10-K 1 chfc20161231-10xk.htm 10-K-2016 Document
 
 
 
 
 
UNITED STATES SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549 
FORM 10-K 

þ Annual Report Pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934 for the fiscal year ended December 31, 2016.
or
¨ 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)
Securities Registered Pursuant to Section 12(b) of the Act:
Common Stock, $1 Par Value Per Share
 
The NASDAQ Stock Market
(Title of Class)
 
(Name of each exchange on which registered)
Securities Registered Pursuant to Section 12(g) of the Act: None
Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act. Yes þ No ¨
Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Act. Yes ¨ No þ
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 Web site, 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 if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of registrant's knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K. þ
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 ¨
 
Smaller reporting company ¨
 
 
 
 
(Do not check if a smaller reporting company)
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).    Yes  ¨    No  þ
The aggregate market value of the registrant's outstanding voting common stock held by non-affiliates of the registrant as of June 30, 2016, determined using the closing price of the registrant's common stock on June 30, 2016 of $37.29 per share, as reported on The NASDAQ Stock Market®, was $1.35 billion. The number of shares outstanding of the registrant's Common Stock, $1 par value per share, as of February 27, 2017, was 71,068,446 shares.
DOCUMENTS INCORPORATED BY REFERENCE
Portions of the definitive Proxy Statement of Chemical Financial Corporation for the April 26, 2017 annual shareholders' meeting are incorporated by reference into Part III of this Form 10-K.
 
 
 
 
 



CHEMICAL FINANCIAL CORPORATION
ANNUAL REPORT ON FORM 10-K
Table of Contents
 
 
 
Page
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 

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 Chemical Financial Corporation (Corporation). Words such as "anticipates," "believes," "estimates," "expects," "forecasts," "intends," "is likely," "judgment," "opinion," "plans," "predicts," "probable," "projects," "should," "trend," "will," and variations of such words and similar expressions are intended to identify such forward-looking statements. Such statements are based upon current beliefs and expectations and involve substantial risks and uncertainties which could cause actual results to differ materially from those expressed or implied by such forward-looking statements. These statements include, among others, statements related to 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, 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, the impact of acquisition transactions on the Corporation's business, 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 this report. 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.
Item 1. Business.
General Business
Chemical Financial Corporation (Corporation), headquartered in Midland, Michigan, is a financial holding company registered under the Bank Holding Company Act of 1956 and incorporated in the State of Michigan. At December 31, 2016, the Corporation's consolidated total assets, loans, deposits and shareholders' equity were $17.36 billion, $12.99 billion, $12.87 billion and $2.58 billion, respectively, and the Corporation employed approximately 3,300 full-time equivalent employees. For more information about the Corporation's financial condition and results of operations, see the consolidated financial statements and related notes included in Part II, Item 8 of this report.
The Corporation was incorporated in August 1973. On June 30, 1974, the Corporation acquired Chemical Bank and Trust Company (CBT) pursuant to a reorganization in which the former shareholders of CBT became shareholders of the Corporation. CBT's name was changed to Chemical Bank on December 31, 2005. In addition to the acquisition of CBT, the Corporation has acquired 25 community banks and 36 other branch bank offices through December 31, 2016. The Corporation's most recent transactions include the merger with Talmer Bancorp, Inc. (Talmer) during the third quarter of 2016, the acquisitions of Lake Michigan Financial Corporation (Lake Michigan) and Monarch Community Bancorp, Inc. (Monarch) during the second quarter of 2015 and the acquisition of Northwestern Bancorp, Inc. (Northwestern) during the fourth quarter of 2014. These transactions are discussed in more detail under the subheading "Mergers, Acquisitions and Branch Closings" included in Management's Discussion and Analysis of Financial Condition and Results of Operations.
The Corporation's business is concentrated in a single industry segment - commercial banking. The Corporation conducts its commercial banking activity through a single commercial bank subsidiary, Chemical Bank. Chemical Bank offers a full range of traditional banking and fiduciary products and services to residents and business customers in the bank's geographical market areas. These include business and personal checking accounts, savings and individual retirement accounts, time deposit instruments, electronically accessed banking products, residential and commercial real estate financing, commercial lending, consumer financing, debit cards, safe deposit box services, money transfer services, automated teller machines, access to insurance and investment products, corporate and personal wealth management services, mortgage banking and other banking services. Chemical Bank operated through an internal organizational structure of seven regional banking units as of December 31, 2016. In addition, the Corporation owns, directly or indirectly, various non-bank operating and non-operating subsidiaries.
The principal markets for the Corporation's products and services are the communities in Michigan, Northeast Ohio and Northern Indiana where Chemical Bank's branches are located and the areas surrounding these communities. As of December 31, 2016, the Corporation and Chemical Bank served these markets through 249 banking offices. In addition to the banking offices, Chemical Bank operated eight loan production offices and over 272 automated teller machines, both on- and off-bank premises, as of December 31, 2016.
A summary of the composition of the Corporation's loan portfolio at December 31, 2016, 2015 and 2014 was as follows:
 
December 31,
 
2016
 
2015
 
2014
 
Amount
 
Percent of Total
 
Amount
 
Percent of Total
 
Amount
 
Percent of Total
 
(Dollars in thousands)
Composition of Loans:
 
 
 
 
 
 
 
 
 
 
 
Commercial
$
3,217,300

 
25
%
 
$
1,905,879

 
26
%
 
$
1,354,881

 
24
%
Commercial real estate
3,973,140

 
30

 
2,112,162

 
29

 
1,557,648

 
27

Real estate construction and land development
403,772

 
3

 
232,076

 
3

 
171,495

 
3

Residential mortgage
3,086,474

 
24

 
1,429,636

 
20

 
1,110,390

 
19

Consumer installment
1,433,884

 
11

 
877,457

 
12

 
829,570

 
15

Home equity
876,209

 
7

 
713,937

 
10

 
664,246

 
12

Total composition of loans
$
12,990,779

 
100
%
 
$
7,271,147

 
100
%
 
$
5,688,230

 
100
%
The Corporation's loan portfolio totaled $12.99 billion at December 31, 2016, compared to $7.27 billion and $5.69 billion at December 31, 2015 and 2014, respectively. The Corporation's loan portfolio increased $5.72 billion, or 78.7%, during 2016, with commercial loans increasing $1.31 billion, or 68.8%, commercial real estate loans increasing $1.86 billion, or 88.1%, real estate construction and land development increasing $171.7 million, or 74.0%, residential mortgage loans increasing $1.66 billion, or 115.9%, consumer installment loans increasing $556.4 million, or 63.4% and home equity loans increasing $162.3 million, or 22.7%. The growth in loans during 2016 was attributable to $4.88 billion of loans acquired in the merger with Talmer and $837.6 million of organic loan growth. The Corporation's loan portfolio increased $1.58 billion, or 27.8%, during 2015, with the increase

4


attributable to $1.11 billion of loans acquired in the Lake Michigan and Monarch transactions and $476 million of organic loan growth. The Corporation's organic loan growth during 2016 and 2015 was the result of a combination of the Corporation increasing its loan market share in its lending markets and improving economic conditions in the Corporation's geographical concentrations. The Corporation's loan portfolio is not concentrated in any one industry.
The principal source of revenue for the Corporation is interest income and fees on loans, which accounted for 72%, 73% and 72% of total revenue in 2016, 2015 and 2014, respectively. No material part of the business of the Corporation or Chemical Bank is dependent upon a single customer or very few customers. Interest income on investment securities, services charges and fees on deposit accounts, wealth management revenue and mortgage banking are also significant sources of revenue. Interest income on investment securities accounted for 4%, 5% and 6% of total revenue in 2016, 2015 and 2014, respectively. Services charges and fees on deposit accounts accounted for 5%, 7% and 8% of total revenue in 2016, 2015 and 2014, respectively. Wealth management revenue accounted for 4% of total revenue in 2016 and 6% of total revenue in both 2015 and 2014. Mortgage banking revenue accounted for 4% of total revenue in 2016 and 2% of total revenue in both 2015 and 2014.
The Corporation offers services through the Wealth Management department of Chemical Bank. These services include trust, investment management and custodial services; financial and estate planning; and retirement and employee benefit programs. The Wealth Management department earns revenue largely from fees based on the market value of those assets under management, which can fluctuate as the market fluctuates. The Wealth Management department had assets under custodial and management arrangements of $4.41 billion, $3.71 billion and $3.73 billion as of December 31, 2016, 2015 and 2014, respectively. The Wealth Management department also sells investment products (largely annuity products and mutual funds) through its Chemical Financial Advisors program. Customer assets within the Chemical Financial Advisors program were $1.15 billion, $872.9 million and $877.8 million as of December 31, 2016, 2015 and 2014, respectively.
The nature of the business of Chemical Bank is such that it holds title to numerous parcels of real property. These properties are primarily owned for branch offices. However, the Corporation and Chemical Bank may hold properties for other business purposes, as well as on a temporary basis for properties taken in, or in lieu of, foreclosure to satisfy loans in default. Under current state and federal laws, present and past owners of real property may be exposed to liability for the cost of clean up of contamination on or originating from those properties, even if they are wholly innocent of the actions that caused the contamination. These liabilities could exceed the value of the contaminated property and could be material to the financial condition of the Corporation.
Competition
The business of banking is highly competitive. The principal methods of competition for financial services are price (interest rates paid on deposits, interest rates charged on loans and fees charged for services) and service (convenience and quality of services rendered to customers). In addition to competition from other commercial banks, banks face significant competition from non-bank financial institutions, including savings and loan associations, credit unions, finance companies, insurance companies and investment firms. Credit unions and finance companies are particularly significant competitors in the consumer loan market. Banks also compete for deposits with a broad range of other types of investments, including mutual funds and annuities.
Supervision and Regulation
The Corporation and Chemical Bank are subject to extensive supervision and regulation under various federal and state laws. The supervisory and regulatory framework is intended primarily for the protection of depositors and the banking system as a whole, and not for the protection of shareholders and creditors.
Banks are subject to a number of federal and state laws and regulations that have a material impact on their business. These include, among others, minimum capital requirements, state usury laws, state laws relating to fiduciaries, the Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010 (Dodd-Frank Act), the Truth in Lending Act, the Truth in Savings Act, the Equal Credit Opportunity Act, the Fair Housing Act, the Fair Credit Reporting Act, the Servicemembers Civil Relief Act, the Expedited Funds Availability Act, the Community Reinvestment Act, the Real Estate Settlement Procedures Act, the U.S.A. PATRIOT Act, the Bank Secrecy Act, the Foreign Account Tax Compliance Act, Office of Foreign Assets Controls regulations, electronic funds transfer laws, redlining laws, predatory lending laws, laws prohibiting unfair and deceptive acts or practices, antitrust laws, environmental laws, anti-money laundering laws and privacy laws. These laws and regulations can have a significant effect on the operating and financial results of banks.
A summary of significant elements of some of the laws, regulations and regulatory policies applicable to the Corporation and Chemical Bank follows below. The descriptions are qualified in their entirety by reference to the full text of the statutes, regulations and policies that are described. These statutes, regulations and policies are continually subject to review by Congress, state legislatures and federal and state regulatory agencies. A change in statutes, regulations or regulatory policies applicable to the Corporation and Chemical Bank could have a material effect on the business of the Corporation and Chemical Bank.

5


Regulatory Agencies
The Corporation is a legal entity separate and distinct from Chemical Bank. The Corporation is regulated by the Federal Reserve Board (FRB) as a financial holding company and a bank holding company under the Bank Holding Company Act of 1956 (BHC Act). The BHC Act provides for general regulation of financial holding companies by the FRB and functional regulation of banking activities by banking regulators. The Corporation is also under the jurisdiction of the Securities and Exchange Commission (SEC) and is subject to the disclosure and regulatory requirements of the Securities Act of 1933 and the Securities Exchange Act of 1934. The Corporation's common stock is traded on The NASDAQ Stock Market® (NASDAQ) under the symbol CHFC and is subject to the NASDAQ Listing Rules.
Chemical Bank is chartered by the State of Michigan and supervised, examined and regulated by the Michigan Department of Insurance and Financial Services (DIFS). Chemical Bank, as a member of the Federal Reserve System, is also supervised, examined and regulated by the FRB. Chemical Bank is also subject to regulation by the Consumer Financial Protection Bureau, which has responsibility for enforcing the principal federal consumer protection laws, such as the Truth in Lending Act, the Equal Credit Opportunity Act, and Real Estate Settlement Procedures Act, and the Truth in Savings Act, among others, for institutions that have assets in excess of $10 billion. Deposits of Chemical Bank are insured by the Federal Deposit Insurance Corporation (FDIC) to the maximum extent provided by law.
Bank Holding Company Activities
In general, the BHC Act limits the business of bank holding companies to banking, managing or controlling banks and other activities that the FRB has determined to be closely related to the business of banking. In addition, bank holding companies that qualify and elect to be financial holding companies may engage in any activities that are financial in nature or complementary to a financial activity and do not pose a substantial risk to the safety and soundness of depository institutions or the financial system without prior approval of the FRB. Activities that are financial in nature include securities underwriting and dealing, insurance underwriting and making merchant banking investments.
In order for the Corporation to maintain financial holding company status, both the Corporation and Chemical Bank must be categorized as "well-capitalized" and "well-managed" under applicable regulatory guidelines. If the Corporation or Chemical Bank ceases to meet these requirements, the FRB may impose corrective capital and/or managerial requirements and place limitations on the Corporation's ability to conduct the broader financial activities permissible for financial holding companies. In addition, if the deficiencies persist, the FRB may require the Corporation to divest of Chemical Bank. The Corporation and Chemical Bank were both categorized as "well-capitalized" and "well-managed" as of December 31, 2016.
The BHC Act requires prior approval of the FRB for any direct or indirect acquisition of more than 5% of the voting shares of a commercial bank or its parent holding company by the Corporation. In reviewing applications seeking approval of merger and acquisition transactions, the bank regulatory authorities will consider, among other things, the competitive effect and public benefits of the transactions, the capital position of the combined organization, the Corporation's performance record under the Community Reinvestment Act of 1977 (CRA), the Corporation's adherence to banking regulations and fair lending laws and the effectiveness of the subject organizations in combating money laundering activities.
Interstate Banking and Branching
Bank holding companies may acquire banks located in any state in the United States without regard to geographic restrictions or reciprocity requirements imposed by state law. Banks may establish interstate branch networks through acquisitions of other banks. The establishment of de novo interstate branches or the acquisition of individual branches of a bank in another state (rather than the acquisition of an out-of-state bank in its entirety) is allowed only if specifically authorized by state law.
Michigan permits both U.S. and non-U.S. banks to establish branch offices in Michigan. The Michigan Banking Code permits, in appropriate circumstances and with the approval of the DIFS, (1) acquisition of Michigan banks by FDIC-insured banks, savings banks or savings and loan associations located in other states, (2) sale by a Michigan bank of branches to an FDIC-insured bank, savings bank or savings and loan association located in a state in which a Michigan bank could purchase branches of the purchasing entity, (3) consolidation of Michigan banks and FDIC-insured banks, savings banks or savings and loan associations located in other states having laws permitting such consolidation, (4) establishment of branches in Michigan by FDIC-insured banks located in other states, the District of Columbia or U.S. territories or protectorates having laws permitting a Michigan bank to establish a branch in such jurisdiction, and (5) establishment by foreign banks of branches located in Michigan. A Michigan bank holding company may acquire a non-Michigan bank and a non-Michigan bank holding company may acquire a Michigan bank.

