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Section 1: 10-Q (10-Q)

Document
 
 
 
 
 
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, 2019
¨
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.)
 
 
333 W. Fort Street, Suite 1800
Detroit, Michigan
 
48226
(Address of Principal Executive Offices)
 
(Zip Code)
(800) 867-9757
(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," "smaller reporting company" and "emerging growth company" in Rule 12b-2 of the Exchange Act. (Check one):
Large accelerated filer
 
þ
 
Accelerated filer
 
¨
Non-accelerated filer
 
¨ 
 
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
Securities registered pursuant to Section 12(b) of the Act:
Title of each class
Trading Symbol(s)
Name of each exchange on which registered
Common Stock
CHFC
The NASDAQ Stock Market
The number of shares outstanding of the registrant’s Common Stock, $1 par value, as of May 3, 2019, was 71,551,637 shares.
 
 
 
 
 



INDEX
Chemical Financial Corporation
Form 10-Q
Index to Form 10-Q
 
 
 
Page
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
     December 31, 2018
 
 
 
 
Consolidated Statements of Income for the Three Months Ended March 31, 2019 and 2018 (unaudited)
 
 
 
 
Consolidated Statements of Comprehensive Income for the Three Months Ended March 31, 2019 and 2018 (unaudited)
 
 
 
 
Consolidated Statements of Changes in Shareholders’ Equity for the Three Months Ended March 31, 2019 and 2018 (unaudited)
 
 
 
 
Consolidated Statements of Cash Flows for the Three Months Ended March 31, 2019 and 2018 (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 us. 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. These statements include, among others, statements related to: our belief that unrealized losses on our investment securities at March 31, 2019 were temporary in nature, our strategic plan to develop customer relationships that will drive core deposit growth and stability, management's belief that our commercial and commercial real estate loan portfolios are generally well-secured, management's opinion that our borrowing capacity could be expanded, the impact of projected changes in net interest income assuming changes to short-term market interest rates, statements regarding our risk exposure, statements related to our proposed merger with TCF Financial Corporation ("TCF"), including the expected timing of the consummation of the merger, as well as statements related to the anticipated effects on results of operations and financial condition from expected developments. 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 us, specifically, are also inherently uncertain.

Forward-looking statements are based upon current beliefs and expectations and involve substantial risks and uncertainties which change over time, are difficult to predict and are generally beyond our control. Accordingly, such 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. We undertake no obligation to update, amend or clarify forward-looking statements, whether as a result of new information, future events or otherwise, except as required by law. Risk factors include, without limitation:

our ability to attract and retain new commercial lenders and other bankers as well as key operations staff in light of competition for experienced employees in the banking industry;
operational and regulatory challenges associated with our information technology systems and policies and procedures in light of our rapid growth and systems conversion in 2018;
our ability to grow deposits;
our inability to execute on our strategy to expand investments and commercial lending;
our inability to efficiently manage our operating expenses;
the possibility that our previously announced merger with TCF does not close when expected or at all because required regulatory, shareholder or other approvals and other conditions to closing are not received or satisfied on a timely basis or at all;
the occurrence of any event, change or other circumstance that could give rise the to the right of Chemical, TCF or both to terminate the merger agreement;
the outcome of pending or threatened litigation or of matters before regulatory agencies, whether currently existing or commencing in the future, including litigation related to our proposed merger with TCF;
the diversion of management time from core banking functions due to merger-related issues;
potential difficulty in maintaining relationships with clients, employees or business partners as a result of our proposed merger with TCF;
the possibility that the anticipated benefits of our proposed merger with TCF, including anticipated cost savings and strategic gains, are not realized when expected or at all, including as a result of the impact of, or problems arising from, the integration of the two companies or as a result of the strength of the economy, competitive factors in the areas where Chemical and TCF do business, or as a result of other unexpected factors or events;
the impact of purchase accounting with respect to the proposed merger with TCF, or any change in the assumptions used regarding the assets purchased and liabilities assumed to determine their fair value;
diversion of management's attention from ongoing business operations and opportunities as a result of the proposed merger with TCF;
potential adverse reactions or changes to business or employee relationships, including those resulting from the announcement or completion of the proposed merger with TCF;

3


the outcome of pending or threatened litigation or of matters before regulatory agencies, whether currently existing or commencing in the future, including pending or future litigation related to our proposed merger with TCF;
economic conditions (both generally and in our markets) may be less favorable than expected, which could result in, among other things, a deterioration in credit quality, a reduction in demand for credit and a decline in real estate values;
a general decline in the real estate and lending markets, particularly in our market areas, could negatively affect our financial results;
increased cybersecurity risk, including potential network breaches, business disruptions, or financial losses;
increases in competitive pressure in the banking and financial services industry;
increased capital requirements, other regulatory requirements or enhanced regulatory supervision;
the inability to sustain revenue and earnings growth;
the inability to efficiently manage operating expenses;
current or future restrictions or conditions imposed by our regulators on our operations may make it more difficult for us to achieve our goals;
legislative or regulatory changes, including changes in accounting standards and compliance requirements, may adversely affect us;
changes in the interest rate environment may reduce margins or the volumes or values of the loans we make or have acquired; and
economic, governmental, or other factors may prevent the projected population, residential, and commercial growth in the markets in which we operate.

In addition, risk factors include, but are not limited to, the risk factors described in Item 1A of our Annual Report on Form 10-K for the year ended December 31, 2018 or disclosed in documents filed or furnished by the Corporation with or to the SEC after the filing of such Annual Report on Form 10-K. 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.

4


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, 2019
 
December 31, 2018
 
 
(Unaudited)
 
 
Assets
 
 
Cash and cash equivalents:
 
 
 
 
Cash and cash due from banks
 
$
206,372

 
$
228,527

Interest-bearing deposits with the Federal Reserve Bank and other banks and federal funds sold
 
311,204

 
267,312

Total cash and cash equivalents
 
517,576


495,839

Investment securities:
 
 
 
 
Carried at fair value
 
3,301,054

 
3,021,832

Held-to-maturity, at amortized cost (fair value of $627,615 and $618,672, respectively)
 
622,519

 
624,099

Total investment securities
 
3,923,573

 
3,645,931

Loans held-for-sale, at fair value
 
23,535

 
85,030

Loans
 
15,324,048

 
15,269,779

Allowance for loan losses
 
(110,284
)
 
(109,984
)
Net loans
 
15,213,764

 
15,159,795

Premises and equipment
 
122,452

 
123,442

Loan servicing rights, at fair value
 
64,701

 
71,013

Goodwill
 
1,134,568

 
1,134,568

Core deposit intangibles
 
27,195

 
28,556

Interest receivable and other assets
 
772,949

 
754,167

Total assets
 
$
21,800,313

 
$
21,498,341

Liabilities
 
 
 
