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CHEMICAL FINANCIAL CORP - 10-Q - Management's Discussion and Analysis of Financial Condition and Results of Operations
[October 24, 2014]

CHEMICAL FINANCIAL CORP - 10-Q - Management's Discussion and Analysis of Financial Condition and Results of Operations


(Edgar Glimpses Via Acquire Media NewsEdge) The following is management's discussion and analysis of certain significant factors that have affected the financial condition and results of operations of Chemical Financial Corporation (Corporation) during the periods included in the consolidated financial statements included in this report.

Critical Accounting Policies The Corporation's consolidated financial statements are prepared in accordance with United States generally accepted accounting principles (GAAP), Securities and Exchange Commission (SEC) rules and interpretive releases and general practices within the industry in which the Corporation operates. Application of these principles requires management to make estimates, assumptions and complex judgments that affect the amounts reported in the consolidated financial statements and accompanying notes. These estimates, assumptions and judgments are based on information available as of the date of the financial statements; accordingly, as this information changes, the consolidated financial statements could reflect different estimates, assumptions and judgments. Actual results could differ significantly from those estimates. Certain policies inherently have a greater reliance on the use of estimates, assumptions and judgments and, as such, have a greater possibility of producing results that could be materially different than originally reported. Management has identified the determination of the allowance for loan losses, accounting for loans acquired in business combinations, pension plan accounting, income and other taxes, fair value measurements and the evaluation of goodwill impairment to be the accounting areas that require the most subjective or complex judgments and, as such, could be most subject to revision as new or additional information becomes available or circumstances change, including overall changes in the economic climate and/or market interest rates. Therefore, management considers them to be critical accounting policies and discusses them directly with the Audit Committee of the board of directors. The Corporation's significant accounting policies are more fully described in Note 1 to the audited consolidated financial statements contained in the Corporation's Annual Report on Form 10-K for the year ended December 31, 2013 and the more significant assumptions and estimates made by management are more fully described in "Management's Discussion and Analysis of Financial Condition and Results of Operations - Critical Accounting Policies" in the Corporation's Annual Report on Form 10-K for the year ended December 31, 2013. There were no material changes to the Corporation's significant accounting policies or the estimates made pursuant to those policies during the most recent quarter.

Acquisitions Pending Acquisition of Northwestern Bancorp, Inc.

On March 10, 2014, the Corporation and Northwestern Bancorp, Inc.

(Northwestern), the parent company of Northwestern Bank, a community bank based in Traverse City, Michigan, entered into a definitive agreement whereby the Corporation will acquire Northwestern in an all cash transaction valued at $120 million, subject to adjustment under limited circumstances. The Corporation anticipates the transaction, with cost savings fully phased in and excluding the impact of nonrecurring transaction-related expenses, to be immediately accretive to earnings per share. Regulatory approval for the transaction was received on September 30, 2014 and the transaction is expected to close on October 31, 2014, subject to customary closing conditions. The Corporation recognized $1.3 million and $2.2 million of pre-tax nonrecurring transaction-related expenses during the three and nine months ended September 30, 2014, respectively.

Acquisition of 21 Branches On December 7, 2012, Chemical Bank acquired 21 branches located in the Northeast and Battle Creek regions of Michigan, including $404 million in deposits and $44 million in loans (branch acquisition transaction). The Corporation paid a premium on deposits of $11.5 million, or approximately 2.85% of total deposits acquired and the loans were purchased at a discount of 1.75%. In connection with the branch acquisition transaction, the Corporation recorded goodwill of $6.8 million, which represented the excess of the purchase price over the fair value of identifiable net assets acquired, and other intangible assets attributable to customer core deposits of $5.6 million.

Acquisition of O.A.K. Financial Corporation On April 30, 2010, the Corporation acquired O.A.K. Financial Corporation (OAK) and OAK's wholly-owned bank subsidiary, Byron Bank, for total consideration of $83.7 million. Byron Bank, which was subsequently consolidated with and into Chemical Bank, provided traditional banking services and products through 14 banking offices serving communities in Ottawa, Allegan and Kent counties in west Michigan. At April 30, 2010, OAK had total assets of $820 million, including total loans of $627 million, and total deposits of $693 million, including brokered deposits of $193 million. In connection with the acquisition of OAK, the Corporation recorded goodwill of $43.5 million, which represented the synergies and economies of scale expected from combining the operations of the Corporation and OAK. In addition, the Corporation recorded other intangible assets in conjunction with the acquisition of OAK of $9.8 million.

46 -------------------------------------------------------------------------------- Summary The Corporation's net income was $16.8 million, or $0.51 per diluted share, in the third quarter of 2014, compared to net income of $15.0 million, or $0.53 per diluted share, in the third quarter of 2013 and net income of $16.2 million, or $0.54 per diluted share, in the second quarter of 2014. Excluding nonrecurring transaction-related expenses attributable to the pending acquisition of Northwestern, net income was $17.6 million, or $0.53 per diluted share, in the third quarter of 2014. Net income, excluding nonrecurring transaction-related expenses, in the third quarter of 2014, was 17% higher than the third quarter of 2013 due to a combination of higher net interest income, higher noninterest income and a lower provision for loan losses, which were partially offset by higher operating expenses. Net income, excluding nonrecurring transaction-related expenses, in the third quarter of 2014 was 5.6% higher than the second quarter of 2014 due primarily to higher net interest income.

Return on average assets, on an annualized basis, was 1.04% in the third quarter of 2014, compared to 1.00% in the third quarter of 2013 and 1.04% in the second quarter of 2014. Return on average equity, on an annualized basis, was 8.4% in the third quarter of 2014, compared to 9.6% in the third quarter of 2013 and 9.1% in the second quarter of 2014. The decreases in return on average shareholders' equity in the third quarter of 2014, compared to both the second quarter of 2014 and the third quarter of 2013, was primarily attributable to increases in shareholders' equity resulting from the Corporation's September 2013 and June 2014 common equity offerings and nonrecurring transaction-related expenses. Nonrecurring transaction-related expenses in the third quarter of 2014 reduced the Corporation's return on average assets by 5 basis points and return on average shareholders' equity by 42 basis points.

The Corporation's net income was $46.8 million, or $1.51 per diluted share, for the nine months ended September 30, 2014, compared to net income of $42.4 million, or $1.53 per diluted share, for the nine months ended September 30, 2013. Net income, excluding nonrecurring transaction-related expenses, was $48.3 million, or $1.55 per diluted share, for the nine months ended September 30, 2014, up 14% over the same period for 2013 due to a combination of higher net interest income and a lower provision for loan losses, which were partially offset by lower noninterest income and higher operating expenses.

Non-GAAP Financial Measures This report contains references to financial measures which are not defined in GAAP. Such non-GAAP financial measures include the Corporation's tangible equity to assets ratio, presentation of net interest income on a fully taxable equivalent (FTE) basis and information presented excluding nonrecurring transaction-related expenses, including net income, diluted earnings per share, return on average assets, return on average shareholders' equity and operating expenses. These non-GAAP financial measures have been included as the Corporation believes they are helpful for investors to analyze and evaluate the Corporation's financial condition.

Financial Condition Total Assets Total assets were $6.60 billion at September 30, 2014, an increase of $365 million, or 5.9%, from total assets of $6.23 billion at June 30, 2014, an increase of $412 million, or 6.7%, from total assets of $6.18 billion at December 31, 2013, and an increase of $339 million, or 5.4%, from total assets of $6.26 billion at September 30, 2013.

Interest-earning assets were $6.22 billion at September 30, 2014, an increase of $363 million, or 6.2%, from interest-earning assets of $5.86 billion at June 30, 2014, an increase of $402 million, or 6.9%, from interest-earning assets of $5.82 billion at December 31, 2013, and an increase of $318 million, or 5.4%, from interest-earning assets of $5.90 billion at September 30, 2013.

The increases in total assets and interest-earning assets during the three months ended September 30, 2014 were primarily due to seasonal increases in municipal customer deposits that were partially used to fund loan growth. The increases in total assets and interest-earning assets during the twelve-month period ended September 30, 2014 were primarily attributable to an increase in customer deposits that were used to partially fund loan growth. The increases were also partially attributable to $76 million of net proceeds received by the Corporation in its June 2014 common equity offering.

Investment Securities The carrying value of investment securities totaled $894.8 million at September 30, 2014, a decrease of $29.3 million, or 3.2%, from investment securities of $924.1 million at June 30, 2014, a decrease of $63.7 million, or 6.6%, from investment securities of $958.5 million at December 31, 2013, and a decrease of $93.0 million, or 9.4%, from investment securities of $987.7 million at September 30, 2013. The decreases in investment securities were attributable to the Corporation utilizing some of the liquidity from maturing investment securities to partially fund loan growth.

47 --------------------------------------------------------------------------------A summary of the composition of the carrying value of the Corporation's investments securities portfolio follows: September 30, December 31, September 30, 2014 June 30, 2014 2013 2013 (In thousands)Available-for-sale: Government sponsored agencies $ 76,938 $ 88,708 $ 93,763 $ 85,925 State and political subdivisions 40,964 41,608 43,798 45,572 Residential mortgage-backed securities 251,039 265,368 299,366 308,160 Collateralized mortgage obligations 140,445 153,283 180,941 198,458 Corporate bonds 65,183 65,352 65,275 65,434 Preferred stock 1,642 1,656 1,427 1,597 Total available-for-sale investment securities 576,211 615,975 684,570 705,146 Held-to-maturity: State and political subdivisions 308,062 297,630 263,405 272,079 Trust preferred securities 10,500 10,500 10,500 10,500 Total held-to-maturity investment securities 318,562 308,130 273,905 282,579 Total investment securities $ 894,773 $ 924,105 $ 958,475 $ 987,725 At September 30, 2014, the Corporation's investment securities portfolio consisted of: government sponsored agency (GSA) debt obligations, comprised primarily of variable-rate instruments backed by the Small Business Administration and Student Loan Marketing Corporation, totaling $76.9 million; state and political subdivisions debt obligations, comprised primarily of general debt obligations of issuers primarily located in the State of Michigan, totaling $349.0 million; residential mortgage-backed securities (MBSs), comprised primarily of fixed-rate instruments backed by a U.S. government agency (Government National Mortgage Association) or government sponsored enterprises (Federal Home Loan Mortgage Corporation and Federal National Mortgage Association), totaling $251.0 million; collaterized mortgage obligations (CMOs), comprised of approximately 66% fixed-rate and 34% variable-rate instruments backed by the same U.S. government agency and government sponsored enterprises as the residential MBSs with average maturities of less than three years, totaling $140.4 million; corporate bonds, comprised primarily of debt obligations of large U.S. global financial organizations, totaling $65.2 million; preferred stock securities, comprised of two large regional/national banks, totaling $1.6 million; and trust preferred securities (TRUPs), comprised of a 100% interest in a $10.0 million variable-rate TRUP of a small non-public bank holding company in Michigan and another variable-rate TRUP totaling $0.5 million. Variable-rate instruments comprised 22% of the Corporation's investment securities portfolio at September 30, 2014.

The Corporation utilizes third-party pricing services to obtain market value prices for its investment securities portfolio. On a quarterly basis, the Corporation validates the reasonableness of prices received from the third-party pricing services through independent price verification on a sample of investment securities in the portfolio, data integrity validation based upon comparison of current market prices to prior period market prices and analysis of overall expectations of movement in market prices based upon the changes in the related yield curves and other market factors. On a periodic basis, the Corporation reviews the pricing methodology of the third-party pricing vendors and the results of the vendors' internal control assessments to ensure the integrity of the process that the vendors use to develop market pricing for the Corporation's investment securities portfolio.