6


Dividends
The Corporation's primary source of funds available to pay dividends to shareholders is from dividends paid to it by Chemical Bank. Federal and state banking laws and regulations limit both the extent to which Chemical Bank can lend or otherwise supply funds to the Corporation and also place certain restrictions on the amount of dividends Chemical Bank may pay to the Corporation.
The Corporation and Chemical Bank are subject to regulatory policies and requirements relating to the payment of dividends, including requirements to maintain capital above regulatory minimums, which could prohibit the payment of dividends under circumstances where the payment could be deemed an unsafe and unsound banking practice. Chemical Bank is required to obtain prior approval from the FRB for the declaration and payment of dividends to the Corporation if the total of all dividends declared in any calendar year will exceed the total of (i) Chemical Bank's net income (as defined by regulation) for that year plus (ii) the retained net income (as defined by regulation) for the preceding two years. In addition, federal regulatory authorities have stated that banking organizations should generally pay dividends only out of current operating earnings. Further, the FRB has indicated that bank holding companies should carefully review their dividend policy and has discouraged payment ratios that are at maximum allowable levels unless both asset quality and capital are very strong. Chemical Bank declared and paid dividends to the Corporation of $110.5 million and $56.9 million in 2016 and 2015, respectively. The Corporation utilized proceeds from the dividend from Chemical Bank in 2016 to fund a portion of the cash component of the merger consideration in the Talmer transaction. The Corporation utilized a portion of the proceeds from the dividend from Chemical Bank in 2015 to pay off subordinated debentures, which were acquired as part of the Lake Michigan transaction, during the first quarter of 2016. Dividends received from Chemical Bank in the past are not necessarily indicative of amounts that may be paid or available to be paid in the future.
Source of Strength
Under FRB policy, the Corporation is expected to act as a source of financial strength to Chemical Bank and to commit resources to support Chemical Bank. In addition, if DIFS deems Chemical Bank's capital to be impaired, DIFS may require Chemical Bank to restore its capital by a special assessment on the Corporation as Chemical Bank's only shareholder. If the Corporation failed to pay any assessment, the Corporation's directors would be required, under Michigan law, to sell the shares of Chemical Bank's stock owned by the Corporation to the highest bidder at either a public or private auction and use the proceeds of the sale to restore Chemical Bank's capital.
Capital Requirements
The Corporation and Chemical Bank are subject to regulatory "risk-based" capital guidelines. Failure to meet these capital guidelines could subject the Corporation or Chemical Bank to a variety of enforcement remedies, including issuance of a capital directive, the termination of deposit insurance by the FDIC, a prohibition on accepting brokered deposits, and other restrictions on its business. In addition, Chemical Bank would generally not receive regulatory approval of any application that requires the consideration of capital adequacy, such as a branch or merger application, unless it could demonstrate a reasonable plan to meet the capital requirement within a reasonable period of time.
The Federal Deposit Insurance Corporation Improvement Act (FDICIA) requires, among other things, federal banking agencies to take "prompt corrective action" in respect of depository institutions that do not meet minimum capital requirements. FDICIA sets forth the following five capital categories: "well-capitalized," "adequately-capitalized," "undercapitalized," "significantly-undercapitalized" and "critically-undercapitalized." A depository institution's capital category will depend upon how its capital levels compare with various relevant capital measures as established by regulation, which include Tier 1 and total risk-based capital ratio measures and a leverage capital ratio measure.
Federal banking regulators are required to take specified mandatory supervisory actions and are authorized to take other discretionary actions with respect to institutions in the three undercapitalized categories. The severity of the action depends upon the capital category in which the institution is placed. Subject to a narrow exception, the banking regulator must generally appoint a receiver or conservator for an institution that is critically undercapitalized. An institution in any of the undercapitalized categories is required to submit an acceptable capital restoration plan to its appropriate federal banking agency. An undercapitalized institution is also generally prohibited from paying any dividends, increasing its average total assets, making acquisitions, establishing any branches, accepting or renewing any brokered deposits or engaging in any new line of business, except under an accepted capital restoration plan or with FDIC approval.

7


In July 2013, the FRB and the FDIC approved final rules implementing the Basel Committee on Banking Supervision's (BCBS) capital guidelines for U.S. banks (commonly known as Basel III). Under Basel III, which began for the Corporation and Chemical Bank on January 1, 2015 and are subject to a phase-in period through January 1, 2019, minimum capital requirements were increased for both the quantity and quality of capital held by the Corporation and Chemical Bank. Basel III added a new common equity Tier 1 capital to risk-weighted assets ratio (CET ratio) of 4.5% and a capital conservation buffer of 2.5% of risk-weighted assets, which when fully phased-in, effectively results in a minimum CET ratio of 7.0%. Basel III also raised the minimum ratio of Tier 1 capital to risk-weighted assets from 4.0% to 6.0% (which, with the capital conservation buffer, effectively results in a minimum Tier 1 capital ratio of 8.5% when fully phased-in) and requires a minimum leverage ratio of 4.0%.
A summary of the actual and minimum Basel III regulatory capital ratios for the Corporation and Chemical Bank as of December 31, 2016 follows:
 
Leverage Ratio
 
Common Equity Tier 1 Capital Ratio
 
Tier 1 Risk-Based Capital Ratio
 
Total Risk-Based Capital Ratio
 
 
 
 
 
 
 
 
Actual Capital Ratios:
 
 
 
 
 
 
 
Chemical Financial Corporation
9.0%
 
10.7%
 
10.7%
 
11.5%
Chemical Bank
9.5%
 
11.4%
 
11.4%
 
12.0%
Minimum for capital adequacy purposes
4.0%
 
4.5%
 
6.0%
 
8.0%
Minimum to be well capitalized under prompt corrective action regulations
5.0%
 
6.5%
 
8.0%
 
10.0%
Minimum for capital adequacy, including capital conservation buffer(1)
4.0%
 
7.0%
 
8.5%
 
10.5%
(1) Assumes fully phased in capital conservation buffer of 2.5%. The capital conservation buffer will be phased in beginning January 1, 2016 at 0.625% and increasing by the same amount each year until fully implemented in January 2019. Failure to maintain the required capital conservation buffer may limit the Corporation's and Chemical Bank's ability to pay dividends or discretionary bonuses, among other things.
At December 31, 2016, the capital ratios of the Corporation and Chemical Bank exceeded the regulatory guidelines for institutions to be categorized as "well-capitalized." Under certain circumstances, the appropriate banking agency may treat a well capitalized, adequately capitalized or undercapitalized institution as if the institution were in the next lower capital category. Additional information on the Corporation and Chemical Bank's capital ratios may be found under Note 19 to the consolidated financial statements under Item 8 of this report.
FDIC Insurance
The FDIC formed the Deposit Insurance Fund (DIF) in accordance with the Federal Deposit Insurance Reform Act of 2005 (Reform Act). The FDIC implemented the Reform Act to create a stronger and more stable insurance system. The FDIC maintains the insurance reserves of the DIF by assessing depository institutions an insurance premium. The DIF insures deposit accounts of Chemical Bank up to a maximum amount per separately insured depositor. Under the Dodd-Frank Act, the maximum amount of federal deposit insurance coverage permanently increased from $100,000 to $250,000 per depositor, per institution.
FDIC insured depository institutions are required to pay deposit insurance premiums based on an insured depository institution’s assessment base, calculated as its average consolidated total assets minus its average tangible equity. Chemical Bank’s current annualized premium assessments can range from $0.15 to $0.40 for each $100 of its assessment base. The rate charged depends on Chemical Bank’s performance on the FDIC’s "large and highly complex institution" risk-assessment scorecard, which includes factors such as Chemical Bank’s regulatory rating, its ability to withstand asset and funding-related stress, and the relative magnitude of potential losses to the FDIC in the event of Chemical Bank’s failure. The Corporation's FDIC DIF insurance premiums were $7.4 million in 2016, compared to $5.5 million in 2015 and $4.3 million in 2014.

In March 2016, the FDIC adopted rules to impose a surcharge, as required by the Dodd-Frank Act, on the quarterly deposit insurance assessments of insured depository institutions having total consolidated assets of at least $10 billion (like Chemical Bank). The surcharge would begin the calendar quarter after the DIF reserve ratio first reaches or exceeds 1.15% and would continue through the quarter that it first reaches or exceeds 1.35%.  Effective July 1, 2016, the FDIC began to assess large institution surcharges under this new rule.  Large banks will pay a quarterly surcharge, in addition to regular assessments, equal to an annual rate of 4.5 basis points. The assessment base for the surcharge will be a large bank's regular assessment base reduced by $10 billion (and subject to adjustment for affiliated banks). The surcharge will remain in place through the quarter that the DIF reserve ratio first reaches or exceeds 1.35%, but no later than December 31, 2018. If the DIF reserve ratio has not reached 1.35% by that date, the FDIC will impose a shortfall assessment on large banks in the first quarter of 2019, and collect it on June 30, 2019.


8



Safety and Soundness Standards
As required by FDICIA, the federal banking agencies' prompt corrective action powers impose progressively more restrictive constraints on operations, management and capital distributions, depending on the category in which an institution is classified. These actions can include: requiring an insured depository institution to adopt a capital restoration plan guaranteed by the institution's parent company; placing limits on asset growth and restrictions on activities, including restrictions on transactions with affiliates; restricting the interest rates the institution may pay on deposits; prohibiting the payment of principal or interest on subordinated debt; prohibiting the holding company from making capital distributions without prior regulatory approval; and, ultimately, appointing a receiver for the institution.
The federal banking agencies also have adopted guidelines prescribing safety and soundness standards relating to internal controls and information systems, internal audit systems, loan documentation, credit underwriting, interest rate exposure, asset growth, and compensation and benefits. The federal regulatory agencies may take action against a financial institution that does not meet such standards.
Depositor Preference
The Federal Deposit Insurance Act provides that, in the event of the "liquidation or other resolution" of an insured depository institution, the claims of depositors of the institution, including the claims of the FDIC on behalf of insured depositors, and certain claims for administrative expenses of the FDIC as a receiver, will have priority over other general unsecured claims against the institution. If an insured depository institution fails, insured and uninsured depositors, along with the FDIC, will have priority in payment ahead of unsecured, non-deposit creditors, including depositors whose deposits are payable only outside of the United States and the parent bank holding company, with respect to any extensions of credit they have made to such insured depository institution.
The Dodd-Frank Act
The Dodd-Frank Act, enacted in July 2010, represents a comprehensive overhaul of the financial services industry within the United States, including establishing the federal Consumer Financial Protection Bureau (CFPB) and requiring the CFPB and other federal agencies to implement many new and significant rules and regulations. The CFPB has issued significant new regulations, which became effective in January 2014, that impact consumer mortgage lending and servicing. In addition, the CFPB has issued regulations, which became effective October 1, 2015, that change the disclosure requirements and forms used under the Truth in Lending Act and the Real Estate Settlement Procedures Act. Compliance with these new laws and regulations and other regulations under consideration by the CFPB have and will likely result in additional costs and could change the products and/or services that are currently being offered, which could be significant and could adversely impact the Corporation's results of operations, financial condition or liquidity.
Enhanced Prudential Standards
A publicly traded bank holding company with $10 billion or more in consolidated assets must comply with certain provisions of the Federal Reserve's enhanced prudential standards (EPS). The holding company is required to establish a stand-alone, board level risk committee that must have a formal written charter approved by the board of directors. The risk committee is charged with approving and periodically reviewing the risk-management policies of the company and overseeing the operation of its global risk-management framework. The Corporation has a Standing Risk Management Committee of the board of directors.
Stress Tests
The Dodd-Frank Act mandates company-run stress tests requirements for U.S. bank holding companies with total consolidated assets of $10 billion to $50 billion. The stress tests require bank holding companies to assess the potential impact of three macroeconomic scenarios - baseline, adverse, and seriously adverse - on the company's consolidated losses, revenues, balance sheet (including risk-weighted assets) and capital. Chemical will be required to submit a stress test report in 2018.

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The Durbin Amendment
The Dodd-Frank Act included provisions that require that interchange fees in debit card transactions be "reasonable and proportionate" in relation to the cost of the transaction incurred by the card issuer (the "Durbin Amendment"). Under rules issued by the Federal Reserve, interchange fees on a debit card transaction are capped at $0.21 per transaction plus five basis points multiplied by that amount of the transaction are conclusively determined to be reasonable and proportionate. In addition, an issuer may charge up to 1 cent on each debit card transaction as a fraud prevention adjustment if the issuer meets certain fraud prevention standards. The interchange fee restrictions in the Durbin Amendment apply to debit card issuers with $10 billion or more in total consolidated assets. Chemical Bank became subject to these interchange restrictions beginning on January 1, 2017.
The Volcker Rule
The Volcker Rule implements Section 619 of the Dodd-Frank Act. The Volcker Rule prohibits "banking entities," such as the Corporation, Chemical Bank and their affiliates and subsidiaries, from owning, sponsoring, or having certain relationships with hedge funds and private equity funds (referred to as "covered funds") and engaging in short-term proprietary trading of securities, derivatives, commodity futures and options on these instruments.
The Volcker Rule excepts certain transactions from the general prohibition against proprietary trading, including transactions in government securities (e.g., U.S. Treasuries or any instruments issued by the GNMA, FNMA, FHLMC, a Federal Home Loan Bank, or any state or a political division of any state, among others); transactions in connection with underwriting or market-making activities; and, transactions as a fiduciary on behalf of customers. Banking entities may also engage in risk-mitigating hedges if the entity can demonstrate that the hedge reduces or mitigates a specific, identifiable risk or aggregate risk position of the entity. The banking entity is required to conduct an analysis supporting its hedging strategy and the effectiveness of the hedges must be monitored and, if necessary, adjusted on an ongoing basis. Banking entities with more than $50 billion in total consolidated assets and liabilities that engage in permitted trading transactions are required to implement enhanced compliance programs, to regularly report data on trading activities to the regulators, and to provide a CEO attestation that the entity’s compliance program is reasonably designed to comply with the Volcker Rule.
Although the Volcker Rule became effective on April 1, 2014, on December 18, 2014, the Federal Reserve exercised its unilateral authority to extend the compliance deadline until July 21, 2016, with respect to covered funds. The Federal Reserve further indicated its intent to grant an additional one-year extension of the compliance deadline until July 21, 2017, and indicated it would re-evaluate its rules relating to the process by which banking entities would be able to apply for further five-year extensions.
Community Reinvestment Act (CRA)
Banks are subject to the provisions of the CRA. Under the terms of the CRA, the appropriate federal bank regulatory agency is required, in connection with its examination of a bank, to assess such bank's record in meeting the credit needs of the community served by that bank, including low and moderate income neighborhoods, consistent with the safe and sound operation of the institution. Under the CRA, institutions are assigned a rating of "outstanding," "satisfactory," "needs to improve," or "substantial non-compliance." The regulatory agency's assessment of the bank's record is made available to the public. Further, a bank's federal regulatory agency is required to assess the CRA compliance record of any bank that has applied to: (1) obtain deposit insurance coverage for a newly chartered institution, (2) establish a new branch office that will accept deposits, (3) relocate an office, or (4) merge or consolidate with, or acquire the assets or assume the liabilities of, a federally regulated financial institution. In the case of a bank holding company applying for approval to acquire a bank or another bank holding company, the FRB will assess the CRA compliance record of each subsidiary bank of the applicant bank holding company, and such compliance records may be the basis for denying the application. Upon receiving notice that a subsidiary bank is rated less than "satisfactory," a financial holding company will be prohibited from additional activities that are permitted to a financial holding company and from acquiring any company engaged in such activities. Chemical Bank's CRA rating was "outstanding" as of December 31, 2016.
Financial Privacy
Federal banking regulations limit the ability of banks and other financial institutions to disclose non-public information about consumers to nonaffiliated third parties. These limitations require disclosure of privacy policies to consumers and, in some circumstances, allow consumers to prevent disclosure of certain personal information to a nonaffiliated third party. These regulations affect how consumer information is transmitted through diversified financial companies and conveyed to outside vendors.

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Chemical Bank is also subject to regulatory guidelines establishing standards for safeguarding customer information. These guidelines describe the federal banking agencies’ expectation for the creation, implementation and maintenance of an information security program, which would include administrative, technical and physical safeguards appropriate to the size and complexity of the institution and the nature and scope of its activities. The standards set forth in the guidelines are intended to ensure the security and confidentiality of customer records and information, protect against any anticipated threats or hazards to the security or integrity of such records and protect against unauthorized access to or use of such records or information that could result in substantial harm or inconvenience to any customer.

Anti-Money Laundering and the USA Patriot Act

A major focus of governmental policy on financial institutions has been aimed at combating money laundering and terrorist financing. The Bank Secrecy Act of 1970 ("BSA") and subsequent laws and regulations require the bank to take steps to prevent the use of the bank or its systems to facilitate the flow of illegal or illicit money or terrorist funds. Those requirements include ensuring effective board and management oversight, establishing policies and procedures, performing comprehensive risk assessments, developing effective monitoring and reporting capabilities, ensuring adequate training and establishing a comprehensive independent audit of BSA compliance activities. The USA PATRIOT Act of 2001 (USA Patriot Act) substantially broadened the scope of United States anti-money laundering laws and regulations by imposing significant compliance and due diligence obligations, creating new crimes and penalties and expanding the extra-territorial jurisdiction of the United States. The United States Treasury Department has issued, and in some cases proposed, a number of regulations that apply various requirements of the USA Patriot Act to financial institutions. These regulations impose obligations on financial institutions to maintain appropriate policies, procedures and controls to detect, prevent and report money laundering and terrorist financing and to verify the identity of their customers. Certain of those regulations impose specific due diligence requirements on financial institutions that maintain correspondent or private banking relationships with non-U.S. financial institutions or persons. Failure of a financial institution to maintain and implement adequate programs to combat money laundering and terrorist financing, or to comply with all of the relevant laws or regulations, could have serious legal and reputational consequences for the institution.