 
Deposits:
 
 
 
 
Noninterest-bearing
 
$
3,835,427

 
$
3,809,252

Interest-bearing
 
12,226,572

 
11,784,030

Total deposits
 
16,061,999

 
15,593,282

Collateralized customer deposits
 
413,199

 
382,687

Short-term borrowings
 
1,740,000

 
2,035,000

Long-term borrowings
 
426,035

 
426,002

Interest payable and other liabilities
 
261,571

 
225,110

Total liabilities
 
18,902,804

 
18,662,081

Shareholders' equity
 
 
 
 
Preferred stock, no par value:
 
 
 
 
Authorized – 2,000,000 shares at 3/31/19 and 12/31/18, none issued
 

 

Common stock, $1.00 par value per share:
 
 
 
 
Authorized – 135,000,000 shares at 3/31/19 and12/31/18
 
 
 
 
Issued and outstanding – 71,550,673 shares at 3/31/19 and 71,460,119 shares at 12/31/18
 
71,551

 
71,460

Additional paid-in capital
 
2,209,860

 
2,209,761

Retained earnings
 
654,605

 
616,149

Accumulated other comprehensive loss
 
(38,507
)
 
(61,110
)
Total shareholders' equity
 
2,897,509

 
2,836,260

Total liabilities and shareholders' equity
 
$
21,800,313

 
$
21,498,341

See accompanying notes to Consolidated Financial Statements (unaudited).

5


Chemical Financial Corporation
Consolidated Statements of Income
(Unaudited)
 
 
 
Three Months Ended March 31,
(Dollars in thousands, except per share data)
 
2019
 
2018
Interest income
 
 
 
 
Interest and fees on loans
 
$
183,292

 
$
156,818

Interest on investment securities:
 
 
 
 
Taxable
 
20,501

 
12,419

Tax-exempt
 
7,170

 
5,556

Dividends on nonmarketable equity securities
 
1,738

 
1,901

Interest on deposits with the Federal Reserve Bank and other banks and federal funds sold
 
1,280

 
1,240

Total interest income
 
213,981

 
177,934

Interest expense
 
 
 
 
Interest on deposits
 
38,998

 
15,917

Interest on collateralized customer deposits
 
627

 
524

Interest on short-term borrowings
 
9,178

 
8,166

Interest on long-term borrowings
 
2,354

 
1,464

Total interest expense
 
51,157

 
26,071

   Net interest income
 
162,824

 
151,863

Provision for loan losses
 
2,059

 
6,256

Net interest income after provision for loan losses
 
160,765

 
145,607

Noninterest income
 
 
 
 
Service charges and fees on deposit accounts
 
7,967

 
9,434

Wealth management revenue
 
5,872

 
6,311

Other charges and fees for customer services
 
4,824

 
4,783

Net gain on sale of loans and other mortgage banking revenue
 
894

 
12,535

Net gain on sale of investment securities
 
87

 

Other
 
5,213

 
7,491

Total noninterest income
 
24,857

 
40,554

Operating expenses
 
 
 
 
Salaries, wages and employee benefits
 
60,017

 
55,557

Occupancy
 
8,277

 
8,011

Equipment and software
 
6,979

 
7,659

Outside processing and service fees
 
11,726

 
10,356

Merger expenses
 
5,424

 

Other
 
16,592

 
20,027

Total operating expenses
 
109,015

 
101,610

Income before income taxes
 
76,607

 
84,551

Income tax expense
 
13,665

 
12,955

Net income
 
$
62,942

 
$
71,596

Earnings per common share:
 
 
 
 
Basic
 
$
0.88

 
$
1.01

Diluted
 
$
0.87

 
$
0.99

See accompanying notes to Consolidated Financial Statements (unaudited).

6


Chemical Financial Corporation
Consolidated Statements of Comprehensive Income
(Unaudited)
 
 
 
Three Months Ended March 31,
(Dollars in thousands)
 
2019
 
2018
Net income
 
$
62,942

 
$
71,596

Other comprehensive income (loss), net of tax:
 
 
 
 
Unrealized holding gains (losses) on securities carried at fair value arising during the period
 
37,444

 
(27,606
)
Reclassification adjustment for gains included in net income
 
(87
)
 

Tax effect
 
(7,845
)
 
5,797

Net unrealized gains (losses) on securities carried at fair value, net of tax
 
29,512

 
(21,809
)
Unrealized gains (losses) on interest rate swaps designated as cash flow hedges
 
(7,552
)
 
7,963

Reclassification adjustment for (gains) losses included in net income
 
(1,288
)
 
242

Tax effect
 
1,856

 
(1,723
)
Net unrealized (losses) gains on interest rate swaps designated as cash flow hedges, net of tax
 
(6,984
)
 
6,482

Adjustment for pension and other postretirement benefits
 
95

 
142

Tax effect
 
(20
)
 
(30
)
Net adjustment for pension and other postretirement benefits
 
75

 
112

Other comprehensive income (loss), net of tax
 
22,603

 
(15,215
)
Total comprehensive income, net of tax
 
$
85,545

 
$
56,381


See accompanying notes to Consolidated Financial Statements (unaudited).

7


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
For the three months ended March 31, 2019
 
 
 
 
 
 
 
 
Beginning Balance
$
71,460

 
$
2,209,761

 
$
616,149

 
$
(61,110
)
 
$
2,836,260

Comprehensive income
 
 
 
 
62,942

 
22,603

 
85,545

Cash dividends declared and paid of $0.34 per share
 
 
 
 
(24,486
)
 
 
 
(24,486
)
Net shares issued under share-based compensation plans
91

 
(2,274
)
 
 
 
 
 
(2,183
)
Share-based compensation expense

 
2,373

 
 
 
 
 
2,373

Ending Balance
$
71,551

 
$
2,209,860

 
$
654,605

 
$
(38,507
)
 
$
2,897,509

For the three months ended March 31, 2018
 
 
 
 
 
 
 
 
Beginning Balance
$
71,207

 
$
2,203,637

 
$
419,403

 
$
(25,498
)
 
$
2,668,749

Cumulative effect adjustment of change in accounting policy, net of tax impact(1)
 
 
 
 
1,680

 
(341
)
 
1,339

Comprehensive income
 
 
 
 
71,596

 
(15,215
)
 
56,381

Cash dividends declared and paid of $0.28 per share
 
 
 
 
(20,075
)
 
 
 
(20,075
)
Net shares issued under share-based compensation plans
143

 
(3,486
)
 
 
 
 
 
(3,343
)
Share-based compensation expense

 
1,652

 
 
 
 
 
1,652

Ending Balance
$
71,350

 
$
2,201,803

 
$
472,604

 
$
(41,054
)
 
$
2,704,703

(1) 
Refer to Note 1, Basis of Presentation and Significant Accounting Policies, Note 6, Other Real Estate Owned and Repossessed Assets and Note 20, Accumulated Other Comprehensive Loss for further details on changes in accounting policy.

