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EX-32.1 - EXHIBIT 32.1 - TCF FINANCIAL CORPchfc2017q1exhibit321.htm
EX-31.2 - EXHIBIT 31.2 - TCF FINANCIAL CORPchfc2017q1exhibit312.htm
EX-31.1 - EXHIBIT 31.1 - TCF FINANCIAL CORPchfc2017q1exhibit311.htm
EX-10.1 - EXHIBIT 10.1 - TCF FINANCIAL CORPchfc2017q1exhibit101.htm
EX-3.1 - EXHIBIT 3.1 - TCF FINANCIAL CORPchfc2017q1exhibit31.htm
 
 
 
 
 
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549 
FORM 10-Q 
(Mark One)
þ
Quarterly Report Pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934
For the quarterly period ended March 31, 2017
 
¨
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
 
¨
 
 
 
 
 
 
 
Emerging growth company
 
¨
 
 
 
 
If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act. ¨
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 May 8, 2017, was 71,121,541 shares.
 
 
 
 
 



INDEX
Chemical Financial Corporation
Form 10-Q
Index to Form 10-Q
 
 
 
Page
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Consolidated Statements of Financial Position as of March 31, 2017 (unaudited) and December 31, 2016
 
 
 
 
Consolidated Statements of Income for the Three Months Ended March 31, 2017 and 2016 (unaudited)
 
 
 
 
Consolidated Statements of Comprehensive Income for the Three Months Ended March 31, 2017 and 2016 (unaudited)
 
 
 
 
Consolidated Statements of Changes in Shareholders’ Equity for the Three Months Ended March 31, 2017 and 2016 (unaudited)
 
 
 
 
Consolidated Statements of Cash Flows for the Three Months Ended March 31, 2017 and 2016 (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.
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, 2016. 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
(Dollars in thousands, except per share data)
 
March 31, 2017
 
December 31, 2016
 
 
(Unaudited)
 
 
Assets
 
 
Cash and cash equivalents:
 
 
 
 
Cash and cash due from banks
 
$
191,940

 
$
237,758

Interest-bearing deposits with the Federal Reserve Bank and other banks
 
249,840

 
236,644

Total cash and cash equivalents
 
441,780

 
474,402

Investment securities:
 
 
 
 
Available-for-sale, at fair value
 
1,275,846

 
1,234,964

Held-to-maturity, at amortized cost (fair value of $639,800 and $608,531, respectively)
 
647,192

 
623,427

Total investment securities
 
1,923,038

 
1,858,391

Loans held-for-sale, at fair value
 
39,123

 
81,830

Loans
 
13,273,392

 
12,990,779

Allowance for loan losses
 
(78,774
)
 
(78,268
)
Net loans
 
13,194,618

 
12,912,511

Premises and equipment
 
142,763

 
145,012

Loan servicing rights ($64,604 and $48,085 measured at fair value, respectively)
 
64,604

 
58,315

Goodwill
 
1,133,534

 
1,133,534

Other intangible assets
 
38,848

 
40,211

Interest receivable and other assets
 
658,665

 
650,973

Total assets
 
$
17,636,973

 
$
17,355,179

Liabilities
 
 
 
 
Deposits:
 
 
 
 
Noninterest-bearing
 
$
3,399,287

 
$
3,341,520

Interest-bearing
 
9,733,060

 
9,531,602

Total deposits
 
13,132,347

 
12,873,122

Interest payable and other liabilities
 
114,789

 
134,637

Securities sold under agreements to repurchase with customers
 
398,910

 
343,047

Short-term borrowings
 
900,000

 
825,000

Long-term borrowings
 
490,876

 
597,847

Total liabilities
 
15,036,922

 
14,773,653

Shareholders’ equity
 
 
 
 
Preferred stock, no par value:
 
 
 
 
Authorized – 2,000,000 shares at 3/31/17 and 12/31/2016, none issued
 

 

Common stock, $1.00 par value per share:
 
 
 
 
Authorized – 100,000,000 shares at 3/31/17 and 12/31/16
 
 
 
 
Issued and outstanding – 71,117,908 shares at 3/31/17 and 70,599,133 shares at 12/31/16
 
71,118

 
70,599

Additional paid-in capital
 
2,194,705

 
2,210,762

Retained earnings
 
372,193

 
340,201

Accumulated other comprehensive loss
 
(37,965
)
 
(40,036
)
Total shareholders’ equity
 
2,600,051

 
2,581,526

Total liabilities and shareholders’ equity
 
$
17,636,973

 
$
17,355,179

See accompanying notes to Consolidated Financial Statements (unaudited).

4


Chemical Financial Corporation
Consolidated Statements of Income
(Unaudited)
 
 
 
Three Months Ended March 31,
(Dollars in thousands, except per share data)
 
2017
 
2016
Interest income
 
 
 
 
Interest and fees on loans
 
$
132,485

 
$
74,401

Interest on investment securities:
 
 
 
 
Taxable
 
4,756

 
1,929

Tax-exempt
 
4,235

 
2,665

Dividends on nonmarketable equity securities
 
621

 
256

Interest on deposits with the Federal Reserve Bank, other banks and Federal funds sold
 
799

 
213

Total interest income
 
142,896

 
79,464

Interest expense
 
 
 
 
Interest on deposits
 
8,916

 
4,059

Interest on short-term borrowings
 
1,658

 
100

Interest on long-term borrowings
 
2,225

 
975

Total interest expense
 
12,799

 
5,134

   Net interest income
 
130,097

 
74,330

Provision for loan losses
 
4,050

 
1,500

Net interest income after provision for loan losses
 
126,047

 
72,830

Noninterest income
 
 
 
 
Service charges and fees on deposit accounts
 
8,004

 
5,720

Wealth management revenue
 
5,827

 
5,201

Other charges and fees for customer services
 
8,891

 
6,392

Mortgage banking revenue
 
9,160

 
1,405

Gain on sale of investment securities
 
90

 
19

Other
 
6,038

 
682

Total noninterest income
 
38,010

 
19,419

Operating expenses
 
 
 
 
Salaries, wages and employee benefits
 
60,248

 
33,890

Occupancy
 
7,392

 
4,905

Equipment and software
 
8,517

 
4,404

Merger and acquisition-related transaction expenses
 
4,167

 
2,594

Other
 
23,872

 
13,094

Total operating expenses
 
104,196

 
58,887

Income before income taxes
 
59,861

 
33,362

Income tax expense
 
12,257

 
9,757

Net income
 
$
47,604

 
$
23,605

Earnings per common share:
 
 
 
 
Basic
 
$
0.67

 
$
0.61

Diluted
 
0.67

 
0.60

Cash dividends declared per common share
 
$
0.27

 
$
0.26

See accompanying notes to Consolidated Financial Statements (unaudited).

5


Chemical Financial Corporation
Consolidated Statements of Comprehensive Income
(Unaudited)
 
 
 
Three Months Ended March 31,
(Dollars in thousands)
 
2017
 
2016
Net income
 
$
47,604

 
$
23,605

Other comprehensive income, net of tax:
 
 
 
 
Unrealized holding gains on securities available-for-sale arising during the period
 
2,739

 
4,199

Reclassification adjustment for gains on realized income
 
(90
)
 
(19
)
Tax effect
 
(927
)
 
(1,463
)
Net unrealized gains on securities available-for-sale, net of tax
 
1,722

 
2,717

Adjustment for pension and other postretirement benefits
 
537

 
(577
)
Tax effect
 
(188
)
 
202

Net adjustment for pension and other postretirement benefits
 
349

 
(375
)
Other comprehensive income, net of tax
 
2,071

 
2,342

Total comprehensive income, net of tax
 
$
49,675

 
$
25,947

See accompanying notes to Consolidated Financial Statements (unaudited).

6


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

(Dollars in thousands)
 
Common
stock
 
Additional
paid-in
capital
 
Retained
earnings
 
Accumulated other
comprehensive
income (loss)
 
Total
Balances at December 31, 2015
 
$
38,168

 
$
725,280

 
$
281,558

 
$
(29,032
)
 
$
1,015,974

Comprehensive income
 
 
 
 
 
23,605

 
2,342

 
25,947

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

 
273

 
 
 
 
 
309

Shares issued – restricted stock units
 
43

 
(770
)
 
 
 
 
 
(727
)
Share-based compensation expense
 
1

 
748

 
 
 
 
 
749

Balances at March 31, 2016
 
$
38,248

 
$
725,531

 
$
295,202

 
$
(26,690
)
 
$
1,032,291

 
 
 
 
 
 
 
 
 
 
 
Balances at December 31, 2016
 
$
70,599

 
$
2,210,762

 
$
340,201

 
$
(40,036
)
 
$
2,581,526

Cumulative effect adjustment of change in accounting policy, net of tax impact(1)
 
 
 
 
 
3,659

 
 
 
3,659

Comprehensive income
 
 
 
 
 
47,604

 
2,071

 
49,675

Cash dividends declared and paid of $0.27 per share
 
 
 
 
 
(19,271
)
 
 
 
(19,271
)
Shares issued – stock options
 
508

 
(17,204
)
 
 
 
 
 
(16,696
)
Shares issued – restricted stock units
 
35

 
(1,330
)
 
 
 
 
 
(1,295
)
Net shares – restricted stock awards
 
(25
)
 
(1,256
)
 
 
 
 
 
(1,281
)
Share-based compensation expense
 
1

 
3,733

 
 
 
 
 
3,734

Balances at March 31, 2017
 
$
71,118

 
$
2,194,705

 
$
372,193

 
$
(37,965
)
 
$
2,600,051

(1) Refer to Footnote 1, Basis of Presentation and Accounting Policies and Footnote 8, Loan Servicing Rights, for further details on this change in accounting policy election.
See accompanying notes to Consolidated Financial Statements (unaudited).

7


Chemical Financial Corporation
Consolidated Statements of Cash Flows
(Unaudited)
 
 
Three Months Ended March 31,
(Dollars in thousands)
 
2017
 
2016
Cash flows from operating activities
 
 
 
 
Net income
 
$
47,604

 
$
23,605

Adjustments to reconcile net income to net cash provided by operating activities:
 
 
 
 
Provision for loan losses
 
4,050

 
1,500

Gain on sales of loans
 
(6,120
)
 
(1,296
)
Proceeds from sales of loans
 
191,531

 
45,928

Loans originated for sale
 
(142,704
)
 
(43,972
)
Net gains on sale of investment securities
 
(90
)
 
(19
)
Net gains from sales/writedowns of other real estate and repossessed assets
 
(700
)
 
(547
)
Depreciation of premises and equipment
 
4,521

 
2,775

Amortization of intangible assets
 
1,513

 
2,169

Additions to loan servicing rights
 
(1,753
)
 
(331
)
Valuation change in loan servicing rights
 
1,125

 

Net amortization of premiums and discounts on investment securities
 
4,129

 
1,493

Share-based compensation expense
 
3,734

 
749

Deferred income tax expense (benefit)
 
17,948

 

Net increase in interest receivable and other assets
 
(29,660
)
 
(737
)
Net decrease in interest payable and other liabilities
 
(19,282
)
 
(11,875
)
Net cash provided by operating activities
 
75,846

 
19,442

Cash flows from investing activities
 
 
 
 
Investment securities – available-for-sale:
 
 
 
 
Proceeds from maturities, calls and principal reductions
 
60,885

 
42,281

Proceeds from sales and redemptions
 

 
644

Purchases
 
(102,702
)
 

Investment securities – held-to-maturity:
 
 
 
 
Proceeds from maturities, calls and principal reductions
 
9,408

 
8,133

Purchases
 
(33,628
)
 
(16,965
)
Net increase in loans
 
(290,438
)
 
(101,915
)
Proceeds from sales of other real estate and repossessed assets
 
5,734

 
2,705

Purchases of premises and equipment, net of disposals
 
(2,272
)
 
(2,406
)
Net cash used in investing activities
 
(353,013
)
 
(67,523
)
Cash flows from financing activities
 
 
 
 
Net increase in interest- and noninterest-bearing demand deposits and savings accounts
 
350,763

 
234,102

Net decrease in time deposits
 
(91,538
)
 
(40,753
)
Net increase (decrease) in securities sold under agreements to repurchase with customers and other short-term borrowings
 
130,863

 
(113,816
)
Proceeds from issuance of long-term borrowings
 

 
50,000

Repayment of long-term borrowings
 
(107,000
)
 
(18,558
)
Cash dividends paid
 
(19,271
)
 
(9,961
)
Proceeds from directors’ stock plans and exercise of stock options, net of shares withheld
 
1,578

 
382

Cash paid for payroll taxes upon conversion of share-based awards
 
(20,850
)
 
(730
)
Net cash provided by financing activities
 
244,545

 
100,666

Net increase (decrease) in cash and cash equivalents
 
(32,622
)
 
52,585

Cash and cash equivalents at beginning of period
 
474,402

 
238,789

Cash and cash equivalents at end of period
 
$
441,780

 
$
291,374

 
 
 
 
 
Supplemental disclosures of cash flow information:
 
 
 
 
Interest paid
 
$
12,989

 
$
5,080

Income tax refunds, net of income taxes paid
 
(24,397
)
 

Loans transferred to other real estate and repossessed assets
 
4,281

 
1,667

See accompanying notes to Consolidated Financial Statements (unaudited).

8


Chemical Financial Corporation
Notes to Consolidated Financial Statements (Unaudited)
March 31, 2017




Note 1: Basis of Presentation and 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 Michigan, Ohio and Indiana as a state-chartered commercial bank. Chemical Bank operates through an internal organizational structure of seven 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, wealth management revenue and mortgage banking revenue.
Basis of Presentation and Principles of Consolidation
The accompanying unaudited consolidated financial statements of the Corporation and its subsidiaries have been prepared in accordance with United States ("U.S.") generally accepted accounting principles ("GAAP") for interim financial information and with 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, 2016. In the opinion of management, the accompanying unaudited interim consolidated financial statements contain all adjustments believed necessary to present fairly the financial condition and results of operations of the Corporation for the periods presented. Operating results for the three months ended March 31, 2017 are not necessarily indicative of the results that may be expected for the year ending December 31, 2017.
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, income taxes, goodwill impairment and those assets that require fair value measurement. Actual results could differ from these estimates.
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.
Loan Servicing Rights
Effective January 1, 2017, the Corporation elected to account for all loan servicing rights ("LSRs") previously accounted for under the lower of cost or fair value method under the fair value method. The guidance in ASC Subtopic 860-50, "Transfers and Servicing-Servicing Assets and Liabilities" provides that an entity may make an irrevocable decision to subsequently measure a class of servicing assets and servicing liabilities at fair value at the beginning of any fiscal year. The guidance allows for the Corporation to apply this election prospectively to all new and existing servicing assets and servicing liabilities. Management believes this election will provide more comparable results to peers as many of those within our industry group account for loans servicing rights under the fair value method. The change in accounting policy in the first quarter of 2017 results in a cumulative adjustment to increase retained earnings in the amount of $3.7 million, net of taxes.
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 "Interest receivable and other assets" on the Consolidated Statements of Financial Position. The Corporation utilizes the

9


Chemical Financial Corporation
Notes to Consolidated Financial Statements (Unaudited)
March 31, 2017



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. The Corporation recognized additional income tax expense attributable to the amortization of investments in qualified affordable housing projects of $0.8 million and $0.6 million during the three months ended March 31, 2017 and 2016, respectively. The Corporation's remaining investment in qualified affordable housing projects accounted for under the proportional amortization method totaled $31.8 million at March 31, 2017 and $29.5 million at December 31, 2016.
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 $10.7 million and $10.9 million at March 31, 2017 and December 31, 2016, 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 "Interest payable and other liabilities" on the Consolidated Statements of Financial Position. The Corporation's remaining unfunded equity contributions totaled $18.5 million and $16.0 million at March 31, 2017 and December 31, 2016, respectively.
Management analyzes these investments for potential impairment when events or changes in circumstances indicate that it is more-likely-than-not that the carrying amount of the investment will not be realized. An impairment loss is measured as the amount by which the carrying amount of an investment exceeds its fair value. There were no impairment losses recognized as of March 31, 2017 or December 31, 2016.
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.

10


Chemical Financial Corporation
Notes to Consolidated Financial Statements (Unaudited)
March 31, 2017



Note 2: Mergers and Acquisitions
Merger with Talmer Bancorp, Inc.
On August 31, 2016, the Corporation completed a merger with Talmer Bancorp, Inc. ("Talmer") for total consideration of $1.61 billion. As a result of the merger, the Corporation issued 32.1 million shares of its common stock based on an exchange ratio where each Talmer shareholder received 0.4725 shares of the Corporation's common stock, and $1.61 in cash, for each share of Talmer common stock. In conjunction with the merger, the Corporation entered into and drew on a $125.0 million credit facility. The proceeds from the credit facility were used to pay off the Corporation's $25.0 million line-of-credit and a $37.5 million line-of-credit of Talmer, with the remaining proceeds used to partially fund the cash portion of the merger consideration. The Corporation incurred $4.2 million and $2.6 million of merger and acquisition-related transaction expenses during the three months ended March 31, 2017 and 2016, respectively, primarily related to the merger with Talmer. As a result of the merger, Talmer Bank and Trust became a wholly-owned subsidiary of the Corporation. Talmer Bank and Trust was consolidated with and into Chemical Bank during the fourth quarter of 2016.
The Company determined that the merger with Talmer constitutes a business combination as defined by ASC 805. Accordingly, the assets acquired and liabilities assumed were recorded at their fair values on the date of acquisition. Fair values were determined in accordance with the guidance provided in ASC Topic 820, Fair Value Measurements. In many cases the determination of the fair values required management to make estimates about discount rates, future expected cash flows, market conditions and other future events that are highly subjective in nature and subject to change. The following allocation is based on the information that was available to make preliminary estimates of the fair value and may change as additional information becomes available and additional analyses are completed. While the Corporation believes that information provided a reasonable basis for estimating the fair values, it expects that it could obtain additional information and evidence during the measurement period that may result in changes to the estimated fair value amounts. This measurement period ends on the earlier of one year after the merger date or the date we receive the information about the facts and circumstances that existed at the merger date. Subsequent adjustments, if necessary, will be reflected in future filings. These refinements include: (1) changes in the estimated fair value of loans acquired: (2) changes in the estimated fair value of intangible assets acquired: (3) changes in deferred tax assets related to fair value estimates and a change in the expected realization of items considered to be net operating loss carry forwards and (4) a change in the goodwill caused by the net effect of these adjustments.

11


Chemical Financial Corporation
Notes to Consolidated Financial Statements (Unaudited)
March 31, 2017



(Dollars in thousands)
 
 
Consideration paid:
 
 
Stock
 
$
1,504,811

Cash
 
107,638

Total consideration
 
1,612,449

 
 
 
Fair value of identifiable assets acquired:
 
 
Cash and cash equivalents
 
433,352

Investment securities:
 
 
Available-for-sale
 
808,894

Held-to-maturity
 
1,657

Loans held-for-sale
 
244,916

Loans
 
4,882,402

Premises and equipment
 
38,793

Loan servicing rights
 
42,462

Other intangible assets
 
19,088

Interest receivable and other assets
 
395,119

Total identifiable assets acquired
 
$
6,866,683

 
 
 
Fair value of liabilities assumed:
 
 
Noninterest-bearing deposits
 
1,236,902

Interest-bearing deposits
 
4,057,716

Interest payable and other liabilities
 
99,482

Securities sold under agreements to repurchase with customers
 
19,704

Short-term borrowings
 
387,500

Long-term borrowings
 
299,597

Total liabilities assumed
 
$
6,100,901

 
 
 
Fair value of net identifiable assets acquired
 
$
765,782

Goodwill resulting from acquisition
 
$
846,667


12


Chemical Financial Corporation
Notes to Consolidated Financial Statements (Unaudited)
March 31, 2017



Information regarding loans accounted for under ASC 310-30 at the merger date is as follows:
(Dollars in thousands)
 
 
Accounted for under ASC 310-30:
 
 
Contractual cash flows
 
$
5,968,488

Contractual cash flows not expected to be collected (nonaccretable difference)
 
223,959

Expected cash flows
 
5,744,529

Interest component of expected cash flows (accretable yield)
 
862,127

Fair value at acquisition
 
$
4,882,402


Unaudited Pro Forma Combined Results of Operations

The following unaudited pro forma financial information presents the consolidated results of operation of the Corporation and Talmer as if the merger had occurred as of January 1, 2016. The unaudited pro forma combined results of operations are presented solely for information purposes and are not intended to represent or be indicative of the consolidated results of operations that Chemical would have reported had these transactions been completed as of the dates and for the periods presented, nor are they necessarily indicative of future results. In particular, no adjustments have been made to eliminate the amount of Talmer's provision for loan losses incurred prior to the acquisition date that would not have been necessary had the acquired loans been recorded at fair value as of the beginning of each period indicated. In accordance with Article 11 of SEC Regulation S-X, transaction costs directly attributable to the acquisitions have been excluded.
 
 
For the three months ended,
(Dollars in thousands)
 
March 31, 2017(1)
 
March 31, 2016
Net interest and other income
 
$
168,107

 
$
157,932

Net Income
 
47,604

 
39,028

Earnings per share:
 
 
 
 
Basic
 
$
0.67

 
$
0.56

Diluted
 
0.67

 
0.55

(1) As the business combination was effective August 31, 2016, there were no proforma adjustments for the three months ended March 31, 2017.        

13


Chemical Financial Corporation
Notes to Consolidated Financial Statements (Unaudited)
March 31, 2017



Note 3: 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.
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, loans held-for-sale, loan servicing rights and derivatives 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 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. Additionally included in Level 2 valuations are loans held for sale and derivative assets and liabilities.
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, LSRs 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. Transfers of asset or liabilities between levels of the fair value hierarchy are recognized at the beginning of the reporting period, when applicable.
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.

14


Chemical Financial Corporation
Notes to Consolidated Financial Statements (Unaudited)
March 31, 2017



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: Investment securities classified as 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.
Loans held-for-sale: The Corporation has elected the fair value option for all residential mortgage loans held-for-sale. 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.
Loan servicing rights: Effective January 1, 2017, the Corporation elected to account for all LSRs under the fair value measurement method. LSRs acquired related to the merger with Talmer effective August 31, 2016 were also previously accounted for under the fair value measurement method based on accounting election.  A third party valuation model is used to determine the fair value at the end of each reporting period utilizing a discounted cash flow analysis using interest rates and prepayment speed assumptions currently quoted for comparable instruments and a discount rate determined by management.  Because of the nature of the valuation inputs, the Corporation classifies loan servicing rights as Level 3.  Refer to Note 8, “Loan Servicing Rights,” for the assumptions included in the valuation of loan servicing rights.
Derivatives: The Corporation enters into interest rate lock commitments with prospective borrowers to be sold into the secondary market and forward commitments for the future delivery of mortgage loans to third party investors, which are carried at fair value on a recurring basis. The fair value of these commitments is based on the fair value of related mortgage loans determined using observable market data. Interest rate lock commitments are adjusted for expectations of exercise and funding. This adjustment is not considered to be a material input. The Corporation classifies interest rate lock commitments and forward contracts related to mortgage loans to be delivered for sale as recurring Level 2.
 
Derivative instruments held or issued for customer-initiated activities are traded in over-the counter markets where quoted market prices are not readily available. Fair value for over-the-counter derivative instruments is measured on a recurring basis using third party models that use primarily market observable inputs, such as yield curves and option volatilities. The fair value for these derivatives may include a credit valuation adjustment that is determined by applying a credit spread for the counterparty or the Corporation, as appropriate, to the total expected exposure of the derivative after considering collateral and other master netting arrangements. These adjustments, which are considered Level 3 inputs, are based on estimates of current credit spreads to evaluate the likelihood of default. The Corporation assessed the significance of the impact of the credit valuation adjustments on the overall valuation of its derivative positions at both March 31, 2017 and December 31, 2016 and it was determined that the credit valuation adjustments were not significant to the overall valuation of its derivatives. As a result, the Corporation classifies its customer-initiated derivatives valuations in Level 2 of the fair value hierarchy.

Written and purchased option derivatives consist of instruments to facilitate an equity-linked time deposit product (the "Power Equity CD"). The Power Equity CD is a time deposit that provides the purchaser a guaranteed return of principal at maturity plus a potential equity return, while the Corporation receives a known stream of funds based on equity returns. The written and purchased options are mirror derivative instruments which are carried at fair value on the Consolidated Statements of Financial Position. Fair value measurements for the Power Equity CD are determined using quoted prices of underlying stocks, along with other terms and features of the derivative instrument. As a result, the Power Equity CD derivatives are classified as Level 2 valuations.

Disclosure of Recurring Basis Fair Value Measurements
For assets and liabilities measured at fair value on a recurring basis, quantitative disclosures about the fair value measurements for each major category of assets and liabilities follow:

15


Chemical Financial Corporation
Notes to Consolidated Financial Statements (Unaudited)
March 31, 2017



(Dollars in thousands)
Quoted Prices In Active Markets for Identical Assets
(Level 1)
 
Significant Other
Observable Inputs
(Level 2)
 
Significant
Unobservable
Inputs
(Level 3)
 
Total
March 31, 2017
 
 
 
 
 
 
 
Investment securities – available-for-sale:
 
 
 
 
 
 
 
U.S. Treasury securities
$
5,793

 
$

 
$

 
$
5,793

Government sponsored agencies

 
224,339

 

 
224,339

State and political subdivisions

 
300,409

 

 
300,409

Residential mortgage-backed securities

 
256,544

 

 
256,544

Collateralized mortgage obligations

 
367,321

 

 
367,321

Corporate bonds

 
89,253

 

 
89,253

Preferred stock and trust preferred securities

 
32,187

 

 
32,187

Total investment securities – available-for-sale
5,793

 
1,270,053

 

 
1,275,846

Loans held-for-sale

 
39,123

 

 
39,123

Loan servicing rights

 

 
64,604

 
64,604

Derivative assets:
 
 
 
 
 
 
 
Customer-initiated derivatives

 
6,377

 

 
6,377

Interest rate lock commitments

 
2,178

 

 
2,178

Power Equity CD

 
2,234

 

 
2,234

Total derivatives

 
10,789

 

 
10,789

Total assets at fair value
$
5,793

 
$
1,319,965

 
$
64,604

 
$
1,390,362

Derivative liabilities:
 
 
 
 
 
 
 
Customer-initiated derivatives

 
6,342

 

 
6,342

Forward contracts related to mortgage loans to be delivered for sale

 
342

 

 
342

Power Equity CD

 
2,234

 

 
2,234

Total derivatives

 
8,918

 

 
8,918

Total liabilities at fair value
$

 
$
8,918

 
$

 
$
8,918

December 31, 2016
 
 
 
 
 
 
 
Investment securities – available-for-sale:
 
 
 
 
 
 
 
U.S. Treasury securities
$
5,793

 
$

 
$

 
$
5,793

Government sponsored agencies

 
215,011

 

 
215,011

State and political subdivisions

 
300,088

 

 
300,088

Residential mortgage-backed securities

 
272,282

 

 
272,282

Collateralized mortgage obligations

 
320,025

 

 
320,025

Corporate bonds

 
89,474

 

 
89,474

Preferred stock and trust preferred securities

 
32,291

 

 
32,291

Total investment securities – available-for-sale
5,793

 
1,229,171

 

 
1,234,964

Loans held-for-sale

 
81,830

 

 
81,830

Loan servicing rights

 

 
48,085

 
48,085

Derivative assets:
 
 
 
 
 
 
 
Customer-initiated derivatives

 
4,406

 

 
4,406

Forward contracts related to mortgage loans to be delivered for sale

 
635

 

 
635

Interest rate lock commitments

 
956

 

 
956

Power Equity CD

 
2,218

 

 
2,218

Total derivatives

 
8,215

 

 
8,215

Total assets at fair value
$
5,793

 
$
1,319,216

 
$
48,085

 
$
1,373,094

Derivative liabilities:
 
 
 
 
 
 
 
Customer-initiated derivatives

 
4,141

 

 
4,141

Power Equity CD

 
2,218

 

 
2,218

Total derivatives

 
6,359

 

 
6,359

Total liabilities at fair value
$

 
$
6,359

 
$

 
$
6,359

There were no transfers between levels within the fair value hierarchy during the three months ended March 31, 2017.

16


Chemical Financial Corporation
Notes to Consolidated Financial Statements (Unaudited)
March 31, 2017



The following table summarizes the changes in Level 3 assets measured at fair value on a recurring basis.
 
 
Three months ended March 31, 2017
(Dollars in thousands)
 
Loan servicing
rights
Balance, beginning of period
 
$
48,085

Transfer in based on new accounting policy election(1)
 
15,891

Gains (losses):
 
 

Recorded in earnings (realized):
 
 
Recorded in “Mortgage banking revenue”
 
(1,125
)
New originations
 
1,753

Balance, end of period
 
$
64,604

(1) Refer to Note 1 for further details.

The Corporation has elected the fair value option for loans held-for-sale.  These loans are intended for sale and the Corporation believes that the fair value is the best indicator of the resolution of these loans. Interest income is recorded based on the contractual terms of the loans in accordance with the Corporation's policy on loans held for investment in “Interest and fees on loans” in the Consolidated Statements of Income. There were no loans held-for-sale on nonaccrual status or 90 days past due and on accrual status as of March 31, 2017 and December 31, 2016.
 
The aggregate fair value, contractual balance (including accrued interest), and gain or loss for loans held-for-sale carried at fair value was as follows:
(Dollars in thousands)
 
March 31, 2017
 
December 31, 2016
Aggregate fair value
 
$
39,123

 
$
81,830

Contractual balance
 
37,701

 
81,009

Unrealized gain (loss)
 
1,422

 
821

 
The total amount of gains (losses) from loans held-for-sale included in the Consolidated Statements of Income were as follows:
 
 
For the three months ended
March 31,
(Dollars in thousands)
 
2017
 
2016
Interest income(1)
 
$
551

 
$
19

Change in fair value(2)
 
601

 

Total included in earnings
 
$
1,152

 
$
19

(1) Included in "Interest and fees on loans" in the Consolidated Statements of Income.
(2) Included in "Mortgage banking revenue" in the Consolidated Statements of Income.

Assets and Liabilities Recorded at Fair Value on a Nonrecurring Basis

Loans: 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 management determines the fair value of the collateral is further impaired below the independent appraised value. When management determines the fair value of the

17


Chemical Financial Corporation
Notes to Consolidated Financial Statements (Unaudited)
March 31, 2017



collateral is further impaired below appraised value, discounts ranging between 10% and 25% of the appraised value are used depending on the nature of the collateral and the age of the most recent appraisal.

Goodwill: 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 March 31, 2017 and December 31, 2016, no goodwill was impaired.
Other intangible assets: Other intangible assets consist of core deposit intangible assets and non-compete intangible assets. 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 March 31, 2017 and December 31, 2016, there was no impairment identified for core deposit intangible assets or non-compete intangible assets.
Loan servicing rights: Prior to January 1, 2017, LSRs originated by the Corporation and those acquired in acquisitions of other institutions prior to the merger with Talmer were accounted for under the amortization method. The fair value of these LSRs were 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 reflected a value less than the carrying value, LSRs were adjusted to fair value, as determined by the model, through a valuation allowance. The Corporation classified the LSRs subject to nonrecurring fair value measurements as Level 3 valuations. At December 31, 2016, the Corporation recognized a valuation allowance of $8 thousand related to impairment within certain pools attributable to the Corporation's servicing portfolios. As a result, the LSRs related to these servicing portfolios were considered to be recorded at fair value on a nonrecurring basis as of December 31, 2016.
Other real estate owned and repossessed assets: The carrying amounts for other real estate and repossessed assets are reported in the Consolidated Statements of Financial Position under “Interest receivable and other assets.” Other real estate and repossessed assets include real estate and other types of assets repossessed by the Corporation. Other real estate and repossessed assets are recorded at the lower of cost or fair value upon the transfer of a loan to other real estate and repossessed assets and, subsequently, 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 other real estate and repossessed assets 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, discounts ranging between 10% and 25% of the appraised value are used depending on the nature of the property and the age of the most recent appraisal.

18


Chemical Financial Corporation
Notes to Consolidated Financial Statements (Unaudited)
March 31, 2017



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 follows:
(Dollars in thousands)
 
Quoted Prices
In Active
Markets for
Identical
Assets
(Level 1)
 
Significant
Other
Observable
Inputs
(Level 2)
 
Significant
Unobservable
Inputs
(Level 3)
 
Total
March 31, 2017
 
 
 
 
 
 
 
 
Impaired originated loans
 
$

 
$

 
$
63,180

 
$
63,180

Other real estate/repossessed assets
 

 

 
2,240

 
2,240

Total
 
$

 
$

 
$
65,420

 
$
65,420

December 31, 2016
 
 
 
 
 
 
 
 
Impaired originated loans
 
$

 
$

 
$
62,184

 
$
62,184

Other real estate/repossessed assets
 

 

 
1,386

 
1,386

Loan servicing rights
 

 

 
2

 
2

Total
 
$

 
$

 
$
63,572

 
$
63,572

There were no liabilities recorded at fair value on a nonrecurring basis at March 31, 2017 and December 31, 2016.
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:
(Dollars in thousands)
 
Fair Value at
March 31, 2017
 
Valuation Technique
 
Significant Unobservable Inputs
 
Range
Impaired originated loans
 
$
63,180

 
Appraisal of collateral
 
Discount for type of collateral and age of appraisal
 
10%-25%
Other real estate/repossessed assets
 
2,240

 
Appraisal of property
 
Discount for type of property and age of appraisal
 
10%-25%
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 FASB ASC Topic 820, "Fair Value Measurement", 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.
The methodologies for estimating the fair value of financial assets and financial liabilities on a recurring or nonrecurring basis are discussed above. At March 31, 2017 and December 31, 2016, 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.

19


Chemical Financial Corporation
Notes to Consolidated Financial Statements (Unaudited)
March 31, 2017



Investment securities — held-to-maturity: Fair value measurements for investment securities — held-to-maturity 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 includes investment securities issued by state and political subdivisions. Level 3 valuations include trust preferred investment securities.
Nonmarketable equity securities: Fair value measurements of nonmarketable equity securities, which consist 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: The fair values of loans that are not considered impaired are estimated using a discounted cash flow model. The cash flows take into consideration current portfolio interest rates and repricing characteristics as well as assumptions relating to prepayment speeds. The discount rates take into consideration the current market interest rate environment, a credit risk component based on the credit characteristics of each loan portfolio, and a liquidity premium reflecting the liquidity or illiquidity of the market. The fair value measurements for loans are Level 3 valuations.
Deposits: The fair values of deposit accounts without defined maturities, such as interest- and noninterest-bearing checking, savings and money market accounts, are estimated to be 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 therefore classified as Level 2 valuations. However, if the estimated fair value is less than the carrying value, the carrying value is reported as the fair value.
Securities sold under agreements to repurchase: Fair value measurements are based on the present value of future estimated cash flows using current interest rates offered to the Corporation under similar terms and are Level 2 valuations.
Short-term borrowings: Short-term borrowings consist of short-term FHLB advances. 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: Long-term borrowings consist of long-term FHLB advances, securities sold under agreements to repurchase with an unaffiliated financial institution, a term 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 and are therefore classified as Level 2 valuations.
Financial guarantees: 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.


20


Chemical Financial Corporation
Notes to Consolidated Financial Statements (Unaudited)
March 31, 2017



A summary of carrying amounts and estimated fair values of the Corporation’s financial instruments not recorded at fair value in their entirety on a recurring basis on the Consolidated Statements of Financial Position was as follows:
 
 
Level in Fair Value Measurement
Hierarchy
 
March 31, 2017
 
December 31, 2016
(Dollars in thousands)
 
 
Carrying
Amount
 
Fair
Value
 
Carrying
Amount
 
Fair
Value
Financial assets:
 
 
 
 
 
 
 
 
 
 
Cash and cash equivalents
 
Level 1
 
$
441,780

 
$
441,780

 
$
474,402

 
$
474,402

Investment securities:
 
 
 
 
 
 
 
 
 
 
Held-to-maturity
 
Level 2
 
646,692

 
639,450

 
622,927

 
608,221

Held-to-maturity
 
Level 3
 
500

 
350

 
500

 
310

Nonmarketable equity securities
 
Level 2
 
129,939

 
129,939

 
97,350

 
97,350

Net loans(1)
 
Level 3
 
13,194,618

 
13,347,793

 
12,912,511

 
13,069,315

Interest receivable
 
Level 2
 
45,863

 
45,863

 
42,235

 
42,235

Financial liabilities:
 
 
 
 
 
 
 
 
 
 
Deposits:
 
 
 
 
 
 
 
 
 
 
Deposits without defined maturities
 
Level 2
 
$
10,213,518

 
$
10,213,518

 
$
9,862,755

 
$
9,862,755

Time deposits
 
Level 2
 
2,918,829

 
2,919,153

 
3,010,367

 
3,010,048

Total deposits
 
 
 
13,132,347

 
13,132,671

 
12,873,122

 
12,872,803

Interest payable
 
Level 2
 
5,225

 
5,225

 
5,415

 
5,415

Securities sold under agreements to repurchase with customers
 
Level 2
 
398,910

 
398,910

 
343,047

 
343,047

Short-term borrowings
 
Level 2
 
900,000

 
899,777

 
825,000

 
825,000

Long-term borrowings
 
Level 2
 
490,876

 
486,161

 
597,847

 
591,227

 
(1)
Included $63.2 million and $62.2 million of impaired loans recorded at fair value on a nonrecurring basis at March 31, 2017 and December 31, 2016, respectively.


21


Chemical Financial Corporation
Notes to Consolidated Financial Statements (Unaudited)
March 31, 2017



Note 4: Investment Securities
The following is a summary of the amortized cost and fair value of investment securities available-for-sale and investment securities held-to-maturity at March 31, 2017 and December 31, 2016:
 
 
Investment Securities Available-for-Sale
(Dollars in thousands)
 
Amortized
Cost
 
Unrealized
Gains
 
Unrealized
Losses
 
Fair
Value
March 31, 2017
 
 
 
 
 
 
 
 
U.S. Treasury securities
 
$
5,792

 
$
1

 
$

 
$
5,793

Government sponsored agencies
 
225,993

 
153

 
1,807

 
224,339

State and political subdivisions
 
309,518

 
140

 
9,249

 
300,409

Residential mortgage-backed securities
 
260,703

 
45

 
4,204

 
256,544

Collateralized mortgage obligations
 
371,084

 
75

 
3,838

 
367,321

Corporate bonds
 
90,438

 
27

 
1,212

 
89,253

Preferred stock and trust preferred securities
 
31,426

 
1,042

 
281

 
32,187

Total
 
$
1,294,954

 
$
1,483

 
$
20,591

 
$
1,275,846

December 31, 2016
 
 
 
 
 
 
 
 
U.S. Treasury securities
 
$
5,788

 
$
5

 
$

 
$
5,793

Government sponsored agencies
 
216,890

 
189

 
2,068

 
215,011

State and political subdivisions
 
311,704

 
163

 
11,779

 
300,088

Residential mortgage-backed securities
 
276,162

 
112

 
3,992

 
272,282

Collateralized mortgage obligations
 
323,965

 
63

 
4,003

 
320,025

Corporate bonds
 
90,859

 
16

 
1,401

 
89,474

Preferred stock and trust preferred securities
 
31,353

 
1,018

 
80

 
32,291

Total
 
$
1,256,721

 
$
1,566

 
$
23,323

 
$
1,234,964


 
 
Investment Securities Held-to-Maturity
(Dollars in thousands)
 
Amortized
Cost
 
Unrealized
Gains
 
Unrealized
Losses
 
Fair
Value
March 31, 2017
 
 
 
 
 
 
 
 
State and political subdivisions
 
$
646,692

 
$
3,830

 
$
11,072

 
$
639,450

Trust preferred securities
 
500

 

 
150

 
350

Total
 
$
647,192

 
$
3,830

 
$
11,222

 
$
639,800

December 31, 2016
 
 
 
 
 
 
 
 
State and political subdivisions
 
$
622,927

 
$
2,648

 
$
17,354

 
$
608,221

Trust preferred securities
 
500

 

 
190

 
310

Total
 
$
623,427

 
$
2,648

 
$
17,544

 
$
608,531

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).
Proceeds from sales of securities and the associated gains and losses recorded in earnings are listed below:
 
 
For the three months ended
March 31,
(Dollars in thousands)
 
2017
 
2016
Proceeds
 
$

 
$
644

Gross gains
 
90

 
19


22


Chemical Financial Corporation
Notes to Consolidated Financial Statements (Unaudited)
March 31, 2017



The following is a summary of the amortized cost and fair value of investment securities at March 31, 2017, by maturity, for both available-for-sale and held-to-maturity investment securities. The maturities of residential mortgage-backed securities and collateralized mortgage obligations are based on scheduled principal payments. The maturities of all other debt securities are based on final contractual maturity.
 
 
March 31, 2017
(Dollars in thousands)
 
Amortized
Cost
 
Fair Value
Investment Securities Available-for-Sale:
 
 
 
 
Due in one year or less
 
$
248,015

 
$
246,683

Due after one year through five years
 
529,893

 
524,707

Due after five years through ten years
 
347,825

 
340,248

Due after ten years
 
167,832

 
162,405

Preferred stock
 
1,389

 
1,803

Total
 
$
1,294,954

 
$
1,275,846

Investment Securities Held-to-Maturity:
 
 
 
 
Due in one year or less
 
$
70,242

 
$
70,210

Due after one year through five years
 
271,055

 
268,753

Due after five years through ten years
 
146,712

 
144,004

Due after ten years
 
159,183

 
156,833

Total
 
$
647,192

 
$
639,800

Securities with a carrying value of $911.9 million and $794.0 million were pledged at March 31, 2017 and December 31, 2016, respectively, to secure borrowings and deposits.    
At March 31, 2017 and December 31, 2016, there were no holdings of securities of any one issuer, other than the U.S. government and its agencies, in an amount greater than 10% of shareholders' equity.

23


Chemical Financial Corporation
Notes to Consolidated Financial Statements (Unaudited)
March 31, 2017




The following schedule summarizes information for both available-for-sale and held-to-maturity investment securities with gross unrealized losses at March 31, 2017 and December 31, 2016, aggregated by category and length of time that individual securities have been in a continuous unrealized loss position. As of March 31, 2017, the Corporation’s securities portfolio consisted of 2,309 securities, 1,418 of which were in an unrealized loss position.
 
 
Less Than 12 Months
 
12 Months or More
 
Total
(Dollars in thousands)
 
Fair
Value
 
Gross
Unrealized
Losses
 
Fair
Value
 
Gross
Unrealized
Losses
 
Fair
Value
 
Gross
Unrealized
Losses
March 31, 2017
 
 
 
 
 
 
 
 
 
 
 
 
Government sponsored agencies
 
$
108,300

 
$
1,445

 
$
11,203

 
$
362

 
$
119,503

 
$
1,807

State and political subdivisions
 
705,870

 
19,603

 
26,084

 
718

 
731,954

 
20,321

Residential mortgage-backed securities
 
248,111

 
4,204

 

 

 
248,111

 
4,204

Collateralized mortgage obligations
 
311,566

 
3,626

 
12,528

 
212

 
324,094

 
3,838

Corporate bonds
 
78,815

 
1,211

 
1,499

 
1

 
80,314

 
1,212

Trust preferred securities
 
10,511

 
281

 
350

 
150

 
10,861

 
431

Total
 
$
1,463,173


$
30,370

 
$
51,664

 
$
1,443

 
$
1,514,837

 
$
31,813

December 31, 2016
 
 
 
 
 
 
 
 
 
 
 
 
Government sponsored agencies
 
$
105,702

 
$
1,707

 
$
15,023

 
$
361

 
$
120,725

 
$
2,068

State and political subdivisions
 
758,063

 
28,158

 
26,810

 
975

 
784,873

 
29,133

Residential mortgage-backed securities
 
244,239

 
3,992

 

 

 
244,239

 
3,992

Collateralized mortgage obligations
 
279,001

 
3,778

 
14,754

 
225

 
293,755

 
4,003

Corporate bonds
 
80,536

 
1,401

 

 

 
80,536

 
1,401

Trust preferred securities
 
10,699

 
80

 
310

 
190

 
11,009

 
270

Total
 
$
1,478,240

 
$
39,116

 
$
56,897

 
$
1,751

 
$
1,535,137

 
$
40,867

    
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 March 31, 2017, represented other-than-temporary impairment (OTTI) as the unrealized losses for these securities resulted primarily from changes in benchmark U.S. Treasury interest rates and not credit issues. Management believed that the unrealized losses on investment securities at March 31, 2017 were temporary in nature and due primarily to changes in interest rates and reduced market liquidity and not as a result of credit-related issues.

At March 31, 2017, the Corporation did not have the intent to sell any of its impaired investment securities and believed that it was more-likely-than-not that the Corporation will not have to sell any such investment securities before a full recovery of amortized cost. Accordingly, at March 31, 2017, the Corporation believed the impairments in its investment securities portfolio were temporary in nature. However, there is no assurance that OTTI may not occur in the future.

24


Chemical Financial Corporation
Notes to Consolidated Financial Statements (Unaudited)
March 31, 2017



Note 5: Loans
Loan portfolio segments are defined as the level at which an entity develops and documents a systematic methodology to determine its allowance. The Corporation has two loan portfolio segments (commercial loans and consumer loans) that it uses in determining the allowance. Both quantitative and qualitative factors are used by management at the loan portfolio segment level in determining the adequacy of the allowance for the Corporation. Classes of loans are a disaggregation of an entity’s loan portfolio segments. Classes of loans are defined as a group of loans which share similar initial measurement attributes, risk characteristics, and methods for monitoring and assessing credit risk. The Corporation has six classes of loans, which are set forth below.
Commercial — Loans and lines of credit to varying types of businesses, including municipalities, school districts and nonprofit organizations, for the purpose of supporting working capital, operational needs and term financing of equipment. Repayment of such loans is generally provided through operating cash flows of the business. Commercial loans are predominately secured by equipment, inventory, accounts receivable, personal guarantees of the owner and other sources of repayment, although the Corporation may also secure commercial loans with real estate.
Commercial real estate — Loans secured by real estate occupied by the borrower for ongoing operations, non-owner occupied real estate leased to one or more tenants and vacant land that has been acquired for investment or future land development.
Real estate construction and land development — Real estate construction loans represent secured loans for the construction of business properties. Real estate construction loans often convert to a commercial real estate loan at the completion of the construction period. Land development loans represent secured development loans made to borrowers for the purpose of infrastructure improvements to vacant land to create finished marketable residential and commercial lots/land. Most land development loans are originated with the intention that the loans will be paid through the sale of developed lots/land by the developers within twelve months of the completion date. Land development loans at March 31, 2017 and December 31, 2016 were primarily comprised of loans to develop residential properties.
Residential mortgage — Loans secured by one- to four-family residential properties, generally with fixed interest rates for periods of fifteen years or less. The loan-to-value ratio at the time of origination is generally 80% or less. Residential mortgage loans with a loan-to-value ratio of more than 80% generally require private mortgage insurance.
Consumer installment — Loans to consumers primarily for the purpose of acquiring automobiles, recreational vehicles and personal watercraft and comprised primarily of indirect loans purchased from dealers. These loans consist of relatively small amounts that are spread across many individual borrowers.
Home equity — Loans and lines of credit whereby consumers utilize equity in their personal residence, generally through a second mortgage, as collateral to secure the loan.

25


Chemical Financial Corporation
Notes to Consolidated Financial Statements (Unaudited)
March 31, 2017



Commercial, commercial real estate, and 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 the Corporation's loans follows:
(Dollars in thousands)
 
Originated
 
Acquired(1)
 
Total Loans
 
March 31, 2017
 
 
 
 
 
 
 
Commercial loan portfolio:
 
 
 
 
 
 
 
Commercial
 
$
1,989,609

 
$
1,263,999

 
$
3,253,608

 
Commercial real estate
 
2,114,540

 
1,983,231

 
4,097,771

 
Real estate construction and land development
 
327,740

 
126,071

 
453,811

 
Subtotal
 
4,431,889

 
3,373,301

 
7,805,190

 
Consumer loan portfolio:
 
 
 
 
 
 
 
Residential mortgage
 
1,594,376

 
1,539,089

 
3,133,465

 
Consumer installment
 
1,342,063

 
138,994

 
1,481,057

 
Home equity
 
591,441

 
262,239

 
853,680

 
Subtotal
 
3,527,880

 
1,940,322

 
5,468,202

 
Total loans
 
$
7,959,769

 
$
5,313,623

 
$
13,273,392

(2