Office of Foreign Assets Control Regulation

The United States Treasury Department Office of Foreign Assets Control (OFAC) has imposed economic sanctions that affect transactions with designated foreign countries, nationals and others. OFAC sanctions targeting countries take many different forms. Generally, however, they contain one or more of the following elements: (i) restrictions on trade with or investment in a sanctioned country, including prohibitions on "U.S. persons" engaging in financial transactions relating to making investments in, or providing investment-related advice or assistance to, a sanctioned country; and (ii) a blocking of assets in which the government or specially designated nationals of the sanctioned country have an interest, by prohibiting transfers of property subject to U.S. jurisdiction (including property in the possession or control of U.S. persons). Blocked assets (e.g., property and bank deposits) cannot be paid out, withdrawn, set off or transferred in any manner without a license from OFAC. Failure to comply with these sanctions could have serious legal and reputational consequences.
Incentive Compensation
The regulatory agencies have issued comprehensive guidance on incentive compensation policies intended to ensure that the incentive compensation policies of banking organizations do not undermine the safety and soundness of such organizations by encouraging excessive risk-taking. The guidance, which covers all employees that have the ability to materially affect the risk profile of an organization, either individually or as part of a group, is based upon the key principles that a banking organization's incentive compensation arrangements should (i) provide incentives that do not encourage risk-taking beyond the organization's ability to effectively identify and manage risks, (ii) be compatible with effective internal controls and risk management and (iii) be supported by strong corporate governance, including active and effective oversight by the organization's board of directors.
The FRB reviews, as part of the regular, risk-focused examination process, the incentive compensation arrangements of banking organizations, such as the Corporation, that are not "large, complex banking organizations." The findings will be included in reports of examination. Deficiencies will be incorporated into the organization's supervisory ratings, which can affect the organization's ability to make acquisitions and take other actions. Enforcement actions may be taken against a banking organization if its incentive compensation arrangements, or related risk-management control or governance processes, pose a risk to the organization's safety and soundness and the organization is not taking prompt and effective measures to correct the deficiencies.

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Mergers, Acquisitions, Consolidations and Divestitures
The Corporation's current strategy for growth includes strengthening its presence in core markets, expanding into contiguous markets and broadening its product offerings, while taking into account the integration and other risks of growth. The Corporation evaluates strategic acquisition opportunities and conducts due diligence activities in connection with possible transactions. As a result, discussions, and in some cases, negotiations and transactions may take place and future acquisitions involving cash, debt or equity securities may occur, including future acquisitions that may extend beyond contiguous markets. These generally involve payment of a premium over book value and current market price, and therefore, dilution of book value per share will likely occur with any future transaction.
For more information, see the information under the heading "Mergers, Acquisitions and Branch Closings" included in Management's Discussion and Analysis of Financial Condition and Results of Operations, which is here incorporated by reference.
Availability of Information
The Corporation files reports with the Securities and Exchange Commission (SEC). Those reports include the annual report on Form 10-K, quarterly reports on Form 10-Q, current reports on Form 8-K and proxy statements. The public may read and copy any materials the Corporation files with the SEC at the SEC's Public Reference Room at 100 F Street, NE, Washington, DC 20549. The public may obtain information on the operation of the Public Reference Room by calling the SEC at 1-800-SEC-0330. The SEC maintains an internet site that contains reports, proxy and information statements and other information regarding issuers that file electronically with the SEC at www.sec.gov. The Corporation's annual report on Form 10-K, quarterly reports on Form 10-Q, current reports on Form 8-K and proxy statements, and amendments to those reports filed or furnished pursuant to Section 13(a) or 15(d) of the Securities Exchange Act of 1934, including the financial statements and the financial statement schedules, but not including exhibits to those reports, may be obtained without charge upon written request to Dennis L. Klaeser, Chief Financial Officer of the Corporation, at P.O. Box 569, Midland, Michigan 48640-0569 and are accessible at no cost on the Corporation's website at www.chemicalbankmi.com in the "Investor Information" section, as soon as reasonably practicable after they are electronically filed with or furnished to the SEC. Copies of exhibits may be requested at the cost of 30 cents per page from the Corporation's corporate offices. In addition, interactive copies of the Corporation's 2016 Annual Report on Form 10-K and the 2017 Proxy Statement are available at www.edocumentview.com/chfc.

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Item 1A. Risk Factors.
The Corporation's business model is subject to many risks and uncertainties. Although the Corporation seeks ways to manage these risks, the Corporation ultimately cannot predict the future or control all of the risks to which it is subject. Actual results may differ materially from management's expectations. Some of these significant risks and uncertainties are discussed below. The risks and uncertainties described below are not the only ones that the Corporation faces. Additional risks and uncertainties of which the Corporation is unaware, or that it currently deems immaterial, also may become important factors that adversely affect the Corporation and its business. If any of these risks were to occur, the Corporation's business, financial condition or results of operations could be materially and adversely affected. If this were to happen, the market price of the Corporation's common stock per share could decline significantly.
Investments in the Corporation's common stock involve risk.
The market price of the Corporation's common stock may fluctuate significantly in response to a number of factors, including, among other things:
Variations in quarterly or annual results of operations
Changes in dividends paid per share
Deterioration in asset quality, including declining real estate values
Changes in interest rates
Significant acquisitions or business combinations, strategic partnerships, joint ventures or capital commitments by, or involving, the Corporation or its competitors
Failure to integrate acquisitions or realize anticipated benefits from acquisitions
Regulatory actions, including changes to regulatory capital levels, the components of regulatory capital and how regulatory capital is calculated
New regulations that limit or significantly change the Corporation's ability to continue to offer existing banking products
Volatility of stock market prices and volumes
Issuance of additional shares of common stock or other debt or equity securities of the Corporation
Changes in market valuations of similar companies
Uncertainties, disruptions and fluctuations in the credit and financial markets, either nationally or globally
Changes in securities analysts' estimates of financial performance or recommendations
New litigation or contingencies or changes in existing litigation or contingencies
New technology used, or services offered, by competitors
Breaches in information security systems of the Corporation and/or its customers and competitors
Changes in accounting policies or procedures required by standard setting or other regulatory agencies
New developments in the financial services industry
News reports relating to trends, concerns and other issues in the financial services industry
Perceptions in the marketplace regarding the financial services industry, the Corporation and/or its competitors
Rumors or erroneous information
Geopolitical conditions such as acts or threats of terrorism or military conflicts
The Corporation is subject to lending risk.
A significant source of risk for the Corporation arises from the possibility that losses will be sustained because borrowers, guarantors and related parties may fail to perform in accordance with the terms of their loan agreements. Most loans originated by the Corporation are secured, but some loans are unsecured depending on the nature of the loan. With respect to secured loans, the collateral securing repayment includes a wide variety of real and personal property that may be insufficient to cover the amounts owed. Collateral values are adversely affected by changes in prevailing economic, environmental and other conditions, including declines in the value of real estate, changes in interest rates, changes in monetary and fiscal policies of the federal government, terrorist activity, environmental contamination and other external events.
The Corporation maintains an allowance for loan losses, which is a reserve established through a provision for loan losses charged to net income that represents management's estimate of probable losses that have been incurred within the existing portfolio of loans. The level of the allowance for loan losses reflects management's continuing evaluation of specific credit risks, loan loss experience, current loan portfolio quality, the value of real estate, present economic, political and regulatory conditions and unidentified losses inherent in the current loan portfolio. The determination of the appropriate level of the allowance for loan losses inherently involves a high degree of subjectivity and requires the Corporation to make significant estimates of current credit risks and future trends, all of which may undergo material changes. Deterioration in economic conditions and declines in real estate values affecting borrowers, new information regarding existing loans, identification of additional problem loans and other factors, both within and outside of the Corporation's control, may require an increase in the allowance for loan losses. In addition, bank regulatory agencies periodically review the Corporation's allowance for loan losses and may require an increase in the

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allowance for loan losses or the recognition of further loan charge-offs, based on judgments different than those of management. Any significant increase in the allowance for loan losses would likely result in a significant decrease in net income and may have a material adverse effect on the Corporation's financial condition and results of operations. See the sections captioned "Allowance for Loan Losses" in Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations and Note 5 - Loans in the notes to consolidated financial statements in Item 8. Financial Statements and Supplementary Data, located elsewhere in this report for further discussion related to the Corporation's process for determining the appropriate level of the allowance for loan losses.
Potential acquisitions or mergers may disrupt the Corporation's business and dilute shareholder value.
The Corporation seeks acquisition or merger partners that are culturally similar and have experienced management and possess either significant market presence or have potential for improved profitability through financial management, economies of scale or expanded services. Acquiring or merging other banks, businesses, or branches involves various risks commonly associated with acquisitions or mergers, including, among other things:
Delay in completing an acquisition or merger due to litigation or the regulatory approval process
The recording of assets and liabilities of the acquired or merged company at fair value may materially dilute shareholder value at the transaction date and could have a material adverse effect on the Corporation's financial condition and results of operations
The time and costs associated with identifying and evaluating potential acquisition or merger targets
Potential exposure to unknown or contingent liabilities of the acquired or merged company
The estimates and judgments used to evaluate credit, operations, management and market risks with respect to the acquired or merged company may not be accurate
Exposure to potential asset quality issues of the acquired or merged company
The time and costs of evaluating new markets, hiring experienced local management and opening new offices, and the time lags between these activities and the generation of sufficient assets and deposits to support the costs of the expansion
The diversion of the Corporation's management's attention to the negotiation of a transaction, and the integration of the operations and personnel of the combining businesses
The introduction of new products and services into the Corporation's business
Potential disruption to the Corporation's business
The incurrence and possible impairment of goodwill and other intangible assets associated with an acquisition or merger and possible adverse short-term effects on the Corporation's results of operations
The possible loss of key employees and customers of the acquired or merged company
Difficulty in estimating the value of the acquired or merged company
Potential changes in banking or tax laws or regulations that may affect the acquired or merged company
Difficulty or unanticipated expense associated with converting the operating systems of the acquired or merged company to those of the Corporation
The transactions may be more expensive to complete and the anticipated benefits, including cost savings and strategic gains, may be significantly harder or take longer to achieve than expected or may not be achieved in their entirety as a result of unexpected factors or events, including economic and financial conditions.
The Corporation regularly evaluates merger and acquisition opportunities and conducts due diligence activities related to possible transactions with other financial institutions and financial services companies. As a result, merger or acquisition discussions and, in some cases, negotiations and transactions may take place and future mergers or acquisitions involving cash, debt or equity securities may occur at any time. Acquisitions and mergers typically involve the payment of a premium over book value, and, therefore, dilution of the Corporation's tangible book value and ownership interest may occur in connection with any future transaction. Furthermore, failure to realize the expected revenue increases, cost savings, increases in geographic or product presence, and/or other projected benefits from an acquisition could have a material adverse effect on the Corporation's financial condition and results of operations, including net income per common share.
Litigation filed against Talmer, its board of directors and the Corporation could result in the payment of damages following completion of the merger.
In connection with the merger, purported Talmer stockholders have filed putative class action lawsuits against Talmer, its board of directors and the Corporation. These lawsuits could result in substantial costs to the Corporation, including any costs associated with indemnification. The defense or settlement of the lawsuits may adversely affect the Corporation's business, financial condition, results of operations, cash flows and market price.


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As a result of its growth, the Corporation has become subject to additional regulation, increased supervision and increased costs.    
The Dodd-Frank Act imposes additional regulatory requirements on institutions with $10 billion or more in assets. The Corporation crossed this asset threshold as a result of the Talmer merger, and had $17.4 billion in assets as of December 31, 2016. As a result, the Corporation is now subject to the following:
Supervision, examination and enforcement by the CFPB with respect to consumer financial protection laws;
Regulatory stress testing requirements, whereby the Corporation would be required to conduct an annual stress test (using assumptions for baseline, adverse and severely adverse scenarios);
A modified methodology for calculating FDIC insurance assessments and potentially higher assessment rates as a result of institutions with $10 billion or more in assets being required to bear a greater portion of the cost of raising the reserve ratio to 1.35% as required by the Dodd-Frank Act;
Heightened compliance standards under the Volcker Rule;
Enhanced supervision as a larger financial institution; and
Under the Durbin Amendment to the Dodd-Frank Act, institutions with $10 billion or more in assets are subject to a cap on the interchange fees that may be charged in certain electronic debit and prepaid card transactions. The maximum permissible interchange fee for electronic debit transactions is the sum of 21 cents per transaction and 5 basis points multiplied by the value of the transaction. In addition, an issuer may charge up to 1 cent on each transaction as a fraud prevention adjustment if the issuer meets certain fraud prevention standards.
The imposition of these regulatory requirements and increased supervision may require additional commitment of financial resources to regulatory compliance and may increase the Corporation's cost of operations. Further, the results of the stress testing process may lead the Corporation to retain additional capital or alter the mix of its capital components.
The Corporation may face increased pressure from purchasers of its residential mortgage loans to repurchase those loans or reimburse purchasers for losses related to those loans.
The Corporation sells fixed rate long-term residential mortgage loans it originates in the secondary market. Purchasers of residential mortgage loans, such as government sponsored entities, are increasing their efforts to seek to require sellers of residential mortgage loans to either repurchase loans previously sold or reimburse purchasers for losses related to loans previously sold when losses are incurred on a loan previously sold due to actual or alleged failure to strictly conform to the purchaser's purchase criteria. As a result, the Corporation may face increased pressure from purchasers of its residential mortgage loans to repurchase those loans or reimburse purchasers for losses related to those loans and it may face increasing expenses to defend against such claims. If the Corporation is required in the future to repurchase loans previously sold, reimburse purchasers for losses related to loans previously sold, or if it incurs increasing expenses to defend against such claims, the Corporation's financial condition and results of operations would be negatively affected.
The Corporation holds general obligation municipal bonds in its investment securities portfolio. If one or more issuers of these bonds were to become insolvent and default on its obligations under the bonds, it could have a negative effect on the financial condition and results of operations of the Corporation.
Municipal bonds held by the Corporation totaled $923 million at December 31, 2016, and were issued by many different municipalities with no significant concentration in any single municipality. There can be no assurance that the financial conditions of these municipalities will not be materially and adversely affected by future economic conditions. If one or more of the issuers of these bonds were to become insolvent and default on their obligations under the bonds, it could have a negative effect on the financial condition and results of operations of the Corporation.
General economic conditions, and in particular conditions in the States of Michigan, Ohio and Indiana, affect the Corporation's business.
The Corporation is affected by general economic conditions in the United States, although most directly within Michigan, Ohio and Indiana. The Corporation's success depends primarily on the general economic conditions in the States of Michigan, Ohio and Indiana and the specific local markets in which the Corporation operates. The economic conditions in these local markets have a significant impact on the demand for the Corporation's products and services as well as the ability of the Corporation's customers to repay loans, the value of the collateral securing loans and the stability of the Corporation's deposit funding sources. A significant majority of the Corporation's loans are to individuals and businesses in Michigan. Consequently, any prolonged decline in Michigan's economy could have a materially adverse effect on the Corporation's financial condition and results of operations. A significant decline or a prolonged period of the lack of improvement in general economic conditions could impact these local economic conditions and, in turn, have a material adverse effect on the Corporation's financial condition and results of operations.

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If the Corporation does not adjust to changes in the financial services industry, its financial performance may suffer.
The Corporation's ability to maintain its financial performance and return on investment to shareholders will depend largely on its ability to continue to grow its loan portfolio and also, in part, on its ability to maintain and grow its core deposit customer base and expand its financial services to its existing and/or new customers. In addition to other banks, competitors include savings and loan associations, credit unions, securities dealers, brokers, mortgage bankers, investment advisors and finance and insurance companies. The increasingly competitive environment is, in part, a result of changes in the economic environment within the states in which the Corporation does business, regulation, and changes in technology and product delivery systems. New competitors may emerge to increase the degree of competition for the Corporation's customers and services. Financial services and products are also constantly changing. The Corporation's financial performance will also depend, in part, upon customer demand for its products and services and its ability to develop and offer competitive financial products and services.
Consumers may decide not to use banks to complete their financial transactions.
Technology and other changes are allowing customers to complete financial transactions without the involvement of banks. For example, consumers can now pay bills and transfer funds directly without banks. The process of eliminating banks as intermediaries in financial transactions, known as disintermediation, could result in the loss of fee income, the loss of customer deposits and income generated from those deposits and lending opportunities.
Changes in interest rates could reduce the Corporation's net income and cash flow.
The Corporation's net income and cash flow depends, to a great extent, on the difference between the interest earned on loans and securities and the interest paid on deposits and other borrowings. Market interest rates are beyond the Corporation's control, and they fluctuate in response to general economic conditions, the policies of various governmental and regulatory agencies and competition. Changes in monetary policy, including changes in interest rates and interest rate relationships, will influence the origination of loans, the purchase of investments, the generation of deposits, the interest received on loans and securities and the interest paid on deposits and other borrowings. Any significant adverse effects of changes in interest rates on the Corporation's results of operations, or any substantial, unexpected, prolonged change in market interest rates could have a material adverse effect on the Corporation's financial condition and results of operations. See the sections captioned "Net Interest Income" in Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations and "Market Risk" in Item 7A. Quantitative and Qualitative Disclosures About Market Risk, located elsewhere in this report, for further discussion related to the Corporation's management of interest rate risk.
The Corporation may be required to pay additional deposit insurance premiums to the FDIC, which could negatively impact earnings.
Depending upon the magnitude of future losses that the FDIC deposit insurance fund suffers, there can be no assurance that there will not be additional premium increases or assessments in order to replenish the fund. The FDIC may need to set a higher base rate schedule based on future financial institution failures and updated failure and loss projections. Potentially higher FDIC assessment rates than those currently projected or special assessments could have an adverse impact on the Corporation's financial condition and results of operations.
The Corporation is subject to liquidity risk in its operations, which could adversely affect its ability to fund various obligations.
Liquidity risk is the possibility of being unable to meet obligations as they come due or capitalize on growth opportunities as they arise because of an inability to liquidate assets or obtain adequate funding on a timely basis, at a reasonable cost and within acceptable risk tolerances. Liquidity is required to fund various obligations, including credit obligations to borrowers, loan originations, withdrawals by depositors, repayment of debt, dividends to shareholders, operating expenses and capital expenditures. Liquidity is derived primarily from retail deposit growth and earnings retention, principal and interest payments on loans and investment securities, net cash provided from operations and access to other funding. If the Corporation is unable to maintain adequate liquidity, then its business, financial condition and results of operations would be negatively affected.
Evaluation of investment securities for other-than-temporary impairment involves subjective determinations and could materially impact the Corporation's financial condition and results of operations.
The evaluation of impairments is a quantitative and qualitative process, which is subject to risks and uncertainties and is intended to determine whether declines in the fair value of investments should be recognized in current period earnings. The risks and uncertainties include changes in general economic conditions, the issuer's net income, projected net income and financial condition or future recovery prospects, the effects of changes in interest rates or credit spreads and the expected recovery period. Estimating future cash flows involves incorporating information received from third-party sources and making internal assumptions and judgments regarding the future performance of the underlying collateral and/or value of the underlying asset and also assessing the probability that an adverse change in future cash flows has occurred. The determination of the amount of other-than-temporary impairments is based upon the Corporation's quarterly evaluation and assessment of known and inherent risks associated with the respective asset class. Such evaluations and assessments are revised as conditions change and new information becomes available.

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Additionally, the Corporation's management considers a wide range of factors about the security issuer and uses judgment in evaluating the cause of the decline in the estimated fair value of the security and in assessing the prospects for recovery. Inherent in management's evaluation of the security are assumptions and estimates about the operations of the issuer and its future earnings potential. Considerations in the impairment evaluation process include, but are not limited to: (i) the length of time and the extent to which the market value has been less than cost or amortized cost; (ii) the potential for impairments of securities when the issuer is experiencing significant financial difficulties; (iii) the potential for impairments in an entire industry sector or sub-sector; (iv) the potential for impairments in certain economically depressed geographic locations; (v) the potential for impairments of securities where the issuer, series of issuers or industry has suffered a catastrophic type of loss or has exhausted natural resources; (vi) the Corporation's intent and ability to retain the investment for a period of time sufficient to allow for the recovery of its value; (vii) unfavorable changes in forecasted cash flows on residential mortgage-backed and asset-backed securities; and (viii) other subjective factors, including concentrations and information obtained from regulators and rating agencies. Impairments to the carrying value of the Corporation's investment securities may need to be taken in the future, which could have a material adverse effect on the Corporation's financial condition and results of operations.
The Corporation may be required to recognize an impairment of its goodwill or core deposit intangible assets, or to establish a valuation allowance against its deferred income tax assets, which could have a material adverse effect on the Corporation's financial condition and results of operations.
Goodwill represents the excess of the amounts paid to acquire subsidiaries over the fair value of their net assets at the date of acquisition. The Corporation tests goodwill at least annually for impairment. Substantially all of the Corporation's goodwill at December 31, 2016 was recorded on the books of Chemical Bank. The fair value of Chemical Bank is impacted by the performance of its business and other factors. Core deposit intangible (CDI) assets represent the estimated value of stable customer deposits, excluding time deposits, acquired in business combinations, that provide a source of funds that are below market interest rates. The Corporation amortizes its CDI assets over the estimated period the corresponding customer deposits are expect to exist. The Corporation tests its CDI assets periodically for impairment. If the Corporation experiences higher than expected deposit run-off, its CDI assets could be impaired. If it is determined that the Corporation's goodwill or CDI assets have been impaired, the Corporation must recognize a write-down by the amount of the impairment, with a corresponding charge to net income. Such write-downs could have a material adverse effect on the Corporation's financial condition and results of operations. At December 31, 2016, the Corporation had $1.13 billion of goodwill, representing 43.9% of shareholders' equity. The Corporation had $40.2 million of CDI assets at December 31, 2016.
Deferred income tax represents the tax effect of the differences between the book and tax basis of assets and liabilities. Deferred tax assets are assessed periodically by management to determine if they are realizable. Factors in management's determination include the performance of the Corporation, including the ability to generate taxable net income. If, based on available information, it is more-likely-than-not that the deferred income tax asset will not be realized, then a valuation allowance must be established with a corresponding charge to net income. As of December 31, 2016, the Corporation carried a valuation allowance against its deferred tax assets of $2.2 million. Charges to establish a valuation allowance with respect to the Corporation's deferred tax assets could have a material adverse effect on the financial condition and results of operations.
If the Corporation is required to recognize a valuation allowance with respect to its loan servicing rights asset, it could have a material adverse effect on the Corporation's financial condition and results of operations.
At December 31, 2016, the Corporation's loan servicing rights (LSR) asset held at amortized cost had a book value of $10.2 million and a fair value of approximately $15.9 million. The Corporation amortizes its LSR asset not elected for under the fair value accounting method in proportion to and over the period of corresponding net servicing income. The Corporation recognized a valuation allowance of $8 thousand at December 31, 2016 with respect to its LSR asset. If the Corporation is required to recognize an additional valuation allowance with respect to its LSR asset in the future, the Corporation's financial condition and results of operations could be negatively affected.
The Corporation may be a defendant in a variety of litigation and other actions, which may have a material adverse effect on the Corporation's financial condition and results of operations.
The Corporation and Chemical Bank are regularly involved in a variety of litigation arising out of the normal course of business. The Corporation's insurance may not cover all claims that may be asserted against it, and any claims asserted against it, regardless of merit or eventual outcome, may harm its reputation or cause the Corporation to incur unexpected expenses, which could be material in amount. Should the ultimate expenses, judgments or settlements in any litigation exceed the Corporation's insurance coverage, they could have a material adverse effect on the Corporation's financial condition and results of operations. In addition, the Corporation may not be able to obtain appropriate types or levels of insurance in the future, nor may it be able to obtain adequate replacement policies with acceptable terms, if at all.

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Environmental liability associated with commercial lending could result in losses.
In the course of its business, the Corporation may acquire, through foreclosure, properties securing loans it has originated or purchased that are in default. Particularly in commercial real estate lending, there is a risk that hazardous substances could be discovered on these properties. In this event, the Corporation might be required to remove these substances from the affected properties at the Corporation's sole cost and expense. The cost of this removal could substantially exceed the value of affected properties. The Corporation may not have adequate remedies against the prior owner or other responsible parties and could find it difficult or impossible to sell the affected properties. These events could have an adverse effect on the Corporation's business, results of operations and financial condition.
The Corporation depends upon the accuracy and completeness of information about customers.
In deciding whether to extend credit to customers, the Corporation relies on information provided to it by its customers, including financial statements and other financial information. The Corporation may also rely on representations of customers as to the accuracy and completeness of that information and on reports of independent auditors on financial statements. The Corporation's financial condition and results of operations could be negatively impacted to the extent that the Corporation extends credit in reliance on financial statements that do not comply with generally accepted accounting principles or that are misleading or other information provided by customers that is false or misleading.
The Corporation operates in a highly competitive industry and market area.
The Corporation faces substantial competition in all areas of its operations from a variety of different competitors, many of which are larger and may have more financial resources. Such competitors primarily include national and regional banks within the various markets where the Corporation operates, as well as internet banks. The Corporation also faces competition from many other types of financial institutions, including savings and loan associations, credit unions, finance companies, brokerage firms, insurance companies and other financial intermediaries. The financial services industry could become even more competitive as a result of legislative, regulatory and technological changes and continued consolidation. Banks, securities firms and insurance companies can merge under the umbrella of a financial holding company, which can offer virtually any type of financial service, including banking, securities underwriting, insurance (both agency and underwriting) and merchant banking. The Corporation competes with these institutions both in attracting deposits and in making new loans. Technology has lowered barriers to entry into the market and made it possible for non-banks to offer products and services traditionally provided by banks, such as automatic transfer and automatic payment systems. Many of the Corporation's competitors have fewer regulatory constraints and may have lower cost structures, such as credit unions that are not subject to federal income tax. Due to their size, many competitors may be able to achieve economies of scale and, as a result, may offer a broader range of products and services as well as better pricing for those products and services than the Corporation can.
The Corporation's ability to compete successfully depends on a number of factors, including, among other things:
The ability to develop, maintain and build long-term customer relationships based on quality service, high ethical standards and safe, sound assets
The ability to expand the Corporation's market position
The ability to keep up-to-date with technological advancements in both delivering new products and maintaining existing products, while continuing to invest in cybersecurity and control operating costs
The scope, relevance and pricing of products and services offered to meet customer needs and demands
The rate at which the Corporation introduces new products and services relative to its competitors
Customer satisfaction with the Corporation's level of service
Industry and general economic trends
Failure to perform in any of these areas could significantly weaken the Corporation's competitive position, which could adversely affect the Corporation's growth and profitability and have a material adverse effect on the Corporation's financial condition and results of operations.
If the Corporation loses members of its senior management team upon whom it is dependent, it may be less effective in managing its operations and may have more difficulty achieving its strategic objectives.
The Corporation believes its success depends on the continued service of its key executives. Although the Corporation currently intends to retain its existing management, it cannot provide assurances that these individuals will remain with the Corporation. The unexpected loss of the services of one or more of the Corporation's key executives or its inability to find suitable replacements within a reasonable period of time following any such loss, could have a material adverse effect on the Corporation's ability to execute its business strategy and, therefore, have a material adverse effect on its financial condition and results of operations.

18


Legislative or regulatory changes or actions, or significant litigation, could adversely impact the Corporation or the businesses in which it is engaged.
The financial services industry is extensively regulated. The Corporation and Chemical Bank are subject to extensive state and federal regulation, supervision and legislation that govern almost all aspects of their operations. Laws and regulations may change from time to time and are primarily intended for the protection of consumers, depositors and the deposit insurance fund, and not to benefit the Corporation's shareholders. The impact of any changes to laws and regulations or other actions by regulatory agencies may negatively impact the Corporation or its ability to increase the value of its business. Regulatory authorities have extensive discretion in connection with their supervisory and enforcement activities, including the imposition of restrictions on the operation of an institution, the classification of assets by the institution and the adequacy of an institution's allowance for loan losses. Future regulatory changes or accounting pronouncements may increase the Corporation's regulatory capital requirements or adversely affect its regulatory capital levels. Additionally, actions by regulatory agencies or significant litigation against the Corporation or Chemical Bank could require the Corporation to devote significant time and resources to defending its business and may lead to penalties that materially affect the Corporation and its shareholders.
If the Corporation cannot raise additional capital when needed, its ability to further expand its operations through organic growth and acquisitions could be materially impaired.
The Corporation is required by federal and state regulatory authorities to maintain specified levels of capital to support its operations. The Corporation may need to raise additional capital to support its continued growth or in response to regulatory requirements. The Corporation's ability to raise additional capital will depend on conditions in the capital markets at that time, which are outside the Corporation's control, and on its financial performance. The Corporation cannot assure that it will be able to raise additional capital in the future on terms acceptable to the Corporation. If the Corporation cannot raise additional capital when needed, its ability to further expand its operations through organic growth and acquisitions could be materially limited.
The soundness of other financial institutions could adversely affect the Corporation.
The Corporation's ability to engage in routine funding transactions could be adversely affected by the actions and commercial soundness of other financial institutions. Financial services institutions are interrelated as a result of trading, clearing, counterparty or other relationships. The Corporation has exposure to many different industries and counterparties, and it routinely executes transactions with counterparties in the financial services industry. As a result, defaults by, or even rumors or questions about, one or more financial services institutions, or the financial services industry generally, could lead to losses or defaults by the Corporation or by other institutions. Many of these transactions expose the Corporation to credit risk in the event of default of the Corporation's counterparty or client. In addition, the Corporation's credit risk may be exacerbated when the collateral that it holds cannot be realized or is liquidated at prices insufficient to recover the full amount of the loan. The Corporation can give no assurance that any such losses would not materially and adversely affect its business, financial condition or results of operations.
The Corporation's controls and procedures may fail or be circumvented.
Management regularly reviews and updates the Corporation's internal controls and corporate governance policies and procedures. Any system of controls, however well designed and operated, is based in part on certain assumptions and can provide only reasonable, not absolute, assurances that the objectives of the system are met. A significant failure or circumvention of the Corporation's controls and procedures or failure to comply with regulations related to controls and procedures could have a material adverse effect on the Corporation's business, results of operations and financial condition.
Unauthorized disclosure of sensitive or confidential client or customer information, whether through a breach of computer systems or otherwise, could severely harm the Corporation's business.
As part of its business, the Corporation collects, processes and retains sensitive and confidential client and customer information on behalf of itself and other third parties. Despite the security measures the Corporation has in place for its facilities and systems, and the security measures of its third party service providers, the Corporation may be vulnerable to security breaches, acts of vandalism, computer viruses, misplaced or lost data, programming and/or human errors or other similar events. Any security breach involving the misappropriation, loss or other unauthorized disclosure of confidential customer information, whether by the Corporation or by its vendors, could severely damage the Corporation's reputation, expose it to the risks of litigation and liability, disrupt the Corporation's operations and have a material adverse effect on the Corporation's business.

19


The Corporation's information systems may experience an interruption or breach in security.
The Corporation relies heavily on communications and information systems to conduct its business and deliver its products. Any failure, interruption or breach in security of these systems could result in failures or disruptions in the Corporation's customer relationship management, general ledger, deposit, loan and other systems. While the Corporation has policies and procedures designed to prevent or limit the effect of the failure, interruption or security breach of its information systems, there can be no assurance that any such failures, interruptions or security breaches of the Corporation's information systems or its customers' information or computer systems would not damage the Corporation's reputation, result in a loss of customer business, subject the Corporation to additional regulatory scrutiny, or expose the Corporation to civil litigation and financial liability, any of which could have a material adverse effect on the Corporation's financial condition and results of operations.
Severe weather, natural disasters, acts of war or terrorism and other external events could significantly impact the Corporation's business.
Severe weather, natural disasters, acts of war or terrorism and other adverse external events could have a significant impact on the Corporation's ability to conduct business. Such events could affect the stability of the Corporation's deposit base, impair the ability of borrowers to repay outstanding loans, impair the value of collateral securing loans, cause significant property damage, result in loss of revenue and/or cause the Corporation to incur additional expenses. Although management has established disaster recovery policies and procedures, the occurrence of any such event in the future could have a material adverse effect on the Corporation's business, financial condition and results of operations.
The Corporation may issue debt and equity securities that are senior to the Corporation's common stock as to distributions and in liquidation, which could negatively affect the value of the Corporation's common stock.
In the future, the Corporation may increase its capital resources by entering into debt or debt-like financing or issuing debt or equity securities, which could include issuances of senior notes, subordinated notes, preferred stock or common stock. In the event of the Corporation's liquidation, its lenders and holders of its debt securities and preferred stock would receive a distribution of the Corporation's available assets before distributions to the holders of the Corporation's common stock. The Corporation's decision to incur debt and issue securities in future offerings may depend on market conditions and other factors beyond its control. The Corporation cannot predict or estimate the amount, timing or nature of its future offerings and debt financings. Future offerings could reduce the value of shares of the Corporation's common stock and dilute a shareholder's interest in the Corporation.
The Corporation relies on dividends from Chemical Bank for most of its revenue.
The Corporation is a separate and distinct legal entity from Chemical Bank. It receives substantially all of its revenue from dividends from Chemical Bank. These dividends are the principal source of funds to pay cash dividends on the Corporation's common stock. Various federal and/or state laws and regulations limit the amount of dividends that Chemical Bank may pay to the Corporation. In the event Chemical Bank is unable to pay dividends to the Corporation, the Corporation may not be able to pay cash dividends on its common stock. The earnings of Chemical Bank have been the principal source of funds to pay cash dividends to shareholders. Over the long-term, cash dividends to shareholders are dependent upon earnings, as well as capital requirements, regulatory restraints and other factors affecting Chemical Bank. See the section captioned "Supervision and Regulation" in Item 1. Business and Note 19 - Regulatory Capital and Reserve Requirements in the notes to consolidated financial statements included in Item 8. Financial Statements and Supplementary Data, which are located elsewhere in this report.
Item 1B. Unresolved Staff Comments.
None. 
Item 2. Properties.
The executive offices of the Corporation and Chemical Bank are located at 235 E. Main Street in downtown Midland, Michigan, in an office building that is owned by the Corporation. The main branch office of Chemical Bank is located at 333 E. Main Street in downtown Midland, Michigan, in an office building that is owned by Chemical Bank.
The Corporation conducted business through 249 banking offices and eight loan production offices as of December 31, 2016. The Corporation has 220 branches located in Michigan, 27 branches located in Ohio and 2 branches located in Indiana through which it operates. The Corporation leases one main office building in Michigan, 62 branches in Michigan and 18 branches in Ohio. Management believes the terms of the various leases are consistent with market standards and were arrived at through arm's-length bargaining.
The Corporation considers its properties to be suitable and adequate for operating its banking business.