See accompanying notes to Consolidated Financial Statements (unaudited).

8


Chemical Financial Corporation
Consolidated Statements of Cash Flows
(Unaudited)
 
 
Three Months Ended March 31,
(Dollars in thousands)
 
2019
 
2018
Cash flows from operating activities
 
 
 
 
Net income
 
$
62,942

 
$
71,596

Adjustments to reconcile net income to net cash provided by operating activities:
 
 
 
 
Provision for loan losses
 
2,059

 
6,256

Gains on sales of loans
 
(6,150
)
 
(1,508
)
Proceeds from sales of loans
 
195,833

 
190,435

Valuation change in loans held-for-sale
 
2,074

 
700

Loans originated for sale, net of repayments
 
(130,320
)
 
(165,823
)
Net gains on sale of investment securities
 
(87
)
 

Net gains from sales/writedowns of other real estate and repossessed assets
 
(432
)
 
(71
)
Depreciation of premises and equipment
 
4,234

 
4,129

Amortization of intangible assets
 
1,361

 
1,438

Additions to loan servicing rights
 
(2,133
)
 
(1,967
)
Valuation change in loan servicing rights
 
8,445

 
(3,029
)
Net amortization of premiums and discounts on investment securities
 
5,892

 
4,298

Share-based compensation expense
 
2,373

 
1,652

Deferred income tax expense
 
3,735

 
5,356

Change in deferred tax valuation allowance
 

 
(49
)
Cash paid for amounts related to operating leases
 
(1,937
)
 

Net (increase) decrease in interest receivable and other assets
 
(34,462
)
 
4,436

Net increase (decrease) in interest payable and other liabilities
 
38,526

 
(9,060
)
Net cash provided by operating activities
 
151,953

 
108,789

Cash flows from investing activities
 
 
 
 
Investment securities - carried at fair value
 
 
 
 
Proceeds from maturities, calls and principal reductions
 
95,148

 
66,526

Proceeds from sales and redemptions
 
71,502

 

Purchases
 
(414,624
)
 
(431,670
)
Investment securities – held-to-maturity:
 
 
 
 
Proceeds from maturities, calls and principal reductions
 
2,859

 
8,744

Purchases
 
(975
)
 
(8,835
)
Net increase in loans
 
(60,847
)
 
(71,952
)
Proceeds from sales of other real estate and repossessed assets
 
2,295

 
3,351

Purchases of premises and equipment, net of disposals
 
(3,244
)
 
(3,484
)
Proceeds from returns of investment in equity method investments
 
110

 
266

Net cash used in investing activities
 
(307,776
)
 
(437,054
)
Cash flows from financing activities
 
 
 
 
Net increase in interest- and noninterest-bearing demand deposits and savings accounts
 
208,296

 
182,108

Net increase in time deposits
 
260,421

 
142,906

Net (decrease) increase in collateralized customer deposits and other short-term borrowings
 
(264,488
)
 
124,871

Cash dividends paid
 
(24,486
)
 
(20,075
)
Proceeds from directors’ stock plans and exercise of stock options, net of shares withheld
 
388

 
952

Cash paid for payroll taxes upon conversion of share-based awards
 
(2,571
)
 
(4,295
)
Net cash provided by financing activities
 
177,560

 
426,467

Net increase in cash and cash equivalents
 
21,737

 
98,202

Cash and cash equivalents at beginning of period
 
495,839

 
455,991

Cash and cash equivalents at end of period
 
$
517,576

 
$
554,193

Supplemental disclosures of cash flow information:
 
 
 
 
Interest paid
 
$
49,753

 
$
25,038

Net income tax refunds
 
(24,749
)
 
(441
)
Non-cash activities:
 
 
 
 
Loans transferred to other real estate and repossessed assets
 
4,877

 
2,484

Net transfer of loans held-for-sale to (from) loans held-for-investment
 
58

 
(3,307
)

See accompanying notes to Consolidated Financial Statements (unaudited).

9


Chemical Financial Corporation
Notes to Consolidated Financial Statements (Unaudited)
March 31, 2019





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 Detroit, Michigan, that operates through one commercial bank, Chemical Bank. Chemical Bank operates within Michigan, Ohio and Northern Indiana as a Michigan state-chartered commercial bank. Chemical Bank operates through an internal organizational structure of six regional banking units and offers a full range of traditional banking and fiduciary products and services to the residents and business customers in the Corporation'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 generally 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 net gain on sale of loans and other 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, Securities and Exchange Commission ("SEC") rules and interpretive releases and prevailing practices within the banking industry 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, 2018. 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. All significant income and expenses are recorded on the accrual basis. Intercompany accounts and transactions have been eliminated in preparing the Consolidated Financial Statements. Operating results for the three months ended March 31, 2019 are not necessarily indicative of the results that may be expected for the year ending December 31, 2019.

Proposed Merger with TCF Financial Corporation

Chemical and TCF Financial Corporation ("TCF") have entered into an Agreement and Plan of Merger, dated as of January 27, 2019, which we refer to as the merger agreement. Under the merger agreement, Chemical and TCF have agreed to combine their respective companies in a merger of equals, pursuant to which TCF will merge with and into Chemical, with Chemical continuing as the surviving entity, in a transaction we refer to as the merger. Immediately following the merger or at such later time as the parties may mutually agree, Chemical Bank will merge with and into TCF National Bank, with TCF National Bank as the surviving bank, in a transaction we refer to as the bank merger. The merger agreement was approved by the boards of directors of Chemical and TCF, and is subject to shareholder and regulatory approval and other customary closing conditions. The transaction is anticipated to close in late third quarter or early fourth quarter of 2019. The transaction is discussed in more detail in Note 2.

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, income taxes and the valuation of loan servicing rights. Actual results could differ from these estimates.


10


Chemical Financial Corporation
Notes to Consolidated Financial Statements (Unaudited)
March 31, 2019




Reclassifications

Certain amounts appearing in the Consolidated Financial Statements and notes thereto for prior periods have been reclassified to conform to the current presentation. The reclassification had no effect on net income or shareholders’ equity as previously reported, except in case of the cumulative effect adjustment of change in accounting policy as noted.

Recently Adopted Accounting Principles
Standard
Description
Adoption Date
Effect on the financial statements
ASU No. 2014-09 - Revenue from Contracts with Customers (Topic 606)

ASU No. 2016-08 - Principal versus Agent Considerations

ASU No. 2016-10 - Identifying Performance Obligations and Licensing

ASU No. 2016-12 - Narrow-scope Improvements and Practical Expedients ("Updates to Topic 606")

The core principle of the Updates to Topic 606 is that an entity recognizes revenue to depict the transfer of promised goods or services to customers in an amount that reflects the consideration to which the entity expects to be entitled in exchange for those goods or services. The standard is intended to clarify and converge the revenue recognition principles under GAAP and International Financial Reporting Standards and to streamline revenue recognition requirements in addition to expanding required revenue recognition disclosures.
January 1, 2018 under the modified retrospective method
A large majority of the Corporation's revenue is derived from net interest income, which is excluded from the scope of the guidance. Following detailed review of the Corporation's revenue streams not derived from net interest income on financial assets and liabilities, management identified the recognition of gains from other real estate sales financed by the Corporation to be in the scope of this amended guidance. Effective January 1, 2018, revenue for new seller financed other real estate owned sales is determined according to the Updates to Topic 606. If all qualifications are met, gains associated with the sales are recognized into income at the time of closing and therefore not deferred. The cumulative effect of the Updates to Topic 606 increased retained earnings by $1.2 million upon adoption. Additional required disclosures have been included in Note 15, Revenue from Contracts with Customers. The adoption is not expected to have a material impact on the Corporation's net income on an ongoing basis. Refer to Note 6, Other Real Estate Owned and Repossessed Assets, for further detail.
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 amended 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, changes in measurement is recognized in net income, (iii) simplifying 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 assumptions used to estimate the fair value of financial instruments measured at amortized cost; (v) requiring the use of exit price notion when measuring the fair value of financial instruments; (vi) requiring recognition of changes in the fair value related to instrument-specific credit risk in other comprehensive income if financial liabilities are measured at fair value, (vii) requiring separate presentation in financial statements by measurement category, and (viii) clarifying that an entity should evaluate the need for valuation allowance on deferred tax assets related to available-for-sale securities in combination with the entity’s other deferred tax assets.
January 1, 2018 using a modified retrospective approach with the exception of disclosure requirements which are adopted on a prospective basis
The Corporation identified available-for-sale investment securities qualifying as equity investments in the securities portfolio at January 1, 2018. The adoption resulted in recognizing the unrealized fair value related to the identified equity investments as a cumulative effect to retained earnings of $0.3 million. In addition, the Corporation has updated disclosures related to the fair value of financial instruments to the use of the exit price notion.

11


Chemical Financial Corporation
Notes to Consolidated Financial Statements (Unaudited)
March 31, 2019




Standard
Description
Adoption Date
Effect on the financial statements
ASU No. 2016-15, Statement of Cash Flows (Topic 230): Classification of Certain Cash Receipts as Cash Payments ("ASU 2016-15")
ASU 2016-15 was issued to reduce diversity in practice and prevent financial statement restatements by clarifying the presentation and classification of cash receipts and cash payments within the statement of cash flows. Cash flow issues include: debt prepayment or debt extinguishment costs, settlement of insurance claims, proceeds from the settlement of corporate-owned and bank-owned life insurance policies, distribution received from equity method investees, beneficial interests in securitization transactions and separately identifiable cash flows and application of the predominance principle.
January 1, 2018 using retrospective application
The adoption did not have a material effect on the presentation of our Consolidated Statements of Cash Flows, as current policies are either already in-line with the clarifications in the updated guidance, or the related cash flows are not material.
ASU No. 2017-07 - Compensation - Retirement Benefits (Topic 715): Improving the Presentation of Net Periodic Pension Cost ("ASU 2017-07")
ASU 2017-07 improves the income statement presentation of net periodic benefit cost for an entity's pension and postretirement plans. The standard requires employers to disaggregate current service costs from other components of net benefit cost and present it with other compensation cost. Additionally net benefit cost becomes eligible for capitalization.
January 1, 2018 using the retrospective transition method
The adoption did not have a material effect on the Consolidated Statements of Income during the year ended December 31, 2018.
ASU No. 2017-12, Derivatives and Hedging (Topic 815): Targeted Improvement to Account for Hedging Activities ("ASU 2017-12")
ASU 2017-12 eliminates the separate measurement of hedge ineffectiveness as well as the benchmark interest rate concept when applying hedge risk to variable-rate instruments. It also allows a company to elect to perform subsequent effectiveness assessments qualitatively if the initial quantitative hedge effectiveness assessment is found to be highly effective.
January 1, 2018
The early adoption resulted in a cumulative adjustment from opening retained earnings to accumulated other comprehensive income of $3 thousand, which represented all previously recognized hedge ineffectiveness.
ASU No. 2018-15 - Intangible-Goodwill and Other-Internal-Use Software (Subtopic 350-40): Customer's Accounting for Implementation Costs Incurred in a Cloud Computing Arrangement That Is a Service Contract ("ASU 2018-15")
ASU 2018-15 clarifies the accounting treatment for implementation costs for hosting arrangements that are service contracts. The amendments in this update align the requirements for capitalizing implementation costs incurred in a hosting arrangement that is a service contract with the requirements for capitalizing implementation costs incurred to develop or obtain internal use software in accordance with subtopic 350-40. Under this guidance costs for implementation activities during the development stage shall be capitalized. The said capitalized-costs shall be expensed over the term of the hosting arrangement.
Third quarter of 2018 applied retrospectively
The early adoption in the third quarter of 2018 did not have a material effect on the Consolidated Financial Statements.

12


Chemical Financial Corporation
Notes to Consolidated Financial Statements (Unaudited)
March 31, 2019




Standard
Description
Adoption Date
Effect on the financial statements
ASU No. 2016-02 - Leases (Topic 842)

ASU No. 2018-01 - Leases (Topic 842): Land Easement Practical Expedient for Transition to Topic 842

ASU No. 2018-10 - Codification Improvements to Topic 842, Leases

ASU No. 2018-11 - Leases (Topic 842): Targeted Improvements

ASU No. 2018-20 - Leases (Topic 842): Narrow Scope Improvements for Lessors

ASU No. 2019-01 - Leases (Topic 842): Codification Improvements

In February 2016, the FASB established Topic 842, Leases, by issuing Accounting Standards Update (ASU), No. 2016-02, which requires lessees to recognize leases on-balance sheet, lessors to classify leases as sales-type, direct financing, or operating, and disclose key information about leasing arrangements. Topic 842 was subsequently amended by ASU No. 2018-01, Land Easement Practical Expedient for Transition to Topic 842; ASU No. 2018-10, Codification Improvements to Topic 842, Leases; ASU No. 2018-11, Targeted Improvements; ASU No. 2018-20, Narrow Scope Improvements for Lessors; and ASU No. 2019-01, Leases (Topic 842): Codification Improvements.