The Corporation's investment securities portfolio, with a carrying value of $894.8 million at September 30, 2014, had gross impairment of $14.0 million at that date. Management believed that the unrealized losses on investment securities were temporary in nature and due primarily to changes in interest rates on the investment securities and market illiquidity and not as a result of credit-related issues. Accordingly, the Corporation believed the impairment in its investment securities portfolio at September 30, 2014 was temporary in nature and, therefore, no impairment loss was recognized in the Corporation's consolidated statement of income for the three months ended September 30, 2014.

However, other-than-temporary impairment (OTTI) may occur in the future as a result of material declines in the fair value of investment securities resulting from market, credit, economic or other conditions. A further discussion of the assessment of potential impairment and the Corporation's process that resulted in the conclusion that the impairment was temporary in nature follows.

At September 30, 2014, the gross impairment in the Corporation's investment securities portfolio of $14.0 million was comprised as follows: GSA securities, residential MBSs and CMOs, combined, of $3.9 million; state and political subdivisions securities of $6.5 million; corporate bonds of $0.1 million; and TRUPs of $3.5 million. The amortized costs and fair values of investment securities are disclosed in Note 3 to the consolidated financial statements.

48 -------------------------------------------------------------------------------- GSA securities, residential MBSs and CMOs, included in the available-for-sale investment securities portfolio, had a combined amortized cost of $470.8 million and gross impairment of $3.9 million at September 30, 2014. Virtually all of the impaired investment securities in these categories are backed by the full faith and credit of the U.S. government or a guarantee of a U.S. government agency or government sponsored enterprise. The Corporation determined that the impairment on these investment securities was attributable to current market interest rates being higher than the yields being earned on these investment securities. The Corporation concluded that the impairment of its GSA securities, residential MBSs and CMOs was temporary in nature at September 30, 2014.

State and political subdivisions securities, included in the available-for-sale and the held-to-maturity investment securities portfolios, had an amortized cost of $347.7 million and gross impairment of $6.5 million at September 30, 2014.

Approximately 83% of the Corporation's state and political subdivisions securities are from issuers primarily located in the State of Michigan and are general obligations of the issuer, meaning that repayment of these obligations is funded by general tax collections of the issuer. The Corporation holds no debt obligations issued by the City of Detroit, Michigan. The gross impairment was attributable to impaired state and political subdivisions securities with an amortized cost of $168 million that generally mature beyond 2014. It was the Corporation's assessment that the impairment on these investment securities was attributable to current market interest rates being slightly higher than the yield on these investment securities, illiquidity in the market for a portion of these investment securities caused by the market's perception of the Michigan economy, and illiquidity in the market due to the nature of a portion of these investment securities. The Corporation concluded that the impairment of its state and political subdivisions securities was temporary in nature at September 30, 2014.

Corporate bonds, included in the available-for-sale investment securities portfolio, had an amortized cost of $65.0 million and gross impairment of $0.1 million at September 30, 2014. All of the corporate bonds held at September 30, 2014 were of an investment grade. The investment grade ratings of all of the corporate bonds indicated that the obligors' capacities to meet their financial commitments were "strong." It was the Corporation's assessment that the impairment on the corporate bonds was attributable to current market interest rates being slightly higher than the yield on these investment securities and the market perception of the issuers, and not due to credit-related issues. The Corporation concluded that the impairment of its corporate bonds was temporary in nature at September 30, 2014.

At September 30, 2014, the Corporation held two TRUPs in the held-to-maturity investment securities portfolio, with a combined amortized cost of $10.5 million and gross impairment of $3.5 million. Management reviewed available financial information of the issuers of the TRUPs as of September 30, 2014. One TRUP, with an amortized cost of $10.0 million, represents a 100% interest in a TRUP of a non-public bank holding company in Michigan. At September 30, 2014, the Corporation determined that the fair value of this TRUP was $6.7 million. The second TRUP, with an amortized cost of $0.5 million, represents a 10% interest in the TRUP of another non-public bank holding company in Michigan. At September 30, 2014, the Corporation determined the fair value of this TRUP was $0.3 million. The fair value measurements of the two TRUP investments were developed based upon market pricing observations of much larger banking institutions in an illiquid market, adjusted by risk measurements. The fair values of the Corporation's TRUPs were based on calculations of discounted cash flows, and further based upon both observable inputs and appropriate risk adjustments that would be made by market participants. See the additional discussion of the development of the fair values of the TRUPs in Note 3 to the consolidated financial statements.

The issuer of the $10.0 million TRUP reported net income in both the first and second quarters of 2014 and each of the three years ended December 31, 2013 and was categorized as well-capitalized under applicable regulatory requirements during that time. Based on an analysis of financial information provided by the issuer, it was the Corporation's opinion that, as of September 30, 2014, this issuer appeared to be a financially sound financial institution with sufficient liquidity to meet its financial obligations in 2014. The Corporation is not aware of any material adverse changes in the issuer's financial performance since the TRUP was issued and purchased by the Corporation nor any indication that any material adverse trends were developing that would suggest that the issuer would be unable to make all future principal and interest payments under the TRUP. Quarterly common stock cash dividends have consistently been paid by the issuer and the Corporation understands that the issuer's management anticipates cash dividends to continue to be paid in the future. The principal of $10.0 million of this TRUP matures in 2038, with interest payments of 360 basis points over the three-month London Interbank Offered Rate (LIBOR) due quarterly. All scheduled interest payments on this TRUP have been made on a timely basis. At September 30, 2014, the Corporation was not aware of any regulatory orders, memorandums of understanding or cease and desist orders that had been issued to the issuer or its subsidiaries. In reviewing all reasonably available information regarding the issuer, including past performance and its financial and liquidity position, it was the Corporation's opinion that the estimated future cash flows of the issuer supported the carrying value of the TRUP at its original cost of $10.0 million at September 30, 2014. While the total fair value of the TRUP was $3.3 million below the Corporation's amortized cost at September 30, 2014, the Corporation concluded that, based on the overall financial condition of the issuer, the impairment was temporary in nature at September 30, 2014.

The issuer of the $0.5 million TRUP reported net income in 2013 and the first and second quarters of 2014. At September 30, 2014, the issuer was categorized as well-capitalized under applicable regulatory requirements. The principal of $0.5 million of 49 -------------------------------------------------------------------------------- this TRUP matures in 2033, with interest payments due quarterly. All scheduled interest payments on this TRUP have been made on a timely basis. At September 30, 2014, the Corporation was not aware of any regulatory orders, memorandums of understanding or cease and desist orders that had been issued to the issuer of this TRUP or any subsidiary. In reviewing all reasonably available financial information regarding the $0.5 million TRUP, it was the Corporation's opinion that the carrying value of this TRUP at its original cost of $0.5 million was supported by the issuer's financial position at September 30, 2014.

While the fair value of the TRUP was $0.2 million below the Corporation's amortized cost at September 30, 2014, the Corporation concluded that the impairment was temporary in nature at September 30, 2014.

At September 30, 2014, the Corporation expected to fully recover the entire amortized cost basis of each impaired investment security in its investment securities portfolio at that date. Furthermore, at September 30, 2014, the Corporation did not have the intent to sell any of its impaired investment securities and believed that it was more-likely-than-not that the Corporation would not have to sell any of its impaired investment securities before a full recovery of amortized cost. However, there can be no assurance that OTTI losses will not be recognized on the TRUPs or on any other investment security in the future.

Loans The Corporation's loan portfolio is comprised of commercial, commercial real estate, real estate construction and land development loans, referred to as the Corporation's commercial loan portfolio, and residential mortgage, consumer installment and home equity loans, referred to as the Corporation's consumer loan portfolio. At September 30, 2014, the Corporation's loan portfolio was $5.04 billion and consisted of loans in the commercial loan portfolio totaling $2.70 billion, or 54% of total loans, and loans in the consumer loan portfolio totaling $2.34 billion, or 46% of total loans. Loans at fixed interest rates comprised 76% of the Corporation's total loan portfolio at September 30, 2014, June 30, 2014 and December 31, 2013 compared to 75% at September 30, 2013.

Chemical Bank is a full-service commercial bank and the acceptance and management of credit risk is an integral part of the Corporation's business. The Corporation maintains loan policies and credit underwriting standards as part of the process of managing credit risk. These standards include making loans generally only within the Corporation's market areas. The Corporation's lending markets generally consist of communities across the lower peninsula of Michigan, except for the southeastern portion of Michigan. The Corporation has no foreign loans or any loans to finance highly leveraged transactions. The Corporation's lending philosophy is implemented through strong administrative and reporting controls. The Corporation maintains a centralized independent loan review function that monitors the approval process and ongoing asset quality of the loan portfolio.

Total loans were $5.04 billion at September 30, 2014, an increase of $142.1 million, or 2.9%, from total loans of $4.90 billion at June 30, 2014, an increase of $393.3 million, or 8.5%, from total loans of $4.65 billion at December 31, 2013 and an increase of $518.2 million, or 11.5%, from total loans of $4.52 billion at September 30, 2013. The increases in total loans during the three- and twelve-month periods ended September 30, 2014 generally occurred across all major loan categories and across all of the Corporation's banking markets and were attributable to a combination of improving economic conditions and higher loan demand, as well as the Corporation increasing its market share in both its commercial and consumer loan portfolios.

A summary of the composition of the Corporation's loan portfolio, by major loan category, follows: September 30, December 31, September 30, 2014 June 30, 2014 2013 2013 (In thousands) Commercial loan portfolio: Commercial $ 1,239,946 $ 1,212,383 $ 1,176,307 $ 1,128,122 Commercial real estate 1,322,646 1,298,365 1,232,658 1,215,631 Real estate construction 125,782 101,168 89,795 78,361 Land development 10,434 10,956 20,066 23,673 Subtotal 2,698,808 2,622,872 2,518,826 2,445,787 Consumer loan portfolio: Residential mortgage 984,049 970,397 960,423 942,777 Consumer installment 783,443 744,781 644,769 622,040 Home equity 574,620 560,754 523,603 512,067 Subtotal 2,342,112 2,275,932 2,128,795 2,076,884 Total loans $ 5,040,920 $ 4,898,804 $ 4,647,621 $ 4,522,671 A discussion of the Corporation's loan portfolio by category follows.

50 -------------------------------------------------------------------------------- Commercial Loan Portfolio The Corporation's commercial loan portfolio is comprised of commercial loans, commercial real estate loans, real estate construction loans and land development loans. The Corporation's commercial loan portfolio is well diversified across business lines and has no concentration in any one industry.

The commercial loan portfolio of $2.70 billion at September 30, 2014 included 84 loan relationships of $5.0 million or greater. These 84 loan relationships totaled $803.8 million, which represented 30% of the commercial loan portfolio at September 30, 2014, and included 28 loan relationships that had outstanding balances of $10 million or higher, totaling $412.7 million, or 15% of the commercial loan portfolio, at that date. Further, the Corporation had 6 loan relationships at September 30, 2014 with loan balances greater than $5.0 million and less than $10 million, totaling $48.3 million, that had unfunded credit commitments totaling $34.7 million that, if advanced, could result in a loan relationship of $10 million or more.