20


Item 3. Legal Proceedings.
On February 22, 2016, two putative class action and derivative complaints were filed in the Circuit Court for Oakland County, Michigan by individuals purporting to be a shareholder of Talmer. The actions are styled Regina Gertel Lee v. Chemical Financial Corporation, et. al., Case No. 2016-151642-CB and City of Livonia Employees’ Retirement System v. Chemical Financial Corporation et. al., Case No. 2016-151641-CB. These complaints purport to be brought derivatively on behalf of Talmer against the individual defendants, and individually and on behalf of all others similarly situated against Talmer and Chemical. The complaints allege, among other things, that the directors of Talmer breached their fiduciary duties to Talmer’s shareholders in connection with the merger by approving a transaction pursuant to an allegedly inadequate process that undervalues Talmer and includes preclusive deal protection provisions, and that Chemical allegedly aided and abetted the Talmer directors in breaching their duties to Talmer’s shareholders. The complaints also allege that the individual defendants have been unjustly enriched. Both complaints seek various remedies on behalf of the putative class (consisting of all shareholders of Talmer who are not related to or affiliated with any defendant). They request, among other things, that the Court enjoin the merger from being consummated in accordance with its agreed-upon terms, direct the Talmer directors to exercise their fiduciary duties, rescind the merger agreement to the extent that it is already implemented, award the plaintiff all costs and disbursements in each respective action (including reasonable attorneys’ and experts’ fees), and grant such further relief as the court deems just and proper. The City of Livonia plaintiff amended its complaint on April 21, 2016 to add additional factual allegations, including but not limited to allegations that Keefe Bruyette & Woods, Inc. ("KBW") served as a financial advisor for the proposed merger despite an alleged conflict of interest, that Talmer’s board acted under actual or potential conflicts of interest, and that the defendants omitted and/or misrepresented material information about the proposed merger in the Form S-4 Registration Statement relating to the proposed merger. These two cases were consolidated as In re Talmer Bancorp Shareholder Litigation, case number 2016-151641-CB, per an order entered on May 12, 2016. On October 31, 2016, the plaintiffs in this consolidated action again amended their complaint, adding additional factual allegations, adding KBW as a defendant, and asserting that KBW acted in concert with Chemical to aid and abet breaches of fiduciary duty by Talmer's directors. Talmer, Chemical, KBW and the individual defendants all believe that the claims asserted against each of them in the above-described consolidated action are without merit and intend to vigorously defend against these consolidated lawsuits. Talmer, Chemical, and KBW have filed motions for summary disposition requesting dismissal of this lawsuit, and these motions remain pending. 
On June 16, 2016, a complaint was filed in the United States District Court for the Eastern District of Michigan by a purported Talmer shareholder, styled City of Livonia Employees’ Retirement System vChemical Financial Corporation, et. al., Docket No. 1:16-cv-12229. The plaintiff purports to bring the action "individually and on behalf of all others similarly situated," and requests certification as a class action. This lawsuit alleges violations of Section 14(a) and 20(a) of the Securities Exchange Act of 1934. The Complaint alleges, among other things, that the Defendants issued materially incomplete and misleading disclosures in the Form S-4 Registration Statement relating to the proposed merger. The Complaint contains requests for relief that include, among other things, that the Court enjoin the proposed transaction unless and until additional information is provided to Talmer’s shareholders, declare that the Defendants violated the securities laws in connection with the proposed merger, award compensatory damages, interest, attorneys’ and experts’ fees, and that the Court grant such other relief as it deems just and proper. Talmer, Chemical, and the individual defendants all believe that the claims asserted against each of them in this lawsuit are without merit and intend to vigorously defend against this lawsuit. On October 18, 2016, the Court entered a stipulated order staying this action until the Oakland County Circuit Court issues rulings on motions to dismiss that the defendants anticipate filing in In re Talmer Bancorp Shareholder Litigation, case number 2016-151641-CB.
As of December 31, 2016, Chemical Bank was a party, as plaintiff or defendant, to a number of other legal proceedings all of which were considered ordinary routine litigation incidental to its business or immaterial.
Item 4. Mine Safety Disclosures.
Not applicable.

21


PART II.
Item 5. Market for Registrant's Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities.
The Corporation's common stock is traded on The NASDAQ Stock Market® under the symbol CHFC. As of December 31, 2016, there were approximately 70.6 million shares of the Corporation's common stock issued and outstanding, held by approximately 4,979 shareholders of record. The table below sets forth the range of high and low sales prices for transactions reported on The NASDAQ Stock Market® for the Corporation's common stock for the periods indicated.
 
2016
 
2015
 
High
 
Low
 
High
 
Low
First quarter
$
36.45

 
$
29.40

 
$
31.56

 
$
28.16

Second quarter
40.14

 
34.29

 
34.27

 
29.73

Third quarter
47.62

 
35.73

 
34.49

 
30.09

Fourth quarter
55.55

 
40.93

 
37.26

 
30.98

The earnings of Chemical Bank are the principal source of funds for the Corporation to pay cash dividends to its shareholders. Accordingly, cash dividends are dependent upon the earnings, capital needs, regulatory constraints, and other factors affecting Chemical Bank. See Note 19 to the consolidated financial statements in Item 8 of this report for a discussion of such limitations. The Corporation has paid regular cash dividends every quarter since it began operation as a bank holding company in 1973. Based on the financial condition of the Corporation at December 31, 2016, management expects the Corporation to pay quarterly cash dividends on its common shares in 2017. However, there can be no assurance as to future dividends because they are dependent on the Corporation's future earnings, capital requirements and financial condition, and may require regulatory approval. On February 20, 2017, the Corporation declared a first quarter 2017 cash dividend of $0.27 per share, payable on March 17, 2017.
The following table summarizes the quarterly cash dividends paid to shareholders over the past five years.
 
Years Ended December 31,
 
2016
 
2015
 
2014
 
2013
 
2012
First quarter
$
0.26

 
$
0.24

 
$
0.23

 
$
0.21

 
$
0.20

Second quarter
0.26

 
0.24

 
0.23

 
0.21

 
0.20

Third quarter
0.27

 
0.26

 
0.24

 
0.22

 
0.21

Fourth quarter
0.27

 
0.26

 
0.24

 
0.23

 
0.21

Total
$
1.06

 
$
1.00

 
$
0.94

 
$
0.87

 
$
0.82


22


Shareholder Return
The following line graph compares Chemical Financial Corporation's cumulative total shareholder return on its common stock over the last five years, assuming the reinvestment of dividends, to the Standard and Poor's (S&P) 500 Stock Index and the KBW Nasdaq Regional Banking Index (Ticker: KRX). Both of these indices are based upon total return (including reinvestment of dividends) and are market-capitalization-weighted indices. The S&P 500 Stock Index is a broad equity market index published by S&P. The KBW Nasdaq Regional Banking Index is published by Keefe, Bruyette & Woods, Inc. (KBW), an investment banking firm that specializes in the banking industry. The KBW Nasdaq Regional Banking Index is composed of 50 small and mid-cap U.S. regional banks or thrifts that are publicly traded. The line graph assumes $100 was invested on December 31, 2011.
chfc201312_chart-37712a06.jpg
The dollar values for total shareholder return plotted in the above graph are shown below:
 
 
December 31,
 
 
2011
 
2012
 
2013
 
2014
 
2015
 
2016
Chemical Financial Corporation
 
$
100.00

 
$
115.71

 
$
159.28

 
$
159.16

 
$
183.67

 
$
297.64

KBW Nasdaq Regional Banking Index
 
100.00

 
113.25

 
166.31

 
170.34

 
180.41

 
250.80

S&P 500 Stock Index
 
100.00

 
116.00

 
153.57

 
174.60

 
177.01

 
198.18


23


Equity Compensation Plans
Information about the Corporation's equity compensation plans as of December 31, 2016 is set forth in Part III, Item 12 of this report, and is here incorporated by reference.
Purchases of Equity Securities
The following schedule summarizes the Corporation's total monthly share repurchase activity for the fourth quarter of 2016:
 
 
Issuer Purchases of Equity Securities
Period
 
Total Number of Shares Purchased (1)
 
Average Price Paid Per Share
 
Total Number of Shares Purchased as Part of Publicly Announced
 Plans or Programs
 
Maximum Number of Shares that May Yet Be Purchased Under
Plans or Programs
October 1, 2016 to October 31, 2016
 
103,505

 
$
44.03

 

 
500,000
November 1, 2016 to November 30, 2016
 
21,086

 
50.03

 

 
500,000
December 1, 2016 to December 31, 2016
 
2,147

 
52.76

 

 
500,000
    Total
 
126,738

 
$
45.18

 

 

(1)
Represents shares delivered or attested in satisfaction of the exercise price and/or tax withholding obligations by employees who received shares of the Corporation's common stock in 2016 under the Corporation's share-based compensation plans, as these plans permit employees to use the Corporation's stock to satisfy such obligations based on the market value of the Corporation's stock on the date of vesting or date of exercise, as applicable.

24


Item 6. Selected Financial Data.
The following table sets forth our selected historical consolidated financial information for the periods and as of the dates indicated. We derived our balance sheet and income statement data for the years ended December 31, 2016, 2015, 2014, 2013 and 2012 from our audited consolidated financial statements. You should read this information together with Management's Discussion and Analysis of Financial Condition and Results of Operations and our audited consolidated financial statements and the related notes thereto, which are included elsewhere in this Annual Report. The financial information includes the impact of the merger with Talmer on August 31, 2016 and the acquisitions of Lake Michigan on May 31, 2015, Monarch on April 1, 2015 and Northwestern on October 31, 2014 and the acquisition of 21 branch offices from Independent Bank on December 7, 2012. See Note 2 to the consolidated financial statements in Item 8 of this report for information on these acquisitions. Our historical results shown in the following table and elsewhere in this Annual Report are not necessarily indicative of our future performance.

 
 
As of and for the years ended December 31,
(Dollars in thousands, except per share data)
 
2016
 
2015
 
2014
 
2013
 
2012
Earnings Summary
 
 
 
 
 
 
 
 
 
 
Interest income
 
$
410,379

 
$
291,789

 
$
227,261

 
$
214,061

 
$
210,758

Interest expense
 
29,298

 
17,781

 
14,710

 
17,414

 
23,213

Net interest income
 
381,081

 
274,008

 
212,551

 
196,647

 
187,545

Provision for loan losses
 
14,875

 
6,500

 
6,100

 
11,000

 
18,500

Noninterest income
 
122,350

 
80,216

 
63,095

 
60,409

 
54,684

Operating expenses
 
338,418

 
223,894

 
179,925

 
164,948

 
151,921

Income before income taxes
 
150,138

 
123,830

 
89,621

 
81,108

 
71,808

Income tax expense
 
42,106

 
37,000

 
27,500

 
24,300

 
20,800

Net income
 
108,032

 
86,830

 
62,121

 
56,808

 
51,008

Per Common Share Data
 
 
 
 
 
 
 
 
 
 
Basic earnings per common share
 
$
2.21

 
$
2.41

 
$
1.98

 
$
2.02

 
$
1.86

Diluted earnings per common share
 
2.17

 
2.39

 
1.97

 
2.00

 
1.85

Cash dividends declared and paid
 
1.06

 
1.00

 
0.94

 
0.87

 
0.82

Book value at end of period
 
36.57

 
26.62

 
24.32

 
23.38

 
21.69

Tangible book value per share(1)
 
20.20

 
18.73

 
18.57

 
19.17

 
17.03

Market value at end of period
 
54.17

 
34.27

 
30.64

 
31.67

 
23.76

Common shares outstanding (in thousands)
 
70,599

 
38,168

 
32,774

 
29,790

 
27,499

Average diluted common shares (in thousands)
 
49,603

 
36,353

 
31,588

 
28,352

 
27,583

Balance Sheet Data
 
 
 
 
 
 
 
 
 
 
Total assets
 
$
17,355,179

 
$
9,188,797

 
$
7,322,143

 
$
6,184,708

 
$
5,917,252

Investment securities
 
1,858,391

 
1,063,702

 
1,065,277

 
958,475

 
816,786

Total loans
 
12,990,779

 
7,271,147

 
5,688,230

 
4,647,621

 
4,167,735

Total deposits
 
12,873,122

 
7,456,767

 
6,078,971

 
5,122,385

 
4,921,443

Total liabilities
 
14,773,653

 
8,172,823

 
6,525,010

 
5,488,208

 
5,320,911

Total shareholders' equity
 
2,581,526

 
1,015,974

 
797,133

 
696,500

 
596,341

Tangible shareholders' equity(1)
 
1,425,998

 
714,901

 
606,419

 
571,947

 
466,168

Balance Sheet Averages
 

 
 
 
 
 
 
 
 
Total assets
 
$
12,037,155

 
$
8,481,228

 
$
6,473,144

 
$
5,964,592

 
$
5,442,079

Total earning assets
 
10,856,795

 
7,851,134

 
6,095,064

 
5,628,969

 
5,116,127

Total loans
 
9,304,573

 
6,583,846

 
4,976,563

 
4,355,152

 
3,948,407

Total deposits
 
9,397,562

 
6,958,667

 
5,339,422

 
4,964,082

 
4,464,062

Total interest-bearing liabilities
 
7,821,366

 
5,704,205

 
4,349,977

 
4,181,921

 
3,868,108

Total shareholders' equity
 
1,546,721

 
919,328

 
754,211

 
626,555

 
587,451

Performance Ratios
 
 
 
 
 
 
 
 
 
 
Net interest margin
 
3.51
%
 
3.49
%
 
3.49
%
 
3.49
%
 
3.67
%
Net interest margin (fully taxable equivalent)(2)
 
3.60

 
3.58

 
3.59

 
3.59

 
3.76

Return on average assets
 
0.90

 
1.02

 
0.96

 
0.95

 
0.94

Return on average shareholders' equity
 
7.0

 
9.4

 
8.2

 
9.1

 
8.7

Efficiency ratio
 
54.4

 
58.7

 
61.6

 
63.1

 
60.8

Dividend payout ratio
 
48.8

 
41.8

 
47.7

 
43.5

 
44.3

Consolidated Capital Ratios
 
 
 
 
 
 
 
 
 
 
Shareholders' equity as a percentage of total assets
 
14.9
%
 
11.1
%
 
10.9
%
 
11.3
%
 
10.1
%
Tangible shareholders' equity as a percentage of tangible assets(1)
 
8.8

 
8.0

 
8.5

 
9.4

 
8.1

Year end ratios:
 

 
 
 
 
 
 
 
 
Tangible equity to tangible assets ratio(1)
 
8.1

 
8.1

 
8.4

 
9.4

 
8.1

Common equity tier 1 capital(3)
 
10.7

 
10.6

 
N/A

 
N/A

 
N/A

Tier 1 leverage ratio(3)
 
9.0

 
8.6

 
9.3

 
9.9

 
9.2

Tier 1 risk-based capital ratio(3)
 
10.7

 
10.7

 
11.1

 
12.7

 
12.0

Total risk-based capital ratio(3)
 
11.5

 
11.8

 
12.4

 
14.0

 
13.2

Asset Quality
 
 
 
 
 
 
 
 
 
 
Net loan charge-offs
 
$
9,935

 
$
8,855

 
$
9,489

 
$
16,419

 
$
22,342

Net loan charge-offs as a percentage of average loans
 
0.11
%
 
0.13
%
 
0.19
%
 
0.38
%
 
0.57
%
Year end balances:
 
 
 
 
 
 
 
 
 
 
Allowance for loan losses — originated loans
 
$
78,268

 
$
73,328

 
$
75,183

 
$
78,572

 
$
83,991

Allowance for loan losses — acquired loans
 

 

 
500

 
500

 
500

Total nonperforming loans
 
44,334

 
62,225

 
50,644

 
61,897

 
71,298

Total nonperforming assets
 
61,521

 
72,160

 
64,849

 
71,673

 
89,767

Year end ratios:
 

 
 
 
 
 
 
 
 
Allowance for loan losses as a percentage of total originated loans
 
1.05
%
 
1.26
%
 
1.51
%
 
1.81
%
 
2.22
%
Allowance for loan losses as a percentage of nonperforming loans
 
176.5

 
117.8

 
148.5

 
126.9

 
117.8

Nonperforming loans as a percentage of total loans
 
0.34

 
0.86

 
0.89

 
1.33

 
1.71

Nonperforming assets as a percentage of total assets
 
0.35

 
0.79

 
0.89

 
1.16

 
1.52


25


_____________________________________________________________________________
(1)
Denotes a non-GAAP Financial Measure, see section entitled "Non-GAAP Financial Measures" for a reconciliation to the most directly comparable GAAP financial measure.
(2)
Presented on a tax equivalent basis using a 35% tax rate for all periods presented. Denotes a non-GAAP Financial Measure, see section entitled Non-GAAP Financial Measures" for a reconciliation to the most directly comparable GAAP financial measure.
(3)
The years ended December 31, 2016 and 2015 are under Basel III transitional and the years ended December 31, 2014, 2013 and 2012 are under Basel I.



26


Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations
The following discussion describes our results of operations for the years ended December 31, 2016, 2015 and 2014 and also analyzes our financial condition as of December 31, 2016 as compared to December 31, 2015. This discussion should be read in conjunction with the "Selected Financial Data" and our audited consolidated financial statements and accompanying footnotes thereto included elsewhere in this Annual Report. Historical results of operations and the percentage relationships among any amounts included, and any trends that may appear, may not indicate trends in operations or results of operations for any future periods.
We have made, and will continue to make, various forward-looking statements with respect to financial and business matters. Comments regarding our business that are not historical facts are considered forward-looking statements that involve inherent risks and uncertainties. Actual results may differ materially from those contained in these forward-looking statements. For additional information regarding our cautionary disclosures, see "Forward-Looking Statements" beginning on page 1 of this Annual Report.
Business Overview
Chemical Financial Corporation (Corporation) is a financial holding company headquartered in Midland, Michigan with its business concentrated in a single industry segment - commercial banking. The Corporation, through its wholly-owned subsidiary bank, Chemical Bank, offers a full range of traditional banking and fiduciary products and services. These products and services include business and personal checking accounts, savings and individual retirement accounts, time deposit instruments, electronically accessed banking products, residential and commercial real estate financing, commercial lending, consumer financing, debit cards, safe deposit box services, money transfer services, automated teller machines, access to insurance and investment products, corporate and personal wealth management services, mortgage banking and other banking services.
The principal markets for the Corporation's products and services are communities in Michigan, Northeast Ohio and Northern Indiana where the branches of Chemical Bank are located and the areas surrounding these communities. As of December 31, 2016, Chemical Bank served these markets through 220 banking offices located in Michigan, 27 branches located in Northeast Ohio and 2 branches located in Northern Indiana. In addition to its banking offices, Chemical Bank operated eight loan production offices and 272 automated teller machines, both on- and off-bank premises. Chemical Bank operates through an internal organizational structure of seven regional banking units. Chemical Bank's regional banking units are collections of branch banking offices organized by geographical region.
The principal source of revenue for the Corporation is interest and fees on loans, which accounted for 72.0% of total revenue in 2016, 73.1% of total revenue in 2015 and 72.1% of total revenue in 2014. Interest on investment securities, service charges and fees on deposit accounts, wealth management revenue and mortgage banking revenue are also significant sources of revenue, which combined, accounted for 18.0% of total revenue in 2016, 18.8% of total revenue in 2015 and 20.6% of total revenue in 2014. Revenue is influenced by overall economic factors including market interest rates, business and consumer spending, consumer confidence and competitive conditions in the marketplace.
Mergers, Acquisitions and Branch Closings
Merger with Talmer Bancorp, Inc.
On August 31, 2016, the Corporation acquired all the outstanding stock of Talmer Bancorp, Inc. ("Talmer") for total consideration of $1.61 billion, which included stock consideration of $1.50 billion and cash consideration of $107.6 million. As a result of the merger, the Corporation issued 32.1 million shares of its common stock based on an exchange ratio of 0.4725 shares of the Corporation's common stock, and paid $1.61 in cash, for each share of Talmer common stock outstanding. Talmer, a bank holding company, owned Talmer Bank and Trust, which was consolidated with and into Chemical Bank effective November 10, 2016. Talmer Bank and Trust operated a full service community bank offering a full suite of commercial banking, retail banking, mortgage banking, wealth management and trust services to small and medium-sized businesses and individuals through 80 full service banking offices located primarily within southeast Michigan and northeast Ohio, as well as in west Michigan, northeast Michigan, and northern Indiana. The merger with Talmer resulted in increases in the Corporation's total assets of $7.71 billion, including total loans of $4.88 billion, total deposits of $5.29 billion and investment securities of $810.6 million. In connection with the merger with Talmer, the Corporation recorded $846.7 million of goodwill, which was primarily due to the synergies and economies of scale expected from combining the operations of the Corporation and Talmer. In addition, the Corporation recorded $19.1 million of core deposit intangibles in conjunction with the merger.
The Corporation incurred $61.1 million of merger and acquisition-related transaction expenses during the year ended December 31, 2016, primarily related to the merger with Talmer, which reduced diluted earnings per share by $0.81.

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Acquisition of Lake Michigan Financial Corporation
On May 31, 2015, the Corporation acquired all of the outstanding stock of Lake Michigan Financial Corporation (Lake Michigan) for total consideration of $187.4 million, which included stock consideration of $132.9 million and cash consideration of $54.5 million. As a result of the acquisition, the Corporation issued approximately 4.3 million shares of its common stock, based on an exchange ratio of 1.326 shares of its common stock, and paid $16.64 in cash, for each share of Lake Michigan common stock outstanding. Lake Michigan, a bank holding company, owned The Bank of Holland and The Bank of Northern Michigan, which combined operated five banking offices in Holland, Grand Haven, Grand Rapids, Petoskey and Traverse City, Michigan. The Bank of Holland and The Bank of Northern Michigan were consolidated with and into Chemical Bank on November 13, 2015. The acquisition of Lake Michigan resulted in increases in the Corporation's total assets of $1.24 billion, including total loans of $985.5 million, and total deposits of $924.7 million, as of the acquisition date. In connection with the acquisition of Lake Michigan, the Corporation recorded $101.1 million of goodwill, which was primarily attributable to the synergies and economies of scale expected from combining the operations of the Corporation and Lake Michigan. In addition, the Corporation recorded $8.6 million of core deposit and other intangible assets in conjunction with the acquisition.
Acquisition expenses associated with the acquisition of Lake Michigan totaled $5.5 million during 2015, which reduced net income per common share by $0.11 in 2015.
Acquisition of Monarch Community Bancorp, Inc.
On April 1, 2015, the Corporation acquired all of the outstanding stock of Monarch Community Bancorp, Inc. (Monarch) in an all-stock transaction valued at $27.2 million. As a result of the acquisition, the Corporation issued 860,575 shares of its common stock based on an exchange ratio of 0.0982 shares of its common stock for each share of Monarch common stock outstanding. Monarch, a bank holding company, owned Monarch Community Bank, which operated five full service branch offices in Coldwater, Marshall, Hillsdale and Union City, Michigan. Monarch Community Bank was consolidated with and into Chemical Bank on May 8, 2015. The acquisition of Monarch resulted in increases in the Corporation's total assets of $182.8 million, including total loans of $121.8 million, and total deposits of $144.3 million, as of the acquisition date. In connection with the acquisition of Monarch, the Corporation recorded $5.3 million of goodwill, which was primarily attributable to the synergies and economies of scale expected from combining the operations of the Corporation and Monarch. In addition, the Corporation recorded $1.9 million of core deposit intangible assets in conjunction with the acquisition.
Acquisition expenses associated with the acquisition of Monarch totaled $2.3 million during 2015, which reduced net income per common share by $0.04 in 2015.
Acquisition of Northwestern Bancorp, Inc.
On October 31, 2014, the Corporation acquired all of the outstanding stock of Northwestern Bancorp, Inc. (Northwestern) for total cash consideration of $121.0 million. Northwestern, a bank holding company which owned Northwestern Bank, provided traditional banking services and products through 25 banking offices serving communities in the northwestern lower peninsula of Michigan. At the acquisition date, Northwestern added total assets of $815.0 million, including total loans of $475.3 million, and total deposits of $794.4 million, to the Corporation. Northwestern Bank was consolidated with and into Chemical Bank as of the acquisition date. In connection with the acquisition of Northwestern, the Corporation recorded $60.3 million of goodwill, which was primarily attributable to the synergies and economies of scale expected from combining the operations of the Corporation and Northwestern. In addition, the Corporation recorded $12.9 million of core deposit intangible assets in conjunction with the acquisition.
Acquisition expenses associated with the acquisition of Northwestern totaled $5.8 million during 2014, which reduced net income per common share by $0.14 in 2014.
Acquisition of 21 Branches
On December 7, 2012, Chemical Bank acquired 21 branches from Independent Bank, a subsidiary of Independent Bank Corporation (branch acquisition transaction). In addition to the branch offices, which are located in the northeast and Battle Creek regions of Michigan, the acquisition included $404 million in deposits and $44 million in loans. The purchase price of the branch offices, including equipment, was $8.1 million and the Corporation paid a premium on deposits of $11.5 million, or approximately 2.85% of total deposits acquired. The loans were purchased at a discount of 1.75%. In connection with the acquisition of the branches, the Corporation recorded goodwill of $6.8 million, which represented the excess of the purchase price over the fair value of identifiable net assets acquired, and other intangible assets attributable to customer core deposits of $5.6 million.
Branch Sales
In the fourth quarter of 2016, the Corporation sold the acquired Talmer Bank and Trust branch offices located in Chicago, Illinois and Las Vegas, Nevada. The sales of these two branches resulted in a total net gain on sale of $7.4 million.

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Critical Accounting Policies
The Corporation's consolidated financial statements are prepared in accordance with United States generally accepted accounting principles (GAAP), Securities and Exchange Commission (SEC) rules and interpretive releases and general practices within the industry in which the Corporation operates. Application of these principles requires management to make estimates, assumptions and complex judgments that affect the amounts reported in the consolidated financial statements and accompanying notes. These estimates, assumptions and judgments are based on information available as of the date of the financial statements; accordingly, as this information changes, the consolidated financial statements could reflect different estimates, assumptions and judgments. Actual results could differ significantly from those estimates. Certain policies inherently have a greater reliance on the use of estimates, assumptions and judgments and, as such, have a greater possibility of producing results that could be materially different than originally reported. The Corporation utilizes third-party sources to assist with developing estimates, assumptions and judgments regarding certain amounts reported in the consolidated financial statements and accompanying notes. When third-party sources are utilized, the Corporation's management remains responsible for complying with GAAP. To execute management's responsibilities, the Corporation has processes in place to develop an understanding of the third-party methodologies and to design and implement specific internal controls over valuation.
The significant accounting policies followed by the Corporation are presented in Note 1 to the consolidated financial statements included in Item 8 of this report. These policies, along with the disclosures presented in the other notes to the consolidated financial statements and in "Management's Discussion and Analysis of Financial Condition and Results of Operations," provide information on how significant assets and liabilities are measured in the consolidated financial statements and how those measurements are determined. Based on the techniques used and the sensitivity of financial statement amounts to the methods, estimates and assumptions underlying those amounts, management has identified the determination of the allowance for loan losses, accounting for business combinations (including acquired loans), income and other taxes, fair value measurements and the evaluation of goodwill impairment to be the accounting areas that require the most subjective or complex judgments, and as such, could be most subject to revision as new or additional information becomes available or circumstances change, including overall changes in the economic climate and/or market interest rates. Management reviews the following critical accounting policies with the Audit Committee of the board of directors at least annually.
Allowance for Loan Losses
The allowance for loan losses (allowance) is calculated with the objective of maintaining a reserve sufficient to absorb losses inherent in the loan portfolio. Loans represent the Corporation's largest asset type on the consolidated statements of financial position. The determination of the amount of the allowance is considered a critical accounting estimate because it requires significant judgment and the use of estimates related to the amount and timing of expected cash flows and collateral values on impaired loans, estimated losses on non-impaired loans in the commercial loan portfolio (comprised of commercial, commercial real estate, real estate construction and land development loans) and on pools of homogeneous loans based on historical loss experience, and consideration of current economic trends and conditions, all of which may be susceptible to significant change. The principal assumption used in deriving the allowance is the estimate of a loss percentage for each type of loan. In determining the allowance and the related provision for loan losses, the Corporation considers four principal elements: (i) valuation allowances based upon probable losses identified during the review of impaired loans in the commercial loan portfolio, (ii) reserves established for adversely-rated loans in the commercial loan portfolio and nonaccrual residential mortgage, consumer installment and home equity loans, (iii) reserves, by loan classes, on all other loans based principally on a five-year historical loan loss experience, loan loss trends and giving consideration to estimated loss emergence periods, and (iv) a reserve for qualitative factors that take into consideration risks inherent in the originated loan portfolio that differ from historical loan loss experience. It is extremely difficult to identify and accurately measure the amount of losses that are inherent in the Corporation's loan portfolio. The Corporation uses a defined methodology to quantify the necessary allowance and related provision for loan losses, but there can be no assurance that the methodology will successfully identify and estimate all of the losses that are inherent in the loan portfolio. Such methodology utilizes historical loss experience (net charge-offs) adjusted for qualitative factors, including trends in credit quality, composition of and growth in the Corporation's loan portfolio, and the overall economic environment in the Corporation's markets. These qualitative factors include many estimates and judgments. As a result, the Corporation could record future provisions for loan losses that may be significantly different than the levels that have been recorded in the three-year period ended December 31, 2016. Notes 1 and 5 to the consolidated financial statements further describe the methodology used to determine the allowance. In addition, a discussion of the factors driving changes in the amount of the allowance is included under the subheading "Allowance for Loan Losses" in "Management's Discussion and Analysis of Financial Condition and Results of Operations."
The Corporation has a loan review function that is independent of the loan origination function. At least annually, the loan review function reviews management's evaluation of the allowance and performs a detailed credit quality review, including analysis of collateral values, of loans in the commercial loan portfolio, particularly focusing on larger balance loans and loans that have deteriorated below certain levels of credit risk. In many cases, the estimate of collateral values includes significant judgments and assumptions.

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Accounting for Business Combinations
Pursuant to the guidance of Financial Accounting Standards Board (FASB) Accounting Standards Codification (ASC) Topic 805, Business Combinations (ASC 805), the Corporation recognizes assets acquired, including identified intangible assets, and the liabilities assumed in acquisitions at their fair values as of the acquisition date, with the acquisition-related transaction and restructuring costs expensed in the period incurred. Determining the fair value of assets acquired and liabilities assumed often involves estimates based on third-party valuations, such as appraisals, or internal valuations based on discounted cash flow analyses or other valuation techniques that may include estimates of attrition, inflation, asset growth rates, discount rates, multiples of earnings or other relevant factors. In addition, the determination of the useful lives over which an intangible asset will be amortized is subjective.
Accounting for Acquired Loans
ASC Topic 310-30, Loans and Debt Securities Acquired with Deteriorated Credit Quality (ASC 310-30), provides the GAAP guidance for accounting for loans acquired in a business combination that have experienced a deterioration in credit quality from origination to acquisition for which it is probable that the purchaser will be unable to collect all contractually required payments receivable, including both principal and interest.
Loans purchased with evidence of credit deterioration since origination and for which it is probable that all contractually required payments will not be collected are considered to be impaired. In the assessment of credit quality deterioration, the Corporation must make numerous assumptions, interpretations and judgments using internal and third-party credit quality information to determine whether or not it is probable that the Corporation will be able to collect all contractually required payments. This is a point in time assessment and inherently subjective due to the nature of the available information and judgment involved. Evidence of credit quality deterioration as of the acquisition date may include statistics such as past due and nonaccrual status, recent borrower credit scores and loan-to-value percentages. Those loans that qualify under ASC 310-30 are recorded at fair value at acquisition, which involves estimating the expected cash flows to be received. Accordingly, the associated allowance for loan losses related to these loans is not carried over at the acquisition date. ASC 310-30 also allows investors to aggregate acquired loans into loan pools that have common risk characteristics and use a composite interest rate and expectation of cash flows to be collected for the loan pools. The Corporation understands, as outlined in the American Institute of Certified Public Accountants' open letter to the Office of the Chief Accountant of the SEC dated December 18, 2009, and pending further standard setting, that for acquired loans that do not meet the scope criteria of ASC 310-30, a company may elect to account for such acquired loans pursuant to the provisions of either ASC Topic 310-20, Nonrefundable Fees and Other Costs, or ASC 310-30. The Corporation elected to apply ASC 310-30, by analogy, to loans acquired in the Talmer, Lake Michigan, Monarch, Northwestern and OAK acquisitions that were determined not to have deteriorated credit quality, and therefore, did not meet the scope criteria of ASC 310-30. Accordingly, the Corporation follows the accounting and disclosure guidance of ASC 310-30 for these loans. Notes 1, 2 and 5 to the consolidated financial statements contain additional information related to loans acquired in the Talmer, Lake Michigan, Monarch, Northwestern and OAK acquisitions.
The excess of cash flows of a loan, or pool of loans, expected to be collected over the estimated fair value is referred to as the "accretable yield" and is recognized into interest income over the estimated remaining life of the loan, or pool of loans, on a level-yield basis. The difference between the contractually required payments of a loan, or pool of loans, and the cash flows expected to be collected at acquisition, considering the impact of prepayments and estimates of future credit losses expected to be incurred over the life of the loan, or pool of loans, is referred to as the "nonaccretable difference."
The Corporation is required to quarterly evaluate its estimates of cash flows expected to be collected from acquired loans. These evaluations require the continued usage of key assumptions and estimates, similar to the initial estimate of fair value. Given the current economic environment, the Corporation must apply judgment to develop its estimates of cash flows for acquired loans given the impact of changes in property values, default rates, loss severities and prepayment speeds. Decreases in the estimates of expected cash flows will generally result in a charge to the provision for loan losses and a resulting increase to the allowance for loan losses. Increases in the estimates of expected cash flows will generally result in adjustments to the accretable yield, which will increase amounts recognized in interest income in subsequent periods. Dispositions of acquired loans, which may include sales of loans to third parties, receipt of payments in full or in part by the borrower and foreclosure of the collateral, result in removal of the loan from the acquired loan portfolio at its carrying amount. As a result of the significant amount of judgment involved in estimating future cash flows expected to be collected for acquired loans, the adequacy of the allowance for loan losses could be significantly impacted by changes in expected cash flows resulting from changes in credit quality of acquired loans.
Acquired loans that were classified as nonperforming loans prior to being acquired and acquired loans that are not performing in accordance with contractual terms subsequent to acquisition are not classified as nonperforming loans subsequent to acquisition because the loans are recorded in pools at net realizable value based on the principal and interest the Corporation expects to collect on such loans. Judgment is required to estimate the timing and amount of cash flows expected to be collected when the loans are not performing in accordance with the original contractual terms.

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Income and Other Taxes
The Corporation is subject to the income and other tax laws of the United States, the State of Michigan and other states where nexus has been created. These laws are complex and are subject to different interpretations by the taxpayer and the various taxing authorities. In determining the provisions for income and other taxes, management must make judgments and estimates about the application of these inherently complex laws, related regulations and case law. In the process of preparing the Corporation's tax returns, management attempts to make reasonable interpretations of enacted tax laws. These interpretations are subject to challenge by the tax authorities upon audit or to reinterpretation based on management's ongoing assessment of facts and evolving case law.
The Corporation and its subsidiaries file a consolidated federal income tax return. The provision for federal income taxes is based on income and expenses, as reported in the consolidated financial statements, rather than amounts reported on the Corporation's federal income tax return. When income and expenses are recognized in different periods for tax purposes than for book purposes, applicable deferred tax assets and liabilities are recognized for the future tax consequences attributable to the differences between the financial statement carrying amounts of existing assets and liabilities and their respective tax bases. Deferred tax assets and liabilities are measured using enacted tax rates expected to apply to taxable income in the years in which those temporary differences are expected to be recovered or settled. The effect on deferred tax assets and liabilities of a change in tax rates is recognized as income or expense in the period that includes the enactment date.
On a quarterly basis, management assesses the reasonableness of its effective federal tax rate based upon its estimate of taxable income and the applicable taxes expected for the full year, including the impact of any discrete items that have occurred. Deferred tax assets and liabilities are reassessed on a quarterly basis, including the need for a valuation allowance for deferred tax assets. The need for reserves for uncertain tax positions is reviewed quarterly based upon developments in tax law and the status of examinations or audits. As of December 31, 2016 and 2015, there were no federal income tax reserves recorded for uncertain tax positions.
Goodwill
Goodwill represents the excess of the purchase price of the Corporation's acquisition of various banks and bank branches over the fair value of the net assets acquired in the various acquisitions. The Corporation's goodwill totaled $1.13 billion at December 31, 2016, compared to $287.4 million at December 31, 2015. The increase in goodwill during 2016 was due to the merger with Talmer. Goodwill is not amortized, but rather is tested by management annually for impairment, or more frequently if triggering events occur and indicate potential impairment, in accordance with ASC Topic 350-20, Goodwill (ASC 350-20). ASC 350-20 allows an entity to assess qualitative factors to determine whether it is more-likely-than-not that the fair value of a reporting unit is less than its carrying amount. ASC 350-20 also allows an entity to bypass the qualitative assessment approach and determine if goodwill is impaired utilizing a quantitative assessment approach. The Corporation performed its 2016 annual goodwill impairment assessment as of October 31, 2016 utilizing the qualitative assessment approach.
In evaluating whether it is more-likely-than-not that the fair value of a reporting unit is less than its carrying amount, the Corporation assesses relevant events and circumstances, including macroeconomic conditions, industry and market considerations, overall financial performance, changes in the composition or carrying amount of assets and liabilities, the market price of the Corporation's common stock, and other relevant factors. Based on the qualitative assessment performed, the Corporation determined that no goodwill impairment was evident as of the October 31, 2016 assessment date. The Corporation also determined that no triggering events occurred that indicated potential impairment of goodwill from the most recent assessment date through December 31, 2016 and that the Corporation's goodwill was not impaired at December 31, 2016. However, the Corporation could incur impairment charges related to goodwill in the future due to changes in financial results or other matters that could affect the fair value of the Corporation's reporting units.
Fair Value Measurements
The Corporation determines the fair value of its assets and liabilities in accordance with ASC Topic 820, Fair Value Measurements and Disclosures (ASC 820). ASC 820 establishes a standard framework for measuring and disclosing fair value under GAAP. Estimates, assumptions and judgments may be necessary when assets and liabilities are required to be recorded at fair value or when a decline in the value of an asset not carried at fair value on the financial statements warrants an impairment write-down or a valuation reserve to be established. Carrying assets and liabilities at fair value inherently results in more financial statement volatility. The fair values and the information used to record valuation adjustments for certain assets and liabilities are based either on quoted market prices or are provided by third-party sources, when available. When third-party information is not available, valuation adjustments are estimated by management primarily through the use of internal discounted cash flow analyses, and to the extent available, observable market-based inputs.
A number of valuation techniques are used to determine the fair value of assets and liabilities in the Corporation's financial statements. The valuation techniques include quoted market prices for investment securities, appraisals of real estate from

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independent licensed appraisers and other valuation techniques. Fair value measurements for assets and liabilities where limited or no observable market data exists are based primarily upon estimates, and are often calculated based on the economic and competitive environment, the characteristics of the asset or liability and other factors. Therefore, the valuation results cannot be determined with precision and may not be realized in an actual sale or immediate settlement of the asset or liability. Additionally, there are inherent weaknesses in any calculation technique, and changes in the underlying assumptions used, including discount rates and estimates of future cash flows, could significantly affect the results of current or future values. Significant changes in the aggregate fair value of assets and liabilities required to be measured at fair value or for impairment are recognized in the income statement under the framework established by GAAP. See Note 3 to the Corporation's consolidated financial statements for more information on fair value measurements.
Accounting Standards Updates
See Note 1 to the Consolidated Financial Statements included in this report for details of accounting pronouncements adopted by the Corporation during 2016. See the following section for a description of pronouncements that have been released but are not adopted by the Corporation.
Pending Accounting Pronouncements
Revenue Recognition    
In May 2014, the Financial Accounting Standards Board ("FASB") issued ASU 2014-09, Revenue from Contracts with Customers (“ASU 2014-09”), which outlines a single comprehensive model for entities to use in accounting for revenue arising from contracts with customers and supersedes most current revenue recognition guidance.  The core principle of the revenue model 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 ASU 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. In March 2016, the FASB issued ASU 2016-08, Principal versus Agent Considerations (Reporting Revenue Gross versus Net), ("ASU 2016-08"), which further clarifies ASU 2014-09 by providing implementation guidance on principal versus agent considerations. In April 2016, the FASB issued ASU 2016-10, Identifying Performance Obligations and Licensing, ("ASU 2016-10"), which provides additional clarification of ASU 2014-09 by amending guidance related to the identification of performance obligations and licensing implementation. ASU 2016-08 and ASU 2016-10 do not change the core principal of ASU 2014-09, but are intended to improve the operations and understanding of principal versus agent considerations, performance obligation identification and licensing implementation. In May 2016, the FASB issued ASU 2016-12, Narrow-Scope Improvements and Practical Expedients, ("ASU 2016-12"), which amends certain aspects of ASU 2014-09, which include collectibility, presentation of sales taxes and other taxes collected from customers, noncash consideration and transition technical corrections. ASU 2016-12 completes the FASB deliberations of clarifications to ASU 2014-09 that have been conducted over the last year. In August 2015, the FASB issued ASU 2015-14, Deferral of the Effective Date ("ASU 2015-14"), which provides a one year deferral to the effective date, therefore, ASU 2014-09 is effective for public companies for annual periods, and interim periods within those annual periods, beginning on or after December 15, 2017. As such, the Corporation will adopt ASU 2014-09 as of January 1, 2018. Under the provision, the Corporation will have the option to adopt the guidance using either a full retrospective method or a modified transition approach.  The Corporation is currently evaluating the provisions of ASU 2014-09 on the Corporation's consolidated financial condition and results of operations.
Recognition and Measurement
In January 2016, the FASB issued ASU No. 2016-01, Financial Instruments - Overall (Subtopic 825-10): Recognition and Measurement of Financial Assets and Financial Liabilities ("ASU 2016-01"). ASU 2016-01 amends current guidance by: (i) requiring equity investments with readily determinable fair values to be measured at fair value with changes in fair value recognized in net income, (ii) allowing an entity to measure equity investments that do not have readily determinable fair values at either fair value or cost minus impairment, if any, plus or minus changes in observable prices, with changes in measurement recognized in net income, (iii) simplifying the impairment assessment of equity investments without readily determinable fair values by requiring a qualitative assessment to identify impairment, (iv) eliminating the requirement to disclose the methods and significant assumptions used to estimate the fair value for financial instruments measured at amortized cost on the balance sheet; (v) requiring use the of exit price notion when measuring the fair value of financial instruments for disclosure purposes; (vi) requiring recognition of changes in the fair value related to instrument-specific credit risk in other comprehensive income if the fair value option for financial liabilities is elected, (vii) requiring separate presentation in the financial statements of financial assets and financial liabilities by measurement category, and (8) clarifying that an entity should evaluate the need for a valuation allowance on deferred tax assets related to available-for-sale securities in combination with the entity’s other deferred tax assets. ASU 2016-01 is effective for interim and annual reporting periods beginning after December 15, 2017. Early application is permitted as of the beginning of the fiscal year of adoption only for items (iv) and (vi) above. Early adoption of the other items mentioned above is not permitted.

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The adoption of ASU 2016-01 is not expected to have a material impact on the Corporation's consolidated financial condition or results of operations.
Leases
In February 2016, the FASB issued ASU No. 2016-02, Leases (Topic 842) ("ASU 2016-02"). Under ASU 2016-02, the Corporation will be required to recognize the following for all leases (with the exception of short-term leases): (i) a right to use asset, which is an asset that represents the lessee's right to use, or control the use of, a specified asset for the lease term and (ii) a lease liability, which is a liability that represents lessee's obligation to make lease payments arising from a lease, measured on a discounted basis. ASU 2016-02 requires a modified retrospective transition approach for leases existing at, or entered into after, the beginning of the earliest comparative period presented in the financial statements. ASU 2016-02 is effective for public companies for interim and annual periods beginning after December 15, 2018. The adoption of ASU 2016-02 is not expected to have a material impact on the Corporation's results of operations, but it is anticipated to result in a material increase in our assets and liabilities.
Credit Losses
In June, the FASB issued ASU No. 2016-13, Financial Instruments - Credit Losses (Topic 326): Measurement of Credit Losses on Financial Instruments ("ASU 2016-13"). ASU 2016-13 changes how entities will measure credit losses for most financial assets and certain other instruments that are not measured at fair value through net income.
ASU 2016-13 requires an entity measure expected credit losses for financial assets over the estimated lifetime of expected credit loss and record an allowance that, when deducted from the amortized cost basis of the financial asset, presents the net amount expected to be collected on the financial asset. The standard includes the following core concepts in determining the expected credit loss estimate: (a) be based on an asset’s amortized cost (including premiums or discounts, net deferred fees and costs, foreign exchange and fair value hedge accounting adjustments), (b) reflect losses expected over the remaining contractual life of an asset (considering the effect of voluntary prepayments), (c) consider available relevant information about the estimated collectibility of cash flows (including information about past events, current conditions, and reasonable and supportable forecasts), and (d) reflect the risk of loss, even when that risk is remote.
ASU 2016-13 also amends the recording of purchased credit-deteriorated assets. Under the new guidance, an allowance will be recognized at acquisition through a gross-up approach whereby an entity will record as the initial amortized cost the sum of (a) the purchase price and (b) an estimate of credit losses as of the date of acquisition. In addition, the guidance also requires immediate recognition in earnings any subsequent changes, both favorable and unfavorable, in expected cash flows by adjusting this allowance.
ASU 2016-13 amends the impairment model for available-for-sale debt securities and requires entities to determine whether all or a portion of the unrealized loss on an available-for-sale debt security is a credit loss. Management may not use the length of time a security has been in an unrealized loss position as a factor in concluding whether a credit loss exists, as is currently permitted. In addition, an entity will recognize an allowance for credit losses on available-for-sale debt securities as a contra-account to the amortized cost basis rather than as a direct reduction of the amortized cost basis of the investment, as is currently required. As a result, entities will recognize improvements to credit losses on available-for-sale debt securities immediately in earnings rather than as interest income over time under current practice.
New disclosures required by ASU 2016-13 include: (a) for financial assets measured at amortized cost, an entity will be required to disclose information about how it developed its allowance, including changes in the factors that influenced management’s estimate of expected credit losses and the reasons for those changes, (b) for financial receivables and net investments in leases measured at amortized cost, an entity will be required to further disaggregate the information it currently discloses about the credit quality of these assets by year or the asset’s origination or vintage for as many as five annual periods, and (c) for available-for-sale debt securities, an entity will be required to provide a roll-forward of the allowance for credit losses and an aging analysis for securities that are past due.
Upon adoption of ASU 2016-13, a cumulative-effect adjustment to retained earnings will be recorded as of the beginning of the first reporting period in which the guidance is effective. ASU 2016-13 is effective for public companies for interim and annual periods beginning after December 15, 2019, with early adoption permitted for annual periods beginning after December 15, 2018. The Corporation is currently evaluating the provisions of ASU 2016-13 to determine the potential impact on the Corporation's consolidated financial condition and results of operations.
Statement of Cash Flows
In August 2016, the FASB issued ASU No. 2016-15, Statement of Cash Flows (Topic 230): Classification of Certain Cash Receipts and Cash Payments ("ASU 2016-15"), which clarifies guidance on the classification of eight specific cash flow issues. ASU 2016-15 was issued to reduce diversity in practice and prevent financial statement restatements. Cash flow issues include; debt prepayment or debt extinguishment costs, settlement of zero-coupon bonds, contingent consideration payments made after a business combination, proceeds from the settlement of insurance claims, proceeds from the settlement of corporate-owned

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life insurance policies and bank-owned life insurance policies, distributions received from equity method investees, beneficial interests in securitization transactions and separately identifiable cash flows and application of the predominance principle. ASU 2016-15 is effective for public business entities for fiscal years beginning after December 15, 2017, including interim periods within those fiscal years. Under the provision, entities must apply the guidance retrospectively to all periods presented but may apply it prospectively if retrospective application would be impracticable. The Corporation is currently evaluating the provisions of ASU 2016-15.
Mergers and Acquisitions
In January 2017, the FASB issued ASU No. 2017-01, Business Combinations (Topic 805): Clarifying the Definition of a Business ("ASU 2017-01"), which narrows the definition of a business and provides a framework that gives entities a basis for making reasonable judgments about whether a transaction involves an asset or a business.ASU 2017-01 is effective for public business entities in annual periods beginning after December 15, 2017, including interim periods therein. The adoption of ASU 2017-01 is not expected to have a material impact on the Corporation’s consolidated financial condition or results of operations.

Goodwill Impairment Measurement

In January 2017, the FASB issued ASU No. 2017-04, Intangibles - Goodwill and Other (Topic 350): Simplifying the Accounting for Goodwill Impairment, which simplifies the accounting for goodwill impairment. The new guidance removes Step 2 of the goodwill impairment test, which requires a hypothetical purchase price allocation. Subsequent to adoption of ASU 2017-04, goodwill impairment will be the amount by which a reporting unit's carrying value exceeds its fair value, not to exceed the carrying amount of goodwill. All other goodwill impairment guidance largely remains unchanged. ASU 2017-04 will be applied prospectively, and is effective for public business entities for annual and interim goodwill impairment tests beginning after December 15, 2009. The adoption of ASU 2017-04 is not expected to have a material impact on the Corporation's consolidated financial condition or results of operations.
Non-GAAP Financial Measures
This report contains references to financial measures that are not defined in GAAP. Such non-GAAP financial measures include the Corporation's tangible book value per share, tangible equity to tangible assets ratio, presentation of net interest income and net interest margin on a fully taxable equivalent (FTE) basis and information presented excluding certain significant items (transaction expenses, net gain on the sale of branches and the change in fair value in loan servicing rights), including net income, diluted earnings per share, return on average assets, return on average shareholders' equity, operating expenses and the efficiency ratio. Management believes these non-GAAP financial measures provide useful information to both management and investors that is supplementary to our financial condition and results of operations in accordance with GAAP; however, we acknowledge that these non-GAAP financial measures have a number of limitations. Limitations associated with non-GAAP financial measures include the risk that persons might disagree as to the appropriateness of items comprising these measures and that different companies might calculate these measures differently. These disclosures should not be considered an alternative to the Corporation's GAAP results.

A reconciliation of non-GAAP financial measures to the most directly comparable GAAP financial measures is presented below. A reconciliation of net interest income and net interest margin (FTE) to the most directly comparable GAAP financial measure can be found under the subheading "Average Balances, Fully Taxable Equivalent (FTE) Interest and Effective Yields and Rates" of this report.

34


 
 
Year Ended December 31,
(Dollars in thousands, except per share data)
 
2016
 
2015
 
2014
 
2013
 
2012
Reconciliation of Non-GAAP Operating Results
 
 
 
 
 
 
 
 
 
 
Net Income
 
 
 
 
 
 
 
 
 
 
Net income, as reported
 
$
108,032

 
$
86,830

 
$
62,121

 
$
56,808

 
$
51,008

Transaction expenses
 
61,134

 
7,804

 
6,388

 

 

Gain on sales of branch offices
 
(7,391
)
 

 

 

 

Loan servicing rights change in fair value
 
(5,112
)
 

 

 

 

Significant items
 
48,631

 
7,804

 
6,388

 

 

Income tax benefit(1)
 
(16,258
)
 
(2,320
)
 
(1,833
)
 

 

Significant items, net of tax
 
32,373

 
5,484

 
4,555

 

 

Net income, excluding transaction expenses
 
$
140,405

 
$
92,314

 
$
66,676

 
$
56,808

 
$
51,008

Diluted Earnings Per Share
 
 
 
 
 
 
 
 
 
 
Diluted earnings per share, as reported
 
$
2.17

 
$
2.39

 
$
1.97

 
$
2.00

 
$
1.85

Effect of significant items, net of tax
 
0.64

 
0.15

 
0.14

 

 

Diluted earnings per share, excluding significant items
 
$
2.81

 
$
2.54

 
$
2.11

 
$
2.00

 
$
1.85

Return on Average Assets
 
 
 
 
 
 
 
 
 
 
Return on average assets, as reported
 
0.90
%
 
1.02
%
 
0.96
%
 
0.95
%
 
0.94
%
Effect of significant items, net of tax
 
0.27

 
0.07

 
0.07

 

 

Return on average assets, excluding significant items
 
1.17
%
 
1.09
%
 
1.03
%
 
0.95
%
 
0.94
%
Return on Average Shareholders' Equity
 
 
 
 
 
 
 
 
 
 
Return on average shareholders' equity, as reported
 
6.98
%
 
9.44
%
 
8.20
%
 
9.10
%
 
8.70
%
Effect of significant items, net of tax
 
2.10

 
0.60

 
0.60

 

 

Return on average shareholders' equity, excluding significant items
 
9.08
%
 
10.04
%
 
8.80
%
 
9.10
%
 
8.70
%
Efficiency Ratio
 
 
 
 
 
 
 
 
 
 
Net interest income
 
$
381,081

 
$
274,008

 
$
212,551

 
$
196,647

 
$
187,545

Noninterest income
 
122,350

 
80,216

 
63,095

 
60,409

 
54,684

Total revenue - GAAP
 
503,431

 
354,224

 
275,646

 
257,056

 
242,229

Net interest income FTE adj
 
9,642

 
7,452

 
5,975

 
5,355

 
5,037

Loan servicing rights change in fair value
 
(5,112
)
 

 

 

 

Gains on sale of branch offices
 
(7,391
)
 

 

 

 

Gains from closed branch locations and sale of investment securities
 
(669
)
 
(779
)
 

 

 

Total revenue - non-GAAP
 
$
499,901

 
$
360,897

 
$
281,621

 
$
262,411

 
$
247,266

Operating expenses - GAAP
 
$
338,418

 
$
223,894

 
$
179,925

 
$
164,948

 
$
151,921

Transaction expenses
 
(61,134
)
 
(7,804
)
 
(6,388
)
 

 

Amortization of intangibles
 
(5,524
)
 
(4,389
)
 
(2,029
)
 
(1,909
)
 
(1,569
)
Operating expenses - non-GAAP
 
$
271,760

 
$
211,701

 
$
171,508

 
$
163,039

 
$
150,352

Efficiency ratio - GAAP
 
67.2
%
 
63.2
%
 
65.3
%
 
64.2
%
 
62.7
%
Efficiency ratio - adjusted non-GAAP
 
54.4
%
 
58.7
%
 
60.9
%
 
62.1
%
 
60.8
%
(1) Assumes transaction expenses are deductible at an income tax rate of 35%, except for the impact of estimated nondeductible expenses incurred in periods when the Corporation completes merger and acquisition transactions.

35


 
 
December 31,
(Dollars in thousands, except per share data)
 
2016
 
2015
 
2014
 
2013
 
2012
Tangible Book Value
 
 
 
 
 
 
 
 
 
 
Shareholders' equity, as reported
 
$
2,581,526

 
$
1,015,974

 
$
797,133

 
$
696,500

 
$
596,341

Goodwill, CDI and noncompete agreements, net of tax
 
(1,155,528
)
 
(301,073
)
 
(190,714
)
 
(124,553
)
 
(130,173
)
Tangible shareholders' equity
 
$
1,425,998


$
714,901


$
606,419


$
571,947


$
466,168

Common shares outstanding
 
70,599

 
38,168

 
32,774

 
29,790

 
27,499

Book value per share (shareholders' equity, as reported, divided by common shares outstanding)
 
$
36.57

 
$
26.62

 
$
24.32

 
$
23.38

 
$
21.69

Tangible book value per share (tangible shareholders' equity divided by common shares outstanding)
 
$
20.20

 
$
18.73

 
$
18.50

 
$
19.20

 
$
16.95

Tangible Shareholders' Equity to Tangible Assets
 
 
 
 
 
 
 
 
 
 
Total assets, as reported
 
$
17,355,179

 
$
9,188,797

 
$
7,322,143

 
$
6,184,708

 
$
5,917,252

Goodwill, CDI and noncompete agreements, net of tax
 
(1,155,528
)
 
(301,073
)
 
(190,714
)
 
(124,553
)
 
(130,173
)
Tangible assets
 
$
16,199,651

 
$
8,887,724

 
$
7,131,429

 
$
6,060,155

 
$
5,787,079

Shareholders' equity to total assets
 
14.9
%
 
11.1
%
 
10.9
%
 
11.3
%
 
10.1
%
Tangible shareholders' equity to tangible assets
 
8.8
%
 
8.0
%
 
8.5
%
 
9.4
%
 
8.1
%

Financial Highlights
The following discussion and analysis is intended to cover significant factors affecting the Corporation's consolidated statements of financial position and income included in this report. It is designed to provide a more comprehensive review of the consolidated operating results and financial position of the Corporation than could be obtained from an examination of the financial statements alone.

36


Net Income
Net income in 2016 was $108.0 million or $2.17 per diluted share, compared to net income in 2015 of $86.8 million, or $2.39 per diluted share and net income in 2014 of $62.1 million, or $1.97 per diluted share. Net income included merger and acquisition-related expenses "transaction expenses" of $61.1 million in 2016 and $7.8 million in 2015. Net income in 2016 additionally included net gain on the sale of branches of $7.4 million and a benefit due to the change in fair value of loan servicing rights of $5.1 million. Excluding transaction expenses, net gain on sale of branches and the change in the fair value of loan servicing rights ("significant items"), net income in 2016 was $140.4 million or $2.81 per diluted share, compared to net income in 2015 of $92.3 million, or $2.54 per diluted share.(1) Excluding significant items, the increase in net income in 2016, compared to 2015, was primarily attributable to incremental earnings resulting from the merger with Talmer, while the increase in net income in 2015, compared to 2014, was primarily attributable to the Lake Michigan, Monarch and Northwestern acquisitions.
The Corporation's return on average assets was 0.90% in 2016, 1.02% in 2015, and 0.96% in 2014 and the Corporation's return on average shareholders' equity was 6.98% in 2016, 9.44% in 2015, 8.20% in 2014. Excluding significant items, the Corporation's return on average assets was 1.17% in 2016 and 1.09% in 2015, and the Corporation's return on average shareholders' equity was 9.08% in 2016 and 10.04% in 2015.(1) 
(1)Net income, excluding significant items, diluted earnings per share, excluding significant items, return on average shareholders' equity, excluding significant items, and return on average assets, excluding significant items, are non-GAAP financial measures. Please refer to the section entitled "Non-GAAP Financial Measures."
Assets
Total assets were $17.4 billion at December 31, 2016, an increase of $8.17 billion, or 88.9%, from total assets at December 31, 2015 of $9.2 billion. The increase in total assets during 2016 was primarily attributable to the merger with Talmer, which increased the Corporation's total assets by $7.71 billion as of the merger date. The increase in total assets during 2016 was also attributable to loan growth that was funded by a combination of organic growth in customer deposits, an increase in FHLB advances and proceeds from maturing investment securities.
Average assets were $12.04 billion during 2016, an increase of $3.56 billion, or 41.9%, from average assets of $8.48 billion during 2015. Average assets during 2015 increased $2.01 billion, or 31.0%, from average assets of $6.47 billion during 2014. The increase in average assets during 2016, as compared to 2015, was attributable to a combination of the $7.71 billion of assets acquired in the merger with Talmer completed August 31, 2016 and additional net loan growth. The increase in average assets during 2015, as compared to 2014, was attributable to a combination of the $1.47 billion of assets acquired in the Lake Michigan and Monarch transactions and organic loan growth.

37


Investment Securities
The following table summarizes the maturities and yields of the carrying value of investment securities by investment category, and fair value by investment category, at December 31, 2016 and 2015:
 
Maturity as of December 31, 2016(1)
 
 
 
 
 
 
 
Within
One Year
 
After One
but Within
Five Years
 
After Five
but Within
Ten Years
 
After
Ten Years
 
Total
Carrying
Value(2)
 
Total
Fair
Value
(Dollars in thousands)
Amount
 
Yield(3)
 
Amount
 
Yield(3)
 
Amount
 
Yield(3)
 
Amount
 
Yield(3)
 
Amount
 
Yield(3)
 
Available-for-Sale:
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
U.S. Treasury securities
$
5,793

 
0.95
%
 
$

 
%
 
$

 
%
 
$

 
%
 
$
5,793

 
0.95
%
 
$
5,793

Government sponsored agencies
71,233

 
1.11

 
82,888

 
1.43

 
56,363

 
1.78

 
4,527

 
1.85

 
215,011

 
1.42

 
215,011

State and political subdivisions
9,438

 
2.53

 
70,435

 
2.11

 
116,239

 
2.39

 
103,976

 
2.94

 
300,088

 
2.52

 
300,088

Residential mortgage-backed securities
54,204

 
1.55

 
143,937

 
1.60

 
48,400

 
2.08

 
25,741

 
2.31

 
272,282

 
1.74

 
272,282

Collateralized mortgage obligations
87,400

 
2.04

 
135,646

 
2.26

 
79,496

 
2.42

 
17,483

 
2.58

 
320,025

 
2.26

 
320,025

Corporate bonds
7,778

 
1.47

 
52,315

 
1.85

 
29,381

 
3.66

 

 

 
89,474

 
2.41

 
89,474

Preferred stock and trust preferred securities

 

 

 

 

 

 
32,291

 
2.95

 
32,291

 
2.95

 
32,291

Total investment securities available-for-sale
235,846

 
1.62

 
485,221

 
1.86

 
329,879

 
2.36

 
184,018

 
2.79

 
1,234,964

 
2.09

 
1,234,964

Held-to-Maturity:
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
State and political subdivisions
66,090

 
2.18

 
262,136

 
2.74

 
145,225

 
3.90

 
149,476

 
3.13

 
622,927

 
3.04

 
608,221

Trust preferred securities

 

 

 

 

 

 
500

 
4.00

 
500

 
4.00

 
310

Total investment securities held-to-maturity
66,090

 
2.18

 
262,136

 
2.74

 
145,225

 
3.90

 
149,976

 
3.13

 
623,427

 
3.05

 
608,531

Total investment securities
$
301,936

 
1.74
%
 
$
747,357

 
2.17
%
 
$
475,104

 
2.83
%
 
$
333,994

 
2.95
%
 
$
1,858,391

 
2.41
%
 
$
1,843,495

(1)
Residential mortgage-backed securities, collateralized mortgage obligations and certain government sponsored agencies are based on scheduled principal maturity. All other investment securities are based on final contractual maturity.
(2)
The aggregate book value of securities issued by any single issuer, other than the U.S. government and government sponsored agencies, did not exceed 10% of the Corporation's shareholders' equity.
(3)
Yields are weighted by amount and time to contractual maturity, are on a taxable equivalent basis using a 35% federal income tax rate and are based on carrying value. Yields disclosed are actual yields based on carrying value at December 31, 2016. Approximately 10% of the Corporation's investment securities at December 31, 2016 were variable-rate financial instruments.

38


 
Maturity as of December 31, 2015(1)
 
 
 
 
 
 
 
Within
One Year
 
After One
but Within
Five Years
 
After Five
but Within
Ten Years
 
After
Ten Years
 
Total
Carrying
Value(2)
 
Total
Fair
Value
(Dollars in thousands)
Amount
 
Yield(3)
 
Amount
 
Yield(3)
 
Amount
 
Yield(3)
 
Amount
 
Yield(3)
 
Amount
 
Yield(3)
 
Available-for-Sale:
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
U.S. Treasury securities
$

 
%
 
$
5,765

 
0.95
%
 
$

 
%
 
$

 
%
 
$
5,765

 
0.95
%
 
$
5,765

Government sponsored agencies
59,963

 
0.66

 
132,207

 
1.11

 
2,648

 
1.08

 
171

 
1.14

 
194,989

 
0.97

 
194,989

State and political subdivisions
1,976

 
3.25

 
11,403

 
4.26

 
1,741

 
5.89

 

 

 
15,120

 
4.32

 
15,120

Residential mortgage-backed securities
42,110

 
1.39

 
114,971

 
1.37