This guidance provides that lessees will be required to recognize the following for all operating leases (with the exception of short-term leases): 1) a lease liability, which is the present value of a lessee's obligation to make lease payments, and 2) a right-of-use (ROU) asset, which is an asset that represents the lessee's right to use, or control the use of, a specified asset for the lase term. Lessor accounting under the new guidance remains largely unchanged as it is substantially equivalent to existing guidance for sales-type leases, direct financing leases and operating leases.

Upon adoption, a modified retrospective transition approach is required, applying the new standard to all leases existing at the date of initial application.

January 1, 2019
Upon adoption as of January 1, 2019, the Corporation elected certain practical expedients offered through the guidance, including foregoing the restatement of comparative periods, the use of hindsight, and the 'package of practical expedients' whereby it did not reassess (i) whether any expired or existing contracts contain leases, (ii) the lease classification for any expired or existing leases and (iii) initial direct costs for any existing leases.

In conjunction with the adoption, the Corporation elected to not recognize on its balance sheet, assets or liabilities related to short-term leases, of which the Corporation had none as of March 31, 2019.

The adoption had a material impact on the Consolidated Statements of Financial Position, but did not have a material impact on the Consolidated Statements of Income or Consolidated Statements of Cash Flows. At adoption on January 1, 2019, the Corporation recognized an operating lease ROU asset of $37.2 million and an operating lease liability of $38.2 million. Refer to Note 11, Leases, for further detail.
    
Effective during the three months ended 2019, the Corporation also adopted the following standards, none of which had a material impact to the Corporation's financial statements or financial statement disclosures:
Standard
 
Effective Date
2017-06
Plan Accounting: Defined Benefit Pension Plans (Topic 960)
 
January 1, 2019
2018-07
Compensation - Stock Compensation (Topic 718)
 
January 1, 2019
2018-08
Clarifying the Scope and the Accounting Guidance for Contributions Received and Contributions Made
 
January 1, 2019
2018-09
Codification Improvements
 
January 1, 2019
2018-16
Derivatives and Hedging (Topic 815): Inclusion of the Secured Overnight Financing Rate (SOFR) Overnight Index Swap (OIS) Rate as a Benchmark Interest Rate for Hedge Accounting Purposes
 
January 1, 2019

Note 2: Mergers and Acquisitions

Pending Merger with TCF Financial Corporation

On January 27, 2019, the Corporation entered into an Agreement and Plan of Merger with TCF under which, the companies will combine in an all-stock merger of equals transaction. Under the terms of the agreement, which was unanimously approved by the boards of directors of both companies, TCF will merge into Chemical, and the combined holding company and bank will operate under the TCF name and brand following the closing of the transaction. TCF is headquartered in Wayzata, Minnesota with reported assets of approximately $23.7 billion as of December 31, 2018.

Under the terms of the Merger Agreement, TCF shareholders will receive 0.5081 shares of Chemical common stock for each share of TCF common stock based on a fixed exchange ratio, equivalent to $21.58 per TCF share based on the closing price

13


as of January 25, 2019. Each outstanding share of 5.70% Series C Non-Cumulative Perpetual Preferred Stock of TCF will be converted into the right to receive one share of a newly created series of preferred stock of Chemical. Subject to receipt of regulatory approvals and satisfaction of other customary closing conditions, including approval of both Chemical and TCF shareholders, the transaction is anticipated to close in late third quarter or early fourth quarter of 2019.
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 liabilities and to determine fair value disclosures. Investment securities — carried at fair value, loans held-for-sale, loan servicing rights ("LSRs") 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 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 and government-sponsored enterprise debt obligations, including securities issued by the Federal Home Loan Bank ("FHLB"), 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 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 impaired loans, goodwill, core deposit 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 assets 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

14


Chemical Financial Corporation
Notes to Consolidated Financial Statements (Unaudited)
March 31, 2019




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: Investment securities are recorded at fair value on a recurring basis with the exception of those classified as held-to-maturity. 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 elected the fair value option for all 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: The Corporation has elected to account for all LSRs under the fair value measurement method. 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 risk management or 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, 2019 and December 31, 2018 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 risk management interest rate swaps designated as cash flow hedges and 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.


15


Chemical Financial Corporation
Notes to Consolidated Financial Statements (Unaudited)
March 31, 2019




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:

(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, 2019
 
 
 
 
 
 
 
Investment securities – carried at fair value:
 
 
 
 
 
 
 
Government and government-sponsored enterprises
$

 
$
387,390

 
$

 
$
387,390

State and political subdivisions

 
554,743

 

 
554,743

Residential mortgage-backed securities

 
202,240

 

 
202,240

Collateralized mortgage obligations

 
1,802,924

 

 
1,802,924

Corporate bonds

 
306,147

 

 
306,147

Trust preferred securities

 
47,610

 

 
47,610

Total investment securities – carried at fair value

 
3,301,054

 

 
3,301,054

Loans held-for-sale

 
23,535

 

 
23,535

Loan servicing rights

 

 
64,701

 
64,701

Derivative assets:
 
 
 
 
 
 
 
Customer-initiated derivatives

 
39,398

 

 
39,398

Interest rate lock commitments

 
1,758

 

 
1,758

Power Equity CD

 
881

 

 
881

Risk management derivatives

 
5,322

 

 
5,322

Total derivatives

 
47,359

 

 
47,359

Total assets at fair value
$

 
$
3,371,948

 
$
64,701

 
$
3,436,649

Derivative liabilities:
 
 
 
 
 
 
 
Customer-initiated derivatives

 
40,672

 

 
40,672

Forward contracts related to mortgage loans to be delivered for sale

 
653

 

 
653

Power Equity CD

 
881

 

 
881

Risk management derivatives

 
7,292

 

 
7,292

Total derivatives

 
49,498

 

 
49,498

Total liabilities at fair value
$

 
$
49,498

 
$

 
$
49,498




16


Chemical Financial Corporation
Notes to Consolidated Financial Statements (Unaudited)
March 31, 2019




(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
December 31, 2018
 
 
 
 
 
 
 
Investment securities – carried at fair value:
 
 
 
 
 
 
 
Government and government-sponsored enterprises
$

 
$
351,700

 
$

 
$
351,700

State and political subdivisions

 
516,286

 

 
516,286

Residential mortgage-backed securities

 
213,428

 

 
213,428

Collateralized mortgage obligations

 
1,601,298

 

 
1,601,298

Corporate bonds

 
293,063

 

 
293,063

Trust preferred securities

 
46,057

 

 
46,057

Total investment securities – carried at fair value

 
3,021,832

 

 
3,021,832

Loans held-for-sale

 
85,030

 

 
85,030

Loan servicing rights

 

 
71,013

 
71,013

Derivative assets:
 
 
 
 
 
 
 
Customer-initiated derivatives

 
26,680

 

 
26,680

Interest rate lock commitments

 
1,049

 

 
1,049

Power Equity CD

 
718

 

 
718

Risk management derivatives

 
10,148

 

 
10,148

Total derivatives

 
38,595

 

 
38,595

Total assets at fair value
$

 
$
3,145,457

 
$
71,013

 
$
3,216,470

Derivative liabilities:
 
 
 
 
 
 
 
Customer-initiated derivatives
$

 
$
27,664

 
$

 
$
27,664

Forward contracts related to mortgage loans to be delivered for sale

 
719

 

 
719

Power Equity CD

 
718

 

 
718

Risk management derivatives

 
3,278

 

 
3,278

Total derivatives

 
32,379

 

 
32,379

Total liabilities at fair value
$

 
$
32,379

 
$

 
$
32,379


There were no transfers between levels within the fair value hierarchy during the three months ended March 31, 2019 and 2018.

The following table summarizes the changes in Level 3 assets measured at fair value on a recurring basis.
 
 
Three Months Ended March 31,
 
 
2019
 
2018
(Dollars in thousands)
 
Loan servicing rights
Balance, beginning of period
 
$
71,013

 
$
63,841

Gains (losses):
 
 
 
 
Recorded in earnings (realized):
 
 
 
 
Recorded in "Net gain on sale of loans and other mortgage banking revenue"
 
(8,445
)
 
3,029

New originations
 
2,133

 
1,967

Balance, end of period
 
$
64,701


$
68,837



17


Chemical Financial Corporation
Notes to Consolidated Financial Statements (Unaudited)
March 31, 2019




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, 2019 and December 31, 2018.
 
The aggregate fair value, contractual balance (including accrued interest), and gain or loss for loans held-for-sale carried at fair value option was as follows:
(Dollars in thousands)
 
March 31,
2019
 
December 31,
2018
Aggregate fair value
 
$
23,535

 
$
85,030

Contractual balance
 
22,660

 
82,080

Unrealized gain
 
875

 
2,950

 
The total amount of gains from loans held-for-sale included in the Consolidated Statements of Income was as follows:
 
 
Three Months Ended March 31,
(Dollars in thousands)
 
2019
 
2018
Interest income(1)
 
$
633

 
$
376

Change in fair value(2)
 
(2,075
)
 
(700
)
Net gain on sales of loans(2)
 
6,150

 
1,508

Total included in earnings
 
$
4,708

 
$
1,184

(1) 
Included in "Interest and fees on loans" in the Consolidated Statements of Income.
(2) 
Included in "Net gain on sale of loans and other mortgage banking revenue" in the Consolidated Statements of Income.

Assets and Liabilities Recorded at Fair Value on a Nonrecurring Basis

Investment securities: Investment securities classified as held-to-maturity are recorded at fair value if the value is below amortized cost and the Corporation has determined that such unrealized loss is an other-than-temporary impairment. 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.
    
Impaired 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 collateral is further impaired below the appraised value, discounts ranging between 20% and 30% 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, 2019 and December 31, 2018, no goodwill was impaired.

18


Chemical Financial Corporation
Notes to Consolidated Financial Statements (Unaudited)
March 31, 2019




Core deposit intangibles: Core deposit intangible assets are recorded at fair value when initially recorded. Subsequently, core deposit 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 impairment is identified, the Corporation classifies the impaired core deposit intangible asset subject to nonrecurring fair value measurements as Level 3 valuations. At March 31, 2019 and December 31, 2018, there was no impairment identified for core deposit intangible assets.
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 20% and 30% of the appraised value are used depending on the nature of the property and the age of the most recent appraisal.
Disclosure of Nonrecurring Basis Fair Value Measurements
Certain assets may be required to be measured at fair value on a nonrecurring basis. The carrying value of these assets represent end of period values, which approximate the fair value measurements that occurred on the various measurement dates during the period. For assets measured at fair value on a nonrecurring basis, quantitative disclosures about fair value measurements for each major category of assets follow:
(Dollars in thousands)
 
Significant Unobservable
Inputs (Level 3)
March 31, 2019
 
 
Impaired loans
 
$
62,118

Other real estate and repossessed assets
 
1,360

Total
 
$
63,478

December 31, 2018
 
 
Impaired loans
 
$
63,247

Other real estate and repossessed assets
 
883

Total
 
$
64,130

There were no liabilities recorded at fair value on a nonrecurring basis at either March 31, 2019 or December 31, 2018.
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, 2019
 
Valuation Technique
 
Significant Unobservable Inputs
 
Range
Impaired loans
 
$
62,118

 
Appraisal of collateral
 
Discount for type of collateral and age of appraisal
 
20%-30%
Other real estate and repossessed assets
 
1,360

 
Appraisal of property
 
Discount for type of property and age of appraisal
 
20%-30%
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. 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 the exit-price notion, using unobservable inputs requiring management's judgment to

19


Chemical Financial Corporation
Notes to Consolidated Financial Statements (Unaudited)
March 31, 2019




estimate the fair values of its financial instruments, which is considered a Level 3 valuation. This Level 3 valuation is affected by the assumptions made and, accordingly, is not necessarily indicative of amounts that would 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.
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 are disclosed in the table below.
 
Level in Fair Value Measurement
Hierarchy
 
March 31, 2019
 
December 31, 2018
(Dollars in thousands)
 
Carrying
Amount
 
Fair
Value
 
Carrying
Amount
 
Fair
Value
Financial assets:
 
 
 
 
 
 
 
 
 
Investment securities:
 
 
 
 
 
 
 
 
 
Held-to-maturity
Level 2
 
$
622,019

 
$
627,165

 
$
623,599

 
$
618,232

Held-to-maturity
Level 3
 
500

 
450

 
500

 
440

Net loans(1)
Level 3
 
15,213,764

 
15,084,122

 
15,159,795

 
14,907,789

Financial liabilities:
 
 
 
 
 
 
 
 
 
Time deposits
Level 2
 
$
4,334,669

 
$
4,315,319

 
$
4,074,248

 
$
4,041,212

Collateralized customer deposits
Level 2
 
413,199

 
413,075

 
382,687

 
382,370

Short-term borrowings
Level 2
 
1,740,000

 
1,739,883

 
2,035,000

 
2,034,719

Long-term borrowings
Level 2
 
426,035

 
424,613

 
426,002

 
423,258

(1) 
Included $62.1 million and $63.2 million of impaired loans recorded at fair value on a nonrecurring basis at March 31, 2019 and December 31, 2018, respectively.