Commercial loans consist of loans and lines of credit to varying types of businesses, including municipalities, school districts and nonprofit organizations, for the purpose of supporting working capital and operational needs and term financing of equipment. Repayment of such loans is generally provided through operating cash flows of the customer. Commercial loans are generally secured with inventory, accounts receivable, equipment, personal guarantees of the owner or other sources of repayment, although the Corporation may also obtain real estate as collateral.

Commercial loans were $1.24 billion at September 30, 2014, an increase of $27.6 million, or 2.3%, from commercial loans of $1.21 billion at June 30, 2014, an increase of $63.6 million, or 5.4%, from commercial loans of $1.18 billion at December 31, 2013 and an increase of $111.8 million, or 9.9%, from commercial loans of $1.13 billion at September 30, 2013. The increases in commercial loans were the result of a combination of increased market share and improving economic conditions in the Corporation's lending markets. Commercial loans represented 24.6% of the Corporation's loan portfolio at September 30, 2014, compared to 24.7%, 25.3% and 25.0% at June 30, 2014, December 31, 2013 and September 30, 2013, respectively.

Commercial real estate loans include loans that are secured by real estate occupied by the borrower for ongoing operations, non-owner occupied real estate leased to one or more tenants and vacant land that has been acquired for investment or future land development. Commercial real estate loans were $1.32 billion at September 30, 2014, an increase of $24.3 million, or 1.9%, from commercial real estate loans of $1.30 billion at June 30, 2014, an increase of $90.0 million, or 7.3%, from commercial real estate loans of $1.23 billion at December 31, 2013 and an increase of $107.0 million, or 8.8%, from commercial real estate loans of $1.22 billion at September 30, 2013. The increases in commercial real estate loans were the result of a combination of increased market share and improving economic conditions in the Corporation's lending markets. Loans secured by owner occupied properties, non-owner occupied properties and vacant land comprised 58%, 39% and 3%, respectively, of the Corporation's commercial real estate loans outstanding at September 30, 2014.

Commercial real estate loans represented 26.2% of the Corporation's loan portfolio at September 30, 2014, compared to 26.5% at both June 30, 2014 and December 31, 2013 and 26.9% at September 30, 2013.

Commercial and commercial real estate lending is generally considered to involve a higher degree of risk than residential mortgage, consumer installment and home equity lending as they typically involve larger loan balances concentrated in a single borrower. In addition, the payment experience on loans secured by income-producing properties and vacant land loans is typically dependent on the success of the operation of the related project and is typically affected by adverse conditions in the real estate market and in the economy. The Corporation generally attempts to mitigate the risks associated with commercial and commercial real estate lending by, among other things, lending primarily in its market areas, lending across industry lines, not developing a concentration in any one line of business and using prudent loan-to-value ratios in the underwriting process. It is management's belief that the Corporation's commercial and commercial real estate loan portfolios are generally well-secured.

Real estate construction loans are primarily originated for construction of commercial properties and often convert to a commercial real estate loan at the completion of the construction period. Real estate construction loans were $125.8 million at September 30, 2014, an increase of $24.6 million, or 24.3%, from real estate construction loans of $101.2 million at June 30, 2014, an increase of $36.0 million, or 40.1%, from real estate construction loans of $89.8 million at December 31, 2013 and an increase of $47.4 million, or 60.5%, from real estate construction loans of $78.4 million at September 30, 2013. The increases in real estate construction loans were largely attributable to advances during the third quarter of 2014 totaling $19.4 million on twelve new and existing commercial construction projects and advances during the second quarter of 2014 totaling $11.4 million on four new and existing commercial construction projects, representing a combination of owner and non-owner occupied properties. Real estate construction loans represented 2.5% of the Corporation's loan portfolio at September 30, 2014, compared to 2.1%, 1.9% and 1.7% at June 30, 2014, December 31, 2013 and September 30, 2013, respectively.

Land development loans include loans made to developers for the purpose of infrastructure improvements to vacant land to create finished marketable residential and commercial lots/land. A majority of the Corporation's land development loans consist of loans to develop residential real estate. Land development loans are generally originated with the intention that the loans will be repaid through the sale of finished properties by the developers within twelve months of the completion date. Land development loans were $10.4 million at September 30, 2014, a decrease of $0.5 million, or 4.8%, from land development loans of $11.0 million at 51 -------------------------------------------------------------------------------- June 30, 2014, a decrease of $9.6 million, or 48%, from land development loans of $20.1 million at December 31, 2013 and a decrease of $13.2 million, or 56%, from land development loans of $23.7 million at September 30, 2013. The decreases in land development loans were largely due to the Corporation receiving payments on loans resulting from the sales of both unimproved land and finished properties by the developers. Land development loans represented 0.2% of the Corporation's loan portfolio at both September 30, 2014 and June 30, 2014, compared to 0.4% at December 31, 2013 and 0.5% at September 30, 2013.

Real estate construction and land development lending involves a higher degree of risk than commercial real estate lending and residential mortgage lending because of the uncertainties of construction, including the possibility of costs exceeding the initial estimates, the need to obtain a tenant or purchaser of the property if it will not be owner-occupied or the need to sell developed properties. The Corporation generally attempts to mitigate the risks associated with real estate construction and land development lending by, among other things, lending primarily in its market areas, using prudent underwriting guidelines and closely monitoring the construction process. At September 30, 2014, $3.2 million, or 31%, of the Corporation's $10.4 million of land development loans were impaired, whereby the Corporation determined it was probable that the full amount of principal and interest would not be collected on these loans in accordance with their original contractual terms.

Consumer Loan Portfolio The Corporation's consumer loan portfolio is comprised of residential mortgage loans, consumer installment loans and home equity loans and lines of credit.

Residential mortgage loans consist primarily of one- to four-family residential loans with fixed interest rates of fifteen years or less with amortization periods generally from fifteen to thirty years. The Corporation generally sells fixed interest rate residential mortgage loans originated with maturities of fifteen years or more in the secondary market. The loan-to-value ratio at the time of origination is generally 80% or less. Loans with more than an 80% loan-to-value ratio generally require private mortgage insurance. At September 30, 2014, approximately 70% of the Corporation's residential mortgage loans had an original loan-to-value ratio of 80% or less.

Residential mortgage loans were $984.0 million at September 30, 2014, an increase of $13.7 million, or 1.4%, from residential mortgage loans of $970.4 million at June 30, 2014, an increase of $23.6 million, or 2.5%, from residential mortgage loans of $960.4 million at December 31, 2013 and an increase of $41.3 million, or 4.4%, from residential mortgage loans of $942.8 million at September 30, 2013. Residential mortgage loans had historically involved the least amount of credit risk in the Corporation's loan portfolio, although the risk on these loans has increased over the last several years as the unemployment rate has increased and real estate property values have declined in the State of Michigan. Residential mortgage loans also include loans to consumers for the construction of single family residences that are secured by these properties. Residential mortgage construction loans to consumers were $35.3 million at September 30, 2014, compared to $37.0 million at June 30, 2014, $37.9 million at December 31, 2013 and $34.1 million at September 30, 2013.

Residential mortgage loans represented 19.5% of the Corporation's loan portfolio at September 30, 2014, compared to 19.8%, 20.7% and 20.8% at June 30, 2014, December 31, 2013 and September 30, 2013, respectively. The Corporation had residential mortgage loans with maturities beyond five years and that were at fixed interest rates totaling $311 million at September 30, 2014 and June 30, 2014, compared to $320 million and $321 million at December 31, 2013 and September 30, 2013, respectively.

The Corporation's consumer installment loans consist of relatively small loan amounts to consumers to finance personal items (primarily automobiles, recreational vehicles and marine vehicles), including indirect loans purchased from dealerships. Consumer installment loans were $783.4 million at September 30, 2014, an increase of $38.7 million, or 5.2%, from consumer installment loans of $744.8 million at June 30, 2014, an increase of $138.7 million, or 21.5%, from consumer installment loans of $644.8 million at December 31, 2013 and an increase of $161.4 million, or 25.9%, from consumer installment loans of $622.0 million at September 30, 2013. The increase in consumer installment loans during the three and nine months ended September 30, 2014 was largely attributable to Chemical Bank's spring and fall loan programs.

At September 30, 2014, collateral securing consumer installment loans was comprised approximately as follows: automobiles - 58%; recreational vehicles - 26%; marine vehicles - 12%; other collateral - 3%; and unsecured - 1%. Consumer installment loans represented 15.5% of the Corporation's loan portfolio at September 30, 2014, compared to 15.2%, 13.9% and 13.8% at June 30, 2014, December 31, 2013 and September 30, 2013, respectively.

52 -------------------------------------------------------------------------------- The Corporation's home equity loans, including home equity lines of credit, are comprised of loans to consumers who utilize equity in their personal residence, including junior lien mortgages, as collateral to secure the loan or line of credit. Home equity loans were $574.6 million at September 30, 2014, an increase of $13.9 million, or 2.5%, from home equity loans of $560.8 million at June 30, 2014, an increase of $51.0 million, or 9.7%, from home equity loans of $523.6 million at December 31, 2013 and an increase of $62.6 million, or 12.2%, from home equity loans of $512.1 million at September 30, 2013. The increase in home equity loans during the nine months ended September 30, 2014 was also primarily attributable to Chemical Bank's spring and fall loan programs. At September 30, 2014, approximately 59% of the Corporation's home equity loans were first lien mortgages and 41% were junior lien mortgages. Home equity loans represented 11.4% of the Corporation's loan portfolio at September 30, 2014 and June 30, 2014, compared to 11.3% at December 31, 2013 and September 30, 2013. Home equity lines of credit comprised 32% of the Corporation's home equity loans at September 30, 2014, compared to 33% at June 30, 2014 and 35% at December 31, 2013 and September 30, 2013. The majority of the Corporation's home equity lines of credit are comprised of loans with payments of interest only and original maturities of up to ten years.

Consumer installment and home equity loans generally have shorter terms than residential mortgage loans, but generally involve more credit risk than residential mortgage lending because of the type and nature of the collateral.

The Corporation experienced decreases in losses on consumer installment and home equity loans, with net loan losses totaling 29 basis points (annualized) of average consumer installment and home equity loans during the first nine months of 2014, compared to 43 basis points of average consumer installment and home equity loans in 2013. Consumer installment and home equity loans are spread across many individual borrowers, which minimizes the risk per loan transaction.

The Corporation originates consumer installment and home equity loans utilizing a computer-based credit scoring analysis to supplement the underwriting process.

Consumer installment and home equity lending collections are dependent on the borrowers' continuing financial stability and are more likely to be affected by adverse personal situations. Collateral values on properties securing consumer installment and home equity loans are negatively impacted by many factors, including the physical condition of the collateral and property values, although losses on consumer installment and home equity loans are often more significantly impacted by the unemployment rate and other economic conditions.

The unemployment rate in the State of Michigan was 7.2% at September 30, 2014 compared to 7.5%, 8.4% and 8.8% at June 30, 2014, December 31, 2013 and September 30, 2013, respectively, and higher than the national average of 5.9% at September 30, 2014.

Nonperforming Assets Nonperforming assets include nonperforming loans, which consist of originated loans for which the accrual of interest has been discontinued (nonaccrual loans), originated loans that are past due as to principal or interest by 90 days or more and still accruing interest and nonperforming loans that have been modified under troubled debt restructurings (TDRs). Nonperforming assets also include assets obtained through foreclosures and repossessions. The Corporation transfers an originated loan that is 90 days or more past due to nonaccrual status (except for loans that are secured by residential real estate, which are transferred at 120 days past due), unless it believes the loan is both well-secured and in the process of collection. For loans classified as nonaccrual, including those with modifications, the Corporation does not expect to receive all principal and interest payments, and therefore, any payments are recognized as principal reductions when received. Conversely, the Corporation expects to receive all principal and interest payments on loans that meet the definition of nonperforming TDR status. TDRs continue to be reported as nonperforming loans until a six-month payment history of principal and interest payments is sustained in accordance with the terms of the loan modification, at which time the loan is no longer considered a nonperforming asset and the Corporation moves the loan to a performing TDR status.

Nonperforming assets were $81.1 million at September 30, 2014, a decrease of $3.0 million, or 3.6%, from $84.1 million at June 30, 2014, a decrease of $10.7 million, or 11.6%, from $91.8 million at December 31, 2013 and a decrease of $6.8 million, or 7.7%, from $87.9 million at September 30, 2013. Nonperforming assets represented 1.23%, 1.35%, 1.48%, and 1.40% of total assets at September 30, 2014, June 30, 2014, December 31, 2013 and September 30, 2013, respectively. The decreases in nonperforming assets during the three- and twelve-month periods ended September 30, 2014 are a sign of continued improvement in the overall credit quality of the Corporation's loan portfolio and the continued improvement in the economic climate in Michigan. The Corporation's nonperforming assets are not concentrated in any one industry or any one geographical area within Michigan. At September 30, 2014, there were only two commercial loan relationships exceeding $2.5 million, totaling $11.5 million, which were in nonperforming status. While the economic climate in Michigan continues to improve, based on declines in both residential and commercial real estate appraised values due to the weakness in the Michigan economy over the past several years, management continues to evaluate and, when appropriate, obtain new appraisals or discount appraised values of existing appraisals to compute net realizable values of nonperforming real estate secured loans and other real estate properties.

53 --------------------------------------------------------------------------------The following schedule provides a summary of nonperforming assets: September 30, December 31, 2014 June 30, 2014 2013 (Dollars in thousands) Nonaccrual loans: Commercial $ 18,213 $ 18,773 $ 18,374 Commercial real estate 23,858 25,361 28,598 Real estate construction 162 160 371 Land development 1,467 2,184 2,309 Residential mortgage 6,693 6,325 8,921 Consumer installment 527 536 676 Home equity 2,116 2,296 2,648 Total nonaccrual loans 53,036 55,635 61,897 Accruing loans contractually past due 90 days or more as to interest or principal payments: Commercial 16 15 536 Commercial real estate 87 69 190 Residential mortgage 380 376 537 Home equity 1,779 1,075 734 Total accruing loans contractually past due 90 days or more as to interest or principal payments 2,262 1,535 1,997 Nonperforming TDRs: Commercial loan portfolio 11,797 11,049 13,414 Consumer loan portfolio 3,647 5,516 4,676 Total nonperforming TDRs 15,444 16,565 18,090 Total nonperforming loans 70,742 73,735 81,984 Other real estate and repossessed assets(1) 10,354 10,392 9,776 Total nonperforming assets $ 81,096 $ 84,127 $ 91,760 Nonperforming loans as a percent of total loans 1.40 % 1.51 % 1.76 % Nonperforming assets as a percent of total assets 1.23 % 1.35 % 1.48 % (1) Includes property acquired through foreclosure and by acceptance of a deed in lieu of foreclosure and other property held-for-sale.

The Corporation's nonaccrual loans that meet the definition of a TDR (nonaccrual TDR) totaled $40.5 million at September 30, 2014, compared to $43.7 million at June 30, 2014 and $37.3 million at December 31, 2013. These loans have been modified by providing the borrower a financial concession that is intended to improve the Corporation's probability of collection of the amounts due.

The following schedule summarizes changes in nonaccrual loans during the three and nine months ended September 30, 2014 and 2013.

Three Months Ended Nine Months Ended September 30, September 30, 2014 2013 2014 2013 (In thousands)Balance at beginning of period $ 55,635 $ 56,024 $ 61,897 $ 71,298 Additions during period 7,794 11,846 22,095 27,974 Principal balances charged off (3,129 ) (3,726 ) (8,832 ) (12,906 ) Transfers to other real estate/repossessed assets (2,964 ) (1,328 ) (6,340 ) (3,701 ) Returned to accrual status (1,180 ) (3,750 ) (6,914 ) (11,844 ) Payments received (3,120 ) (3,780 ) (8,870 ) (15,535 ) Balance at end of period $ 53,036 $ 55,286 $ 53,036 $ 55,286 54-------------------------------------------------------------------------------- Nonperforming Loans The following schedule provides the composition of nonperforming loans, by major loan category, as of September 30, 2014, June 30, 2014, and December 31, 2013.

September 30, 2014 June 30, 2014 December 31, 2013 Percent Percent Percent Amount of Total Amount of Total Amount of Total (Dollars in thousands) Commercial loan portfolio: Commercial $ 22,495 31.8 % $ 23,205 31.5 % $ 22,617 27.6 % Commercial real estate 31,426 44.4 32,012 43.4 36,082 44.0 Real estate construction 162 0.2 160 0.2 371 0.5 Land development 1,517 2.2 2,234 3.0 4,722 5.7 Subtotal-commercial loan portfolio 55,600 78.6 57,611 78.1 63,792 77.8 Consumer loan portfolio: Residential mortgage 10,720 15.2 12,217 16.6 14,134 17.3 Consumer installment 527 0.7 536 0.7 676 0.8 Home equity 3,895 5.5 3,371 4.6 3,382 4.1 Subtotal-consumer loan portfolio 15,142 21.4 16,124 21.9 18,192 22.2 Total nonperforming loans $ 70,742 100.0 % $ 73,735 100.0 % $ 81,984 100.0 % Total nonperforming loans were $70.7 million at September 30, 2014, a decrease of $3.0 million, or 4.1%, compared to $73.7 million at June 30, 2014, and a decrease of $11.2 million, or 13.7%, compared to $82.0 million at December 31, 2013. The Corporation's nonperforming loans in the commercial loan portfolio were $55.6 million at September 30, 2014, a decrease of $2.0 million, or 3.5%, from $57.6 million at June 30, 2014 and a decrease of $8.2 million, or 12.8%, from $63.8 million at December 31, 2013. The decreases in nonperforming loans in the commercial loan portfolio were attributable to a combination of improving economic conditions and net loan charge-offs. Nonperforming loans in the commercial loan portfolio comprised 79% of total nonperforming loans at September 30, 2014, compared to 78% at both June 30, 2014 and December 31, 2013.

The Corporation's nonperforming loans in the consumer loan portfolio were $15.1 million at September 30, 2014, a decrease of $1.0 million, or 6.1%, from $16.1 million at June 30, 2014 and a decrease of $3.1 million, or 16.8%, from $18.2 million at December 31, 2013. The decreases in nonperforming loans in the consumer loan portfolio were primarily attributable to net loan charge-offs.

Nonperforming Loans - Commercial Loan Portfolio Nonperforming commercial loans were $22.5 million at September 30, 2014, a decrease of $0.7 million, or 3.1%, from $23.2 million at June 30, 2014 and a decrease of $0.1 million, or 0.5%, from $22.6 million at December 31, 2013.

Nonperforming commercial loans comprised 1.8% of total commercial loans at September 30, 2014, compared to 1.9% at June 30, 2014 and December 31, 2013. At September 30, 2014, approximately 40% of the Corporation's nonperforming commercial loans were secured by income-producing farmland, with the largest concentration of these nonperforming commercial loans to one customer relationship totaling $5.8 million that was secured by income-producing farmland and other assets. At September 30, 2014, the loans in this relationship were believed to be adequately secured and the Corporation did not require a specific impairment reserve on them at that date.

Nonperforming commercial real estate loans were $31.4 million at September 30, 2014, a decrease of $0.6 million, or 1.8%, from $32.0 million at June 30, 2014 and a decrease of $4.7 million, or 12.9%, from $36.1 million at December 31, 2013. Nonperforming commercial real estate loans comprised 2.4% of total commercial real estate loans at September 30, 2014, compared to 2.5% and 2.9% at June 30, 2014 and December 31, 2013, respectively. Nonperforming commercial real estate loans secured by owner occupied real estate, non-owner occupied real estate and vacant land totaled $17.6 million, $6.3 million and $7.5 million, respectively, at September 30, 2014, and comprised 2.5%, 1.4% and 20.8%, respectively, of total owner occupied real estate, non-owner occupied real estate and vacant land loans included in the Corporation's originated commercial real estate loans at September 30, 2014. At September 30, 2014, the Corporation's nonperforming commercial real estate loans were comprised of a diverse mix of commercial lines of business and were also geographically disbursed throughout the Corporation's market areas. The largest concentration of nonperforming commercial real estate loans at September 30, 2014 was one customer relationship totaling $5.6 million that was primarily secured by vacant land. This same customer relationship had nonperforming land development loans of $0.1 million and nonperforming residential mortgage loans of $0.4 million. At September 30, 2014, the loans in this relationship were believed to be adequately secured and the Corporation did not require a specific impairment reserve on them at that date.

55 -------------------------------------------------------------------------------- Nonperforming real estate construction loans were $0.2 million at both September 30, 2014 and June 30, 2014, compared $0.4 million at December 31, 2013. Nonperforming real estate construction loans comprised 0.1% of total real estate construction loans at September 30, 2014, compared to 0.2% and 0.4% at June 30, 2014 and December 31, 2013, respectively.

Nonperforming land development loans were $1.5 million at September 30, 2014, a decrease of $0.7 million, or 32%, from $2.2 million at June 30, 2014 and a decrease of $3.2 million, or 68%, from $4.7 million at December 31, 2013.

Nonperforming land development loans comprised 14.5% of total land development loans at September 30, 2014, compared to 20.4% and 23.5% at June 30, 2014 and December 31, 2013, respectively. The decreases in land development loans during the three- and nine-month periods ended September 30, 2014 were primarily attributable to the Corporation receiving payments on these loans. At September 30, 2014, nonperforming land development loans were secured primarily by residential real estate improved lots and housing units.

At September 30, 2014, the Corporation had nonperforming loans in the commercial loan portfolio of $3.8 million that were secured by real estate and were in various stages of foreclosure, compared to $4.6 million at June 30, 2014 and $5.0 million at December 31, 2013.

The following schedule presents information related to stratification of nonperforming loans in the commercial loan portfolio by dollar amount at September 30, 2014, June 30, 2014 and December 31, 2013.

September 30, 2014 June 30, 2014 December 31, 2013 Number of Number of Number of Borrowers Amount Borrowers Amount Borrowers Amount (Dollars in thousands) $5,000,000 or more 2 $ 11,469 2 $ 11,987 2 $ 12,267 $2,500,000 - $4,999,999 - - - - - - $1,000,000 - $2,499,999 5 7,854 6 9,291 6 9,858 $500,000 - $999,999 26 18,028 25 18,087 27 19,813 $250,000 - $499,999 21 6,866 17 5,874 25 8,318 Under $250,000 157 11,383 165 12,372 181 13,536 Total 211 $ 55,600 215 $ 57,611 241 $ 63,792 Nonperforming Loans - Consumer Loan Portfolio Nonperforming residential mortgage loans were $10.7 million at September 30, 2014, a decrease of $1.5 million, or 12.3%, from $12.2 million at June 30, 2014 and a decrease of $3.4 million, or 24.2%, from $14.1 million at December 31, 2013. Nonperforming residential mortgage loans comprised 1.1% of total residential mortgage loans at September 30, 2014, compared to 1.3% and 1.5% of total residential mortgage loans at June 30, 2014 and December 31, 2013, respectively. At September 30, 2014, a total of $1.9 million of nonperforming residential mortgage loans were in various stages of foreclosure, compared to $3.6 million at June 30, 2014 and $4.0 million at December 31, 2013.

Nonperforming consumer installment loans were $0.5 million at both September 30, 2014 and June 30, 2014, compared to $0.7 million at December 31, 2013.

Nonperforming consumer installment loans comprised 0.1% of total consumer installment loans at September 30, 2014, December 31, 2013 and June 30, 2014.

Nonperforming home equity loans were $3.9 million at September 30, 2014, an increase of $0.5 million, or 15%, from $3.4 million at both June 30, 2014 and December 31, 2013. Nonperforming home equity loans comprised 0.7% of total home equity loans at September 30, 2014, compared to 0.6% at both June 30, 2014 and December 31, 2013.

Troubled Debt Restructurings (TDRs) The generally unfavorable economic climate in Michigan in recent years has resulted in a large number of both business and consumer customers experiencing cash flow difficulties and thus the inability to maintain their loan balances in a performing status. The Corporation determined that it was probable that certain customers who were past due on their loans, if provided a modification of their loans by reducing their monthly payments, would be able to bring their loan relationships to a performing status. The Corporation believes loan modifications will potentially result in a lower level of loan losses and loan collection costs than if the Corporation proceeded immediately through the foreclosure process with these borrowers. The loan modifications involve granting concessions to borrowers who are experiencing financial difficulty and, therefore, these loans meet the criteria to be considered TDRs.

56 -------------------------------------------------------------------------------- The Corporation's performing and nonperforming TDRs continue to accrue interest at the loan's original interest rate as the Corporation expects to collect the remaining principal balance on the loan. A TDR is reported as a nonperforming loan (nonperforming TDR) until a six-month payment history of principal and interest payments is sustained in accordance with the loan modification, at which time the Corporation moves the loan to a performing status (performing TDR). If a performing TDR becomes contractually past due more than 30 days, it is transferred to a nonperforming status. Accordingly, all of the Corporation's performing TDRs at September 30, 2014 were current or less than 30 days past due. The Corporation's nonaccrual loans that meet the definition of a TDR do not accrue interest as the Corporation does not expect to collect the full amount of principal and interest owed from the borrower on these loans.

The following summarizes the Corporation's TDRs at September 30, 2014, June 30, 2014 and December 31, 2013: Nonperforming TDRs Performing Past Due TDRs Current 31-90 Days Subtotal Nonaccrual TDRs Total (In thousands) September 30, 2014 Commercial loan portfolio $ 28,606 $ 10,352 $ 1,445 $ 11,797 $ 36,549 $ 76,952 Consumer loan portfolio 15,982 2,887 760 3,647 3,996 23,625 Total TDRs $ 44,588 $ 13,239 $ 2,205 $ 15,444 $ 40,545 $ 100,577 June 30, 2014 Commercial loan portfolio $ 29,296 $ 10,005 $ 1,044 $ 11,049 $ 40,351 $ 80,696 Consumer loan portfolio 14,837 4,156 1,360 5,516 3,334 23,687 Total TDRs $ 44,133 $ 14,161 $ 2,404 $ 16,565 $ 43,685 $ 104,383 December 31, 2013 Commercial loan portfolio $ 26,839 $ 10,860 $ 2,554 $ 13,414 $ 31,961 $ 72,214 Consumer loan portfolio 12,732 3,797 879 4,676 5,321 22,729 Total TDRs $ 39,571 $ 14,657 $ 3,433 $ 18,090 $ 37,282 $ 94,943 The Corporation's performing and nonperforming TDRs in the commercial loan portfolio generally consist of loans where the Corporation has allowed borrowers to either (i) temporarily defer scheduled principal payments and make interest-only payments for a short period of time (generally six months to one year) at the stated interest rate of the original loan agreement, (ii) lower payments due to a modification of the loan's original contractual terms, or (iii) enter into moderate extensions of the loan's original contractual maturity date. These TDRs are individually evaluated for impairment. Based on this evaluation, the Corporation does not expect to incur a loss on these TDRs based on its assessment of the borrowers' expected cash flows, as the pre- and post-modification effective yields are approximately the same for these loans.

Accordingly, no additional provision for loan losses has been recognized related to these TDRs. Nonperforming TDRs that have made at least six consecutive months of principal and interest payments under a formal modification agreement are classified by the Corporation as performing TDRs. If a TDR in the commercial loan portfolio becomes 90 days past due as to principal or interest, or if it becomes probable that any remaining principal and interest payments due on the loan will not be collected in accordance with the modified contractual terms, the loan is transferred to nonaccrual TDR status.

Due to the borrowers' sustained repayment histories, the Corporation had performing TDRs in the commercial loan portfolio of $28.6 million, $29.3 million and $26.8 million at September 30, 2014, June 30, 2014 and December 31, 2013, respectively. The Corporation also had nonperforming TDRs in the commercial loan portfolio of $11.8 million, $11.0 million and $13.4 million at September 30, 2014, June 30, 2014 and December 31, 2013, respectively. The Corporation's nonperforming TDRs in the commercial loan portfolio are categorized as a risk grade 7 (substandard - accrual) under the Corporation's risk rating system, which is further described in Note 4 to the consolidated financial statements.

The weighted average contractual interest rate of the Corporation's performing and nonperforming TDRs in the commercial loan portfolio was 5.49% at September 30, 2014, compared to 5.46% at June 30, 2014 and 5.61% at December 31, 2013. At September 30, 2014, the Corporation had $36.5 million of nonaccrual TDRs in the commercial loan portfolio, compared to $40.4 million and $32.0 million, at June 30, 2014 and December 31, 2013, respectively.

57 -------------------------------------------------------------------------------- A summary of changes in the Corporation's performing and nonperforming TDRs in the commercial loan portfolio for the three and nine months ended September 30, 2014 follows: Three Months Ended September 30, 2014 Nine Months Ended September 30, 2014 Performing Nonperforming Total Performing Nonperforming Total (In thousands) Balance at beginning of period $ 29,296 $ 11,049 $ 40,345 $ 26,839 $ 13,414 $ 40,253 Additions for modifications - 564 564 - 3,811 3,811 Transfers to performing TDR status 307 (307 ) - 4,866 (4,866 ) - Transfers to nonperforming TDR status (790 ) 790 - (984 ) 984 - Transfers from nonaccrual status 466 - 466 2,014 905 2,919 Transfers to nonaccrual status - (181 ) (181 ) (1,072 ) (1,633 ) (2,705 ) Principal payments and pay-offs (673 ) (118 ) (791 ) (3,057 ) (818 ) (3,875 ) Balance at end of period $ 28,606 $ 11,797 $ 40,403 $ 28,606 $ 11,797 $ 40,403 The Corporation's TDRs in the consumer loan portfolio generally consist of loans where the Corporation has reduced a borrower's monthly payments by decreasing the interest rate charged on the loan (generally to a range of 3% to 5%) for a specified period of time (generally 24 months). Once the borrowers have made at least six consecutive months of principal and interest payments under a formal modification agreement, they are classified as performing TDRs. These loans are moved to nonaccrual TDR status if the loan becomes 90 days past due as to principal or interest, or sooner if conditions warrant.

The Corporation had performing TDRs in the consumer loan portfolio of $16.0 million, $14.8 million and $12.7 million at September 30, 2014, June 30, 2014 and December 31, 2013, respectively. The Corporation also had nonperforming TDRs in the consumer loan portfolio of $3.6 million, $5.5 million and $4.7 million at September 30, 2014, June 30, 2014 and December 31, 2013, respectively. The weighted average contractual interest rate on the Corporation's performing and nonperforming TDRs in the consumer loan portfolio was 4.72% at September 30, 2014, compared to 4.66% at June 30, 2014 and 4.55% at December 31, 2013. At September 30, 2014, the Corporation had $4.0 million of nonaccrual TDRs in the consumer loan portfolio, compared to $3.3 million and $5.3 million, at June 30, 2014 and December 31, 2013, respectively.

The Corporation's cumulative redefault rate as of September 30, 2014 on its performing and nonperforming TDRs, which represents the percentage of these TDRs that transferred to nonaccrual status since the Corporation began such modifications in 2009, was 24% for performing and nonperforming TDRs in the commercial loan portfolio and 21% for performing and nonperforming TDRs in the consumer loan portfolio. The Corporation's cumulative redefault rate does not include loans that have been modified while in nonaccrual status that remain in nonaccrual status as the Corporation does not expect to collect the full amount of principal and interest owed from the borrower on these loans.

Other Real Estate and Repossessed Assets Other real estate and repossessed assets are components of nonperforming assets.

These include other real estate (ORE), comprised of residential and commercial real estate and land development properties acquired through foreclosure or by acceptance of a deed in lieu of foreclosure, and repossessed assets, comprised of other personal and commercial assets. ORE totaled $10.2 million at September 30, 2014, an increase of $0.1 million, or 0.6%, from $10.1 million at June 30, 2014 and an increase of $0.7 million, or 7.1%, from $9.5 million at December 31, 2013. Repossessed assets totaled $0.2 million at September 30, 2014, compared to $0.3 million at both June 30, 2014 and December 31, 2013.

The following schedule provides the composition of ORE at September 30, 2014, June 30, 2014 and December 31, 2013: September 30, 2014 June 30, 2014 December 31, 2013 (In thousands) Composition of ORE: Vacant land $ 2,912 $ 2,379 $ 2,827 Commercial real estate properties 4,436 5,229 4,678 Residential real estate properties 2,842 2,518 2,013 Total ORE $ 10,190 $ 10,126 $ 9,518 58--------------------------------------------------------------------------------The following schedule summarizes ORE activity during the three and nine months ended September 30, 2014 and 2013.

Three Months Ended September 30, Nine Months Ended September 30, 2014 2013 2014 2013 (Inthousands) Balance at beginning of period $ 10,126 $ 13,314 $ 9,518 $ 18,057 Additions 2,758 840 6,154 2,866 Write-downs to fair value (75 ) (129 ) (330 ) (977 ) Dispositions (2,619 ) (2,351 ) (5,152 ) (8,272 ) Balance at end of period $ 10,190 $ 11,674 $ 10,190 $ 11,674 The Corporation's ORE is carried at the lower of cost or fair value less estimated cost to sell. The historically large inventory of real estate properties for sale across the State of Michigan has resulted in an increase in the Corporation's carrying time and cost of holding ORE. Consequently, the Corporation had $6.0 million in ORE at September 30, 2014 that had been held in excess of one year, of which $3.1 million had been held in excess of three years. Because the redemption period on foreclosures is relatively long in Michigan (six months to one year) and the Corporation had $5.7 million of nonperforming loans that were in the process of foreclosure at September 30, 2014, it is anticipated that the level of the Corporation's ORE will remain at historically elevated levels.

All of the Corporation's ORE properties have been written down to fair value through a charge-off against the allowance for loan losses at the time the loan was transferred to ORE or through a subsequent write-down, recorded as an operating expense, to recognize a further market value decline of the property after the initial transfer date. Accordingly, at September 30, 2014, the carrying value of ORE of $10.2 million was reflective of $18.3 million in charge-offs or write-downs and represented 36% of the contractual loan balance remaining at the time these loans were classified as nonperforming.

During the nine months ended September 30, 2014, the Corporation sold 123 ORE properties for net proceeds of $6.9 million. On an average basis, the net proceeds from these sales represented 135% of the carrying value of the property at the time of sale, with the net proceeds representing 56% of the remaining contractual loan balance at the time these loans were classified as nonperforming.

Nonperforming assets at September 30, 2014, June 30, 2014 and December 31, 2013 did not include impaired acquired loans totaling $10.2 million, $10.4 million and $9.8 million, respectively, even though these loans were not performing in accordance with their original contractual terms. Acquired loans that are not performing in accordance with contractual terms are not reported as nonperforming loans because these loans are recorded in pools at their net realizable value based on the principal and interest the Corporation expects to collect on these loan pools. Acquired loans not performing in accordance with the loan's original contractual terms are included in the Corporation's impaired loan schedule in Note 4 to the consolidated financial statements.

Impaired Loans A loan is considered impaired when management determines it is probable that all of the principal and interest due will not be paid according to the original contractual terms of the loan agreement. Impaired loans are accounted for at the lower of the present value of expected cash flows discounted at the loan's effective interest rate or the estimated fair value of the collateral, if the loan is collateral dependent. A portion of the allowance for loan losses is specifically allocated to impaired loans. The process of measuring impaired loans and the allocation of the allowance for loan losses requires judgment and estimation. The eventual outcome may differ from amounts estimated.

Impaired loans include nonaccrual loans (including nonaccrual TDRs), performing and nonperforming TDRs and acquired loans that were not performing in accordance with their original contractual terms. Impaired loans totaled $123.3 million at September 30, 2014, a decrease of $3.5 million compared to $126.8 million at June 30, 2014 and a decrease of $6.0 million compared to $129.3 million at December 31, 2013.

59 -------------------------------------------------------------------------------- A summary of impaired loans at September 30, 2014, June 30, 2014 and December 31, 2013 follows: September 30, December 31, 2014 June 30, 2014 2013 (In thousands) Impaired loans - commercial loan portfolio: Originated commercial loan portfolio: Nonaccrual loans $ 43,700 $ 46,478 $ 49,652 Nonperforming TDRs 11,797 11,049 13,414 Performing TDRs 28,606 29,296 26,839 Subtotal 84,103 86,823 89,905 Acquired commercial loan portfolio 10,229 10,447 9,787 Total impaired loans - commercial loan portfolio 94,332 97,270 99,692 Impaired loans - consumer loan portfolio: Nonaccrual loans 9,336 9,157 12,245 Nonperforming TDRs 3,647 5,516 4,676 Performing TDRs 15,982 14,837 12,732 Total impaired loans - consumer loan portfolio 28,965 29,510 29,653 Total impaired loans $ 123,297 $ 126,780 $ 129,345 The following schedule summarizes impaired loans to commercial borrowers and the related valuation allowance at September 30, 2014, June 30, 2014 and December 31, 2013 and partial loan charge-offs (confirmed losses) taken on these impaired loans: Cumulative Inherent Valuation Confirmed Loss Amount Allowance Losses Percentage (Dollars in thousands) September 30, 2014 Impaired loans - originated commercial loan portfolio: With valuation allowance and no charge-offs $ 3,767 $ 1,052 $ - 28 % With valuation allowance and charge-offs 1,265 123 458 34 With charge-offs and no valuation allowance 21,005 - 17,712 46 Without valuation allowance or charge-offs 58,066 - - - Total 84,103 $ 1,175 $ 18,170 19 % Impaired acquired loans 10,229 Total impaired loans to commercial borrowers $ 94,332 June 30, 2014 Impaired loans - originated commercial loan portfolio: With valuation allowance and no charge-offs $ 5,385 $ 1,153 $ - 21 % With valuation allowance and charge-offs 1,889 187 1,589 51 With charge-offs and no valuation allowance 22,515 - 16,654 43 Without valuation allowance or charge-offs 57,034 - - - Total 86,823 $ 1,340 $ 18,243 19 % Impaired acquired loans 10,447 Total impaired loans to commercial borrowers $ 97,270 December 31, 2013 Impaired loans - originated commercial loan portfolio: With valuation allowance and no charge-offs $ 4,534 $ 1,020 $ - 22 % With valuation allowance and charge-offs 559 61 528 54 With charge-offs and no valuation allowance 23,759 - 19,643 45 Without valuation allowance or charge-offs 61,053 - - - Total 89,905 $ 1,081 $ 20,171 19 % Impaired acquired loans 9,787 Total impaired loans to commercial borrowers $ 99,692 60-------------------------------------------------------------------------------- After analyzing the various components of the customer relationships and evaluating the underlying collateral of impaired loans, the Corporation determined that impaired loans of the commercial loan portfolio totaling $5.0 million at September 30, 2014 required a specific allocation of the allowance for loan losses (valuation allowance) of $1.2 million, compared to $7.3 million of impaired loans in the commercial loan portfolio with a valuation allowance of $1.3 million at June 30, 2014 and $5.1 million of impaired loans in the commercial loan portfolio with a valuation allowance of $1.1 million at December 31, 2013. Confirmed losses represent partial loan charge-offs on impaired loans due primarily to the receipt of a recent third-party property appraisal indicating the value of the collateral securing the loan was below the loan balance and management determined that full collection of the loan balance is not likely. The Corporation's performing and nonperforming TDRs in the commercial loan portfolio did not require a valuation allowance as the Corporation expected to collect the full principal and interest owed on each of these loans in accordance with their modified terms.

The Corporation generally does not recognize a valuation allowance for impaired loans in the consumer loan portfolio as these loans are comprised of smaller-balance homogeneous loans that are collectively evaluated for impairment. However, the Corporation had a valuation allowance attributable to TDRs in the consumer loan portfolio of $0.3 million at September 30, 2014, compared to $0.4 million at June 30, 2014 and $0.5 million at December 31, 2013, related to the reduction in the present value of expected future cash flows for these loans discounted at their original effective interest rates.

Impaired loans included acquired loans totaling $10.2 million, $10.4 million and $9.8 million at September 30, 2014, June 30, 2014 and December 31, 2013, respectively, that were not performing in accordance with the original contractual terms of the loans. These loans did not require a valuation allowance as they are recorded in pools at their net realizable value based on the principal and interest the Corporation expects to collect on these loan pools. These loans are not included in the Corporation's nonperforming loans.

Allowance for Loan Losses The allowance for loan losses (allowance) provides for probable losses in the originated loan portfolio that have been identified with specific customer relationships and for probable losses believed to be inherent in the remainder of the originated loan portfolio but that have not been specifically identified.

The allowance is comprised of specific valuation allowances (assessed for originated loans that have known credit weaknesses), pooled allowances based on assigned risk ratings and historical loan loss experience for each loan type, and an unallocated allowance for imprecision due to the subjective nature of the specific and pooled allowance methodology. Management evaluates the allowance on a quarterly basis in an effort to ensure the level is adequate to absorb probable losses inherent in the loan portfolio. This evaluation process is inherently subjective as it requires estimates that may be susceptible to significant change and has the potential to affect net income materially. The Corporation's methodology for measuring the adequacy of the allowance is comprised of several key elements, which include a review of the loan portfolio, both individually and by category, and consideration of changes in the mix and volume of the loan portfolio, actual loan loss experience, review of collateral values, the financial condition of the borrowers, industry and geographical exposures within the portfolio, economic conditions and employment levels of the Corporation's local markets and other factors affecting business sectors.

Management believes that the allowance is currently maintained at an appropriate level, considering the inherent risk in the loan portfolio. Future significant adjustments to the allowance may be necessary due to changes in economic conditions, delinquencies or the level of loan losses incurred.

The following schedule summarizes information related to the Corporation's allowance for loan losses: September 30, December 31, 2014 June 30, 2014 2013 (Dollars in thousands) Allowance for loan losses: Originated loans $ 76,506 $ 77,293 $ 78,572 Acquired loans 500 500 500 Total $ 77,006 $ 77,793 $ 79,072 Nonperforming loans $ 70,742 $ 73,735 $ 81,984 Allowance for originated loans as a percent of: Total originated loans 1.60 % 1.67 % 1.81 % Nonperforming loans 108 % 105 % 96 % Nonperforming loans, less impaired originated loans for which the expected loss has been charged-off 154 % 151 % 135 % 61--------------------------------------------------------------------------------The following schedule summarizes activity related to the Corporation's allowance for loan losses: Three Months Ended Nine Months Ended June 30, December 31, September 30, September 30, 2014 2014 2013 September 30, 2014 2013 (Dollars in thousands) Allowance for loan losses - beginning of period $ 77,793 $ 78,473 $ 81,532 $ 79,072 $ 84,491 Provision for loan losses 1,500 1,500 2,000 4,600 9,000 Loan charge-offs: Commercial (897 ) (793 ) (1,071 ) (2,222 ) (3,033 ) Commercial real estate (712 ) (1,007 ) (1,584 ) (2,242 ) (5,779 ) Real estate construction (13 ) - (37 ) (113 ) - Land development (111 ) (14 ) (214 ) (179 ) (562 ) Residential mortgage (513 ) (566 ) (591 ) (1,872 ) (2,287 ) Consumer installment (990 ) (924 ) (1,175 ) (3,040 ) (2,818 ) Home equity (386 ) (71 ) (1,209 ) (801 ) (786 ) Total loan charge-offs (3,622 ) (3,375 ) (5,881 ) (10,469 ) (15,265 ) Recoveries of loans previously charged off: Commercial 362 224 623 885 1,160 Commercial real estate 300 224 351 806 735 Real estate construction - - - - - Land development 127 141 7 464 16 Residential mortgage 209 225 64 523 282 Consumer installment 301 312 339 938 1,011 Home equity 36 69 37 187 102 Total loan recoveries 1,335 1,195 1,421 3,803 3,306 Net loan charge-offs (2,287 ) (2,180 ) (4,460 ) (6,666 ) (11,959 ) Allowance for loan losses - end of period $ 77,006 $ 77,793 $ 79,072 $ 77,006 $ 81,532 Net loan charge-offs as a percent of average loans (annualized) 0.18 % 0.18 % 0.39 % 0.18 % 0.37 % The allowance of the acquired loan portfolio was not carried over on the date of acquisition. The acquired loans were recorded at their estimated fair values at the date of acquisition, with the estimated fair values including a component for expected credit losses. Acquired loans are subsequently evaluated for further credit deterioration in loan pools, which consist of loans with similar credit risk characteristics. If an acquired loan pool experiences a decrease in expected cash flows, as compared to those expected at the acquisition date, a portion of the allowance is allocated to acquired loans. At September 30, 2014, the allowance for loan losses on the acquired loan portfolio was $0.5 million and was related to two consumer loan pools performing slightly below original expectations. As part of its ongoing assessment of the acquired loan portfolio, management has determined that the overall credit quality of the acquired loan portfolio has improved, which has resulted in improvement in expected cash flows of loan pools in the acquired commercial loan portfolio. Accordingly, management reclassified $10.0 million during the first quarter of 2014 from the nonaccretable difference to the accretable yield for these acquired commercial loan pools, which will increase amounts recognized into interest income over the estimated remaining lives of these loan pools.

62 --------------------------------------------------------------------------------Deposits Total deposits were $5.43 billion at September 30, 2014, an increase of $339.0 million, or 6.7%, from total deposits of $5.09 billion at June 30, 2014, an increase of $309.5 million, or 6.0%, from total deposits of $5.12 billion at December 31, 2013 and an increase of $240.6 million, or 4.6%, from total deposits of $5.19 billion at September 30, 2013. The increase in total deposits during the third quarter of 2014 was largely attributable to a seasonal increase in municipal deposit accounts. The increase in total deposits for the twelve-month period ended September 30, 2014 was partially attributable to organic deposit growth and partially attributable to the Corporation converting approximately $40 million of securities sold under agreements to repurchase with business customers, which are classified as short-term borrowings, into interest-bearing checking deposit accounts. The organic deposit growth included increases in interest- and noninterest-bearing demand deposit and savings accounts that were partially offset by a decline in certificate of deposit accounts. Interest- and noninterest-bearing demand deposit and savings accounts were $4.19 billion at September 30, 2014, compared to $3.84 billion at September 30, 2013. In comparison, certificate of deposit accounts were $1.24 billion at September 30, 2014, compared to $1.35 billion at September 30, 2013.

It is the Corporation's strategy to develop customer relationships that will drive core deposit growth and stability. The Corporation's competitive position within many of its market areas has historically limited its ability to materially increase core deposits without adversely impacting the weighted average cost of the deposit portfolio. While competition for core deposits remained strong throughout the Corporation's markets during the twelve months ended September 30, 2014, the Corporation's efforts to expand its deposit relationships with existing customers, the Corporation's financial strength and a general trend in customers holding more liquid assets have resulted in the Corporation continuing to experience increases in customer deposits.

At September 30, 2014, the Corporation's time deposits, which consist of certificates of deposit, totaled $1.24 billion, of which $356 million have stated maturities during the remainder of 2014. The Corporation expects the majority of these maturing time deposits to be renewed by customers. The following schedule summarizes the scheduled maturities of the Corporation's time deposits as of September 30, 2014: Weighted Average Maturity Schedule Amount Interest Rate (Dollars in thousands) 2014 fourth quarter maturities $ 356,361 0.58 % 2015 maturities 575,223 0.96 2016 maturities 127,883 1.10 2017 maturities 77,881 1.23 2018 maturities 56,714 1.19 2019 maturities and beyond 45,971 1.52 Total time deposits $ 1,240,033 0.91 % Borrowed Funds Borrowed funds include short-term borrowings, including securities sold under agreements to repurchase with customers, federal funds purchased and Federal Home Loan Bank (FHLB) advances.

Securities sold under agreements to repurchase with customers represent funds deposited by customers, generally on an overnight basis, that are collateralized by investment securities owned by Chemical Bank, as these deposits are not covered by Federal Deposit Insurance Corporation (FDIC) insurance. These funds have been a stable source of liquidity, much like its core deposit base, and are generally only provided to customers that have an established banking relationship with Chemical Bank. The Corporation's securities sold under agreements to repurchase do not qualify as sales for accounting purposes.

Federal funds purchased represent unsecured borrowings from nonaffiliated third-party financial institutions, generally on an overnight basis, to cover short-term liquidity needs. The Corporation had no federal funds purchased at September 30, 2014. At June 30, 2014, the Corporation had federal funds purchased of $12.0 million.

Short-term borrowings were $323.1 million, $305.4 million, $327.4 million and $357.6 million at September 30, 2014, June 30, 2014, December 31, 2013 and September 30, 2013, respectively. Short-term borrowings, which are highly interest rate sensitive, decreased $4.3 million, or 1.3%, during the nine months ended September 30, 2014 and decreased $34.5 million, or 9.7%, during the twelve months ended September 30, 2014. The decrease in short-term borrowings during the twelve-month period ended September 30, 2014 was largely attributable to the Corporation converting approximately $40 million of securities sold under agreements to repurchase with business customers into interest-bearing checking deposit accounts.

63 -------------------------------------------------------------------------------- FHLB advances are borrowings from the Federal Home Loan Bank of Indianapolis that are secured by both a blanket security agreement of residential mortgage first lien loans with an aggregate book value equal to at least 145% of the advances and FHLB capital stock owned by Chemical Bank. The carrying value of residential mortgage first lien loans eligible as collateral under the blanket security agreement was $919 million at September 30, 2014. During the first quarter of 2013, the Corporation prepaid all of its FHLB advances outstanding totaling $34.3 million, resulting in a prepayment fee expense of $0.8 million.

There were no FHLB advances outstanding at September 30, 2014, June 30, 2014, December 31, 2013 or September 30, 2013.

Credit-Related Commitments The Corporation has credit-related commitments that may impact its liquidity.

The following schedule summarizes the Corporation's credit-related commitments and expected expiration dates by period as of September 30, 2014. Because many of these commitments historically have expired without being drawn upon, the total amount of these commitments does not necessarily represent future liquidity requirements of the Corporation.

Less than 1-3 3-5 More than 1 year years years 5 years Total (In thousands) Unused commitments to extend credit: Commercial loans $ 506,001 $ 115,193 $ 34,722 $ 59,524 $ 715,440 Home equity lines of credit 26,770 36,332 73,152 12,994 149,248 Unsecured consumer loans 10,259 2,510 6,019 985 19,773 Residential mortgage construction loans 34,183 - - - 34,183 Total unused commitments to extend credit 577,213 154,035 113,893 73,503 918,644 Undisbursed loan commitments 181,130 - - - 181,130 Standby letters of credit 33,525 2,867 353 - 36,745 Total credit-related commitments $ 791,868 $ 156,902 $ 114,246 $ 73,503 $ 1,136,519 Undisbursed loan commitments at September 30, 2014 included $19 million of residential mortgage loans that were expected to be sold in the secondary market.

Capital Total shareholders' equity was $801.6 million at September 30, 2014, compared to $793.5 million at June 30, 2014, $696.5 million at December 31, 2013 and $673.3 million at September 30, 2013. Total shareholders' equity as a percentage of total assets was 12.2% at September 30, 2014, compared to 12.7% at June 30, 2014, 11.3% at December 31, 2013 and 10.8% at September 30, 2013. The Corporation's tangible equity, which is defined as total shareholders' equity less goodwill and other acquired intangible assets, totaled $677.5 million, $668.9 million, $571.0 million and $547.0 million at September 30, 2014, June 30, 2014, December 31, 2013 and September 30, 2013, respectively. The Corporation's tangible equity to assets ratio was 10.5% at September 30, 2014 compared to 11.0% at June 30, 2014, 9.4% at December 31, 2013 and 8.9% at September 30, 2013.

During June 2014, the Corporation issued and sold 2,875,000 shares of common stock at a public offering price of $28.00 per share. The net proceeds from the issuance and sale of the common stock, after deducting the underwriting discount and issuance-related expenses, totaled $76.2 million. During September 2013, the Corporation issued and sold 2,213,750 shares of common stock at a public offering price of $26.00 per share. The net proceeds from the issuance and sale of the common stock, after deducting the underwriting discount and issuance-related expenses, totaled $53.9 million.

The Corporation and Chemical Bank both continue to maintain strong capital positions, which significantly exceeded the minimum levels prescribed by the Board of Governors of the Federal Reserve System (Reserve Board) at September 30, 2014, as shown in the following schedule: Tier 1 Total Risk-Based Risk-Based Leverage Capital Capital Actual Capital Ratios: Chemical Financial Corporation 11.1 % 13.8 % 15.0 % Chemical Bank 8.8 10.9 12.2 Minimum required for capital adequacy purposes 4.0 4.0 8.0 Minimum required for "well-capitalized" capital adequacy purposes 5.0 6.0 10.0 64-------------------------------------------------------------------------------- Shelf Registration The Corporation filed an automatic shelf registration statement on Form S-3 with the Securities and Exchange Commission (SEC) on June 12, 2014, which became immediately effective, for an indeterminate amount of securities. The automatic shelf registration statement, which replaced a previously filed universal shelf registration statement for up to $100 million in securities, provides the Corporation with the ability to raise capital, subject to SEC rules and limitations, if the board of directors of the Corporation decides to do so.

Basel III On July 2, 2013, the Reserve Board approved the final rules implementing the Basel Committee on Banking Supervision's (BCBS) capital guidelines for U.S.

banks. Under the final rules, minimum requirements will increase for both the quantity and quality of capital held by the Corporation and Chemical Bank. The rules include a new common equity Tier 1 capital to risk-weighted assets ratio of 4.5% and a common equity Tier 1 capital conservation buffer of 2.5% of risk-weighted assets. The final rules also raise the minimum ratio of Tier 1 capital to risk-weighted assets from 4.0% to 6.0% and require a minimum leverage ratio of 4.0%. On July 9, 2013, the FDIC also approved, as an interim final rule, the regulatory capital requirements for U.S. banks, following the actions of the Reserve Board. The FDIC's rule is identical in substance to the final rules issued by the Reserve Board.

The phase-in period for the final rules will begin for the Corporation and Chemical Bank on January 1, 2015, with full compliance with all of the final rule's requirements phased in over a multi-year schedule. Management continues to evaluate the provisions of the final rules and their expected impact on the Corporation and Chemical Bank and anticipates that the capital ratios for the Corporation and Chemical Bank under Basel III will continue to exceed the "well capitalized" minimum capital requirements.

Results of Operations Net Interest Income Net interest income is the difference between interest income on earning assets, such as loans, investment and non-marketable equity securities and interest-bearing deposits with the Federal Reserve Bank (FRB), and interest expense on liabilities, such as deposits and borrowings. Net interest income, on a fully taxable equivalent (FTE) basis, is the difference between interest income and interest expense adjusted for the tax benefit received on tax-exempt commercial loans and investment securities. Net interest margin is calculated by dividing net interest income (FTE) by average interest-earning assets, annualized as applicable. Net interest spread is the difference between the average yield on interest-earning assets and the average cost of interest-bearing liabilities. Because noninterest-bearing sources of funds, or free funds (principally demand deposits and shareholders' equity), also support earning assets, the net interest margin exceeds the net interest spread.

Net interest income (FTE) was $54.6 million in the third quarter of 2014, compared to $50.6 million in the third quarter of 2013 and $52.9 million in the second quarter of 2014. The presentation of net interest income on an FTE basis is not in accordance with GAAP but is customary in the banking industry. This non-GAAP measure ensures comparability of net interest income arising from both taxable and tax-exempt loans and investment securities. The adjustments to determine net interest income (FTE) were $1.5 million, $1.3 million and $1.4 million for each of the three-month periods ended September 30, 2014, September 30, 2013 and June 30, 2014, respectively. These adjustments were computed using a 35% federal income tax rate.

65 -------------------------------------------------------------------------------- Average Balances, Fully Tax Equivalent (FTE) Interest and Effective Yields and Rates* The following schedule presents the average daily balances of the Corporation's major categories of assets and liabilities, interest income and expense on an FTE basis, average interest rates earned and paid on the assets and liabilities, net interest income (FTE), net interest spread and net interest margin for the three months ended September 30, 2014, September 30, 2013, and June 30, 2014.

Three Months Ended September 30, 2014 September 30, 2013 June 30, 2014 Effective Effective Effective Average Interest Yield/ Average Interest Yield/ Average Interest Yield/ Balance (FTE) Rate* Balance (FTE) Rate* Balance (FTE) Rate* ASSETS (Dollars in Thousands) Interest-Earning Assets: Loans** $ 4,970,635 $ 52,900 4.23 % $ 4,432,538 $ 49,525 4.44 % $ 4,830,341 $ 51,284 4.26 % Taxable investment securities 616,191 2,194 1.42 759,431 2,714 1.43 651,685 2,248 1.38 Tax-exempt investment securities 300,975 2,827 3.76 242,664 2,423 3.99 253,468 2,576 4.07 Other interest-earning assets 25,572 160 2.48 25,572 150 2.33 25,572 411 6.45 Interest-bearing deposits with the FRB 133,618 94 0.28 161,337 110 0.27 146,483 99 0.27 Total interest-earning assets 6,046,991 58,175 3.82 5,621,542 54,922 3.88 5,907,549 56,618 3.84 Less: Allowance for loan losses 77,536 82,714 78,626 Other Assets: Cash and cash due from banks 133,465 130,598 116,390 Premises and equipment 74,738 73,874 74,353 Interest receivable and other assets 234,802 223,688 233,908 Total Assets $ 6,412,460 $ 5,966,988 $ 6,253,574 LIABILITIES AND SHAREHOLDERS' EQUITY Interest-Bearing Liabilities: Interest-bearing demand deposits $ 1,206,075 $ 308 0.10 % $ 1,094,526 $ 262 0.09 % $ 1,149,063 $ 273 0.10 % Savings deposits 1,441,114 327 0.09 1,355,289 304 0.09 1,416,961 315 0.09 Time deposits 1,264,477 2,834 0.89 1,367,792 3,594 1.04 1,336,551 3,038 0.91 Short-term borrowings 325,960 92 0.11 350,308 124 0.14 347,583 94 0.11 FHLB advances - - - - - - - - - Total interest-bearing liabilities 4,237,626 3,561 0.33 4,167,915 4,284 0.41 4,250,158 3,720 0.35 Noninterest-bearing deposits 1,337,651 - - 1,142,663 - - 1,249,006 - - Total deposits and borrowed funds 5,575,277 3,561 0.25 5,310,578 4,284 0.32 5,499,164 3,720 0.27 Interest payable and other liabilities 42,472 35,499 40,055 Shareholders' equity 794,711 620,911 714,355 Total Liabilities and Shareholders' Equity $ 6,412,460 $ 5,966,988 $ 6,253,574 Net Interest Spread (average yield earned minus average rate paid) 3.49 % 3.47 % 3.49 % Net Interest Income (FTE) $ 54,614 $ 50,638 $ 52,898 Net Interest Margin (Net Interest Income (FTE) divided by total average interest-earning assets) 3.59 % 3.58 % 3.59 % * Fully taxable equivalent (FTE) basis using a federal income tax rate of 35%.

** Nonaccrual loans and loans held-for-sale are included in average balances reported and are included in the calculation of yields. Also, tax equivalent interest includes net loan fees.

66 -------------------------------------------------------------------------------- The following schedule presents the average daily balances of the Corporation's major categories of assets and liabilities, interest income and expense on an FTE basis, average interest rates earned and paid on the assets and liabilities, net interest income (FTE), net interest spread and net interest margin for the nine months ended September 30, 2014 and 2013.

Nine Months Ended September 30, 2014 September 30, 2013 Effective Effective Average Interest Yield/ Average Interest Yield/ Balance (FTE) Rate* Balance (FTE) Rate* ASSETS (Dollars in Thousands) Interest-Earning Assets: Loans** $ 4,833,468 $ 153,928 4.26 % $ 4,289,024 $ 146,396 4.56 % Taxable investment securities 652,969 6,825 1.39 720,675 7,737 1.43 Tax-exempt investment securities 270,699 8,018 3.95 229,486 7,234 4.20 Other interest-earning assets 25,572 809 4.23 25,572 701 3.66 Interest-bearing deposits with the FRB 156,299 318 0.27 312,593 611 0.26 Total interest-earning assets 5,939,007 169,898 3.82 5,577,350 162,679 3.90 Less: Allowance for loan losses 78,488 83,839 Other Assets: Cash and cash due from banks 123,390 121,116 Premises and equipment 74,618 74,092 Interest receivable and other assets 234,413 228,645 Total Assets $ 6,292,940 $ 5,917,364 LIABILITIES AND SHAREHOLDERS' EQUITY Interest-Bearing Liabilities: Interest-bearing demand deposits $ 1,189,200 $ 868 0.10 % $ 1,076,468 $ 745 0.09 % Savings deposits 1,424,494 958 0.09 1,348,890 901 0.09 Time deposits 1,307,174 9,014 0.92 1,405,756 11,344 1.08 Short-term borrowings 333,809 307 0.12 338,203 359 0.14 FHLB advances - - - 2,587 47 2.43 Total interest-bearing liabilities 4,254,677 11,147 0.35 4,171,904 13,396 0.43 Noninterest-bearing deposits 1,260,582 - - 1,098,733 - - Total deposits and borrowed funds 5,515,259 11,147 0.27 5,270,637 13,396 0.34 Interest payable and other liabilities 40,360 37,673 Shareholders' equity 737,321 609,054 Total Liabilities and Shareholders' Equity $ 6,292,940 $ 5,917,364 Net Interest Spread (average yield earned minus average rate paid) 3.47 % 3.47 % Net Interest Income (FTE) $ 158,751 $ 149,283 Net Interest Margin (Net Interest Income (FTE) divided by total average interest-earning assets) 3.57 % 3.58 % * Fully taxable equivalent (FTE) basis using a federal income tax rate of 35%.

** Nonaccrual loans and loans held-for-sale are included in average balances reported and are included in the calculation of yields. Also, tax equivalent interest includes net loan fees.

67 -------------------------------------------------------------------------------- Net interest income (FTE) of $54.6 million in the third quarter of 2014 was $4.0 million, or 7.9%, higher than net interest income (FTE) of $50.6 million in the third quarter of 2013, with the increase primarily attributable to an increase of $538 million in the average volume of loans outstanding and the favorable impact of time deposits repricing lower during the twelve months ended September 30, 2014, both of which were partially offset by the unfavorable impact of loans repricing during the twelve months ended September 30, 2014. The net interest margin was 3.59% in the third quarter of 2014, compared to 3.58% in the third quarter of 2013. The average yield on interest-earning assets decreased slightly to 3.82% in the third quarter of 2014, from 3.88% in the third quarter of 2013, with the decrease primarily attributable to the repricing of loans at lower interest rates. The average yield on loans decreased 21 basis points to 4.23% in the third quarter of 2014 from 4.44% in the third quarter of 2013. The average cost of interest-bearing liabilities also decreased to 0.33% in the third quarter of 2014, from 0.41% in the third quarter of 2013, with the decrease primarily attributable to the repricing of time deposits at lower interest rates as they matured and were renewed in the continued low interest rate environment.

Net interest income (FTE) of $54.6 million in the third quarter of 2014 was $1.7 million, or 3.2%, higher than net interest income (FTE) of $52.9 million in the second quarter of 2014, with the increase primarily attributable to an increase of $140 million in the average volume of loans outstanding. The net interest margin was 3.59% in both the third quarter of 2014 and the second quarter of 2014. The average yield on interest-earning assets decreased slightly to 3.82% in the third quarter of 2014, from 3.84% in the second quarter of 2014. The average cost of interest-bearing liabilities also decreased slightly to 0.33% in the third quarter of 2014 from 0.35% in the second quarter of 2014.

Net interest income (FTE) of $158.8 million in the nine months ended September 30, 2014 was $9.5 million, or 6.3%, higher than net interest income (FTE) of $149.3 million in the nine months ended September 30, 2013, with the increase primarily attributable to an increase of $544 million in the average volume of loans outstanding and the favorable impact of time deposits repricing lower during the twelve months ended September 30, 2014, both of which were partially offset by the unfavorable impact of loans repricing during the twelve months ended September 30, 2014. The net interest margin was 3.57% in the nine months ended September 30, 2014, compared to 3.58% in the nine months ended September 30, 2013.

Changes in the Corporation's net interest income are influenced by a variety of factors, including changes in the level and mix of interest-earning assets and interest-bearing liabilities, current and prior years' interest rate changes, the level and direction of interest rates, the difference between short-term and long-term interest rates (the steepness of the yield curve) and the general strength of the economies in the Corporation's markets. Risk management plays an important role in the Corporation's level of net interest income. The ineffective management of credit risk, and more significantly interest rate risk, can adversely impact the Corporation's net interest income. Management monitors the Corporation's consolidated statement of financial position to reduce the potential adverse impact on net interest income caused by significant changes in interest rates. The Corporation's policies in this regard are further discussed under the subheading "Market Risk." The Reserve Board influences the general market rates of interest, including the deposit and loan rates offered by many financial institutions. The prime interest rate, which is the rate offered on loans to borrowers with strong credit, was 3.25% at the end of 2008 and has remained at this historically low rate through September 30, 2014. The prime interest rate has historically been 300 basis points higher than the federal funds rate. At its most recent meeting in September 2014, the Federal Open Market Committee (FOMC) did not provide a clear timeline for when it will raise the target range for the federal funds rate, which is currently at between zero and 0.25%. Based on the results of this meeting, the management of the Corporation expects the federal funds rate to remain unchanged until at least the beginning of 2015. Therefore, the prime interest rate is expected to remain at or near its current historical low level of 3.25% for the remainder of 2014. The majority of the Corporation's variable interest rate loans in the commercial loan portfolio are tied to the prime rate.

The Corporation is primarily funded by core deposits, which is a lower-cost funding base than wholesale funding and historically has had a positive impact on the Corporation's net interest income and net interest margin. Based on the current historically low level of market interest rates and the Corporation's current low levels of interest rates on its core deposit transaction accounts, further market interest rate reductions would likely not result in a significant decrease in interest expense.

68 -------------------------------------------------------------------------------- Volume and Rate Variance Analysis The following schedule allocates the dollar change in net interest income (FTE) between the portion attributable to changes in the average volume of interest-earning assets and interest-bearing liabilities, including changes in the mix of assets and liabilities, and changes in average interest rates earned and paid, for the three months ended September 30, 2014, compared to the three months ended September 30, 2013 and June 30, 2014.

Three Months Ended September 30, 2014 Compared to Three Months Ended September 30, 2013 Compared to Three Months Ended June 30, 2014 Increase (Decrease) Increase (Decrease) Due to Changes in Due to Changes in Average Average Combined Increase/ Average Average Combined Increase/ Volume** Yield/Rate** (Decrease) Volume** Yield/Rate** (Decrease) (In Thousands) Changes in Interest Income on Interest-Earning Assets: Loans $ 5,719 $ (2,344 ) $ 3,375 $ 1,738 $ (122 ) $ 1,616 Taxable investment securities/other assets (502 ) (8 ) (510 ) (122 ) (183 ) (305 ) Tax-exempt investment securities 556 (152 ) 404 464 (213 ) 251 Interest-bearing deposits with the FRB (20 ) 4 (16 ) (9 ) 4 (5 ) Total change in interest income on interest-earning assets 5,753 (2,500 ) 3,253 2,071 (514 ) 1,557 Changes in Interest Expense on Interest-Bearing Liabilities: Interest-bearing demand deposits 31 15 46 22 13 35 Savings deposits 9 14 23 9 3 12 Time deposits (249 ) (511 ) (760 ) (101 ) (103 ) (204 ) Short-term borrowings (7 ) (25 ) (32 ) (1 ) (1 ) (2 ) FHLB advances - - - - - - Total change in interest expense on interest-bearing liabilities (216 ) (507 ) (723 ) (71 ) (88 ) (159 ) Total Change in Net Interest Income (FTE)* $ 5,969 $ (1,993 ) $ 3,976 $ 2,142 $ (426 ) $ 1,716* