifies impaired core deposit intangible assets and impaired non-compete intangible assets subject to nonrecurring fair value measurements as Level 3 valuations. At June 30, 2016, December 31, 2015 and June 30, 2015, there was no impairment identified for core deposit intangible assets or non-compete intangible assets. The fair value of MSRs is initially estimated using a model that calculates the net present value of estimated future cash flows using various assumptions, including prepayment speeds, the discount rate and servicing costs. If the valuation model reflects a value less than the carrying value, MSRs are adjusted to fair value, as determined by the model, through a valuation allowance. The Corporation classifies MSRs subject to nonrecurring fair value measurements as Level 3 valuations. At June 30, 2016 , the Corporation recognized a valuation allowance of $0.4 million related to impairment within certain pools attributable to the Corporation's servicing portfolios that were acquired in the Northwestern and Monarch transactions. As a result, the MSRs related to these servicing portfolios were considered to be recorded at fair value on a nonrecurring basis as of June 30, 2016. At December 31, 2015 and June 30, 2015, there was no impairment identified for MSRs and, therefore, no other intangible assets were recorded at fair value on a nonrecurring basis.
The carrying amounts for other real estate (ORE) and repossessed assets (RA) are reported in the consolidated statements of financial position under “Interest receivable and other assets.” ORE and RA include real estate and other types of assets repossessed by the Corporation. ORE and RA are recorded at the lower of cost or fair value upon the transfer of a loan to ORE or RA and, subsequently, ORE and RA continue to be measured and carried at the lower of cost or fair value. Fair value is based upon independent market prices, appraised values of the property or management’s estimation of the value of the property. The Corporation records ORE and RA as Level 3 valuations as management generally determines that the fair value of the property is impaired below the appraised value. When management determines the fair value of the property is further impaired below appraised value, discount factors ranging between 70% and 75% of the appraised value are used depending on the nature of the property and the age of the most recent appraisal.
44
Chemical Financial Corporation
Notes to Consolidated Financial Statements (Unaudited)
June 30, 2016
Disclosure of Nonrecurring Basis Fair Value Measurements
For assets measured at fair value on a nonrecurring basis, quantitative disclosures about fair value measurements for each major category of assets were as follows:
Quoted Prices In Active Markets for Identical Assets (Level 1) | Significant Other Observable Inputs (Level 2) | Significant Unobservable Inputs (Level 3) | Total | |||||||||||||
(In thousands) | ||||||||||||||||
June 30, 2016 | ||||||||||||||||
Impaired originated loans | $ | — | $ | — | $ | 23,655 | $ | 23,655 | ||||||||
Other real estate/repossessed assets | — | — | 8,440 | 8,440 | ||||||||||||
Mortgage servicing rights | — | — | 6,153 | 6,153 | ||||||||||||
Total | $ | — | $ | — | $ | 38,248 | $ | 38,248 | ||||||||
December 31, 2015 | ||||||||||||||||
Impaired originated loans | $ | — | $ | — | $ | 42,065 | $ | 42,065 | ||||||||
Other real estate/repossessed assets | — | — | 9,935 | 9,935 | ||||||||||||
Total | $ | — | $ | — | $ | 52,000 | $ | 52,000 | ||||||||
June 30, 2015 | ||||||||||||||||
Impaired originated loans | $ | — | $ | — | $ | 24,517 | $ | 24,517 | ||||||||
Other real estate/repossessed assets | — | — | 14,197 | 14,197 | ||||||||||||
Total | $ | — | $ | — | $ | 38,714 | $ | 38,714 | ||||||||
There were no liabilities recorded at fair value on a nonrecurring basis at June 30, 2016, December 31, 2015 and June 30, 2015.
The following table presents additional information about the significant unobservable inputs used in the fair value measurement of financial assets measured on a nonrecurring basis that were categorized within the Level 3 of the fair value hierarchy (fair value in thousands):
Fair Value at June 30, 2016 | Valuation Technique | Significant Unobservable Inputs | Range | |||||||
Impaired originated loans | $ | 23,655 | Appraisal of collateral | Discount for type of collateral and age of appraisal | 20%-30% | |||||
Other real estate/repossessed assets | 8,440 | Appraisal of property | Discount for type of property and age of appraisal | 25%-30% | ||||||
Mortgage servicing rights | 6,153 | Discounted cash flow | Constant prepayment rate | 12%-22% | ||||||
Discount rate | 10%-11% | |||||||||
Disclosures about Fair Value of Financial Instruments
GAAP requires disclosures about the estimated fair value of the Corporation's financial instruments, including those financial assets and liabilities that are not measured and reported at fair value on a recurring or nonrecurring basis. However, the method of estimating fair value for certain financial instruments, such as loans, that are not required to be measured on a recurring or nonrecurring basis, as prescribed by ASC 820, Fair Value Measurements and Disclosures, does not incorporate the exit-price concept of fair value. The Corporation utilized the fair value hierarchy in computing the fair values of its financial instruments. In cases where quoted market prices were not available, the Corporation employed present value methods using unobservable inputs requiring management's judgment to estimate the fair values of its financial instruments, which are considered Level 3 valuations. These Level 3 valuations are affected by the assumptions made and, accordingly, do not necessarily indicate amounts that could be realized in a current market exchange. It is also the Corporation's general practice and intent to hold the majority of its financial instruments until maturity and, therefore, the Corporation does not expect to realize the estimated amounts disclosed.
45
Chemical Financial Corporation
Notes to Consolidated Financial Statements (Unaudited)
June 30, 2016
The methodologies for estimating the fair value of financial assets and financial liabilities on a recurring or nonrecurring basis are discussed above. At June 30, 2016, December 31, 2015 and June 30, 2015, the estimated fair values of cash and cash equivalents, interest receivable and interest payable approximated their carrying values at those dates. The methodologies for other financial assets and financial liabilities follow.
Fair value measurement for investment securities — held-to-maturity is based upon quoted prices, if available. If quoted prices are not available, fair values are measured using independent pricing models or other model-based valuation techniques that include market inputs such as benchmark yields, reported trades, broker/dealer quotes, issuer spreads, two-sided markets, benchmark securities, bids, offers, reference data and industry and economic events. Fair value measurements using Level 2 valuations of investment securities — held-to-maturity include the majority of the Corporation's investment securities issued by state and political subdivisions. Level 3 valuations include certain securities issued by state and political subdivisions and trust preferred investment securities.
Fair value measurements of nonmarketable equity securities, which consisted of Federal Home Loan Bank (FHLB) and Federal Reserve Bank (FRB) stock, are based on their redeemable value, which is cost. The market for these securities is restricted to the issuer of the stock and subject to impairment evaluation. It is not practicable to determine the fair value of these securities within the fair value hierarchy due to the restrictions placed on their transferability.
Loans held-for-sale are carried at fair value, as the Corporation elected the fair value option on these loans. The fair values of loans held-for-sale are based on the market price for similar loans sold in the secondary market, and therefore, are classified as Level 2 valuations.
The fair value of variable interest rate loans that reprice regularly with changes in market interest rates are based on carrying values. The fair values for fixed interest rate loans are estimated using discounted cash flow analyses, using the Corporation’s interest rates currently being offered for loans with similar terms to borrowers of similar credit quality. The resulting fair value amounts are adjusted to estimate the impact of changes in the credit quality of borrowers after the loans were originated. The fair value measurements for loans are Level 3 valuations.
The fair values of deposit accounts without defined maturities, such as interest- and noninterest-bearing checking, savings and money market accounts, are equal to the amounts payable on demand. The fair values for variable-interest rate time deposits with defined maturities approximate their carrying amounts. Fair value measurements for fixed-interest rate time deposits with defined maturities are based on the discounted value of contractual cash flows, using the Corporation’s interest rates currently being offered for deposits of similar maturities, and are Level 3 valuations. However, if the estimated fair value is less than the carrying value, the carrying value is reported as the fair value.
Short-term borrowings consist of securities sold under agreements to repurchase with customers, short-term FHLB advances and federal funds purchased. Fair value measurements for short-term borrowings are based on the present value of future estimated cash flows using current interest rates offered to the Corporation for debt with similar terms and are Level 2 valuations.
Long-term borrowings consist of long-term FHLB advances, securities sold under agreements to repurchase with an unaffiliated financial institution, a non-revolving line-of-credit and subordinated debt obligations. Fair value measurements for long-term borrowings are based on the present value of future estimated cash flows using current interest rates offered to the Corporation for debt with similar terms. Long-term FHLB advances and the non-revolving line-of-credit included in long-term borrowings are Level 2 valuations, while securities sold under agreements to repurchase with an unaffiliated financial institution and subordinated debt obligations are Level 3 valuations.
The Corporation’s unused commitments to extend credit, standby letters of credit and loan commitments have no carrying amount and have been estimated to have no realizable fair value. Historically, a majority of the unused commitments to extend credit have not been drawn upon and, generally, the Corporation does not receive fees in connection with these commitments other than standby letter of credit fees, which are not significant.
Fair value measurements have not been made for items that are not defined by GAAP as financial instruments, including such items as the value of the Corporation’s Wealth Management department and the value of the Corporation’s core deposit base. The Corporation believes it is impractical to estimate a representative fair value for these types of assets, even though management believes they add significant value to the Corporation.
46
Chemical Financial Corporation
Notes to Consolidated Financial Statements (Unaudited)
June 30, 2016
A summary of carrying amounts and estimated fair values of the Corporation’s financial instruments included in the consolidated statements of financial position was as follows:
Level in Fair Value Measurement Hierarchy | June 30, 2016 | December 31, 2015 | June 30, 2015 | ||||||||||||||||||||||
Carrying Amount | Fair Value | Carrying Amount | Fair Value | Carrying Amount | Fair Value | ||||||||||||||||||||
(In thousands) | |||||||||||||||||||||||||
Assets: | |||||||||||||||||||||||||
Cash and cash equivalents | Level 1 | $ | 232,960 | $ | 232,960 | $ | 238,789 | $ | 238,789 | $ | 215,034 | $ | 215,034 | ||||||||||||
Investment securities: | |||||||||||||||||||||||||
Available-for-sale | Level 1 | 5,810 | 5,810 | 5,765 | 5,765 | 8,294 | 8,294 | ||||||||||||||||||
Available-for-sale | Level 2 | 452,742 | 452,742 | 547,966 | 547,966 | 677,412 | 677,412 | ||||||||||||||||||
Held-to-maturity | Level 2 | 552,328 | 568,130 | 509,471 | 512,405 | 469,337 | 466,278 | ||||||||||||||||||
Held-to-maturity | Level 3 | 500 | 285 | 500 | 300 | 500 | 300 | ||||||||||||||||||
Nonmarketable equity securities | NA | 47,775 | 47,775 | 36,907 | 36,907 | 36,142 | 36,142 | ||||||||||||||||||
Loans held-for-sale | Level 2 | 13,990 | 13,990 | 10,327 | 10,327 | 7,798 | 7,798 | ||||||||||||||||||
Net loans | Level 3 | 7,575,763 | 7,593,013 | 7,197,819 | 7,201,994 | 6,959,802 | 6,969,655 | ||||||||||||||||||
Interest receivable | Level 2 | 23,111 | 23,111 | 21,953 | 21,953 | 21,668 | 21,668 | ||||||||||||||||||
Liabilities: | |||||||||||||||||||||||||
Deposits without defined maturities | Level 2 | $ | 5,904,618 | $ | 5,904,618 | $ | 5,809,355 | $ | 5,809,355 | $ | 5,547,764 | $ | 5,547,764 | ||||||||||||
Time deposits | Level 3 | 1,560,028 | 1,563,446 | 1,647,412 | 1,647,412 | 1,745,215 | 1,745,215 | ||||||||||||||||||
Interest payable | Level 2 | 1,389 | 1,389 | 1,578 | 1,578 | 1,557 | 1,557 | ||||||||||||||||||
Short-term borrowings | Level 2 | 556,213 | 556,213 | 397,199 | 397,199 | 532,291 | 532,291 | ||||||||||||||||||
Long-term borrowings | Level 2 | 354,320 | 359,043 | 206,394 | 206,394 | 106,469 | 106,469 | ||||||||||||||||||
Long-term borrowings | Level 3 | 17,277 | 17,228 | 35,997 | 35,997 | 42,021 | 42,021 | ||||||||||||||||||
Note 10: Earnings Per Common Share
Basic earnings per common share for the Corporation is computed by dividing net income by the weighted average number of common shares outstanding during the period. Basic earnings per common share excludes any dilutive effect of common stock equivalents.
Diluted earnings per common share for the Corporation is computed by dividing net income by the sum of the weighted average number of common shares outstanding and the dilutive effect of common stock equivalents using the treasury stock method. Average shares of common stock for diluted net income per common share include shares to be issued upon the exercise of stock options granted under the Corporation’s share-based compensation plans, restricted stock units that may be converted to stock and stock to be issued under the deferred stock compensation plan for non-employee directors. For any period in which a net loss is recorded, the assumed exercise of stock options, restricted stock units that may be converted to stock and stock to be issued under the deferred stock compensation plan would have an anti-dilutive impact on the net loss per common share and thus are excluded in the diluted earnings per common share calculation.
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Chemical Financial Corporation
Notes to Consolidated Financial Statements (Unaudited)
June 30, 2016
The following summarizes the numerator and denominator of the basic and diluted earnings per common share computations:
Three Months Ended June 30, | Six Months Ended June 30, | ||||||||||||||
2016 | 2015 | 2016 | 2015 | ||||||||||||
(In thousands, except per share data) | |||||||||||||||
Numerator for both basic and diluted earnings per common share, net income | $ | 25,707 | $ | 19,024 | $ | 48,969 | $ | 36,859 | |||||||
Denominator for basic earnings per common share, weighted average common shares outstanding | 38,258 | 35,162 | 38,228 | 33,992 | |||||||||||
Weighted average common stock equivalents | 342 | 235 | 332 | 235 | |||||||||||
Denominator for diluted earnings per common share | 38,600 | 35,397 | 38,560 | 34,227 | |||||||||||
Basic earnings per common share | $ | 0.67 | $ | 0.54 | $ | 1.28 | $ | 1.08 | |||||||
Diluted earnings per common share | $ | 0.67 | $ | 0.54 | $ | 1.27 | $ | 1.08 | |||||||
The average number of exercisable employee stock option awards outstanding that were “out-of-the-money,” whereby the option exercise price per share exceeded the market price per share and, therefore, were not included in the computation of diluted earnings per common share because they would have been anti-dilutive totaled zero and 80,700 for the three months ended June 30, 2016 and 2015, respectively, and zero and 100,875 for the six months ended June 30, 2016 and 2015, respectively.
Note 11: Share-Based Compensation
The Corporation maintains share-based compensation plans under which it periodically grants share-based awards for a fixed number of shares to certain officers of the Corporation. The fair value of share-based awards is recognized as compensation expense over the requisite service or performance period. During the three-month periods ended June 30, 2016 and 2015, share-based compensation expense related to stock options, restricted stock units and other share-based awards totaled $1.0 million and $0.8 million, respectively. During the six months ended June 30, 2016 and 2015, share-based compensation expense related to stock options, restricted stock units and other share-based awards totaled $1.8 million and $1.5 million, respectively.
During the six-month period ended June 30, 2016, the Corporation granted options to purchase 441,167 shares of common stock, 99,208 restricted stock units and 940 shares of common stock to certain officers of the Corporation. On April 20, 2015, the shareholders of the Corporation approved the Stock Incentive Plan of 2015, which provides for 1,300,000 shares of the Corporation's common stock to be made available for future equity-based awards and canceled the amount of shares available for future grant under prior share-based compensation plans. At June 30, 2016, there were 703,493 shares of common stock available for future grants under the Stock Incentive Plan of 2015.
Stock Options
The Corporation issues stock options to certain officers. Stock options are issued at the current market price of the Corporation's common stock on the date of grant and expire ten years from the date of grant. Stock options granted after 2012 vest ratably over a five-year period. Stock options granted prior to 2013 generally vest ratably over a three-year period.
48
Chemical Financial Corporation
Notes to Consolidated Financial Statements (Unaudited)
June 30, 2016
A summary of activity for the Corporation’s stock options as of and for the six months ended June 30, 2016 is presented below:
Non-Vested Stock Options Outstanding | Stock Options Outstanding | |||||||||||||||||
Number of Options | Weighted- Average Exercise Price Per Share | Weighted- Average Grant Date Fair Value Per Share | Number of Options | Weighted- Average Exercise Price Per Share | ||||||||||||||
Outstanding at December 31, 2015 | 479,755 | $ | 28.75 | $ | 8.49 | 1,054,739 | $ | 25.38 | ||||||||||
Granted | 441,167 | 32.81 | 6.15 | 441,167 | 32.81 | |||||||||||||
Exercised | — | — | — | (96,058 | ) | 21.81 | ||||||||||||
Vested | (118,273 | ) | 28.30 | 8.40 | — | — | ||||||||||||
Forfeited/expired | (33,901 | ) | 31.00 | 7.25 | (33,901 | ) | 31.00 | |||||||||||
Outstanding at June 30, 2016 | 768,748 | $ | 31.04 | $ | 7.21 | 1,365,947 | $ | 27.89 | ||||||||||
Exercisable/vested at June 30, 2016 | 597,199 | $ | 23.84 | |||||||||||||||
The weighted-average remaining contractual terms were 7.1 years for all outstanding stock options and 4.9 years for exercisable stock options at June 30, 2016. The intrinsic value of all outstanding in-the-money stock options and exercisable in-the-money stock options was $11.2 million and $8.1 million, respectively, at June 30, 2016. The aggregate intrinsic values of outstanding and exercisable options at June 30, 2016 were calculated based on the closing market price of the Corporation’s common stock on June 30, 2016 of $37.29 per share less the exercise price. Options with intrinsic values less than zero, or “out-of-the-money” options, are not included in the aggregate intrinsic value reported.
At June 30, 2016, unrecognized compensation expense related to stock options totaled $5.2 million and is expected to be recognized over a remaining weighted average period of 3.8 years. Stock options granted prior to 2016 contain change-of-control provisions that may get triggered if the merger with Talmer is completed. In the event the change-of control provisions are triggered, unrecognized compensation expense related to these stock options will become immediately recognized by the Corporation.
The fair value of the stock options granted during the six months ended June 30, 2016 was estimated on the date of grant using the Black-Scholes option pricing model with the following assumptions.
Expected dividend yield | 3.30 | % | |
Risk-free interest rate | 1.39 | % | |
Expected stock price volatility | 27.9 | % | |
Expected life of options – in years | 6.5 | ||
Weighted average fair value of options granted | $ | 6.15 | |
Restricted Stock Units
In addition to stock options, the Corporation grants restricted stock performance units and restricted stock service-based units (collectively referred to as restricted stock units) to certain officers. The restricted stock performance units vest based on the Corporation achieving certain performance target levels and the grantee completing the requisite service period. The restricted stock performance units are eligible to vest from 0.5x to 1.5x the number of units originally granted depending on which, if any, of the performance target levels are met. However, if the minimum performance target levels are not achieved, no shares will become vested or be issued for that respective year’s restricted stock performance units. The restricted stock service-based units vest upon satisfaction of a service condition. Upon achievement of the performance target level and/or satisfaction of a service condition, if applicable, the restricted stock units are converted into shares of the Corporation’s common stock on a one-to-one basis. Compensation expense related to restricted stock units is recognized over the expected requisite performance or service period, as applicable.
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Chemical Financial Corporation
Notes to Consolidated Financial Statements (Unaudited)
June 30, 2016
A summary of the activity for restricted stock units as of and for the six months ended June 30, 2016 is presented below:
Number of Units | Weighted- Average Grant Date Fair Value Per Unit | ||||||
Outstanding at December 31, 2015 | 207,989 | $ | 26.41 | ||||
Granted | 99,208 | 30.78 | |||||
Converted into shares of common stock | (45,787 | ) | 22.89 | ||||
Forfeited/expired | (4,126 | ) | 29.65 | ||||
Outstanding at June 30, 2016 | 257,284 | $ | 28.67 | ||||
At June 30, 2016, unrecognized compensation expense related to restricted stock units totaled $4.9 million and is expected to be recognized over a remaining weighted average period of 2.7 years. Restricted stock units granted prior to 2016 contain change-of-control provisions that may get triggered if the merger with Talmer is completed. In the event the change-of control provisions are triggered, unrecognized compensation expense related to these restricted stock units will become immediately recognized by the Corporation.
Note 12: Pension and Other Postretirement Benefit Plans
The Corporation's retirement plans include a qualified pension plan, a nonqualified pension plan, a nonqualified postretirement benefit plan, a 401(k) savings plan, and a multi-employer defined benefit plan.
Qualified and Nonqualified Pension Plans and Nonqualified Postretirement Benefit Plans
The components of net periodic benefit cost for the Corporation’s qualified and nonqualified pension plans and nonqualified postretirement benefit plan are as follows:
Three Months Ended June 30, | Six Months Ended June 30, | |||||||||||||||
2016 | 2015 | 2016 | 2015 | |||||||||||||
(In thousands) | ||||||||||||||||
Defined Benefit Pension Plans | ||||||||||||||||
Service cost | $ | 277 | $ | 273 | $ | 554 | $ | 545 | ||||||||
Interest cost | 1,358 | 1,332 | 2,716 | 2,664 | ||||||||||||
Expected return on plan assets | (2,140 | ) | (2,161 | ) | (4,281 | ) | (4,322 | ) | ||||||||
Amortization of prior service credit | — | (1 | ) | — | (2 | ) | ||||||||||
Amortization of unrecognized net loss | 572 | 1,056 | 1,144 | 2,112 | ||||||||||||
Net periodic benefit cost | $ | 67 | $ | 499 | $ | 133 | $ | 997 | ||||||||
Postretirement Benefit Plan | ||||||||||||||||
Service cost | $ | 2 | $ | 4 | $ | 4 | $ | 8 | ||||||||
Interest cost | 33 | 33 | 66 | 67 | ||||||||||||
Amortization of prior service cost | 29 | 32 | 58 | 65 | ||||||||||||
Amortization of unrecognized net gain | (25 | ) | — | (49 | ) | (1 | ) | |||||||||
Net periodic benefit cost | $ | 39 | $ | 69 | $ | 79 | $ | 139 | ||||||||
The Corporation’s pension plan does not have a contribution requirement in 2016. The Corporation did not make a contribution to the pension plan during 2015. The discount rate used to compute the Corporation's pension plan expense for 2016 is 4.55%.
401(k) Savings Plan
401(k) Savings Plan expense for the Corporation’s match of participants’ base compensation contributions and a 4% of eligible pay contribution to certain employees who are not grandfathered under the pension plan was $1.4 million and $1.3 million for the three months ended June 30, 2016 and 2015, respectively, and $2.7 million and $2.4 million for the six months ended June 30, 2016 and 2015, respectively.
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Chemical Financial Corporation
Notes to Consolidated Financial Statements (Unaudited)
June 30, 2016
Multi-Employer Defined Benefit Plan
In conjunction with the April 1, 2015 acquisition of Monarch, the Corporation acquired a participation in the Pentegra Defined Benefit Plan for Financial Institutions (Pentegra DB Plan), a qualified defined benefit pension plan. Employee benefits for Monarch employees under the Plan were frozen effective April 1, 2004. The Pentegra DB Plan operates as a multi-employer plan for accounting purposes and as a multiple-employer plan under the Employee Retirement Income Security Act of 1974 and the Internal Revenue Code (IRC). The Pentegra DB Plan is a single plan under IRC Section 413(c) and, as a result, all of the plan's assets stand behind all of the plan's liabilities. Accordingly, contributions made by a participating employer may be used to provide benefits to participants of other participating employers. No contributions were made by the Corporation to the Pentegra DB Plan for the three and six months ended June 30, 2016.
Note 13: Financial Guarantees
In the normal course of business, the Corporation is a party to financial instruments containing credit risk that are not required to be reflected in the consolidated statements of financial position. For the Corporation, these financial instruments are financial and performance standby letters of credit. The Corporation has risk management policies to identify, monitor and limit exposure to credit risk. To mitigate credit risk for these financial guarantees, the Corporation generally determines the need for specific covenant, guarantee and collateral requirements on a case-by-case basis, depending on the nature of the financial instrument and the customer’s creditworthiness. At June 30, 2016, December 31, 2015 and June 30, 2015, the Corporation had $47 million, $39 million and $45 million, respectively, of outstanding financial and performance standby letters of credit that expire in five years or less. The majority of these standby letters of credit are collateralized. The Corporation determined that there were no potential losses from standby letters of credit at June 30, 2016, December 31, 2015 and June 30, 2015.
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Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations
The following is management's discussion and analysis of certain significant factors that have affected the financial condition and results of operations of Chemical Financial Corporation ("Corporation") during the periods included in the consolidated financial statements included in this report.
Critical Accounting Policies
The Corporation's consolidated financial statements are prepared in accordance with United States generally accepted accounting principles ("GAAP"), Securities and Exchange Commission ("SEC") rules and interpretive releases and general practices within the industry in which the Corporation operates. Application of these principles requires management to make estimates, assumptions and complex judgments that affect the amounts reported in the consolidated financial statements and accompanying notes. These estimates, assumptions and judgments are based on information available as of the date of the financial statements; accordingly, as this information changes, the consolidated financial statements could reflect different estimates, assumptions and judgments. Actual results could differ significantly from those estimates. Certain policies inherently have a greater reliance on the use of estimates, assumptions and judgments and, as such, have a greater possibility of producing results that could be materially different than originally reported. Management has identified the determination of the allowance for loan losses, accounting for business combinations (including acquired loans), pension plan accounting, income and other taxes, fair value measurements and the evaluation of goodwill impairment to be the accounting areas that require the most subjective or complex judgments and, as such, could be most subject to revision as new or additional information becomes available or circumstances change, including overall changes in the economic climate and/or market interest rates. Therefore, management considers them to be critical accounting policies and discusses them directly with the Audit Committee of the board of directors. The Corporation's significant accounting policies are more fully described in Note 1 to the audited consolidated financial statements contained in the Corporation's Annual Report on Form 10-K for the year ended December 31, 2015 and the more significant assumptions and estimates made by management are more fully described in “Management's Discussion and Analysis of Financial Condition and Results of Operations - Critical Accounting Policies” in the Corporation's Annual Report on Form 10-K for the year ended December 31, 2015. There were no material changes to the Corporation's significant accounting policies or the estimates made pursuant to those policies during the most recent quarter.
Mergers, Acquisitions and Branch Closings
Pending Merger with Talmer Bancorp, Inc.
On January 25, 2016, the Corporation entered into an Agreement and Plan of Merger with Talmer Bancorp, Inc. ("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 June 30, 2016, Talmer had total assets of $6.9 billion, including total loans of $5.0 billion, and total deposits of $5.3 billion, including brokered deposits of $389 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. At a special meeting of Talmer shareholders, held on July 14, 2016, Talmer shareholders approved the merger. And at a special meeting of Chemical shareholders, held on July 19, 2016, Chemical shareholders approved the merger. Completion of the merger is subject to regulatory approval, in addition to satisfaction of other customary closing conditions.
Acquisition of Lake Michigan Financial Corporation
On May 31, 2015, the Corporation acquired all of the outstanding stock of Lake Michigan Financial Corporation ("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, owned The Bank of Holland and The Bank of Northern Michigan, which combined operated 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 during the fourth quarter of 2015. The acquisition of Lake Michigan resulted in increases in the Corporation's total assets of $1.24 billion, including total loans of $986 million, and total deposits of $925 million. In connection with the acquisition of Lake Michigan, 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.
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Acquisition of Monarch Community Bancorp, Inc.
On April 1, 2015, the Corporation acquired all of the outstanding stock of Monarch Community Bancorp, Inc. ("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 during the second quarter of 2015. The acquisition of Monarch resulted in increases in the Corporation's total assets of $183 million, including total loans of $122 million, and total deposits of $144 million. 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.
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. As of the October 31, 2014 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 and the Corporation consolidated four branches in communities where Chemical Bank and Northwestern had overlapping branches. In connection with the acquisition of Northwestern, the Corporation recorded $60 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.
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 Corporation paid a premium on deposits of $11.5 million, or approximately 2.85% of total deposits acquired, and 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, which represented the excess of the purchase price over the fair value of identifiable net assets acquired, 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 O.A.K. Financial Corporation ("OAK") and OAK's wholly-owned bank subsidiary, Byron Bank, in an all-stock transaction for total consideration of $83.7 million. Byron Bank, which was subsequently consolidated with and into Chemical Bank, provided traditional banking services and products through 14 banking offices serving communities in Ottawa, Allegan and Kent counties in west Michigan. At April 30, 2010, OAK had total assets of $820 million, including total loans of $627 million, and total deposits of $693 million, including brokered deposits of $193 million. In connection with the acquisition of OAK, the Corporation recorded goodwill of $43.5 million, which represented the synergies and economies of scale expected from combining the operations of the Corporation and OAK. In addition, the Corporation recorded other intangible assets in conjunction with the acquisition of OAK of $9.8 million.
Branch Closings
On April 15, 2016, the Corporation closed eleven branch locations which were identified as having a small core deposit base and/or were in close proximity to other Chemical Bank branch locations.
In conjunction with the consolidation of The Bank of Northern Michigan with and into Chemical Bank during the fourth quarter of 2015, the Corporation closed two branches in communities where The Bank of Northern Michigan and Chemical Bank had overlapping branches. In conjunction with the acquisition of Monarch during the second quarter of 2015, the Corporation closed two branches in communities where Monarch Community Bank and Chemical Bank had overlapping branches. In conjunction with the acquisition of Northwestern during the fourth quarter of 2014, the Corporation closed four branches in communities where Northwestern Bank and Chemical Bank had overlapping branches.
Expenses associated with the closing of the aforementioned branch office locations were not significant, with the exception of $1.0 million of fair value write-downs recognized in the second quarter of 2016 related to the eleven branch locations that were closed, as the majority of the employees of these closed branch offices were transferred to other nearby Chemical Bank branch locations or other open positions within Chemical Bank.
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Summary
The Corporation's net income was $25.7 million, or $0.67 per diluted share, in the second quarter of 2016, compared to net income of $23.3 million, or $0.60 per diluted share, in the first quarter of 2016 and net income of $19.0 million, or $0.54 per diluted share, in the second quarter of 2015. Net income in the second quarter of 2016 was 11% higher than the first quarter of 2016 due primarily to higher net interest income, which was partially offset by a higher provision for loan losses. The increase in net interest income was due to a combination of loan growth and an increase in the amount of interest accretion recognized for acquired loans resulting from improvements in expected cash flows from certain pools of acquired loans. Net income in the second quarter of 2016 was 35% higher than the second quarter of 2015 due largely to the Monarch and Lake Michigan acquisitions and strong organic loan growth over the past year. The Corporation's net income was $49.0 million, or $1.27 per diluted share, for the six months ended June 30, 2016, compared to net income of $36.9 million, or $1.08, for the six months ended June 30, 2015, with the increase due to a combination of the impact of the Monarch and Lake Michigan acquisitions and organic loan growth.
Merger and acquisition-related transaction expenses ("transaction expenses") totaled $3.1 million in the second quarter of 2016, $2.6 million in the first quarter of 2016 and $3.5 million in the second quarter of 2015. Excluding transaction expenses, net income was $27.7 million, or $0.72 per diluted share, in the second quarter of 2016, compared to $24.9 million, or $0.65 per diluted share, in the first quarter of 2016 and $21.7 million, or $0.61 per diluted share, in the second quarter of 2015. Excluding transaction expenses, the Corporation's net income was $52.6 million, or $1.37 per diluted share, for the six months ended June 30, 2016, compared to $40.4 million, or $1.18 per diluted share, for the six months ended June 30, 2015.
Return on average assets, on an annualized basis, was 1.11% in the second quarter of 2016, compared to 1.01% in the first quarter of 2016 and 0.94% in the second quarter of 2015. Return on average equity, on an annualized basis, was 10.0% in the second quarter of 2016, compared to 9.2% in the first quarter of 2016 and 8.6% in the second quarter of 2015. Excluding transaction expenses, the Corporation's return on average assets was 1.19% during the second quarter of 2016, compared to 1.09% in the first quarter of 2016 and 1.07% in the second quarter of 2015 and the Corporation's return on average shareholders' equity was 10.8% in the second quarter of 2016, compared to 9.9% in the first quarter of 2016 and 9.8% in the second quarter of 2015.
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Non-GAAP Financial Measures
This report contains references to financial measures which are not defined in GAAP. Such non-GAAP financial measures include the Corporation's tangible book value per share, tangible equity to tangible assets ratio, presentation of net interest income and net interest margin on a fully taxable equivalent (FTE) basis and information presented excluding transaction expenses, including net income, diluted earnings per share, return on average assets, return on average shareholders' equity and operating expenses. These non-GAAP financial measures have been included as the Corporation believes they are helpful for investors to analyze and evaluate the Corporation's financial performance. Limitations associated with non-GAAP financial measures include the risk that persons might disagree as to the appropriateness of items comprising these measures and that different companies might calculate these measures differently. These disclosures should not be considered an alternative to the Corporation's GAAP results.
A reconciliation of a majority of the Corporation's non-GAAP financial measures is presented below. Information related to FTE and transaction expenses can be found under the subheadings "Net Interest Income" and "Operating Expenses" of this report.
Three Months Ended | Six Months Ended | |||||||||||||||||||
June 30, 2016 | March 31, 2016 | June 30, 2015 | June 30, 2016 | June 30, 2015 | ||||||||||||||||
(Dollars in thousands, except per share data) | ||||||||||||||||||||
Non-GAAP Operating Results | ||||||||||||||||||||
Net Income | ||||||||||||||||||||
Net income, as reported | $ | 25,707 | $ | 23,262 | $ | 19,024 | $ | 48,969 | $ | 36,859 | ||||||||||
Transaction expenses, net of tax | 1,985 | 1,686 | 2,659 | 3,671 | 3,544 | |||||||||||||||
Net income, excluding transaction expenses | $ | 27,692 | $ | 24,948 | $ | 21,683 | $ | 52,640 | $ | 40,403 | ||||||||||
Diluted Earnings Per Share | ||||||||||||||||||||
Diluted earnings per share, as reported | $ | 0.67 | $ | 0.60 | $ | 0.54 | $ | 1.27 | $ | 1.08 | ||||||||||
Effect of transaction expenses, net of tax | 0.05 | 0.05 | 0.07 | 0.10 | 0.10 | |||||||||||||||
Diluted earnings per share, excluding transaction expenses | $ | 0.72 | $ | 0.65 | $ | 0.61 | $ | 1.37 | $ | 1.18 | ||||||||||
Return on Average Assets | ||||||||||||||||||||
Return on average assets, as reported | 1.11 | % | 1.01 | % | 0.94 | % | 1.06 | % | 0.96 | % | ||||||||||
Effect of transaction expenses, net of tax | 0.08 | 0.08 | 0.13 | 0.08 | 0.09 | |||||||||||||||
Return on average assets, excluding transaction expenses | 1.19 | % | 1.09 | % | 1.07 | % | 1.14 | % | 1.05 | % | ||||||||||
Return on Average Shareholders' Equity | ||||||||||||||||||||
Return on average shareholders' equity, as reported | 10.0 | % | 9.2 | % | 8.6 | % | 9.6 | % | 8.8 | % | ||||||||||
Effect of transaction expenses, net of tax | 0.8 | 0.7 | 1.2 | 0.7 | 0.9 | |||||||||||||||
Return on average shareholders' equity, excluding transaction expenses | 10.8 | % | 9.9 | % | 9.8 | % | 10.3 | % | 9.7 | % | ||||||||||
Tangible Book Value | June 30, 2016 | March 31, 2016 | December 31, 2015 | June 30, 2015 | ||||||||||||
Shareholders' equity, as reported | $ | 1,050,299 | $ | 1,032,291 | $ | 1,015,974 | $ | 981 | ||||||||
Goodwill, CDI and noncompete agreements, net of tax | (297,044 | ) | (297,821 | ) | (299,123 | ) | (299 | ) | ||||||||
Tangible shareholders' equity | $ | 753,255 | $ | 734,470 | $ | 716,851 | $ | 682 | ||||||||
Common shares outstanding | 38,267 | 38,248 | 38,168 | 38 | ||||||||||||
Book value per share (shareholders' equity, as reported, divided by common shares outstanding) | $ | 27.45 | $ | 26.99 | $ | 26.62 | $ | 25.74 | ||||||||
Tangible book value per share (tangible shareholders' equity divided by common shares outstanding) | $ | 19.68 | $ | 19.20 | $ | 18.78 | $ | 17.89 | ||||||||
Tangible Shareholders' Equity to Tangible Assets | ||||||||||||||||
Total assets | $ | 9,514,172 | $ | 9,303,632 | $ | 9,188,797 | $ | 9,021 | ||||||||
Goodwill, CDI and noncompete agreements, net of tax | (297,044 | ) | (297,821 | ) | (299,123 | ) | (299 | ) | ||||||||
Tangible assets | $ | 9,217,128 | $ | 9,005,811 | $ | 8,889,674 | $ | 8,722 | ||||||||
Tangible shareholders' equity to tangible assets | 8.2 | % | 8.2 | % | 8.1 | % | 7.8 | % | ||||||||
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Financial Condition
Total Assets
Total assets were $9.51 billion at June 30, 2016, an increase of $211 million, or 2.3%, from total assets of $9.30 billion at March 31, 2016, an increase of $325 million or 3.5% from total assets of $9.19 billion at December 31, 2015 and an increase of $493 million, or 5.5%, from total assets of $9.02 billion at June 30, 2015.
Interest-earning assets were $8.77 billion at June 30, 2016, an increase of $199 million, or 2.3%, from interest-earning assets of $8.57 billion at March 31, 2016, an increase of $347 million, or 4.1%, from interest-earning assets of $8.43 billion at December 31, 2015 and an increase of $492 million, or 5.9%, from interest-earning assets of $8.28 billion at June 30, 2015.
The increases in total assets and interest-earning assets during the three- and twelve-month periods ended June 30, 2016 were primarily due to loan growth that was largely funded by wholesale borrowings and maturing investment securities. Loan growth during the twelve months ended June 30, 2016 was also partially funded by organic growth in customer deposits.
Investment Securities
The carrying value of investment securities totaled $1.01 billion at June 30, 2016, a decrease of $21 million, or 2.0%, from investment securities of $1.03 billion at March 31, 2016, a decrease of $52 million, or 4.9%, from investment securities of $1.06 billion at December 31, 2015 and a decrease of $144 million, or 12%, from investment securities of $1.16 billion at June 30, 2015. The Corporation utilized maturing available-for-sale investment securities over the past twelve months to increase its holdings in state and political subdivisions and to partially fund loan growth. The Corporation has increased its holdings in state and political subdivisions as it has been able to identify municipal investments within its operating markets that both met its investment objectives and provided an attractive yield when compared to other investment options.
A summary of the composition of the carrying value of the Corporation's investment securities portfolio follows:
June 30, 2016 | March 31, 2016 | December 31, 2015 | June 30, 2015 | |||||||||||||
(In thousands) | ||||||||||||||||
Available-for-sale: | ||||||||||||||||
U.S. Treasury securities | $ | 5,810 | $ | 5,797 | $ | 5,765 | $ | 8,294 | ||||||||
Government sponsored agencies | 157,022 | 177,637 | 194,989 | 227,907 | ||||||||||||
State and political subdivisions | 13,220 | 15,061 | 15,120 | 26,965 | ||||||||||||
Residential mortgage-backed securities | 168,616 | 179,149 | 187,768 | 212,669 | ||||||||||||
Collateralized mortgage obligations | 100,849 | 118,398 | 132,230 | 167,032 | ||||||||||||
Corporate bonds | 9,712 | 14,708 | 14,627 | 39,678 | ||||||||||||
Preferred stock and trust preferred securities | 3,323 | 3,265 | 3,232 | 3,161 | ||||||||||||
Total available-for-sale investment securities | 458,552 | 514,015 | 553,731 | 685,706 | ||||||||||||
Held-to-maturity: | ||||||||||||||||
State and political subdivisions | 552,328 | 517,800 | 509,471 | 469,337 | ||||||||||||
Trust preferred securities | 500 | 500 | 500 | 500 | ||||||||||||
Total held-to-maturity investment securities | 552,828 | 518,300 | 509,971 | 469,837 | ||||||||||||
Total investment securities | $ | 1,011,380 | $ | 1,032,315 | $ | 1,063,702 | $ | 1,155,543 | ||||||||
At June 30, 2016, the Corporation's investment securities portfolio consisted of: U.S. Treasury securities, comprised of fixed-rate government debt obligations issued by the U.S. Department of Treasury, totaling $5.8 million; government sponsored agency (GSA) debt obligations, comprised primarily of fixed-rate instruments backed by Federal Home Loan Banks, Federal Farm Credit Banks and the Student Loan Marketing Corporation, totaling $157.0 million; state and political subdivisions debt obligations, comprised of general debt obligations of issuers primarily located in the State of Michigan and revenue bonds of certain hospitals and public schools and universities located in the State of Michigan, totaling $565.5 million; residential mortgage-backed securities (MBSs), comprised primarily of fixed-rate instruments backed by a U.S. government agency (Government National Mortgage Association) or government sponsored enterprises (Federal Home Loan Mortgage Corporation and Federal National Mortgage Association), totaling $168.6 million; collaterized mortgage obligations (CMOs), comprised of approximately 75% fixed-rate and 25% variable-rate instruments backed by the same U.S. government agency and government sponsored enterprises as the residential MBSs with average maturities of less than three years, totaling $100.8 million; corporate bonds, comprised primarily of debt obligations of large U.S. global financial organizations, totaling $9.7 million; and preferred stock and trust preferred securities
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(TRUPs), comprised of preferred stock debt instruments of two large regional/national banks and a variable-rate TRUP from a publicly-traded bank holding company included in the available-for-sale investment securities portfolio and a variable-rate TRUP from a small non-public bank holding company included in held-to-maturity investment securities portfolio, totaling $3.8 million. Fixed-rate instruments comprised approximately 90% of the Corporation's investment securities portfolio at June 30, 2016. The Corporation's investment securities portfolio as of June 30, 2016 had a weighted average life of approximately 3.3 years and an effective duration of approximately 2.0 years.
The Corporation utilizes third-party pricing services to obtain market value prices for its investment securities portfolio. On a quarterly basis, the Corporation validates the reasonableness of prices received from the third-party pricing services through independent price verification on a sample of investment securities in the portfolio, data integrity validation based upon comparison of current market prices to prior period market prices and analysis of overall expectations of movement in market prices based upon the changes in the related yield curves and other market factors. On a periodic basis, the Corporation reviews the pricing methodology of the third-party pricing vendors and the results of the vendors' internal control assessments to ensure the integrity of the process that the vendors use to develop market pricing for the Corporation's investment securities portfolio.
The Corporation's investment securities portfolio, with a carrying value of $1.01 billion at June 30, 2016, had gross unrealized losses of $1.3 million at that date. The Corporation's investment securities portfolio had gross unrealized losses of $3.5 million at March 31, 2016, $9.1 million at December 31, 2015 and $11.1 million at June 30, 2015. Management believed that the unrealized losses on investment securities at June 30, 2016 were temporary in nature and due primarily to changes in interest rates on the investment securities and market illiquidity and not as a result of credit-related issues. The improvement in the unrealized loss position of the Corporation's investment securities portfolio as of June 30, 2016 is primarily due to declines in long-term market interest rates. Accordingly, the Corporation believed the unrealized losses in its investment securities portfolio at June 30, 2016 were temporary in nature and, therefore, no impairment loss was recognized in the Corporation's consolidated statement of income for the three months ended June 30, 2016. However, other-than-temporary impairment (OTTI) may occur in the future as a result of material declines in the fair value of investment securities resulting from market, credit, economic or other conditions. A further discussion of the assessment of potential impairment and the Corporation's process that resulted in the conclusion that the unrealized loss impairment was temporary in nature follows.
At June 30, 2016, the gross unrealized losses in the Corporation's investment securities portfolio of $1.3 million were comprised as follows: GSA securities, residential MBSs and CMOs, combined, of $0.7 million; state and political subdivisions securities of $0.3 million; corporate bonds of $0.1 million; and TRUPs of $0.2 million. The amortized costs and fair values of investment securities are disclosed in Note 3 to the consolidated financial statements.
GSA securities, residential MBSs and CMOs, included in the available-for-sale investment securities portfolio, had a combined amortized cost of $424 million and gross unrealized losses of only $0.7 million at June 30, 2016. Virtually all of the impaired investment securities in these categories are backed by the full faith and credit of the U.S. government or a guarantee of a U.S. government agency or government sponsored enterprise. The Corporation determined that the unrealized losses on these investment securities were attributable to current market interest rates being higher than the yields being earned on these investment securities. The Corporation concluded that the unrealized losses attributable to its GSA securities, residential MBSs and CMOs were temporary in nature at June 30, 2016.
State and political subdivisions securities, included in the available-for-sale and the held-to-maturity investment securities portfolios, had an amortized cost of $565 million and gross unrealized losses of only $0.3 million at June 30, 2016. The Corporation's state and political subdivisions securities are almost entirely from issuers primarily located in the State of Michigan and of which approximately 80% are general obligations of the issuer, meaning that repayment of these obligations is funded by general tax collections of the issuer. It was the Corporation's assessment that the impairment on these investment securities was attributable to current market interest rates being slightly higher than the yield on these investment securities and illiquidity in the market due to the nature of a portion of these investment securities. The Corporation concluded that the unrealized losses attributable to its state and political subdivisions securities were temporary in nature at June 30, 2016.
At June 30, 2016, the Corporation held one TRUP in the held-to-maturity investment securities portfolio, with an amortized cost of $0.5 million and gross unrealized loss of $0.2 million. This TRUP represents a 10% interest in the TRUP of a non-public bank holding company in Michigan. The principal of $0.5 million of this TRUP matures in 2033, with interest payments due quarterly. All scheduled interest payments on this TRUP have been made on a timely basis. The Corporation determined that the unrealized loss on this TRUP was attributable to lack of liquidity for issuances of this size. The Corporation concluded that the unrealized loss attributable to this TRUP were temporary in nature at June 30, 2016.
At June 30, 2016, the Corporation expected to fully recover the entire amortized cost basis of each impaired investment security in its investment securities portfolio at that date. Furthermore, at June 30, 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 would not have to sell any of its impaired investment securities before a full recovery of amortized cost. However, there can be no assurance that OTTI losses will not be recognized on the TRUPs or on any other investment security in the future.
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Loans
The Corporation's loan portfolio is comprised of commercial, commercial real estate and real estate construction and land development loans, referred to as the Corporation's commercial loan portfolio, and residential mortgage, consumer installment and home equity loans, referred to as the Corporation's consumer loan portfolio. At June 30, 2016, the Corporation's loan portfolio was $7.65 billion and consisted of loans in the commercial loan portfolio totaling $4.40 billion, or 57% of total loans, and loans in the consumer loan portfolio totaling $3.25 billion, or 43% of total loans. Loans at fixed interest rates comprised 74% of the Corporation's total loan portfolio at June 30, 2016, March 31, 2016, December 31, 2015 and June 30, 2015.
Chemical Bank is a full-service commercial bank and the acceptance and management of credit risk is an integral part of the Corporation's business. 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 or any loans to finance highly leveraged transactions. The Corporation's lending philosophy is implemented through strong administrative and reporting controls. The Corporation maintains a centralized independent loan review function that monitors the approval process and ongoing asset quality of the loan portfolio.
A summary of the composition of the Corporation's loan portfolio, by major loan category, follows:
June 30, 2016 | March 31, 2016 | December 31, 2015 | June 30, 2015 | |||||||||||||
(In thousands) | ||||||||||||||||
Commercial loan portfolio: | ||||||||||||||||
Commercial | $ | 1,953,301 | $ | 1,922,259 | $ | 1,905,879 | $ | 1,754,873 | ||||||||
Commercial real estate: | ||||||||||||||||
Owner occupied | 1,149,439 | 1,126,901 | 1,073,463 | 1,050,334 | ||||||||||||
Nonowner occupied | 954,927 | 959,842 | 982,280 | 1,139,042 | ||||||||||||
Vacant land | 53,367 | 56,308 | 56,419 | 54,137 | ||||||||||||
Total commercial real estate | 2,157,733 | 2,143,051 | 2,112,162 | 2,243,513 | ||||||||||||
Real estate construction and land development | 285,848 | 242,899 | 232,076 | 112,312 | ||||||||||||
Subtotal - commercial loan portfolio | 4,396,882 | 4,308,209 | 4,250,117 | 4,110,698 | ||||||||||||
Consumer loan portfolio: | ||||||||||||||||
Residential mortgage | 1,494,192 | 1,461,120 | 1,429,636 | 1,310,167 | ||||||||||||
Consumer installment | 1,048,622 | 897,078 | 877,457 | 887,907 | ||||||||||||
Home equity | 707,573 | 700,478 | 713,937 | 725,971 | ||||||||||||
Subtotal - consumer loan portfolio | 3,250,387 | 3,058,676 | 3,021,030 | 2,924,045 | ||||||||||||
Total loans | $ | 7,647,269 | $ | 7,366,885 | $ | 7,271,147 | $ | 7,034,743 | ||||||||
Total loans were $7.65 billion at June 30, 2016, an increase of $280 million, or 3.8%, from total loans of $7.37 billion at March 31, 2016, an increase of $376 million, or 5.2%, from total loans of $7.27 billion at December 31, 2015 and an increase of $613 million, or 8.7%, from total loans of $7.03 billion at June 30, 2015. The Corporation's loan growth for the three and twelve months ended June 30, 2016, generally occurred across all loan categories and across all of the Corporation's banking markets and was attributable to a combination of improving economic conditions and higher loan demand, as well as the Corporation increasing its market share in both its commercial and consumer loan portfolios.
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A summary of the Corporation's organic loan growth follows (dollars in millions):
Second Quarter of 2016 | First Quarter of 2016 | Six Months Ended June 30, 2016 | Twelve Months Ended June 30, 2016 | |||||||||||||||||||
Organic Loan Growth | $ | % | $ | $ | $ | % | ||||||||||||||||
Commercial loan portfolio: | ||||||||||||||||||||||
Commercial | $ | 31 | 1.6 | % | $ | 16 | $ | 47 | $ | 198 | 11.3 | % | ||||||||||
Commercial real estate | 15 | 0.7 | 31 | 46 | (86 | ) | (3.8 | ) | ||||||||||||||
Real estate construction and land development | 43 | 17.7 | 11 | 54 | 174 | 154.5 | ||||||||||||||||
Subtotal | 89 | 2.1 | 58 | 147 | 286 | 7.0 | ||||||||||||||||
Consumer loan portfolio: | ||||||||||||||||||||||
Residential mortgage | $ | 33 | 2.3 | $ | 31 | $ | 64 | $ | 184 | 14.0 | ||||||||||||
Consumer installment | 151 | 16.9 | 20 | 171 | 161 | 18.1 | ||||||||||||||||
Home equity | 7 | 1.0 | (13 | ) | (6 | ) | (18 | ) | (2.5 | ) | ||||||||||||
Subtotal | 191 | 6.3 | 38 | 229 | 327 | 11.2 | ||||||||||||||||
Total loans | $ | 280 | 3.8 | % | $ | 96 | $ | 376 | $ | 613 | 8.7 | % | ||||||||||
A discussion of the Corporation’s loan portfolio by category follows.
Commercial Loan Portfolio
The Corporation's commercial loan portfolio is comprised of commercial loans, commercial real estate loans and real estate construction and land development loans. The Corporation's commercial loan portfolio is well diversified across business lines and has no concentration in any one industry. The commercial loan portfolio of $4.40 billion at June 30, 2016 included 153 loan relationships of $5.0 million or greater. These 153 loan relationships totaled $1.59 billion, which represented 36% of the commercial loan portfolio at June 30, 2016, and included 49 loan relationships that had outstanding balances of $10 million or higher, totaling $847 million, or 19% of the commercial loan portfolio, at that date. The Corporation had 13 loan relationships that had outstanding balances of $20 million or higher, totaling $339 million, or 7.7% of the commercial loan portfolio, at June 30, 2016. The Corporation had 29 loan relationships at June 30, 2016 with loan balances greater than $5.0 million and less than $10 million, totaling $240 million, that had unfunded credit commitments totaling $123 million that, if advanced, could result in a loan relationship of $10 million or more.
The Corporation had $54 million of loans to borrowers in the energy and related industries at June 30, 2016, compared to $49 million at March 31, 2016. These loans comprised approximately 1% of loans in the Corporation's commercial loan portfolio at these dates. Of the Corporation's loans in the energy and related industries, only 1% were nonperforming at both June 30, 2016 and March 31, 2016. The Corporation had another $44 million of unfunded credit commitments to borrowers in the energy and related industries at June 30, 2016.
Commercial loans consist of loans and lines of credit to varying types of businesses, including municipalities, school districts and nonprofit organizations, for the purpose of supporting working capital and operational needs and term financing of equipment. Repayment of such loans is generally provided through operating cash flows of the customer. Commercial loans are generally secured with inventory, accounts receivable, equipment, personal guarantees of the owner or other sources of repayment, although the Corporation may also obtain real estate as collateral.
Commercial loans were $1.95 billion at June 30, 2016, compared to $1.92 billion at March 31, 2016, $1.91 billion at December 31, 2015 and $1.75 billion at June 30, 2015. Commercial loans represented 25.5% of the Corporation's loan portfolio at June 30, 2016, compared to 26.1%, 26.2% and 24.9% at March 31, 2016, December 31, 2015 and June 30, 2015, respectively.
Commercial real estate loans include loans that are 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. Commercial real estate loans were $2.16 billion at June 30, 2016, compared to $2.14 billion at March 31, 2016, $2.11 billion at December 31, 2015 and $2.24 billion at June 30, 2015. Loans secured by owner occupied properties, non-owner occupied properties and vacant land comprised 53%, 44% and 3%, respectively, of the Corporation's commercial real estate loans outstanding at June 30, 2016. Commercial real estate loans represented 28.2% of the Corporation's loan portfolio at June 30, 2016, compared to 29.1%, 29.0% and 31.9% at March 31, 2016, December 31, 2015 and June 30, 2015, respectively.
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Commercial and commercial real estate lending are generally considered to involve a higher degree of risk than residential mortgage, consumer installment and home equity lending as they typically involve larger loan balances concentrated in a single borrower. In addition, the payment experience on loans secured by income-producing properties and vacant land loans is typically dependent on the success of the operation of the related project and is typically affected by adverse conditions in the real estate market and in the economy. The Corporation generally attempts to mitigate the risks associated with commercial and commercial real estate lending by, among other things, lending primarily in its market areas, lending across industry lines, not developing a concentration in any one line of business and using prudent loan-to-value ratios in the underwriting process. It is management's belief that the Corporation's commercial and commercial real estate loan portfolios are generally well-secured.
Real estate construction loans are primarily originated for construction of commercial properties and often convert to a commercial real estate loan at the completion of the construction period. Land development loans include loans made to developers for the purpose of infrastructure improvements to vacant land to create finished marketable residential and commercial lots/land. A majority of the Corporation's land development loans consist of loans to develop residential real estate. Land development loans are generally originated as interest only with the intention that the loan principal balance will be repaid through the sale of finished properties by the developers within twelve months of the completion date. Real estate construction and land development loans were $286 million at June 30, 2016, compared to $243 million at March 31, 2016, $232 million at December 31, 2015 and $112 million at June 30, 2015. The increases in real estate construction and land development loans during the three and twelve-month periods ended June 30, 2016 were almost entirely attributable to advances on new and existing commercial construction projects, representing a combination of owner and non-owner occupied commercial properties. Real estate construction and land development loans represented 3.7% of the Corporation's loan portfolio at June 30, 2016, compared to 3.3%, 3.2% and 1.6% at March 31, 2016, December 31, 2015 and June 30, 2015, respectively.
Real estate construction and land development lending involves a higher degree of risk than commercial real estate lending and residential mortgage lending because of the uncertainties of construction, including the possibility of costs exceeding the initial estimates, the need to obtain a tenant or purchaser of the property if it will not be owner-occupied or the need to sell developed properties. The Corporation generally attempts to mitigate the risks associated with real estate construction and land development lending by, among other things, lending primarily in its market areas, using prudent underwriting guidelines and closely monitoring the construction process.
Consumer Loan Portfolio
The Corporation's consumer loan portfolio is comprised of residential mortgage loans, consumer installment loans and home equity loans and lines of credit.
Residential mortgage loans consist primarily of one- to four-family residential loans with fixed interest rates of fifteen years or less, with amortization periods generally from fifteen to thirty years. The loan-to-value ratio at the time of origination is generally 80% or less. Loans with more than an 80% loan-to-value ratio generally require private mortgage insurance. At June 30, 2016, approximately two-thirds of the Corporation's residential mortgage loans had an original loan-to-value ratio of 80% or less.
Residential mortgage loans were $1.49 billion at June 30, 2016, compared to $1.46 billion at March 31, 2016, $1.43 billion at December 31, 2015 and $1.31 billion at June 30, 2015. Residential mortgage loans had historically involved the least amount of credit risk in the Corporation's loan portfolio, although the risk on these loans increased during the most recent economic downturn when the unemployment rate increased and real estate property values declined in the State of Michigan. Residential mortgage loans also include loans to consumers for the construction of single family residences that are secured by these properties. Residential mortgage construction loans to consumers were $69.1 million at June 30, 2016, compared to $60.7 million at March 31, 2016, $62.2 million at December 31, 2015 and $69.6 million at June 30, 2015. Residential mortgage loans represented 19.5% of the Corporation's loan portfolio at June 30, 2016, compared to 19.8%, 19.7% and 18.6% at March 31, 2016, December 31, 2015 and June 30, 2015, respectively. The Corporation had residential mortgage loans with maturities beyond five years and that were at fixed interest rates totaling $396 million at June 30, 2016, compared to $392 million, $379 million and $319 million at March 31, 2016, December 31, 2015 and June 30, 2015, respectively.
The Corporation's consumer installment loans consist of relatively small loan amounts to consumers to finance personal items (primarily automobiles, recreational vehicles and marine vehicles) and are comprised primarily of indirect loans purchased from dealerships. Consumer installment loans were $1.05 billion at June 30, 2016, compared to $897 million at March 31, 2016, $877 million at December 31, 2015 and $888 million at June 30, 2015. The majority of growth in consumer installment loans during the second quarter of 2016 was attributable to indirect loans. At June 30, 2016, collateral securing consumer installment loans was comprised approximately as follows: automobiles - 61%; recreational vehicles - 23%; marine vehicles - 11%; other collateral - 4%; and unsecured - 1%. Consumer installment loans represented 13.7% of the Corporation's loan portfolio at June 30, 2016, compared to 12.2%, 12.1% and 12.6% at March 31, 2016, December 31, 2015 and June 30, 2015, respectively.
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The Corporation's home equity loans, including home equity lines of credit, are comprised of loans to consumers who utilize equity in their personal residence, including junior lien mortgages, as collateral to secure the loan or line of credit. Home equity loans were $708 million at June 30, 2016, compared to $700 million at March 31, 2016, $714 million at December 31, 2015 and $726 million at June 30, 2015. At June 30, 2016, approximately 55% of the Corporation's home equity loans were first lien mortgages and 45% were junior lien mortgages. Home equity loans represented 9.3% of the Corporation's loan portfolio at June 30, 2016, compared to 9.5%, 9.8% and 10.3% at March 31, 2016, December 31, 2015 and June 30, 2015, respectively. Home equity lines of credit comprised $273 million, or 39%, of the Corporation's home equity loans at June 30, 2016, compared to $272 million, or 39%, of home equity loans at March 31, 2016, $278 million, or 39% of home equity loans at December 31, 2015 and $284 million, or 39%, of home equity loans at June 30, 2015. The majority of the Corporation's home equity lines of credit are comprised of loans with payments of interest only and original maturities of up to ten years. These home equity lines of credit include junior lien mortgages whereby the first lien mortgage is held by a nonaffiliated financial institution.
Consumer installment and home equity loans generally have shorter terms than residential mortgage loans, but generally involve more credit risk than residential mortgage lending because of the type and nature of the collateral. The Corporation experienced net loan losses totaling 17 basis points (annualized) of average consumer installment and home equity loans during the first six months of 2016, compared to 19 basis points of average consumer installment and home equity loans in all of 2015. Consumer installment and home equity loans are spread across many individual borrowers, which minimizes the risk per loan transaction. The Corporation originates consumer installment and home equity loans utilizing a computer-based credit scoring analysis to supplement the underwriting process. Consumer installment and home equity lending collections are dependent on the borrowers' continuing financial stability and are more likely to be affected by adverse personal situations. Collateral values on properties securing consumer installment and home equity loans are negatively impacted by many factors, including the physical condition of the collateral and property values, although losses on consumer installment and home equity loans are often more significantly impacted by the unemployment rate and other economic conditions. The unemployment rate in the State of Michigan was 4.6% at June 30, 2016, compared to 4.8%, 5.1% and 5.5% at March 31, 2016, December 31, 2015 and June 30, 2015, respectively, and slightly lower than the national average of 4.9% at June 30, 2016.
Nonperforming Assets
Nonperforming assets include nonperforming loans, which consist of originated loans for which the accrual of interest has been discontinued (nonaccrual loans), originated loans that are past due as to principal or interest by 90 days or more and still accruing interest and nonperforming loans that have been modified under troubled debt restructurings (TDRs). Nonperforming assets also include assets obtained through foreclosures and repossessions. The Corporation transfers an originated loan that is 90 days or more past due to nonaccrual status (except for loans that are secured by residential real estate, which are transferred at 120 days past due), unless it believes the loan is both well-secured and in the process of collection. For loans classified as nonaccrual, including those with modifications, the Corporation does not expect to receive all principal and interest payments, and therefore, any payments are recognized as principal reductions when received. Conversely, the Corporation expects to receive all principal and interest payments on loans that meet the definition of nonperforming TDR status. TDRs continue to be reported as nonperforming loans until a six-month payment history of principal and interest payments is sustained in accordance with the terms of the loan modification, at which time the loan is no longer considered a nonperforming asset and the Corporation moves the loan to a performing TDR status.
Nonperforming assets were $70.4 million at June 30, 2016, a decrease of $12.1 million, or 15%, from $82.5 million at March 31, 2016 and a decrease of $23.4 million, or 25%, from $93.8 million at December 31, 2015. The decrease in nonperforming assets during the second quarter of 2016 was primarily attributable to a reduction in nonperforming loans resulting from a combination of principal paydowns of $6.4 million, $3.9 million of loans upgraded to accruing status and net loan charge-offs. Nonperforming assets represented 0.74%, 0.89% and 1.02% of total assets at June 30, 2016, March 31, 2016 and December 31, 2015, respectively. The Corporation's nonperforming assets are not concentrated in any one industry or any one geographical area within Michigan. Management evaluates and, when appropriate, obtains new appraisals or discount appraised values of existing appraisals to compute net realizable values of nonperforming real estate secured loans and other real estate properties.
Nonperforming assets at June 30, 2016, March 31, 2016 and December 31, 2015 did not include impaired acquired loans totaling $12.5 million, $10.1 million and $12.8 million, respectively, even though these loans were not performing in accordance with their original contractual terms. Acquired loans that are not performing in accordance with contractual terms are not reported as nonperforming loans because these loans are recorded in pools at their net realizable value based on the principal and interest the Corporation expects to collect on these loan pools. Acquired loans not performing in accordance with the loan's original contractual terms are included in the Corporation's impaired loan schedule in Note 4 to the consolidated financial statements.
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The following schedule provides a summary of nonperforming assets:
June 30, 2016 | March 31, 2016 | December 31, 2015 | |||||||||
(Dollars in thousands) | |||||||||||
Nonaccrual loans: | |||||||||||
Commercial | $ | 14,577 | $ | 19,264 | $ | 28,554 | |||||
Commercial real estate | 21,325 | 25,859 | 25,163 | ||||||||
Real estate construction and land development | 496 | 546 | 521 | ||||||||
Residential mortgage | 5,343 | 5,062 | 5,557 | ||||||||
Consumer installment | 285 | 360 | 451 | ||||||||
Home equity | 1,971 | 2,328 | 1,979 | ||||||||
Total nonaccrual loans | 43,997 | 53,419 | 62,225 | ||||||||
Accruing loans contractually past due 90 days or more as to interest or principal payments: | |||||||||||
Commercial | 3 | 370 | 364 | ||||||||
Commercial real estate | 3 | — | 254 | ||||||||
Residential mortgage | 407 | 423 | 402 | ||||||||
Home equity | 1,071 | 679 | 1,267 | ||||||||
Total accruing loans contractually past due 90 days or more as to interest or principal payments | 1,484 | 1,472 | 2,287 | ||||||||
Nonperforming TDRs: | |||||||||||
Commercial loan portfolio | 14,240 | 15,351 | 16,297 | ||||||||
Consumer loan portfolio | 2,233 | 3,013 | 3,071 | ||||||||
Total nonperforming TDRs | 16,473 | 18,364 | 19,368 | ||||||||
Total nonperforming loans | 61,954 | 73,255 | 83,880 | ||||||||
Other real estate and repossessed assets(1) | 8,440 | 9,248 | 9,935 | ||||||||
Total nonperforming assets | $ | 70,394 | $ | 82,503 | $ | 93,815 | |||||
Nonperforming loans as a percent of total loans | 0.81 | % | 0.99 | % | 1.15 | % | |||||
Nonperforming assets as a percent of total assets | 0.74 | % | 0.89 | % | 1.02 | % | |||||
(1) | Includes property acquired through foreclosure and by acceptance of a deed in lieu of foreclosure and other property held-for-sale. |
The Corporation's nonaccrual loans that meet the definition of a TDR (nonaccrual TDR) totaled $32.4 million at June 30, 2016, compared to $32.5 million at March 31, 2016 and $35.9 million at December 31, 2015. These loans have been modified by providing the borrower a financial concession that is intended to improve the Corporation's probability of collection of the amounts due.
The following schedule summarizes changes in nonaccrual loans during the three and six months ended June 30, 2016 and 2015.
Three Months Ended | Six Months Ended | |||||||||||||||
June 30, | June 30, | |||||||||||||||
2016 | 2015 | 2016 | 2015 | |||||||||||||
(In thousands) | ||||||||||||||||
Balance at beginning of period | $ | 53,419 | $ | 53,440 | $ | 62,225 | $ | 50,644 | ||||||||
Additions during period | 5,467 | 8,456 | 10,740 | 19,037 | ||||||||||||
Principal balances charged off | (3,166 | ) | (2,369 | ) | (8,220 | ) | (4,771 | ) | ||||||||
Transfers to other real estate/repossessed assets | (1,455 | ) | (1,744 | ) | (2,902 | ) | (3,526 | ) | ||||||||
Returned to accrual status | (3,874 | ) | (871 | ) | (4,217 | ) | (1,497 | ) | ||||||||
Payments received | (6,394 | ) | (5,697 | ) | (13,629 | ) | (8,672 | ) | ||||||||
Balance at end of period | $ | 43,997 | $ | 51,215 | $ | 43,997 | $ | 51,215 | ||||||||
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Nonperforming Loans
The following schedule provides the composition of nonperforming loans, by major loan category, as of June 30, 2016, March 31, 2016 and December 31, 2015.
June 30, 2016 | March 31, 2016 | December 31, 2015 | |||||||||||||||||||
Amount | Percent of Total | Amount | Percent of Total | Amount | Percent of Total | ||||||||||||||||
(Dollars in thousands) | |||||||||||||||||||||
Commercial loan portfolio: | |||||||||||||||||||||
Commercial | $ | 22,380 | 36.1 | % | $ | 26,900 | 36.7 | % | $ | 33,567 | 40.0 | % | |||||||||
Commercial real estate | 27,758 | 44.8 | 33,485 | 45.7 | 36,602 | 43.6 | |||||||||||||||
Real estate construction and land development | 506 | 0.8 | 1,005 | 1.4 | 984 | 1.2 | |||||||||||||||
Subtotal-commercial loan portfolio | 50,644 | 81.7 | 61,390 | 83.8 | 71,153 | 84.8 | |||||||||||||||
Consumer loan portfolio: | |||||||||||||||||||||
Residential mortgage | 7,983 | 12.9 | 8,498 | 11.6 | 9,030 | 10.8 | |||||||||||||||
Consumer installment | 285 | 0.5 | 360 | 0.5 | 451 | 0.5 | |||||||||||||||
Home equity | 3,042 | 4.9 | 3,007 | 4.1 | 3,246 | 3.9 | |||||||||||||||
Subtotal-consumer loan portfolio | 11,310 | 18.3 | 11,865 | 16.2 | 12,727 | 15.2 | |||||||||||||||
Total nonperforming loans | $ | 61,954 | 100.0 | % | $ | 73,255 | 100.0 | % | $ | 83,880 | 100.0 | % | |||||||||
Total nonperforming loans were $62.0 million at June 30, 2016, a decrease of $11.3 million, or 15%, compared to $73.3 million at March 31, 2016 and a decrease of $21.9 million, or 26%, compared to $83.9 million at December 31, 2015. The decrease in nonperforming loans during the second quarter of 2016 was primarily attributable to a combination of principal paydowns of $6.4 million, $3.9 million of loans upgraded to accruing status and net loan charge-offs. The Corporation's nonperforming loans in the commercial loan portfolio were $50.6 million at June 30, 2016, a decrease of $10.7 million, or 18%, from $61.4 million at March 31, 2016 and a decrease of $20.5 million, or 29%, from $71.2 million at December 31, 2015. Nonperforming loans in the commercial loan portfolio comprised 82% of total nonperforming loans at June 30, 2016, compared to 84% at March 31, 2016 and 85% at December 31, 2015. The Corporation's nonperforming loans in the consumer loan portfolio were $11.3 million at June 30, 2016, a decrease of $0.6 million, or 4.7%, from $11.9 million at March 31, 2016 and a decrease of $1.4 million, or 11.1%, from $12.7 million at December 31, 2015.
Nonperforming Loans — Commercial Loan Portfolio
Nonperforming commercial loans were $22.4 million at June 30, 2016, a decrease of $4.5 million, or 17%, from $26.9 million at March 31, 2016 and a decrease of $11.2 million, or 33%, from $33.6 million at December 31, 2015. The decreases in nonperforming commercial loans was primarily attributable to a combination of principal paydowns and net loan charge-offs. At June 30, 2016, the Corporation's nonperforming commercial loans were not concentrated in any specific industry. Nonperforming commercial loans comprised 1.1% of total commercial loans at June 30, 2016, compared to 1.4% at March 31, 2016 and 1.8% at December 31, 2015.
Nonperforming commercial real estate loans were $27.8 million at June 30, 2016, a decrease of $5.7 million, or 17%, from $33.5 million at March 31, 2016 and a decrease of $8.8 million, or 24%, from $36.6 million at December 31, 2015. Nonperforming commercial real estate loans comprised 1.3% of total commercial real estate loans at June 30, 2016, compared to 1.6% at March 31, 2016 and 1.7% at December 31, 2015. Nonperforming commercial real estate loans secured by owner occupied real estate, non-owner occupied real estate and vacant land totaled $16.8 million, $5.7 million and $5.3 million, respectively, at June 30, 2016, and comprised 1.9%, 0.9% and 13.3%, respectively, of total owner occupied real estate, non-owner occupied real estate and vacant land loans included in the Corporation's originated commercial real estate loans at June 30, 2016. At June 30, 2016, the Corporation's nonperforming commercial real estate loans were comprised of a diverse mix of commercial lines of business and were also geographically disbursed throughout the Corporation's market areas. The largest concentration of nonperforming commercial real estate loans at June 30, 2016 was one customer relationship totaling $4.7 million that was primarily secured by vacant land and has been in nonperforming status for over five years. This same customer relationship had nonperforming land development loans of $0.1 million and nonperforming residential mortgage loans of $0.4 million. At June 30, 2016, the loans in this relationship were believed to be adequately secured and the Corporation did not require a specific impairment reserve on them at that date.
Nonperforming real estate construction and land development loans were $0.5 million at June 30, 2016 and $1.0 million at both March 31, 2016 and December 31, 2015. Nonperforming real estate construction and land development loans comprised 0.2% of total real estate construction and land development loans at June 30, 2016, compared to 0.4% at both March 31, 2016 and December 31, 2015.
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At June 30, 2016, the Corporation had nonperforming loans in the commercial loan portfolio of $3.5 million that were secured by real estate and were in various stages of foreclosure, compared to $4.9 million at March 31, 2016 and $2.1 million at December 31, 2015.
The following schedule presents information related to stratification of nonperforming loans in the commercial loan portfolio by dollar amount at June 30, 2016, March 31, 2016 and December 31, 2015.
June 30, 2016 | March 31, 2016 | December 31, 2015 | |||||||||||||||||||
Number of Borrowers | Amount | Number of Borrowers | Amount | Number of Borrowers | Amount | ||||||||||||||||
(Dollars in thousands) | |||||||||||||||||||||
$5,000,000 or more | — | $ | — | 1 | $ | 6,871 | 1 | $ | 10,009 | ||||||||||||
$2,500,000 – $4,999,999 | 2 | 8,069 | 1 | 4,819 | 3 | 11,622 | |||||||||||||||
$1,000,000 – $2,499,999 | 9 | 14,001 | 11 | 18,445 | 13 | 23,336 | |||||||||||||||
$500,000 – $999,999 | 17 | 12,664 | 17 | 12,448 | 12 | 8,543 | |||||||||||||||
$250,000 – $499,999 | 17 | 5,879 | 22 | 7,757 | 19 | 6,725 | |||||||||||||||
Under $250,000 | 123 | 10,031 | 132 | 11,050 | 136 | 10,918 | |||||||||||||||
Total | 168 | $ | 50,644 | 184 | $ | 61,390 | 184 | $ | 71,153 | ||||||||||||
Nonperforming Loans — Consumer Loan Portfolio
Nonperforming residential mortgage loans were $8.0 million at June 30, 2016, a decrease of $0.5 million, or 6.1%, from $8.5 million at March 31, 2016 and a decrease of $1.0 million, or 12%, from $9.0 million at December 31, 2015. Nonperforming residential mortgage loans comprised 0.5% of total residential mortgage loans at June 30, 2016, compared to 0.6% of total residential mortgage loans at both March 31, 2016 and December 31, 2015. At June 30, 2016, a total of $0.9 million of nonperforming residential mortgage loans were in various stages of foreclosure, compared to $2.3 million at March 31, 2016 and $2.9 million at December 31, 2015.
Nonperforming consumer installment loans were $0.3 million at June 30, 2016, compared to $0.4 million at March 31, 2016 and $0.5 million at December 31, 2015. Nonperforming consumer installment loans comprised less than 0.1% of total consumer installment loans at June 30, 2016, March 31, 2016 and December 31, 2015.
Nonperforming home equity loans were $3.0 million at both June 30, 2016 and March 31, 2016, compared to $3.2 million at December 31, 2015. Nonperforming home equity loans comprised 0.4% of total home equity loans at both June 30, 2016 and March 31, 2016, compared to 0.5% at December 31, 2015.
Troubled Debt Restructurings ("TDRs")
The generally unfavorable economic climate that had existed in Michigan during the most recent economic downturn resulted in a large number of both business and consumer customers experiencing cash flow issues making it difficult to maintain their loan balances in a performing status. The Corporation determined that it was probable that certain customers who were past due on their loans, if provided a modification of their loans by reducing their monthly payments, would be able to bring their loan relationships to a performing status. The Corporation believes loan modifications will potentially result in a lower level of loan losses and loan collection costs than if the Corporation proceeded immediately through the foreclosure process with these borrowers. The loan modifications involve granting concessions to borrowers who are experiencing financial difficulty and, therefore, these loans meet the criteria to be considered TDRs.
The Corporation's performing and nonperforming TDRs continue to accrue interest at the loan's original interest rate as the Corporation expects to collect the remaining principal balance on the loan. A TDR is reported as a nonperforming loan ("nonperforming TDR") until a six-month payment history of principal and interest payments is sustained in accordance with the loan modification, at which time the Corporation moves the loan to a performing status ("performing TDR"). If a performing TDR becomes contractually past due more than 30 days, it is transferred to a nonperforming status. Accordingly, all of the Corporation's performing TDRs at June 30, 2016 were current or less than 30 days past due. The Corporation's nonaccrual loans that meet the definition of a TDR do not accrue interest as the Corporation does not expect to collect the full amount of principal and interest owed from the borrower on these loans.
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The following summarizes the Corporation's TDRs at June 30, 2016, March 31, 2016 and December 31, 2015:
Performing TDRs | Nonperforming TDRs | Nonaccrual TDRs | Total | |||||||||||||||||||||
Current | Past Due 31-90 Days | Subtotal | ||||||||||||||||||||||
(In thousands) | ||||||||||||||||||||||||
June 30, 2016 | ||||||||||||||||||||||||
Commercial loan portfolio | $ | 30,866 | $ | 10,710 | $ | 3,530 | $ | 14,240 | $ | 28,979 | $ | 74,085 | ||||||||||||
Consumer loan portfolio | 18,512 | 1,729 | 504 | 2,233 | 3,402 | 24,147 | ||||||||||||||||||
Total TDRs | $ | 49,378 | $ | 12,439 | $ | 4,034 | $ | 16,473 | $ | 32,381 | $ | 98,232 | ||||||||||||
March 31, 2016 | ||||||||||||||||||||||||
Commercial loan portfolio | $ | 31,896 | $ | 14,206 | $ | 1,145 | $ | 15,351 | $ | 29,368 | $ | 76,615 | ||||||||||||
Consumer loan portfolio | 17,990 | 2,601 | 412 | 3,013 | 3,146 | 24,149 | ||||||||||||||||||
Total TDRs | $ | 49,886 | $ | 16,807 | $ | 1,557 | $ | 18,364 | $ | 32,514 | $ | 100,764 | ||||||||||||
December 31, 2015 | ||||||||||||||||||||||||
Commercial loan portfolio | $ | 29,844 | $ | 15,726 | $ | 571 | $ | 16,297 | $ | 32,682 | $ | 78,823 | ||||||||||||
Consumer loan portfolio | 17,966 | 2,719 | 352 | 3,071 | 3,251 | 24,288 | ||||||||||||||||||
Total TDRs | $ | 47,810 | $ | 18,445 | $ | 923 | $ | 19,368 | $ | 35,933 | $ | 103,111 | ||||||||||||
The Corporation's performing and nonperforming TDRs in the commercial loan portfolio generally consist of loans where the Corporation has allowed borrowers to either (i) temporarily defer scheduled principal payments and make interest-only payments for a short period of time (generally six months to one year) at the stated interest rate of the original loan agreement, (ii) lower payments due to a modification of the loan's original contractual terms, or (iii) enter into moderate extensions of the loan's original contractual maturity date. These TDRs are individually evaluated for impairment. Based on this evaluation, the Corporation does not expect to incur a loss on these TDRs based on its assessment of the borrowers' expected cash flows, as the pre- and post-modification effective yields are approximately the same for these loans. Accordingly, no additional provision for loan losses has been recognized related to these TDRs. Nonperforming TDRs that have made at least six consecutive months of principal and interest payments under a formal modification agreement are classified by the Corporation as performing TDRs. If a TDR in the commercial loan portfolio becomes 90 days past due as to principal or interest, or if it becomes probable that any remaining principal and interest payments due on the loan will not be collected in accordance with the modified contractual terms, the loan is transferred to nonaccrual TDR status.
Due to the borrowers' sustained repayment histories, the Corporation had performing TDRs in the commercial loan portfolio of $30.9 million, $31.9 million and $29.8 million at June 30, 2016, March 31, 2016 and December 31, 2015, respectively. The Corporation also had nonperforming TDRs in the commercial loan portfolio of $14.2 million, $15.4 million and $16.3 million at June 30, 2016, March 31, 2016 and December 31, 2015, respectively. The Corporation's nonperforming TDRs in the commercial loan portfolio are categorized as a risk grade 7 (substandard - accrual) under the Corporation's risk rating system, which is further described in Note 4 to the consolidated financial statements. The weighted average contractual interest rate of the Corporation's performing and nonperforming TDRs in the commercial loan portfolio was 5.60% at June 30, 2016, compared to 5.55% at March 31, 2016 and 5.57% at December 31, 2015. At June 30, 2016, the Corporation had $29.0 million of nonaccrual TDRs in the commercial loan portfolio, compared to $29.4 million and $32.7 million at March 31, 2016 and December 31, 2015, respectively.
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A summary of changes in the Corporation's performing and nonperforming TDRs in the commercial loan portfolio for the three and six months ended June 30, 2016 follows:
Three Months Ended June 30, 2016 | Six Months Ended June 30, 2016 | |||||||||||||||||||||||
Performing | Nonperforming | Total | Performing | Nonperforming | Total | |||||||||||||||||||
(In thousands) | ||||||||||||||||||||||||
Balance at beginning of period | $ | 31,896 | $ | 15,351 | $ | 47,247 | $ | 29,844 | $ | 16,297 | $ | 46,141 | ||||||||||||
Additions for modifications | — | 2,262 | 2,262 | — | 5,683 | 5,683 | ||||||||||||||||||
Transfers to performing TDR status | 1,765 | (1,765 | ) | — | 7,051 | (7,051 | ) | — | ||||||||||||||||
Transfers to nonperforming TDR status | (1,752 | ) | 1,752 | — | (3,298 | ) | 3,298 | — | ||||||||||||||||
Transfers from nonaccrual status | 585 | 337 | 922 | 585 | 385 | 970 | ||||||||||||||||||
Transfers to nonaccrual status | — | (1,426 | ) | (1,426 | ) | (1,080 | ) | (1,527 | ) | (2,607 | ) | |||||||||||||
Principal payments and pay-offs | (1,628 | ) | (2,271 | ) | (3,899 | ) | (2,236 | ) | (2,845 | ) | (5,081 | ) | ||||||||||||
Balance at end of period | $ | 30,866 | $ | 14,240 | $ | 45,106 | $ | 30,866 | $ | 14,240 | $ | 45,106 | ||||||||||||
The Corporation's TDRs in the consumer loan portfolio generally consist of loans where the Corporation has reduced a borrower's monthly payments by decreasing the interest rate charged on the loan (generally to a range of 3% to 5%) for a specified period of time (generally 24 months). Once the borrowers have made at least six consecutive months of principal and interest payments under a formal modification agreement, they are classified as performing TDRs. These loans are moved to nonaccrual TDR status if the loan becomes 90 days past due as to principal or interest, or sooner if conditions warrant.
The Corporation had performing TDRs in the consumer loan portfolio of $18.5 million at June 30, 2015, compared to $18.0 million at both March 31, 2016 and December 31, 2015. The Corporation also had nonperforming TDRs in the consumer loan portfolio of $2.2 million, $3.0 million and $3.1 million at June 30, 2016, March 31, 2016 and December 31, 2015, respectively. The weighted average contractual interest rate on the Corporation's performing and nonperforming TDRs in the consumer loan portfolio was 4.60% at June 30, 2016, compared to 4.64% at March 31, 2016 and 4.66% at December 31, 2015. At June 30, 2016, the Corporation had $3.4 million of nonaccrual TDRs in the consumer loan portfolio, compared to $3.1 million and $3.3 million, at March 31, 2016 and December 31, 2015, respectively.
The Corporation's cumulative redefault rate as of June 30, 2016 on its performing and nonperforming TDRs, which represents the percentage of these TDRs that transferred to nonaccrual status since the Corporation began such modifications in 2009, was 18% for performing and nonperforming TDRs in the commercial loan portfolio and 19% for performing and nonperforming TDRs in the consumer loan portfolio. The Corporation's cumulative redefault rate does not include loans that have been modified while in nonaccrual status that remain in nonaccrual status as the Corporation does not expect to collect the full amount of principal and interest owed from the borrower on these loans.
Other Real Estate and Repossessed Assets
Other real estate and repossessed assets are components of nonperforming assets. These include other real estate ("ORE"), comprised of residential and commercial real estate and land development properties acquired through foreclosure or by acceptance of a deed in lieu of foreclosure, and repossessed assets, comprised of other personal and commercial assets. ORE totaled $8.3 million at June 30, 2016, a decrease of $0.6 million, or 6.8%, from March 31, 2016 and a decrease of $1.4 million, or 14%, from December 31, 2015. The decrease in ORE during the first six months of 2016 was primarily attributable to the sales of ORE properties. Repossessed assets totaled $0.1 million at June 30, 2016, $0.3 million at March 31, 2016 and $0.2 million at December 31, 2015.
The following schedule provides the composition of ORE at June 30, 2016, March 31, 2016 and December 31, 2015:
June 30, 2016 | March 31, 2016 | December 31, 2015 | ||||||||||
(In thousands) | ||||||||||||
Composition of ORE: | ||||||||||||
Vacant land | $ | 2,384 | $ | 2,732 | $ | 3,036 | ||||||
Commercial real estate properties | 4,803 | 4,457 | 4,583 | |||||||||
Residential real estate properties | 1,138 | 1,742 | 2,097 | |||||||||
Total ORE | $ | 8,325 | $ | 8,931 | $ | 9,716 | ||||||
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The following schedule summarizes ORE activity during the three and six months ended June 30, 2016 and 2015.
Three Months Ended June 30, | Six Months Ended June 30, | |||||||||||||||
2016 | 2015 | 2016 | 2015 | |||||||||||||
(In thousands) | ||||||||||||||||
Balance at beginning of period | $ | 8,931 | $ | 14,482 | $ | 9,716 | $ | 13,953 | ||||||||
Additions attributable to acquisitions | — | 440 | — | 440 | ||||||||||||
Other additions | 1,217 | 1,606 | 2,155 | 4,686 | ||||||||||||
Write-downs to fair value | (63 | ) | (298 | ) | (230 | ) | (564 | ) | ||||||||
Dispositions | (1,760 | ) | (2,189 | ) | (3,316 | ) | (4,474 | ) | ||||||||
Balance at end of period | $ | 8,325 | $ | 14,041 | $ | 8,325 | $ | 14,041 | ||||||||
The Corporation's ORE is carried at the lower of cost or fair value less estimated cost to sell. The Corporation had $6.2 million in ORE at June 30, 2016 that had been held in excess of one year, of which $1.7 million had been held in excess of three years. The Corporation had $4.4 million of nonperforming loans that were in the process of foreclosure at June 30, 2016.
All of the Corporation's ORE properties have been written down to fair value through a charge-off against the allowance for loan losses at the time the loan was transferred to ORE, through a subsequent write-down, recorded as an operating expense, to recognize a further market value decline of the property after the initial transfer date, or due to recording at fair value as a result of acquisition transactions. Accordingly, at June 30, 2016, the carrying value of ORE of $8.3 million was reflective of $16.7 million in charge-offs, write-downs and acquisition-related fair value adjustments and represented 33% of the contractual loan balance remaining at the time these loans were classified as nonperforming.
During the six months ended June 30, 2016, the Corporation sold 141 ORE properties for net proceeds of $5.4 million. On an average basis, the net proceeds from these sales represented 162% of the carrying value of the property at the time of sale, with the net proceeds representing 69% of the remaining contractual loan balance at the time these loans were classified as nonperforming.
Impaired Loans
A loan is considered impaired when management determines it is probable that payment of principal and interest due will not be paid according to the original contractual terms of the loan agreement. 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. A portion of the allowance for loan losses is specifically allocated to impaired loans. The process of measuring impaired loans and the allocation of the allowance for loan losses requires judgment and estimation. The eventual outcome may differ from amounts estimated.
Impaired loans include nonaccrual loans (including nonaccrual TDRs), performing and nonperforming TDRs and acquired loans that were not performing in accordance with their original contractual terms. Impaired loans totaled $122.4 million at June 30, 2016, $131.8 million at March 31, 2016 and $142.2 million at December 31, 2015. The decrease in impaired loans during the second quarter of 2016 was primarily attributable to a combination of principal paydowns of $6.4 million on nonaccrual loans, $3.9 million of loans upgraded to accruing status and net loan charge-offs.
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A summary of impaired loans at June 30, 2016, March 31, 2016 and December 31, 2015 follows:
June 30, 2016 | March 31, 2016 | December 31, 2015 | ||||||||||
(In thousands) | ||||||||||||
Impaired loans - commercial loan portfolio: | ||||||||||||
Originated commercial loan portfolio: | ||||||||||||
Nonaccrual loans | $ | 36,398 | $ | 45,669 | $ | 54,238 | ||||||
Nonperforming TDRs | 14,240 | 15,351 | 16,297 | |||||||||
Performing TDRs | 30,866 | 31,896 | 29,844 | |||||||||
Subtotal | 81,504 | 92,916 | 100,379 | |||||||||
Acquired commercial loan portfolio | 12,538 | 10,119 | 12,795 | |||||||||
Total impaired loans - commercial loan portfolio | 94,042 | 103,035 | 113,174 | |||||||||
Impaired loans - consumer loan portfolio: | ||||||||||||
Nonaccrual loans | 7,599 | 7,750 | 7,987 | |||||||||
Nonperforming TDRs | 2,233 | 3,013 | 3,071 | |||||||||
Performing TDRs | 18,512 | 17,990 | 17,966 | |||||||||
Total impaired loans - consumer loan portfolio | 28,344 | 28,753 | 29,024 | |||||||||
Total impaired loans | $ | 122,386 | $ | 131,788 | $ | 142,198 | ||||||
The following schedule summarizes impaired loans to commercial borrowers and the related valuation allowance at June 30, 2016, March 31, 2016 and December 31, 2015 and partial loan charge-offs (confirmed losses) taken on these impaired loans:
Amount | Valuation Allowance | Confirmed Losses | Cumulative Inherent Loss Percentage | ||||||||||||
(Dollars in thousands) | |||||||||||||||
June 30, 2016 | |||||||||||||||
Impaired loans – originated commercial loan portfolio: | |||||||||||||||
With valuation allowance and no charge-offs | $ | 6,794 | $ | 3,009 | $ | — | 44 | % | |||||||
With valuation allowance and charge-offs | 240 | 45 | 173 | 53 | |||||||||||
With charge-offs and no valuation allowance | 16,621 | — | 16,212 | 49 | |||||||||||
Without valuation allowance or charge-offs | 57,849 | — | — | — | |||||||||||
Total | 81,504 | $ | 3,054 | $ | 16,385 | 20 | % | ||||||||
Impaired acquired loans | 12,538 | ||||||||||||||
Total impaired loans to commercial borrowers | $ | 94,042 | |||||||||||||
March 31, 2016 | |||||||||||||||
Impaired loans – originated commercial loan portfolio: | |||||||||||||||
With valuation allowance and no charge-offs | $ | 8,059 | $ | 2,619 | $ | — | 32 | % | |||||||
With valuation allowance and charge-offs | 443 | 117 | 463 | 64 | |||||||||||
With charge-offs and no valuation allowance | 22,275 | — | 19,470 | 47 | |||||||||||
Without valuation allowance or charge-offs | 62,139 | — | — | — | |||||||||||
Total | 92,916 | $ | 2,736 | $ | 19,933 | 20 | % | ||||||||
Impaired acquired loans | 10,119 | ||||||||||||||
Total impaired loans to commercial borrowers | $ | 103,035 | |||||||||||||
December 31, 2015 | |||||||||||||||
Impaired loans – originated commercial loan portfolio: | |||||||||||||||
With valuation allowance and no charge-offs | $ | 20,635 | $ | 6,019 | $ | — | 29 | % | |||||||
With valuation allowance and charge-offs | 2,711 | 178 | 768 | 27 | |||||||||||
With charge-offs and no valuation allowance | 18,718 | — | 16,373 | 47 | |||||||||||
Without valuation allowance or charge-offs | 58,315 | — | — | — | |||||||||||
Total | 100,379 | $ | 6,197 | $ | 17,141 | 20 | % | ||||||||
Impaired acquired loans | 12,795 | ||||||||||||||
Total impaired loans to commercial borrowers | $ | 113,174 | |||||||||||||
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After analyzing the various components of the customer relationships and evaluating the underlying collateral of impaired loans, the Corporation determined that impaired loans in the commercial loan portfolio totaling $7.0 million at June 30, 2016 required a specific allocation of the allowance for loan losses ("valuation allowance") of $3.1 million, compared to $8.5 million of impaired loans in the commercial loan portfolio at March 31, 2016 which required a valuation allowance of $2.7 million and $23.3 million of impaired loans in the commercial loan portfolio at December 31, 2015 which required a valuation allowance of $6.2 million. Confirmed losses represent partial loan charge-offs on impaired loans due primarily to the receipt of a recent third-party property appraisal indicating the value of the collateral securing the loan was below the loan balance and management determined that full collection of the loan balance is not likely. The Corporation's performing and nonperforming TDRs in the commercial loan portfolio did not require a valuation allowance as the Corporation expected to collect the full principal and interest owed on each of these loans in accordance with their modified terms.
The Corporation generally does not recognize a valuation allowance for impaired loans in the consumer loan portfolio as these loans are comprised of smaller-balance homogeneous loans that are collectively evaluated for impairment. However, the Corporation had a valuation allowance attributable to TDRs in the consumer loan portfolio of $0.2 million at June 30, 2016, March 31, 2016 and December 31, 2015 related to the reduction in the present value of expected future cash flows for these loans discounted at their original effective interest rates.
Impaired loans included acquired loans totaling $12.5 million, $10.1 million and $12.8 million at June 30, 2016, March 31, 2016 and December 31, 2015, respectively, that were not performing in accordance with the original contractual terms of the loans. These loans did not require a valuation allowance as they are recorded in pools at their net realizable value based on the principal and interest the Corporation expects to collect on these loan pools. These loans are not included in the Corporation's nonperforming loans.
Allowance for Loan Losses
The allowance for loan losses ("allowance") provides for probable losses in the originated loan portfolio that have been identified with specific customer relationships and for probable losses believed to be inherent in the remainder of the originated loan portfolio but that have not been specifically identified. The allowance is comprised of specific valuation allowances (assessed for originated loans that have known credit weaknesses), pooled allowances based on assigned risk ratings and historical loan loss experience for each loan type, and a qualitative allowance based on environmental factors that take into consideration risks inherent in the originated loan portfolio that differ from historical loan loss experience. Management evaluates the allowance on a quarterly basis in an effort to ensure the level is adequate to absorb probable losses inherent in the loan portfolio. This evaluation process is inherently subjective as it requires estimates that may be susceptible to significant change and has the potential to affect net income materially. The Corporation's methodology for measuring the adequacy of the allowance is comprised of several key elements, which include a review of the loan portfolio, both individually and by category, and consideration of changes in the mix and volume of the loan portfolio, actual delinquency and loan loss experience, review of collateral values, the size and financial condition of the borrowers, industry and geographical exposures within the portfolio, economic conditions and employment levels of the Corporation's local markets and other factors affecting business sectors. Management believes that the allowance is currently maintained at an appropriate level, considering the inherent risk in the loan portfolio. Future significant adjustments to the allowance may be necessary due to changes in economic conditions, delinquencies or the level of loan losses incurred.
The following schedule summarizes information related to the Corporation's allowance for loan losses:
June 30, 2016 | March 31, 2016 | December 31, 2015 | ||||||||||
(Dollars in thousands) | ||||||||||||
Allowance for loan losses: | ||||||||||||
Originated loans | $ | 71,506 | $ | 70,318 | $ | 73,328 | ||||||
Acquired loans | — | — | — | |||||||||
Total | $ | 71,506 | $ | 70,318 | $ | 73,328 | ||||||
Nonperforming loans | $ | 61,954 | $ | 73,255 | $ | 83,880 | ||||||
Allowance for originated loans as a percent of: | ||||||||||||
Total originated loans | 1.12 | % | 1.17 | % | 1.26 | % | ||||||
Nonperforming loans | 115 | % | 96 | % | 87 | % | ||||||
Nonperforming loans, less impaired originated loans for which the expected loss has been charged-off | 158 | % | 138 | % | 113 | % | ||||||
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The following schedule summarizes activity related to the Corporation's allowance for loan losses:
Three Months Ended | Six Months Ended | |||||||||||||||||||
June 30, 2016 | March 31, 2016 | June 30, 2015 | June 30, 2016 | June 30, 2015 | ||||||||||||||||
(Dollars in thousands) | ||||||||||||||||||||
Allowance for loan losses - beginning of period | $ | 70,318 | $ | 73,328 | $ | 75,256 | $ | 73,328 | $ | 75,683 | ||||||||||
Provision for loan losses | 3,000 | 1,500 | 1,500 | 4,500 | 3,000 | |||||||||||||||
Loan charge-offs: | ||||||||||||||||||||
Commercial | (1,682 | ) | (3,336 | ) | (188 | ) | (5,018 | ) | (819 | ) | ||||||||||
Commercial real estate | (860 | ) | (549 | ) | (678 | ) | (1,409 | ) | (1,460 | ) | ||||||||||
Real estate construction and land development | — | (11 | ) | (49 | ) | (11 | ) | (140 | ) | |||||||||||
Residential mortgage | (80 | ) | (349 | ) | (790 | ) | (429 | ) | (1,329 | ) | ||||||||||
Consumer installment | (911 | ) | (996 | ) | (971 | ) | (1,907 | ) | (1,974 | ) | ||||||||||
Home equity | (87 | ) | (217 | ) | (48 | ) | (304 | ) | (145 | ) | ||||||||||
Total loan charge-offs | (3,620 | ) | (5,458 | ) | (2,724 | ) | (9,078 | ) | (5,867 | ) | ||||||||||
Recoveries of loans previously charged off: | ||||||||||||||||||||
Commercial | 529 | 221 | 152 | 750 | 359 | |||||||||||||||
Commercial real estate | 673 | 109 | 97 | 782 | 464 | |||||||||||||||
Real estate construction and land development | — | — | — | — | — | |||||||||||||||
Residential mortgage | 88 | 177 | 129 | 265 | 176 | |||||||||||||||
Consumer installment | 425 | 394 | 381 | 819 | 735 | |||||||||||||||
Home equity | 93 | 47 | 150 | 140 | 391 | |||||||||||||||
Total loan recoveries | 1,808 | 948 | 909 | 2,756 | 2,125 | |||||||||||||||
Net loan charge-offs | (1,812 | ) | (4,510 | ) | (1,815 | ) | (6,322 | ) | (3,742 | ) | ||||||||||
Allowance for loan losses - end of period | $ | 71,506 | $ | 70,318 | $ | 74,941 | $ | 71,506 | $ | 74,941 | ||||||||||
Net loan charge-offs as a percent of average loans (annualized) | 0.10 | % | 0.25 | % | 0.12 | % | 0.17 | % | 0.13 | % | ||||||||||
The allowance of the acquired loan portfolio was not carried over on the date of acquisition. The acquired loans were recorded at their estimated fair values at the date of acquisition, with the estimated fair values including a component for expected credit losses. Acquired loans are subsequently evaluated for further credit deterioration in loan pools, which consist of loans with similar credit risk characteristics. If an acquired loan pool experiences a decrease in expected cash flows, as compared to those expected at the acquisition date, a provision for loan losses and corresponding allowance is recorded for acquired loans. There was no allowance needed for the acquired loan portfolio at June 30, 2016, March 31, 2016 and June 30, 2015.
Deposits
Total deposits were $7.46 billion at June 30, 2016, a decrease of $185 million, or 2.4%, from total deposits of $7.65 billion at March 31, 2016, an increase of $8 million from total deposits of $7.46 billion at December 31, 2015 and an increase of $172 million, or 2.4%, from total deposits of $7.29 billion at June 30, 2015. The decrease in total deposits during the second quarter of 2016 was primarily attributable to a decrease in seasonal municipal deposit accounts. The increase in total deposits for the twelve-month period ended June 30, 2016 was attributable to $268 million of organic growth in customer deposit accounts, which was partially offset by a decrease of $96 million related to maturing brokered deposits that were acquired in the Lake Michigan transaction. The organic growth in customer deposit accounts over the last twelve months included an increase of $357 million in interest- and noninterest-bearing demand deposit and savings accounts that was partially offset by a decline of $89 million in certificate of deposit accounts.
It is the Corporation's strategy to develop customer relationships that will drive core deposit growth and stability. The Corporation's competitive position within many of its market areas has historically limited its ability to materially increase core deposits without adversely impacting the weighted average cost of the deposit portfolio. While competition for core deposits remained strong throughout the Corporation's markets during the twelve months ended June 30, 2016, the Corporation's efforts to expand its deposit relationships with existing customers, the Corporation's financial strength and a general trend in customers holding more liquid assets have resulted in the Corporation continuing to experience increases in customer deposits.
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At June 30, 2016, the Corporation's time deposits, which consist of certificates of deposit, totaled $1.56 billion, of which $523 million have stated maturities during the remainder of 2016. The Corporation expects the majority of these maturing time deposits to be renewed by customers. The following schedule summarizes the scheduled maturities of the Corporation's time deposits as of June 30, 2016:
Maturity Schedule | Amount | Weighted Average Interest Rate | |||||
(Dollars in thousands) | |||||||
2016 maturities: | |||||||
Third quarter | $ | 327,833 | 0.40 | % | |||
Fourth quarter | 195,386 | 0.57 | |||||
2016 remaining maturities | 523,219 | 0.46 | |||||
2017 maturities | 588,902 | 0.83 | |||||
2018 maturities | 192,282 | 1.06 | |||||
2019 maturities | 101,045 | 1.41 | |||||
2020 maturities | 98,041 | 1.60 | |||||
2021 maturities and beyond | 56,539 | 1.64 | |||||
Total time deposits | $ | 1,560,028 | 0.85 | % | |||
Included in the above maturity schedule are brokered deposits that were acquired as part of the Lake Michigan transaction totaling $173 million at June 30, 2016 that mature as follows: $29 million in 2016; $68 million in 2017; $40 million in 2018; $24 million in 2019; $10 million in 2020; and $2 million in 2021 and beyond.
Borrowed Funds
Borrowed funds consist of securities sold under agreements to repurchase with customers, short-term borrowings and long-term borrowings. Short-term borrowings, which generally have an original term to maturity of 30 days or less, consist of short-term Federal Home Loan Bank ("FHLB") advances and federal funds purchased which are utilized by the Corporation to fund short-term liquidity needs. Long-term borrowings consist of securities sold under agreements to repurchase with an unaffiliated third-party financial institution, long-term FHLB advances, a non-revolving line-of-credit, and subordinated debt obligations.
Securities Sold Under Agreements to Repurchase with Customers
Securities sold under agreements to repurchase with customers represent funds deposited by customers that are collateralized by investment securities owned by Chemical Bank, as these deposits are not covered by Federal Deposit Insurance Corporation (FDIC) insurance. These funds have been a stable source of liquidity for Chemical Bank, much like its core deposit base, and are generally only provided to customers that have an established banking relationship with Chemical Bank. The Corporation's securities sold under agreements to repurchase with customers do not qualify as sales for accounting purposes. Securities sold under agreements to repurchase with customers were $256 million at June 30, 2016, compared to $283 million at March 31, 2016, $297 million at December 31, 2015 and $305 million at June 30, 2015.
Short-term Borrowings
Short-term borrowings were $300 million at June 30, 2016, $100 million at December 31, 2015 and $227 million at June 30, 2015. There were no short-term borrowings outstanding at March 31, 2016. The increase in short-term borrowings during the second quarter of 2016 was attributable to the Corporation's liquidity needs to replace the decrease in seasonal municipal deposit accounts and to partially fund loan growth.
FHLB advances are borrowings from the Federal Home Loan Bank of Indianapolis that are generally used to fund loans and are secured by both a blanket security agreement of residential mortgage first lien and other real estate loans with an aggregate book value equal to at least 140% of the advances and FHLB capital stock owned by Chemical Bank. The carrying value of loans eligible as collateral under the blanket security agreement was $2.98 billion at June 30, 2016. The Corporation relies on short-term FHLB advances to cover short-term liquidity needs.
Federal funds purchased represent unsecured borrowings from nonaffiliated third-party financial institutions, generally on an overnight basis, to cover short-term liquidity needs.
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Long-term Borrowings
Long-term borrowings were $372 million at June 30, 2016, $274 million at March 31, 2016, $242 million at December 31, 2015 and $148 million at June 30, 2015.
A summary of the composition of the Corporation's long-term borrowings follows:
June 30, 2016 | March 31, 2016 | December 31, 2015 | June 30, 2015 | |||||||||||||
(In thousands) | ||||||||||||||||
Long-term borrowings: | ||||||||||||||||
Long-term FHLB advances | $ | 329,320 | $ | 231,357 | $ | 181,394 | $ | 81,469 | ||||||||
Securities sold under agreements to repurchase | 17,277 | 17,365 | 17,453 | 23,649 | ||||||||||||
Non-revolving line-of-credit | 25,000 | 25,000 | 25,000 | 25,000 | ||||||||||||
Subordinated debt obligations | — | — | 18,544 | 18,372 | ||||||||||||
Total long-term borrowings | $ | 371,597 | $ | 273,722 | $ | 242,391 | $ | 148,490 | ||||||||
During the second quarter of 2016, the Corporation borrowed $100 million of long-term FHLB advances which have a three-year term at a fixed-rate of 1.00%. During the first quarter of 2016, the Corporation borrowed $50 million of long-term FHLB advances which have a four-year term at a fixed-rate of 1.30%. The Corporation borrowed these FHLB advances to fund liquidity needs primarily resulting from loan growth.
Securities sold under agreements to repurchase with an unaffiliated third-party financial institution represent financing arrangements that are secured by available-for-sale investment securities. These borrowings were obtained as part of the Lake Michigan acquisition. The Corporation intends to pay off these borrowings as they mature, with remaining contractual maturities totaling $8.1 million in 2016 and $9.2 million in 2017.
The Corporation has a $25 million secured non-revolving line-of-credit with an unaffiliated third-party financial institution. The line-of-credit originally matured in May 2016 and was extended for a period of three months. The Corporation drew on the entire amount of the line-of-credit in order to partially fund the cash portion of the purchase price consideration for the Lake Michigan transaction. This line-of-credit bears a variable rate of interest which is based on the one-, two- or three-month LIBOR, as periodically selected by the Corporation, plus a fixed stated rate.
As a result of the Lake Michigan transaction on May 31, 2015, the Corporation acquired subordinated debt obligations in the amount of $18.6 million. The Corporation repaid these debt obligations during the first quarter of 2016.
Credit-Related Commitments
The Corporation has credit-related commitments that may impact its liquidity. The following schedule summarizes the Corporation's credit-related commitments and expected expiration dates by period as of June 30, 2016. Because many of these commitments historically have expired without being drawn upon, the total amount of these commitments does not necessarily represent future liquidity requirements of the Corporation.
Less than 1 year | 1-3 years | 3-5 years | More than 5 years | Total | ||||||||||||||||
(In thousands) | ||||||||||||||||||||
Unused commitments to extend credit: | ||||||||||||||||||||
Loans to commercial borrowers | $ | 754,172 | $ | 221,893 | $ | 73,583 | $ | 168,111 | $ | 1,217,759 | ||||||||||
Loans to consumer borrowers | 213,993 | 141,429 | 119,489 | 14,502 | 489,413 | |||||||||||||||
Total unused commitments to extend credit | 968,165 | 363,322 | 193,072 | 182,613 | 1,707,172 | |||||||||||||||
Undisbursed loan commitments | 442,973 | — | — | — | 442,973 | |||||||||||||||
Standby letters of credit | 35,790 | 5,622 | 1,503 | 3,593 | 46,508 | |||||||||||||||
Total credit-related commitments | $ | 1,446,928 | $ | 368,944 | $ | 194,575 | $ | 186,206 | $ | 2,196,653 | ||||||||||
Undisbursed loan commitments at June 30, 2016 included $47 million of residential mortgage loans that were expected to be sold in the secondary market.
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Capital
Total shareholders' equity was $1.05 billion at June 30, 2016, compared to $1.03 billion at March 31, 2016, $1.02 billion at December 31, 2015 and $981 million at June 30, 2015. Total shareholders' equity as a percentage of total assets was 11.0% at June 30, 2016, compared to 11.1% at both March 31, 2016 and December 31, 2015, and 10.9% at June 30, 2015. The Corporation's tangible equity, which is defined as total shareholders' equity less goodwill and other acquired intangible assets, totaled $753 million, $734 million, $717 million, and $681 million at June 30, 2016, March 31, 2016, December 31, 2015 and June 30, 2015, respectively. The Corporation's tangible equity to assets ratio was 8.2% at June 30, 2016, compared to 8.2% at March 31, 2016, 8.1% at December 31, 2015 and 7.8% at June 30, 2015.
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.
Regulatory Capital
In July 2013, the Federal Reserve Board and FDIC approved final rules implementing the Basel Committee on Banking Supervision's ("BCBS") capital guidelines for U.S. banks (commonly referred to as "Basel III"). Beginning January 1, 2015, the Basel III capital rules include a new minimum common equity Tier 1 capital to risk-weighted assets ("CET Tier 1") ratio of 4.5%, in addition to raising the minimum ratio of Tier 1 capital to risk-weighted assets from 4.0% to 6.0% and requiring a minimum leverage ratio of 4.0%. The Basel III capital rules also establish a new capital conservation buffer of 2.5% of risk-weighted assets, which is phased-in over a four-year period beginning January 1, 2016.
The Corporation and Chemical Bank continue to maintain strong capital positions, which significantly exceeded the minimum capital adequacy levels prescribed by the Board of Governors of the Federal Reserve System (Federal Reserve) at June 30, 2016, as shown in the following schedule:
June 30, 2016 | ||||||||||||
Leverage Ratio | Risk-Based Capital Ratios | |||||||||||
CET Tier 1 | Tier 1 | Total | ||||||||||
Actual Capital Ratios: | ||||||||||||
Chemical Financial Corporation | 8.6 | % | 10.4 | % | 10.4 | % | 11.4 | % | ||||
Chemical Bank | 8.7 | 10.5 | 10.5 | 11.4 | ||||||||
Minimum required for capital adequacy purposes | 4.0 | 4.5 | 6.0 | 8.0 | ||||||||
Minimum required for “well-capitalized” capital adequacy purposes | 5.0 | 6.5 | 8.0 | 10.0 | ||||||||
The Corporation's and Chemical Bank's capital ratios exceeded the minimum levels required to be well capitalized as defined by applicable regulatory requirements as of June 30, 2016. See Note 8 to the consolidated financial statements for more information regarding the Corporation's and Chemical Bank's regulatory capital ratios.
Results of Operations
Net Interest Income
Net interest income is the difference between interest income on earning assets, such as loans, investment and non-marketable equity securities and interest-bearing deposits with the Federal Reserve Bank (FRB) and other banks, and interest expense on liabilities, such as deposits and borrowings. Net interest income, on a fully taxable equivalent (FTE) basis, is the difference between interest income and interest expense adjusted for the tax benefit received on tax-exempt commercial loans and investment securities. Net interest margin is calculated by dividing net interest income (FTE) by average interest-earning assets, annualized as applicable. Net interest spread is the difference between the average yield on interest-earning assets and the average cost of interest-bearing liabilities. Because noninterest-bearing sources of funds, or free funds (principally demand deposits and shareholders' equity), also support earning assets, the net interest margin exceeds the net interest spread.
Net interest income (FTE) was $79.6 million in the second quarter of 2016, compared to $76.5 million in the first quarter of 2016 and $67.5 million in the second quarter of 2015. Net interest income (FTE) was $156.1 million for the six months ended June 30, 2016, compared to $128.3 million for the six months ended June 30, 2015. The presentation of net interest income on an FTE basis is not in accordance with GAAP but is customary in the banking industry. This non-GAAP measure ensures comparability
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of net interest income arising from both taxable and tax-exempt loans and investment securities. The adjustments to determine net interest income (FTE) were $2.1 million, $2.1 million and $1.8 million for each of the three-month periods ended June 30, 2016, March 31, 2016 and June 30, 2015, respectively, and $4.3 million and $3.4 million for the six-month periods ended June 30, 2016 and June 30, 2015, respectively. These adjustments were computed using a 35% federal income tax rate.
Average Balances, Fully Tax Equivalent (FTE) Interest and Effective Yields and Rates*
The following schedule presents the average daily balances of the Corporation's major categories of assets and liabilities, interest income and expense on an FTE basis, average interest rates earned and paid on the assets and liabilities, net interest income (FTE), net interest spread and net interest margin for the three months ended June 30, 2016, March 31, 2016 and June 30, 2015.
Three Months Ended | |||||||||||||||||||||||||||||||||
June 30, 2016 | March 31, 2016 | June 30, 2015 | |||||||||||||||||||||||||||||||
Average Balance | Interest (FTE) | Effective Yield/ Rate* | Average Balance | Interest (FTE) | Effective Yield/ Rate* | Average Balance | Interest (FTE) | Effective Yield/ Rate* | |||||||||||||||||||||||||
ASSETS | (Dollars in Thousands) | ||||||||||||||||||||||||||||||||
Interest-Earning Assets: | |||||||||||||||||||||||||||||||||
Loans** | |||||||||||||||||||||||||||||||||
Commercial | $ | 1,940,197 | $ | 20,711 | 4.29 | % | $ | 1,901,879 | $ | 19,774 | 4.18 | % | $ | 1,516,520 | $ | 16,176 | 4.28 | % | |||||||||||||||
Commercial real estate and real estate construction | 2,419,187 | 30,035 | 4.99 | 2,361,105 | 28,254 | 4.81 | 1,979,578 | 24,034 | 4.87 | ||||||||||||||||||||||||
Residential mortgage | 1,485,267 | 13,805 | 3.72 | 1,453,420 | 13,588 | 3.74 | 1,220,291 | 11,872 | 3.89 | ||||||||||||||||||||||||
Consumer installment and home equity | 1,666,541 | 13,744 | 3.32 | 1,583,067 | 13,483 | 3.43 | 1,556,425 | 13,145 | 3.39 | ||||||||||||||||||||||||
Total loans** | 7,511,192 | 78,295 | 4.19 | 7,299,471 | 75,099 | 4.13 | 6,272,814 | 65,227 | 4.17 | ||||||||||||||||||||||||
Taxable investment securities | 515,303 | 1,798 | 1.40 | 554,524 | 1,929 | 1.39 | 698,521 | 2,202 | 1.26 | ||||||||||||||||||||||||
Tax-exempt investment securities | 484,271 | 4,061 | 3.35 | 496,304 | 4,100 | 3.30 | 396,295 | 3,361 | 3.39 | ||||||||||||||||||||||||
Other interest-earning assets | 43,615 | 777 | 7.16 | 39,493 | 256 | 2.61 | 34,269 | 551 | 6.45 | ||||||||||||||||||||||||
Interest-bearing deposits with the FRB and other banks | 82,246 | 144 | 0.70 | 136,919 | 213 | 0.63 | 132,834 | 128 | 0.39 | ||||||||||||||||||||||||
Total interest-earning assets | 8,636,627 | 85,075 | 3.96 | 8,526,711 | 81,597 | 3.84 | 7,534,733 | 71,469 | 3.80 | ||||||||||||||||||||||||
Less: Allowance for loan losses | 71,790 | 73,547 | 75,079 | ||||||||||||||||||||||||||||||
Other Assets: | |||||||||||||||||||||||||||||||||
Cash and cash due from banks | 148,034 | 158,277 | 148,950 | ||||||||||||||||||||||||||||||
Premises and equipment | 104,488 | 105,959 | 103,907 | ||||||||||||||||||||||||||||||
Interest receivable and other assets | 515,039 | 523,634 | 404,627 | ||||||||||||||||||||||||||||||
Total Assets | $ | 9,332,398 | $ | 9,241,034 | $ | 8,117,138 | |||||||||||||||||||||||||||
LIABILITIES AND SHAREHOLDERS' EQUITY | |||||||||||||||||||||||||||||||||
Interest-Bearing Liabilities: | |||||||||||||||||||||||||||||||||
Interest-bearing demand deposits | $ | 1,892,512 | $ | 582 | 0.12 | % | $ | 1,953,626 | $ | 468 | 0.10 | % | $ | 1,539,348 | $ | 291 | 0.08 | % | |||||||||||||||
Savings deposits | 2,073,412 | 476 | 0.09 | 2,048,867 | 389 | 0.08 | 1,951,477 | 360 | 0.07 | ||||||||||||||||||||||||
Time deposits | 1,582,467 | 3,202 | 0.81 | 1,625,573 | 3,202 | 0.79 | 1,490,753 | 2,979 | 0.80 | ||||||||||||||||||||||||
Short-term borrowings | 418,232 | 226 | 0.22 | 349,699 | 100 | 0.12 | 398,197 | 101 | 0.10 | ||||||||||||||||||||||||
Long-term borrowings | 281,327 | 956 | 1.37 | 266,022 | 975 | 1.47 | 62,901 | 213 | 1.36 | ||||||||||||||||||||||||
Total interest-bearing liabilities | 6,247,950 | 5,442 | 0.35 | 6,243,787 | 5,134 | 0.33 | 5,442,676 | 3,944 | 0.29 | ||||||||||||||||||||||||
Noninterest-bearing deposits | 1,979,423 | — | — | 1,906,896 | — | — | 1,727,850 | — | — | ||||||||||||||||||||||||
Total deposits and borrowed funds | 8,227,373 | 5,442 | 0.27 | 8,150,683 | 5,134 | 0.25 | 7,170,526 | 3,944 | 0.22 | ||||||||||||||||||||||||
Interest payable and other liabilities | 72,011 | 72,422 | 61,749 | ||||||||||||||||||||||||||||||
Shareholders’ equity | 1,033,014 | 1,017,929 | 884,863 | ||||||||||||||||||||||||||||||
Total Liabilities and Shareholders’ Equity | $ | 9,332,398 | $ | 9,241,034 | $ | 8,117,138 | |||||||||||||||||||||||||||
Net Interest Spread (average yield earned minus average rate paid) | 3.61 | % | 3.51 | % | 3.51 | % | |||||||||||||||||||||||||||
Net Interest Income (FTE) | $ | 79,633 | $ | 76,463 | $ | 67,525 | |||||||||||||||||||||||||||
Net Interest Margin (Net Interest Income (FTE) divided by total average interest-earning assets) | 3.70 | % | 3.60 | % | 3.59 | % | |||||||||||||||||||||||||||
* Fully taxable equivalent (FTE) basis using a federal income tax rate of 35%. | |||||||||||||||||||||||||||||||||
** Nonaccrual loans and loans held-for-sale are included in average balances reported and are included in the calculation of yields. Also, tax equivalent interest includes net loan fees. | |||||||||||||||||||||||||||||||||
74
The following schedule presents the average daily balances of the Corporation's major categories of assets and liabilities, interest income and expense on an FTE basis, average interest rates earned and paid on the assets and liabilities, net interest income (FTE), net interest spread and net interest margin for the six months ended June 30, 2016 and June 30, 2015.
Six Months Ended | ||||||||||||||||||||||
June 30, 2016 | June 30, 2015 | |||||||||||||||||||||
Average Balance | Interest (FTE) | Effective Yield/ Rate* | Average Balance | Interest (FTE) | Effective Yield/ Rate* | |||||||||||||||||
ASSETS | (Dollars in Thousands) | |||||||||||||||||||||
Interest-Earning Assets: | ||||||||||||||||||||||
Loans** | ||||||||||||||||||||||
Commercial | $ | 1,921,038 | $ | 40,485 | 4.24 | % | $ | 1,435,204 | $ | 30,332 | 4.26 | % | ||||||||||
Commercial real estate and real estate construction | 2,390,146 | 58,289 | 4.90 | 1,855,943 | 44,887 | 4.88 | ||||||||||||||||
Residential mortgage | 1,469,344 | 27,393 | 3.73 | 1,172,014 | 22,853 | 3.90 | ||||||||||||||||
Consumer installment and home equity | 1,624,804 | 27,227 | 3.37 | 1,527,838 | 25,815 | 3.41 | ||||||||||||||||
Total loans** | 7,405,332 | 153,394 | 4.16 | 5,990,999 | 123,887 | 4.16 | ||||||||||||||||
Taxable investment securities | 534,914 | 3,727 | 1.39 | 716,606 | 4,509 | 1.26 | ||||||||||||||||
Tax-exempt investment securities | 490,287 | 8,161 | 3.33 | 364,264 | 6,293 | 3.46 | ||||||||||||||||
Other interest-earning assets | 41,554 | 1,033 | 5.00 | 31,867 | 749 | 4.74 | ||||||||||||||||
Interest-bearing deposits with the FRB and other banks | 109,582 | 357 | 0.66 | 125,694 | 250 | 0.40 | ||||||||||||||||
Total interest-earning assets | 8,581,669 | 166,672 | 3.90 | 7,229,430 | 135,688 | 3.78 | ||||||||||||||||
Less: Allowance for loan losses | 72,669 | 75,477 | ||||||||||||||||||||
Other Assets: | ||||||||||||||||||||||
Cash and cash due from banks | 153,156 | 143,658 | ||||||||||||||||||||
Premises and equipment | 105,223 | 100,525 | ||||||||||||||||||||
Interest receivable and other assets | 519,337 | 363,040 | ||||||||||||||||||||
Total Assets | $ | 9,286,716 | $ | 7,761,176 | ||||||||||||||||||
LIABILITIES AND SHAREHOLDERS' EQUITY | ||||||||||||||||||||||
Interest-Bearing Liabilities: | ||||||||||||||||||||||
Interest-bearing demand deposits | $ | 1,923,068 | $ | 1,050 | 0.11 | % | $ | 1,523,240 | $ | 615 | 0.08 | % | ||||||||||
Savings deposits | 2,061,141 | 865 | 0.08 | 1,864,891 | 730 | 0.08 | ||||||||||||||||
Time deposits | 1,604,020 | 6,404 | 0.80 | 1,412,162 | 5,637 | 0.80 | ||||||||||||||||
Short-term borrowings | 383,966 | 326 | 0.17 | 370,317 | 199 | 0.11 | ||||||||||||||||
Long-term borrowings | 273,675 | 1,931 | 1.42 | 31,624 | 213 | 1.36 | ||||||||||||||||
Total interest-bearing liabilities | 6,245,870 | 10,576 | 0.34 | 5,202,234 | 7,394 | 0.29 | ||||||||||||||||
Noninterest-bearing deposits | 1,943,159 | — | — | 1,657,864 | — | — | ||||||||||||||||
Total deposits and borrowed funds | 8,189,029 | 10,576 | 0.26 | 6,860,098 | 7,394 | 0.22 | ||||||||||||||||
Interest payable and other liabilities | 72,216 | 57,697 | ||||||||||||||||||||
Shareholders’ equity | 1,025,471 | 843,381 | ||||||||||||||||||||
Total Liabilities and Shareholders’ Equity | $ | 9,286,716 | $ | 7,761,176 | ||||||||||||||||||
Net Interest Spread (average yield earned minus average rate paid) | 3.56 | % | 3.49 | % | ||||||||||||||||||
Net Interest Income (FTE) | $ | 156,096 | $ | 128,294 | ||||||||||||||||||
Net Interest Margin (Net Interest Income (FTE) divided by total average interest-earning assets) | 3.65 | % | 3.57 | % | ||||||||||||||||||
* Fully taxable equivalent (FTE) basis using a federal income tax rate of 35%. | ||||||||||||||||||||||
** Nonaccrual loans and loans held-for-sale are included in average balances reported and are included in the calculation of yields. Also, tax equivalent interest includes net loan fees. | ||||||||||||||||||||||
75
Net interest income (FTE) of $79.6 million in the second quarter of 2016 was $3.2 million, or 4.1%, higher than net interest income (FTE) of $76.5 million in the first quarter of 2016. The increase in net interest income in the second quarter of 2016, compared to the first quarter of 2016, was primarily attributable to loan growth in the second quarter of 2016 and an increase in the amount of interest accretion recognized on acquired loans resulting from improvements in expected cash flows from certain pools of acquired loans. During the second quarter of 2016, the Corporation transferred $10 million of nonaccretable discount to accretable yield due to lower expected losses on loans acquired in both the 2010 acquisition of OAK and the 2014 acquisition of Northwestern. The Corporation's net interest income included $2.5 million of interest accretion on acquired loans in the second quarter of 2016, compared to $0.7 million in the first quarter of 2016. The net interest margin was 3.70% in the second quarter of 2016, compared to 3.60% in the first quarter of 2016. Interest accretion on acquired loans contributed 11 basis points to the Corporation's net interest margin in the second quarter of 2016, compared to 3 basis points in the first quarter of 2016. The average yield on interest-earning assets was 3.96% in the second quarter of 2016, compared to 3.84% in the first quarter of 2016. The average yield on loans increased 6 basis points to 4.19% in the second quarter of 2016 from 4.13% in the first quarter of 2016. Interest accretion on acquired loans comprised 13 basis points of the yield on the Corporation's loan portfolio in the second quarter of 2016, compared to 4 basis points in the first quarter of 2016. The average cost of funds was 0.27% in the second quarter of 2016, compared to 0.25% in the first quarter of 2016.
Net interest income (FTE) of $79.6 million in the second quarter of 2016 was $12.1 million, or 18%, higher than net interest income (FTE) of $67.5 million in the second quarter of 2015, with the increase primarily attributable to the positive impact of organic loan growth and the impact of the Corporation's acquisitions of Monarch and Lake Michigan. The net interest margin was 3.70% in the second quarter of 2016, compared to 3.59% in the second quarter of 2015. Interest accretion on acquired loans contributed 11 basis points to the Corporation's net interest margin in the second quarter of 2016, compared to 4 basis points in the second quarter of 2015. The average yield on interest-earning assets was 3.96% in the second quarter of 2016, compared to 3.80% in the second quarter of 2015. The average yield on loans increased 2 basis points to 4.19% in the second quarter of 2016 from 4.17% in the second quarter of 2015. Interest accretion on acquired loans contributed 13 basis points to the Corporation's loan portfolio in the second quarter of 2016, compared to 5 basis points in the second quarter of 2015. The average cost of funds was 0.27% in the second quarter of 2016, compared to 0.22% in the second quarter of 2015.
Net interest income (FTE) of $156.1 million for the six months ended June 30, 2016 was $27.8 million, or 22%, higher than net interest income (FTE) of $128.3 million for the six months ended June 30, 2015, with the increase primarily attributable to the positive impact of organic loan growth and the impact of the Corporation's acquisitions of Monarch and Lake Michigan. The net interest margin was 3.65% for the six months ended June 30, 2016, compared to 3.57% for the six months ended June 30, 2015.
Changes in the Corporation's net interest income are influenced by a variety of factors, including changes in the level and mix of interest-earning assets and interest-bearing liabilities, current and prior years' interest rate changes, the level and direction of interest rates, the difference between short-term and long-term interest rates (the steepness of the yield curve) and the general strength of the economies in the Corporation's markets. Risk management plays an important role in the Corporation's level of net interest income. The ineffective management of credit risk, and more significantly interest rate risk, can adversely impact the Corporation's net interest income. Management monitors the Corporation's consolidated statement of financial position to reduce the potential adverse impact on net interest income caused by significant changes in interest rates. The Corporation's policies in this regard are further discussed under the subheading “Market Risk.”
The Federal Reserve influences the general market rates of interest, including the deposit and loan rates offered by many financial institutions. The prime interest rate, which is the rate offered on loans to borrowers with strong credit, was 3.25% at the end of 2008 and remained at this historically low rate until December 2015, when it was increased to 3.50%. The prime interest rate has historically been 300 basis points higher than the federal funds rate. The majority of the Corporation's variable interest rate loans in the commercial loan portfolio are tied to the prime rate.
The Corporation is primarily funded by core deposits, which is a lower-cost funding base than wholesale funding and historically has had a positive impact on the Corporation's net interest income and net interest margin. The Corporation anticipates that the loan portfolio will grow at a higher rate than its core deposits, and therefore, expects wholesale funding to provide a portion of its funding base on an ongoing basis in the future. Based on the current historically low level of market interest rates and the Corporation's current low levels of interest rates on its core deposit transaction accounts, further market interest rate reductions would likely not result in a significant decrease in interest expense.
76
Volume and Rate Variance Analysis
The following schedules allocate the dollar change in net interest income (FTE) between the portion attributable to changes in the average volume of interest-earning assets and interest-bearing liabilities, including changes in the mix of assets and liabilities, and changes in average interest rates earned and paid, for the three months ended June 30, 2016, compared to the three months ended March 31, 2016 and June 30, 2015, and for the six months ended June 30, 2016, compared to the six months ended June 30, 2015.
Three Months Ended June 30, 2016 | ||||||||||||||||||||||||
Compared to Three Months Ended March 31, 2016 | Compared to Three Months Ended June 30, 2015 | |||||||||||||||||||||||
Increase (Decrease) Due to Changes in | Increase (Decrease) Due to Changes in | |||||||||||||||||||||||
Average Volume** | Average Yield/Rate** | Combined Increase/ (Decrease) | Average Volume** | Average Yield/Rate** | Combined Increase/ (Decrease) | |||||||||||||||||||
(In Thousands) | ||||||||||||||||||||||||
Changes in Interest Income on Interest-Earning Assets: | ||||||||||||||||||||||||
Loans | $ | 2,097 | $ | 1,099 | $ | 3,196 | $ | 13,283 | $ | (215 | ) | $ | 13,068 | |||||||||||
Taxable investment securities/other assets | (101 | ) | 491 | 390 | (460 | ) | 282 | (178 | ) | |||||||||||||||
Tax-exempt investment securities | (101 | ) | 62 | (39 | ) | 741 | (41 | ) | 700 | |||||||||||||||
Interest-bearing deposits with the FRB and other banks | (91 | ) | 22 | (69 | ) | (61 | ) | 77 | 16 | |||||||||||||||
Total change in interest income on interest-earning assets | 1,804 | 1,674 | 3,478 | 13,503 | 103 | 13,606 | ||||||||||||||||||
Changes in Interest Expense on Interest-Bearing Liabilities: | ||||||||||||||||||||||||
Interest-bearing demand deposits | (24 | ) | 138 | 114 | 76 | 215 | 291 | |||||||||||||||||
Savings deposits | 3 | 84 | 87 | 7 | 109 | 116 | ||||||||||||||||||
Time deposits | (81 | ) | 81 | — | 218 | 5 | 223 | |||||||||||||||||
Short-term borrowings | 100 | 26 | 126 | 70 | 44 | 114 | ||||||||||||||||||
Long-term borrowings | 38 | (57 | ) | (19 | ) | 703 | 51 | 754 | ||||||||||||||||
Total change in interest expense on interest-bearing liabilities | 36 | 272 | 308 | 1,074 | 424 | 1,498 | ||||||||||||||||||
Total Change in Net Interest Income (FTE)* | $ | 1,768 | $ | 1,402 | $ | 3,170 | $ | 12,429 | $ | (321 | ) | $ | 12,108 | |||||||||||
* Taxable equivalent basis using a federal income tax rate of 35%. | ||||||||||||||||||||||||
** The change in interest income and interest expense due to both volume and rate has been allocated to the volume and rate changes in proportion to the relationship of the absolute dollar amounts of the change in each. | ||||||||||||||||||||||||
Six Months Ended June 30, 2016 Compared to Six Months Ended June 30, 2015 | ||||||||||||
Increase (Decrease) Due to Changes in | Combined Increase/ (Decrease) | |||||||||||
Average Volume** | Average Yield/Rate** | |||||||||||
(In Thousands) | ||||||||||||
Changes in Interest Income on Interest-Earning Assets: | ||||||||||||
Loans | $ | 30,956 | $ | (1,449 | ) | $ | 29,507 | |||||
Taxable investment securities/other assets | (1,007 | ) | 509 | (498 | ) | |||||||
Tax-exempt investment securities | 2,116 | (248 | ) | 1,868 | ||||||||
Interest-bearing deposits with the FRB and other banks | (36 | ) | 143 | 107 | ||||||||
Total change in interest income on interest-earning assets | 32,029 | (1,045 | ) | 30,984 | ||||||||
Changes in Interest Expense on Interest-Bearing Liabilities: | ||||||||||||
Interest-bearing demand deposits | 172 | 263 | 435 | |||||||||
Savings deposits | 66 | 69 | 135 | |||||||||
Time deposits | 861 | (94 | ) | 767 | ||||||||
Short-term borrowings | 94 | 22 | 116 | |||||||||
Long-term borrowings | 1,655 | 74 | 1,729 | |||||||||
Total change in interest expense on interest-bearing liabilities | 2,848 | 334 | 3,182 | |||||||||
Total Change in Net Interest Income (FTE)* | $ | 29,181 | $ | (1,379 | ) | $ | 27,802 | |||||
* Taxable equivalent basis using a federal income tax rate of 35%. | ||||||||||||
** The change in interest income and interest expense due to both volume and rate has been allocated to the volume and rate changes in proportion to the relationship of the absolute dollar amounts of the change in each. | ||||||||||||
77
Provision for Loan Losses
The provision for loan losses ("provision") is an increase to the allowance, as determined by management, to provide for probable losses inherent in the originated loan portfolio and for impairment in pools of acquired loans that results from the Corporation experiencing a decrease, if any, in expected cash flows of acquired loans during each reporting period. The provision was $3.0 million in the second quarter of 2016, compared to $1.5 million in both the first quarter of 2016 and the second quarter of 2015. The increase in the provision for loan losses in the second quarter of 2016 was due to loan growth, with loans in the Corporation's originated loan portfolio up $377 million during the second quarter of 2016.
The Corporation experienced net loan charge-offs of $1.8 million in the second quarter of 2016, compared to $4.5 million in the first quarter of 2016 and $1.8 million in the second quarter of 2015. Net loan charge-offs as a percentage of average loans (annualized) were 0.10% in the second quarter of 2016, compared to 0.25% in the first quarter of 2016 and 0.12% in the second quarter of 2015. Net loan charge-offs in the commercial loan portfolio totaled $1.3 million in the second quarter of 2016, compared to net loan charge-offs of $3.6 million in the first quarter of 2016 and net loan charge-offs of $0.7 million in the second quarter of 2015 and represented 74% of total net loan charge-offs during the second quarter of 2016, compared to 79% during the first quarter of 2016 and 37% during the second quarter of 2015. Net loan charge-offs in the second quarter of 2016 and the first quarter of 2016 included $1.0 million and $2.9 million, respectively, from one commercial loan relationship. Net loan charge-offs in the consumer loan portfolio totaled $0.5 million in the second quarter of 2016, compared to $0.9 million in the first quarter of 2016 and $1.1 million in the second quarter of 2015.
The Corporation's provision and net loan charge-offs were $4.5 million and $6.3 million, respectively, for the six months ended June 30, 2016, compared to $3.0 million and $3.7 million, respectively, for the six months ended June 30, 2015.
Noninterest Income
The following summarizes the major components of noninterest income:
Three Months Ended | Six Months Ended | |||||||||||||||||||
June 30, 2016 | March 31, 2016 | June 30, 2015 | June 30, 2016 | June 30, 2015 | ||||||||||||||||
(In thousands) | ||||||||||||||||||||
Service charges and fees on deposit accounts | $ | 6,337 | $ | 5,720 | $ | 6,445 | $ | 12,057 | $ | 12,361 | ||||||||||
Wealth management revenue | 5,782 | 5,201 | 5,605 | 10,983 | 10,676 | |||||||||||||||
Electronic banking fees | 4,786 | 4,918 | 4,775 | 9,704 | 9,347 | |||||||||||||||
Mortgage banking revenue | 1,595 | 1,405 | 1,688 | 3,000 | 3,091 | |||||||||||||||
Other fees for customer services | 1,191 | 1,131 | 1,132 | 2,322 | 2,033 | |||||||||||||||
Title insurance commissions | 486 | 343 | 609 | 829 | 1,126 | |||||||||||||||
Gain on sale of investment securities | 18 | 19 | 28 | 37 | 607 | |||||||||||||||
Bank-owned life insurance | 237 | 196 | 153 | 433 | 236 | |||||||||||||||
Rental income | 153 | 137 | 112 | 290 | 237 | |||||||||||||||
Gain on sale of closed branch offices and other assets | 105 | 157 | 19 | 262 | 19 | |||||||||||||||
Other | 207 | 192 | 108 | 399 | 216 | |||||||||||||||
Total noninterest income | $ | 20,897 | $ | 19,419 | $ | 20,674 | $ | 40,316 | $ | 39,949 | ||||||||||
Noninterest income was $20.9 million in the second quarter of 2016, compared to $19.4 million in the first quarter of 2016 and $20.7 million in the second quarter of 2015. Noninterest income in the second quarter of 2016 was $1.5 million, or 7.6%, higher than the first quarter of 2016, with the increase primarily attributable to higher seasonal overdraft fees and wealth management revenue.
Service charges and fees on deposit accounts, which include overdraft/non-sufficient funds fees, checking account service fees and other deposit account charges, were $6.3 million in the second quarter of 2016, an increase of $0.6 million, or 11%, from the first quarter of 2016 and a decrease of $0.1 million, or 1.7%, from the second quarter of 2015. The increase in service charges and fees on deposit accounts in the second quarter of 2016, compared to the first quarter of 2016, was due primarily to higher seasonal overdraft fees. Overdraft/non-sufficient funds fees included in service charges and fees on deposit accounts were $4.7 million in both the second quarter of 2016 and the second quarter of 2015, compared to $4.2 million in the first quarter of 2016.
78
Wealth management revenue is comprised of investment fees that are generally based on the market value of assets within a trust account, custodial account fees and fees from the sale of investment products. Volatility in the equity and bond markets impacts the market value of trust assets and related investment fees. Wealth management revenue was $5.8 million in the second quarter of 2016, an increase of $0.6 million over the first quarter of 2016 and an increase of $0.2 million over the second quarter of 2015. The increase in wealth management revenue in the second quarter of 2016 over the first quarter of 2016 was primarily attributable to seasonal trust fees earned from the preparation of trust tax returns. Wealth management revenue includes fees from the sale of investment products offered through the Chemical Financial Advisors program. Fees from this program totaled $1.1 million in the second quarter of 2016, compared to $1.2 million in the first quarter of 2016 and $1.0 million in the second quarter of 2015.
Electronic banking fees, which represent income earned by the Corporation from ATM transactions, debit card activity and internet banking fees, were $4.8 million in the second quarter of 2016, a decrease of $0.1 million from the first quarter of 2016 and unchanged compared to the second quarter of 2015.
Mortgage banking revenue ("MBR") includes revenue from originating, selling and servicing residential mortgage loans for the secondary market, net of direct expenses associated with these activities, including mortgage loan originator compensation, amortization of mortgage servicing rights and adjustments to the Corporation's reserve for probable losses related to loans previously sold in the secondary market. MBR was $1.6 million in the second quarter of 2016, an increase of $0.2 million over the first quarter of 2016 and a decrease of $0.1 million compared to the second quarter of 2015. The increase in MBR in the second quarter of 2016, compared to the first quarter of 2016, was largely due to higher gains resulting from an increase in the volume of loans sold in the secondary market, which was partially offset by a $0.4 million impairment of the Corporation's mortgage servicing asset resulting from recent declines in market interest rates. The decrease in MBR in the second quarter of 2016, compared to the second quarter of 2015, was due to the impairment charge, which was partially offset by higher gains resulting from an increase in the volume of loans sold in the secondary market. The Corporation sold $72 million of residential mortgage loans in the secondary market in the second quarter of 2016, compared to $45 million in the first quarter of 2016 and $64 million in the second quarter of 2015.
The Corporation sells residential mortgage loans in the secondary market on both a servicing retained and servicing released basis. These sales include the Corporation entering into residential mortgage loan sale agreements with buyers in the normal course of business. The agreements contain provisions that include various representations and warranties regarding the origination, characteristics and underwriting of the mortgage loans. The recourse of the buyer may result in either indemnification of any loss incurred by the buyer or a requirement for the Corporation to repurchase a loan that the buyer believes does not comply with the representations included in the loan sale agreement. Repurchase and loss indemnification demands received by the Corporation are reviewed by a senior officer on a loan-by-loan basis to validate the claim made by the buyer. The Corporation maintains a reserve for probable losses expected to be incurred from loans previously sold in the secondary market. This contingent liability is based on trends in repurchase and indemnification demands, actual loss experience, information requests, known and inherent risks in the sale of loans in the secondary market and current economic conditions. The Corporation records losses resulting from the repurchase of loans previously sold in the secondary market, as well as adjustments to estimates of future probable losses, as part of its MBR in the period incurred. The Corporation's reserve for probable losses was $3.8 million at both June 30, 2016 and March 31, 2016, compared to $4.5 million at June 30, 2015.
Noninterest income was $40.3 million for the six months ended June 30, 2016, compared to $39.9 million for the six months ended June 30, 2015, with the increase largely attributable to incremental revenue resulting from the impact of the Monarch and Lake Michigan acquisitions being mostly offset by lower gains from the sales of investment securities.
79
Operating Expenses
The following summarizes the major categories of operating expenses:
Three Months Ended | Six Months Ended | |||||||||||||||||||
June 30, 2016 | March 31, 2016 | June 30, 2015 | June 30, 2016 | June 30, 2015 | ||||||||||||||||
(In thousands) | ||||||||||||||||||||
Salaries and wages | $ | 26,887 | $ | 26,743 | $ | 25,535 | $ | 53,630 | $ | 49,276 | ||||||||||
Employee benefits | 6,240 | 7,147 | 6,176 | 13,387 | 11,688 | |||||||||||||||
Occupancy | 5,514 | 4,905 | 4,386 | 10,419 | 8,812 | |||||||||||||||
Equipment and software | 4,875 | 4,404 | 4,480 | 9,279 | 8,878 | |||||||||||||||
Outside processing and service fees | 4,833 | 3,711 | 3,926 | 8,544 | 7,484 | |||||||||||||||
FDIC insurance premiums | 1,338 | 1,407 | 1,337 | 2,745 | 2,562 | |||||||||||||||
Professional fees | 1,020 | 1,036 | 1,258 | 2,056 | 2,495 | |||||||||||||||
Intangible asset amortization | 1,195 | 1,194 | 987 | 2,389 | 1,778 | |||||||||||||||
Advertising and marketing | 793 | 766 | 856 | 1,559 | 1,519 | |||||||||||||||
Postage and express mail | 866 | 984 | 876 | 1,850 | 1,732 | |||||||||||||||
Training, travel and other employee expenses | 870 | 797 | 760 | 1,667 | 1,488 | |||||||||||||||
Telephone | 614 | 730 | 606 | 1,344 | 1,146 | |||||||||||||||
Supplies | 631 | 480 | 525 | 1,111 | 1,044 | |||||||||||||||
Donations | 379 | 611 | 568 | 990 | 876 | |||||||||||||||
Credit-related expenses | (1,331 | ) | 30 | (192 | ) | (1,301 | ) | (59 | ) | |||||||||||
Transaction expenses | 3,054 | 2,594 | 3,457 | 5,648 | 4,819 | |||||||||||||||
Other | 1,307 | 1,348 | 1,244 | 2,655 | 2,267 | |||||||||||||||
Total operating expenses | $ | 59,085 | $ | 58,887 | $ | 56,785 | $ | 117,972 | $ | 107,805 | ||||||||||
Operating expenses were $59.1 million in the second quarter of 2016, compared to $58.9 million in the first quarter of 2016 and $56.8 million in the second quarter of 2015. Operating expenses included transaction expenses of $3.1 million in the second quarter of 2016 and $2.6 million in the first quarter of 2016 primarily related to professional fees incurred to facilitate the pending Talmer merger, while operating expenses included transaction expenses of $3.5 million in the second quarter of 2015 related to professional fees and outside processing and service fees, including conversion and integration costs, associated with completing the Monarch and Lake Michigan acquisitions. Excluding these transaction expenses, operating expenses in the second quarter of 2016 were $56.0 million, a decrease of $0.3 million from operating expenses of $56.3 million in the first quarter of 2016 and an increase of $2.7 million, or 5.1%, over operating expenses of $53.3 million in the second quarter of 2015. The decrease in operating expenses in the second quarter of 2016, compared to the first quarter of 2016, was primarily attributable to lower payroll tax expenses, which are highest in the first quarter of the year, and a reduction in credit-related expenses, while the increase in the second quarter of 2016, compared to the second quarter of 2015, was primarily attributable to incremental operating costs associated with the Lake Michigan and Monarch transactions.
Salaries and wages of $26.9 million in the second quarter of 2016 were virtually unchanged compared to the first quarter of 2016. Salaries and wages in the second quarter of 2016 increased $1.4 million, or 5.3%, over the second quarter of 2015 due primarily to incremental costs associated with the Lake Michigan and Monarch transactions and merit and inflationary salary adjustments that took effect at the beginning of 2016. Performance-based compensation expense was $2.8 million in the second quarter of 2016, compared to $2.5 million in the first quarter of 2016 and $2.6 million in the second quarter of 2015.
Employee benefit costs of $6.2 million in the second quarter of 2016 decreased $0.9 million, or 13%, from the first quarter of 2016 due to a $0.7 million reduction in payroll tax expenses and group health costs being $0.2 million lower. Employee benefit costs were up slightly in the second quarter of 2016, compared to the second quarter of 2015, with higher group health costs being partially offset by lower pension expense. The Corporation's pension expense was lower in the second quarter of 2016, compared to the second quarter of 2015, due to an increase in the discount rate used to measure the present value of expected future benefit obligations and changes in retirement age assumptions for employees.
Occupancy expenses of $5.5 million in the second quarter of 2016 increased $0.6 million, or 12%, over the first quarter of 2016 and $1.1 million, or 26%, over the second quarter of 2015 due primarily to $1.0 million of fair value write-downs recognized in the second quarter of 2016 related to eleven branch locations that were closed during the quarter.
80
Equipment and software expenses of $4.9 million in the second quarter of 2016 were $0.5 million higher than the first quarter of 2016, and $0.4 million higher than the second quarter of 2015 due in part to upgrades in equipment and software in advance of the pending Talmer merger.
Outside processing and service fees of $4.8 million in the second quarter of 2016 were $1.1 million higher than the first quarter of 2016 and $0.9 million higher than the second quarter of 2015 due largely to increases in project costs, many of which have been accelerated to complete them before the pending Talmer merger.
Credit-related expenses are comprised of other real estate ("ORE") net costs and loan collection costs. ORE net costs are comprised of costs to carry ORE, such as property taxes, insurance and maintenance costs, fair value write-downs after a property is transferred to ORE and net gains/losses from the disposition of ORE. Loan collection costs include legal fees, appraisal fees and other costs recognized in the collection of loans with deteriorated credit quality and in the process of foreclosure. Credit-related expenses in the second quarter of 2016 were $1.4 million lower than the first quarter of 2016 and $1.1 million lower than the second quarter of 2015. The decrease in credit-related expenses in the second quarter of 2016, compared to the first quarter of 2016, was primarily attributable to higher gains from the sale of ORE properties and a $0.7 million gain resulting from the receipt of life insurance proceeds on a policy the Corporation had previously obtained as collateral on a loan. In addition to the $0.7 million gain, the decrease in credit-related expenses in the second quarter of 2016, compared to the second quarter of 2015, was primarily attributable to lower ORE writedowns and operating costs. The Corporation recognized net gains from the sales/writedowns of ORE properties of $1.3 million in the second quarter of 2016, compared to $0.6 million in the first quarter of 2016 and $1.0 million in the second quarter of 2015. ORE operating costs and loan collection costs, combined, were $0.6 million in both the second quarter of 2016 and the first quarter of 2016, compared to $0.8 million in the second quarter of 2015.
Operating expenses were $118.0 million for the six months ended June 30, 2016, compared to $107.8 million for the six months ended June 30, 2015, with the increase largely attributable to incremental costs resulting from the impact of the Monarch and Lake Michigan acquisitions being partially offset by lower credit-related expenses resulting from an increase in the amount of gains recognized on other real estate and repossessed assets.
Income Tax Expense
The Corporation records its federal income tax expense using its estimate of the effective income tax rate expected for the full year and applies that rate on a year-to-date basis. The fluctuations in the Corporation's effective federal income tax rate reflect changes each period in the proportion of interest income exempt from federal taxation, nondeductible interest expense and other nondeductible expenses relative to pretax income and tax credits.
The differences between the provision for federal income taxes computed at the federal statutory income tax rate and the amounts recorded in the consolidated financial statements were as follows:
Three Months Ended | Six Months Ended | |||||||||||||||||||
June 30, 2016 | March 31, 2016 | June 30, 2015 | June 30, 2016 | June 30, 2015 | ||||||||||||||||
(Dollars in thousands) | ||||||||||||||||||||
Tax at statutory rate | $ | 12,707 | $ | 11,677 | $ | 9,843 | $ | 24,384 | $ | 18,921 | ||||||||||
Changes resulting from: | ||||||||||||||||||||
Tax-exempt interest income | (1,130 | ) | (1,131 | ) | (940 | ) | (2,261 | ) | (1,776 | ) | ||||||||||
Income tax credits, net | (665 | ) | (634 | ) | (512 | ) | (1,299 | ) | (861 | ) | ||||||||||
Other, net | (312 | ) | 188 | 709 | (124 | ) | 916 | |||||||||||||
Provision for federal income taxes | $ | 10,600 | $ | 10,100 | $ | 9,100 | $ | 20,700 | $ | 17,200 | ||||||||||
Effective federal income tax rate | 29.2 | % | 30.3 | % | 32.4 | % | 29.7 | % | 31.8 | % | ||||||||||
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Liquidity
Liquidity measures the ability of the Corporation to meet current and future cash flow needs in a timely manner. Liquidity risk is the adverse impact on net interest income if the Corporation was unable to meet its cash flow needs at a reasonable cost.
Liquidity is managed to ensure stable, reliable and cost-effective sources of funds are available to satisfy deposit withdrawals and lending and investment opportunities. The ability of a financial institution to meet its current financial obligations is a function of its balance sheet structure, its ability to liquidate assets and its access to alternative sources of funds. The Corporation manages its funding needs by maintaining a level of liquid funds through its asset/liability management process. The Corporation's largest sources of liquidity on a consolidated basis are the deposit base that comes from consumer, business and municipal customers within the Corporation's local markets, principal payments on loans, maturing investment securities, cash held at the FRB and unpledged investment securities available-for-sale. Total deposits decreased $185 million during the three months ended June 30, 2016, although were up $172 million during the twelve months ended June 30, 2016. The decrease in deposits during the three months ended June 30, 2016 was primarily attributable to a decrease in seasonal municipal deposit accounts. The increase in deposits during the twelve months ended June 30, 2016 was attributable to organic growth in customer deposit accounts of $268 million during the past year, which was partially offset by a reduction of $96 million related to maturing brokered deposits that were acquired in the Lake Michigan transaction. The Corporation's loan-to-deposit ratio was 102.4% at June 30, 2016, 96.3% at March 31, 2016, 97.5% at December 31, 2015 and 96.5% at June 30, 2015. The Corporation had $26 million of cash deposits held at the FRB at June 30, 2016, compared to $90 million at March 31, 2016, $15 million at December 31, 2015 and $16 million at June 30, 2015. At June 30, 2016, the Corporation had unpledged investment securities available-for-sale with an amortized cost of $23 million and available unused wholesale sources of liquidity, including FHLB advances and borrowings from the discount window of the FRB.
Chemical Bank is a member of the FHLB and as such has access to short-term and long-term advances from the FHLB that are generally secured by residential mortgage first lien loans. The Corporation had $629 million of short-term and long-term advances outstanding with the FHLB at June 30, 2016, and had no additional borrowing availability from the FHLB, based on its FHLB capital stock and subject to certain requirements, as of that date. The Corporation can also borrow from the FRB's discount window to meet short-term liquidity requirements. These borrowings are required to be secured by investment securities and/or certain loan types, with each category of assets carrying various borrowing capacity percentages. At June 30, 2016, the Corporation maintained an unused borrowing capacity of $35 million with the FRB's discount window based upon pledged collateral as of that date. The Corporation also had the ability to borrow an additional $75 million of federal funds from multiple third-party financial institutions at June 30, 2016. It is management's opinion that the Corporation's borrowing capacity could be expanded, if deemed necessary, as it has additional borrowing capacity available at the FHLB that could be used if it increased its investment in FHLB capital stock, and the Corporation has a significant amount of additional assets that could be used as collateral at the FRB's discount window.
The Corporation manages its liquidity position to provide the cash necessary to pay dividends to shareholders, invest in new subsidiaries, enter new banking markets, pursue investment opportunities and satisfy other operating requirements. The Corporation's primary source of liquidity is dividends from Chemical Bank.
Federal and state banking laws place certain restrictions on the amount of dividends that a bank may pay to its parent company. During the six months ended June 30, 2016, Chemical Bank paid $25.0 million in cash dividends to the Corporation, and the Corporation paid cash dividends to shareholders of $19.9 million. During 2015, Chemical Bank paid $56.9 million in dividends to the Corporation and the Corporation paid cash dividends to shareholders of $36.9 million. The earnings of Chemical Bank are the principal source of funds to pay cash dividends to the Corporation's shareholders. Chemical Bank had net income of $52.6 million during the six months ended June 30, 2016, compared to net income of $92.8 million during all of 2015. Over the long term, cash dividends to shareholders are dependent upon earnings, capital requirements, regulatory restraints and other factors affecting the Corporation and Chemical Bank.
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Market Risk
Market risk is the risk of loss arising from adverse changes in the fair value of financial instruments due primarily to changes in interest rates. Interest rate risk is the Corporation's primary market risk and results from timing differences in the repricing of interest rate sensitive assets and liabilities and changes in relationships between rate indices due to changes in interest rates. The Corporation's net interest income is largely dependent upon the effective management of interest rate risk. The Corporation's goal is to avoid a significant decrease in net interest income, and thus an adverse impact on the profitability of the Corporation, in periods of changing interest rates. Sensitivity of earnings to interest rate changes arises when yields on assets change differently from the interest costs on liabilities. Interest rate sensitivity is determined by the amount of interest-earning assets and interest-bearing liabilities repricing within a specific time period and the magnitude by which interest rates change on the various types of interest-earning assets and interest-bearing liabilities. The management of interest rate sensitivity includes monitoring the maturities and repricing opportunities of interest-earning assets and interest-bearing liabilities. The Corporation's interest rate risk is managed through policies and risk limits approved by the boards of directors of the Corporation and its subsidiary banks and an Asset and Liability Committee (ALCO). The ALCO, which is comprised of executive and senior management from various areas of the Corporation and Chemical Bank, including finance, lending, investments and deposit gathering, meets regularly to execute asset and liability management strategies. The ALCO establishes guidelines and monitors the sensitivity of earnings to changes in interest rates. The goal of the ALCO process is to manage the impact on net interest income and the net present value of future cash flows of probable changes in interest rates within authorized risk limits.
The primary technique utilized by the Corporation to measure its interest rate risk is simulation analysis. Simulation analysis forecasts the effects on the balance sheet structure and net interest income under a variety of scenarios that incorporate changes in interest rates, the shape of the Treasury yield curve, interest rate relationships and the mix of assets and liabilities and loan prepayments. These forecasts are compared against net interest income projected in a stable interest rate environment. While many assets and liabilities reprice either at maturity or in accordance with their contractual terms, several balance sheet components demonstrate characteristics that require an evaluation to more accurately reflect their repricing behavior. Key assumptions in the simulation analysis include prepayments on loans, probable calls of investment securities, changes in market conditions, loan volumes and loan pricing, deposit sensitivity and customer preferences. These assumptions are inherently uncertain as they are subject to fluctuation and revision in a dynamic environment. As a result, the simulation analysis cannot precisely forecast the impact of rising and falling interest rates on net interest income. Actual results will differ from simulated results due to many other factors, including changes in balance sheet components, interest rate changes, changes in market conditions and management strategies.
The Corporation's interest rate sensitivity is estimated by first forecasting the next twelve months of net interest income under an assumed environment of constant market interest rates. The Corporation then compares the results of various simulation analyses to the constant interest rate forecast (base case). At June 30, 2016, the Corporation projected the change in net interest income during the next twelve months assuming short-term market interest rates were to uniformly and gradually increase or decrease by up to 200 basis points in a parallel fashion over the entire yield curve during the same time period. Additionally, at June 30, 2016, the Corporation projected the change in net interest income of an immediate 400 basis point increase in market interest rates. The Corporation did not project a 400 basis point decrease in interest rates at June 30, 2016 as the likelihood of a decrease of this size was considered unlikely given prevailing interest rate levels. These projections were based on the Corporation's assets and liabilities remaining static over the next twelve months, while factoring in probable calls and prepayments of certain investment securities and residential mortgage and consumer loans. The ALCO regularly monitors the Corporation's forecasted net interest income sensitivity to ensure that it remains within established limits.
A summary of the Corporation's interest rate sensitivity at June 30, 2016 follows:
Gradual Change | Immediate Change | ||||||||||||||||
Twelve month interest rate change projection (in basis points) | -200 | -100 | 0 | +100 | +200 | +400 | |||||||||||
Percent change in net interest income vs. constant rates | (5.3 | )% | (2.4 | )% | — | (0.6 | )% | (1.5 | )% | (4.3 | )% | ||||||
At June 30, 2016, the Corporation's model simulations projected that 100, 200 and 400 basis point increases in interest rates would result in negative variances in net interest income of 0.6%, 1.5% and 4.3%, respectively, relative to the base case over the next twelve-month period. At June 30, 2016, the Corporation's model simulations also projected that decreases in interest rates of 100 and 200 basis points would result in negative variances in net interest income of 2.4% and 5.3%, respectively, relative to the base case over the next twelve-month period. The likelihood of a decrease in interest rates beyond 100 basis points at June 30, 2016 was considered to be unlikely given prevailing interest rate levels.
The Corporation's model simulations at June 30, 2016 for a 200 basis point increase in interest rates resulted in a negative variance in net interest income, relative to the base case, primarily due to the Corporation deploying excess cash and maturing variable-
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rate investment securities into fixed-rate loans during 2015. The Corporation's model simulations at June 30, 2016 for an immediate 400 basis point increase in interest rates also resulted in a negative variance in net interest income, relative to the base case, due to the Corporation's loan portfolio being primarily comprised of fixed-rate loans, while a majority of the Corporation's customer deposit accounts are interest-rate sensitive.
Future increases in market interest rates are not expected to have a significant immediate favorable impact on the Corporation's net interest income at the time of such increases because of the low percentage of variable interest rate loans in the Corporation's loan portfolio and a large percentage of variable interest rate loans at interest rate floors at June 30, 2016. The percentage of variable interest rate loans, which comprised approximately 26% of the Corporation's loan portfolio at June 30, 2016, has remained relatively consistent during the twelve-month period ended June 30, 2016. Approximately two-thirds of the Corporation's variable interest rate loans were at an interest rate floor with a majority expected to remain at their floor until they mature or market interest rates rise more than 50 basis points.
Item 3. Quantitative and Qualitative Disclosures About Market Risk
Information concerning quantitative and qualitative disclosures about market risk is contained in the discussion regarding interest rate risk and sensitivity under the captions “Liquidity” and “Market Risk” herein and in the Corporation's Annual Report on Form 10-K for the year ended December 31, 2015 and is here incorporated by reference.
Since December 31, 2015, the Corporation does not believe that there has been a material change in the nature or categories of the Corporation's primary market risk exposure, or the particular markets that present the primary risk of loss to the Corporation. As of the date of this report, the Corporation does not know of or expect there to be any material change in the general nature of its primary market risk exposure in the near term. The methods by which the Corporation manages its primary market risk exposure, as described in its Annual Report on Form 10-K for the year ended December 31, 2015, have not changed materially during the current year. As of the date of this report, the Corporation does not expect to make material changes in those methods in the near term. The Corporation may change those methods in the future to adapt to changes in circumstances or to implement new techniques.
The Corporation's market risk exposure is mainly comprised of its vulnerability to interest rate risk. Prevailing interest rates and interest rate relationships are largely determined by market factors that are beyond the Corporation's control. All information provided in response to this item consists of forward-looking statements. Reference is made to the section captioned “Forward-Looking Statements” in this report for a discussion of the limitations on the Corporation's responsibility for such statements. In this discussion, “near term” means a period of one year following the date of the most recent consolidated statement of financial position contained in this report.
Item 4. Controls and Procedures
An evaluation was performed under the supervision and with the participation of the Corporation's management, including the Chief Executive Officer and Chief Financial Officer, of the effectiveness of the design and operation of the Corporation's disclosure controls and procedures as of the end of the period covered by this report. Based on and as of the time of that evaluation, the Corporation's management, including the Chief Executive Officer and Chief Financial Officer, concluded that the Corporation's disclosure controls and procedures were effective to ensure that information required to be disclosed by the Corporation in the reports it files or submits under the Exchange Act is recorded, processed, summarized and reported, within the time periods specified in the Commission's rules and forms. There was no change in the Corporation's internal control over financial reporting that occurred during the three months ended June 30, 2016 that has materially affected, or that is reasonably likely to materially affect, the Corporation's internal control over financial reporting.
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Part II. Other Information
Item 1. Legal Proceedings
Information required under this item is set forth in Part I., Item 1. of this Quarterly Report of Form 1-Q and is contained in Note 1 of the Notes to Consolidated Financial Statements under the heading "Legal Matters" and is here incorporated by reference.
In addition, the Corporation and Chemical Bank are subject to certain legal actions arising in the ordinary course of business.
Item 1A. Risk Factors
Information concerning risk factors is contained in the discussion under "Risk Factors" (including the risk factors under the heading "Risk Factors" in the Corporation's Form S-4 Registration Statement related to its pending merger with Talmer, filed with, and made effective by, the SEC on June 9, 2016, and in Item 1A, “Risk Factors,” in the Corporation's Annual Report on Form 10-K for the year ended December 31, 2015. As of the date of this report, the Corporation does not believe that there has been a material change in the nature or categories of the Corporation's risk factors, as compared to the information disclosed in the Corporation's Form S-4 Registration Statement, filed with, and made effective by, the SEC on June 9, 2016, or in the Corporation's Annual Report on Form 10-K for the year ended December 31, 2015.
Item 2. Unregistered Sales of Equity Securities and Use of Proceeds
The following schedule summarizes the Corporation's total monthly share repurchase activity for the three months ended June 30, 2016:
Issuer Purchases of Equity Securities | ||||||||||||
Period Beginning on First Day of Month Ended | Total Number of Shares Purchased (1) | Average Price Paid Per Share | Total Number of Shares Purchased as Part of Publicly Announced Plans or Programs | Maximum Number of Shares that May Yet Be Purchased Under Plans or Programs | ||||||||
April 30, 2016 | 5,588 | $ | 37.59 | — | 500,000 | |||||||
May 31, 2016 | 6,966 | 38.74 | — | 500,000 | ||||||||
June 30, 2016 | 2,140 | 39.13 | — | 500,000 | ||||||||
Total | 14,694 | $ | 38.36 | — | ||||||||
(1) | Represents shares delivered or attested in satisfaction of the exercise price and/or tax withholding obligations by employees who received shares of the Corporation's common stock under the Corporation's share-based compensation plans, as these plans permit employees to use the Corporation's stock to satisfy such obligations based on the market value of the stock on the date of exercise or date of vesting, as applicable. |
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 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. 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. No shares have been repurchased under the Corporation's Common Stock Repurchase Program since the authorization.
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Item 6. Exhibits
Exhibits. The following exhibits are filed as part of this report on Form 10-Q:
Exhibit Number | Document | ||
2.1 | Agreement and Plan of Merger, dated January 25, 2016. Previously filed as Exhibit 2.1 to the registrant’s Current Report on Form 8-K dated January 25, 2016, filed with the SEC on January 26, 2016. Here incorporated by reference. | ||
3.1 | Restated Articles of Incorporation. Previously filed as Exhibit 3.1 to the registrant's Quarterly Report on Form 10-Q for the quarter ended March 31, 2015, filed with the SEC on April 30, 2015. Here incorporated by reference. | ||
3.2 | Bylaws. Previously filed as Exhibit 3.2 to the registrant’s Annual Report on Form 10-K for the year ended December 31, 2013, filed with the SEC on February 26, 2014. Here incorporated by reference. | ||
4.1 | Restated Articles of Incorporation. Exhibit 3.1 is here incorporated by reference. | ||
4.2 | Bylaws. Exhibit 3.2 is here incorporated by reference. | ||
31.1 | Certification of Chief Executive Officer. | ||
31.2 | Certification of Chief Financial Officer. | ||
32.1 | Certification pursuant to 18 U.S.C. §1350. | ||
101.1 | Interactive Data File. | ||
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Signatures
Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.
CHEMICAL FINANCIAL CORPORATION | |||
Date: | July 28, 2016 | By: | /s/ David B. Ramaker |
David B. Ramaker | |||
Chairman of the Board, Chief Executive Officer and President | |||
(Principal Executive Officer) | |||
Date: | July 28, 2016 | By: | /s/ Lori A. Gwizdala |
Lori A. Gwizdala | |||
Executive Vice President, Chief Financial Officer and Treasurer | |||
(Principal Financial and Accounting Officer) | |||
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Exhibit Index
Exhibits. The following exhibits are filed as part of this report on Form 10-Q:
Exhibit Number | Document | ||
2.1 | Agreement and Plan of Merger, dated January 25, 2016. Previously filed as Exhibit 2.1 to the registrant’s Current Report on Form 8-K dated January 25, 2016, filed with the SEC on January 26, 2016. Here incorporated by reference. | ||
3.1 | Restated Articles of Incorporation. Previously filed as Exhibit 3.1 to the registrant's Quarterly Report on Form 10-Q for the quarter ended March 31, 2015, filed with the SEC on April 30, 2015. Here incorporated by reference. | ||
3.2 | Bylaws. Previously filed as Exhibit 3.2 to the registrant’s Annual Report on Form 10-K for the year ended December 31, 2013, filed with the SEC on February 26, 2014. Here incorporated by reference. | ||
4.1 | Restated Articles of Incorporation. Exhibit 3.1 is here incorporated by reference. | ||
4.2 | Bylaws. Exhibit 3.2 is here incorporated by reference. | ||
31.1 | Certification of Chief Executive Officer. | ||
31.2 | Certification of Chief Financial Officer. | ||
32.1 | Certification pursuant to 18 U.S.C. §1350. | ||
101.1 | Interactive Data File. | ||
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