The short-term nature of certain assets and liabilities result in their carrying value approximating fair value. These include cash and cash equivalents, nonmarketable equity securities, interest receivable, bank owned life insurance, deposits without defined maturities and interest payable.



20


Chemical Financial Corporation
Notes to Consolidated Financial Statements (Unaudited)
March 31, 2019




Note 4: Investment Securities
The following is a summary of the amortized cost and fair value of investment securities carried at fair value and investment securities held-to-maturity at March 31, 2019 and December 31, 2018:
 
 
Investment Securities Carried at Fair Value
(Dollars in thousands)
 
Amortized
Cost
 
Unrealized
Gains
 
Unrealized
Losses
 
Fair
Value
March 31, 2019
 
 
 
 
 
 
 
 
Debt securities
 
 
 
 
 
 
 
 
Government and government-sponsored enterprises
 
$
389,657

 
$
357

 
$
2,624

 
$
387,390

State and political subdivisions
 
545,823

 
10,100

 
1,180

 
554,743

Residential mortgage-backed securities
 
203,692

 
836

 
2,288

 
202,240

Collateralized mortgage obligations
 
1,812,649

 
5,943

 
15,668

 
1,802,924

Corporate bonds
 
312,112

 
205

 
6,170

 
306,147

Trust preferred securities
 
47,577

 
555

 
522

 
47,610

Total
 
$
3,311,510

 
$
17,996

 
$
28,452

 
$
3,301,054

December 31, 2018
 
 
 
 
 
 
 
 
Debt securities
 
 
 
 
 
 
 
 
Government and government-sponsored enterprises
 
$
354,342

 
$
713

 
$
3,355

 
$
351,700

State and political subdivisions
 
523,178

 
1,141

 
8,033

 
516,286

Residential mortgage-backed securities
 
216,990

 
261

 
3,823

 
213,428

Collateralized mortgage obligations
 
1,623,415

 
2,903

 
25,020

 
1,601,298

Corporate bonds
 
304,243

 
259

 
11,439

 
293,063

Trust preferred securities
 
47,477

 
324

 
1,744

 
46,057

Total
 
$
3,069,645

 
$
5,601

 
$
53,414

 
$
3,021,832


 
 
Investment Securities Held-to-Maturity
(Dollars in thousands)
 
Amortized
Cost
 
Unrealized
Gains
 
Unrealized
Losses
 
Fair
Value
March 31, 2019
 
 
 
 
 
 
 
 
State and political subdivisions
 
$
622,019

 
$
7,392

 
$
2,246

 
$
627,165

Trust preferred securities
 
500

 

 
50

 
450

Total
 
$
622,519

 
$
7,392

 
$
2,296

 
$
627,615

December 31, 2018
 
 
 
 
 
 
 
 
State and political subdivisions
 
$
623,599

 
$
2,548

 
$
7,915

 
$
618,232

Trust preferred securities
 
500

 

 
60

 
440

Total
 
$
624,099

 
$
2,548

 
$
7,975

 
$
618,672


Investment securities are classified at the time they are acquired as either available-for-sale, held-to-maturity or carried at fair value based upon various factors, including asset/liability management strategies, liquidity and profitability objectives and regulatory requirements. Debt securities classified as available-for-sale are recorded at fair value. Investment securities carried at fair value may be sold prior to maturity based upon asset/liability management decisions. Unrealized gains or losses on available-for-sale debt securities are recorded as part of accumulated other comprehensive income in stockholders' equity. Held-to-maturity securities are carried at amortized cost, adjusted for amortization of premiums or accretion of discounts.

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).


21


Chemical Financial Corporation
Notes to Consolidated Financial Statements (Unaudited)
March 31, 2019




Proceeds from sales of investment securities carried at fair value and the associated gains and losses recorded in earnings are listed below:
 
 
Three Months Ended March 31,
(Dollars in thousands)
 
2019
 
2018
Proceeds
 
$
71,502

 
$

Gross gains
 
552

 

Gross losses
 
(465
)
 


The following is a summary of the amortized cost and fair value of investment securities at March 31, 2019, by maturity, for both carried at fair value and held-to-maturity. 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, 2019
(Dollars in thousands)
 
Amortized
Cost
 
Fair Value
Investment Securities Carried at Fair Value:
 
 
 
 
Due in one year or less
 
$
47,145

 
$
47,088

Due after one year through five years
 
85,636

 
84,973

Due after five years through ten years
 
537,851

 
530,965

Due after ten years
 
2,640,878

 
2,638,028

Total
 
$
3,311,510

 
$
3,301,054

Investment Securities Held-to-Maturity:
 
 
 
 
Due in one year or less
 
$
55,696

 
$
55,676

Due after one year through five years
 
229,594

 
230,314

Due after five years through ten years
 
162,812

 
165,238

Due after ten years
 
174,417

 
176,387

Total
 
$
622,519

 
$
627,615

Securities with a carrying value of $971.1 million and $1.05 billion were pledged at March 31, 2019 and December 31, 2018, respectively, to secure borrowings and deposits.    
At March 31, 2019 and December 31, 2018, 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.

22


Chemical Financial Corporation
Notes to Consolidated Financial Statements (Unaudited)
March 31, 2019




The following schedule summarizes information for debt securities both carried at fair value and held-to-maturity with gross unrealized losses at March 31, 2019 and December 31, 2018, aggregated by category and length of time that individual securities have been in a continuous unrealized loss position. As of March 31, 2019, the Corporation's securities portfolio consisted of 2,087 securities, 879 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, 2019
 
 
 
 
 
 
 
 
 
 
 
 
Government and government-sponsored enterprises
 
$
120,690

 
$
937

 
$
112,261

 
$
1,687

 
$
232,951

 
$
2,624

State and political subdivisions
 
15,474

 
32

 
424,934

 
3,394

 
440,408

 
3,426

Residential mortgage-backed securities
 
1,217

 
5

 
120,950

 
2,283

 
122,167

 
2,288

Collateralized mortgage obligations
 
170,414

 
1,093

 
873,914

 
14,575

 
1,044,328

 
15,668

Corporate bonds
 
117,903

 
1,003

 
162,324

 
5,167

 
280,227

 
6,170

Trust preferred securities
 
25,034

 
433

 
2,752

 
139

 
27,786

 
572

Total
 
$
450,732


$
3,503

 
$
1,697,135

 
$
27,245

 
$
2,147,867

 
$
30,748

December 31, 2018
 
 
 
 
 
 
 
 
 
 
 
 
Government and government-sponsored enterprises
 
$
167,164

 
$
1,672

 
$
62,200

 
$
1,683

 
$
229,364

 
$
3,355

State and political subdivisions
 
190,551

 
1,932

 
657,327

 
14,016

 
847,878

 
15,948

Residential mortgage-backed securities
 
20,679

 
85

 
123,757

 
3,738

 
144,436

 
3,823

Collateralized mortgage obligations
 
496,356

 
5,268

 
656,208

 
19,752

 
1,152,564

 
25,020

Corporate bonds
 
169,431

 
5,888

 
103,688

 
5,551

 
273,119

 
11,439

Trust preferred securities
 
34,623

 
1,640

 
2,725

 
164

 
37,348

 
1,804

Total
 
$
1,078,804

 
$
16,485

 
$
1,605,905

 
$
44,904

 
$
2,684,709

 
$
61,389

    
An assessment is performed quarterly by the Corporation to determine whether unrealized losses in its debt 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 debt security, as of March 31, 2019, represented an 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 debt securities at March 31, 2019 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, 2019, the Corporation did not have the intent to sell any of its impaired debt securities and believed that it was more-likely-than-not that the Corporation will not have to sell any such debt securities before a full recovery of amortized cost. Accordingly, at March 31, 2019, the Corporation believed the impairments in its debt securities portfolio were temporary in nature. However, there is no assurance that OTTI may not occur in the future.
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.


23


Chemical Financial Corporation
Notes to Consolidated Financial Statements (Unaudited)
March 31, 2019




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 (owner-occupied), non-owner occupied real estate leased to one or more tenants (non-owner occupied) and vacant land that has been acquired for investment or future land development (vacant land).

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, 2019 and December 31, 2018 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 watercraft and comprised primarily of indirect loans purchased from dealers. These loans generally 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.

Loans held-for-sale, comprised of fixed-rate residential mortgage and construction loans, were $23.5 million at March 31, 2019 and $85.0 million at December 31, 2018. The Corporation sold loans totaling $195.8 million and $190.4 million during the three months ended March 31, 2019 and 2018, respectively.


24


Chemical Financial Corporation
Notes to Consolidated Financial Statements (Unaudited)
March 31, 2019




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, 2019
 
 
 
 
 
 
Commercial loan portfolio:
 
 
 
 
 
 
Commercial
 
$
3,428,432

 
$
625,640

 
$
4,054,072

Commercial real estate:
 
 
 
 
 
 
Owner-occupied
 
1,536,956

 
513,474

 
2,050,430

Non-owner occupied
 
1,961,863

 
774,457

 
2,736,320

Vacant land
 
36,454

 
11,965

 
48,419

Total commercial real estate
 
3,535,273

 
1,299,896

 
4,835,169

Real estate construction and land development
 
592,289

 
30,301

 
622,590

Subtotal
 
7,555,994

 
1,955,837

 
9,511,831

Consumer loan portfolio:
 
 
 
 
 
 
Residential mortgage
 
2,542,943

 
1,006,674

 
3,549,617

Consumer installment
 
1,440,193

 
64,248

 
1,504,441

Home equity
 
603,144

 
155,015

 
758,159

Subtotal
 
4,586,280

 
1,225,937

 
5,812,217

Total loans(2)
 
$
12,142,274

 
$
3,181,774

 
$
15,324,048

December 31, 2018
 
 
 
 
 
 
Commercial loan portfolio:
 
 
 
 
 
 
Commercial
 
$
3,287,087

 
$
715,481

 
$
4,002,568

Commercial real estate:
 
 
 
 
 
 
Owner-occupied
 
1,513,532

 
546,025

 
2,059,557

Non-owner occupied
 
1,966,330

 
818,690

 
2,785,020

Vacant land
 
40,295

 
27,215

 
67,510

Total commercial real estate
 
3,520,157

 
1,391,930

 
4,912,087

Real estate construction and land development
 
566,726

 
30,486

 
597,212

Subtotal
 
7,373,970

 
2,137,897

 
9,511,867

Consumer loan portfolio:
 
 
 
 
 
 
Residential mortgage
 
2,407,305

 
1,051,361

 
3,458,666

Consumer installment
 
1,451,352

 
69,722

 
1,521,074

Home equity
 
612,129

 
166,043

 
778,172

Subtotal
 
4,470,786

 
1,287,126

 
5,757,912

Total loans(2)
 
$
11,844,756

 
$
3,425,023

 
$
15,269,779

(1) 
Loans acquired in the Talmer, Lake Michigan, Monarch, Northwestern and OAK acquisitions were elected to be accounted for under ASC 310-30, Loans and Debt Securities Acquired with Deteriorated Credit Quality (ASC 310-30), by analogy.
(2) 
Reported net of deferred costs totaling $22.2 million and $19.7 million at March 31, 2019 and December 31, 2018, respectively.
    
The Corporation acquired loans at fair value as of the acquisition date, which includes loans acquired in the acquisitions of Talmer Bancorp, Inc. ("Talmer"), Lake Michigan Financial Corporation ("Lake Michigan"), Monarch Community Bancorp, Inc. ("Monarch"), Northwestern Bancorp, Inc. ("Northwestern") and O.A.K. Financial Corporation ("OAK"). Loans acquired in each of these transactions ("Acquired Loans") were elected to be accounted for under ASC 310-30, by analogy, which recognizes the expected shortfall of expected future cash flows, as compared to the contractual amount due, as nonaccretable difference. Any excess of the net present value of expected future cash flows over the acquisition date fair value is recognized as the accretable discount, or accretable yield. The accretable yield is recognized over the expected remaining life of the acquired loans on a pool basis. In the event an acquired loan is renewed or extended, the loan continues to be accounted for as an acquired loan on a pool basis in accordance with ASC 310-30.


25


Chemical Financial Corporation
Notes to Consolidated Financial Statements (Unaudited)
March 31, 2019




Activity for the accretable yield, which includes contractually due expected cash flows 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:
(Dollars in thousands)
 
Talmer
 
Lake Michigan
 
Monarch
 
North-western
 
OAK
 
Total
Three Months Ended March 31, 2019
 
 
 
 
 
 
 
 
 
 
 
 
Balance at beginning of period
 
$
505,332

 
$
73,132

 
$
17,832

 
$
41,455

 
$
9,574

 
$
647,325

Accretion recognized in interest income
 
(38,031
)
 
(5,551
)
 
(774
)
 
(3,420
)
 
(1,369
)
 
(49,145
)
Net reclassification (to) from nonaccretable difference(1)
 
2,412

 
1,414

 
(91
)
 
609

 
140

 
4,484

Balance at end of period
 
$
469,713

 
$
68,995

 
$
16,967

 
$
38,644

 
$
8,345

 
$
602,664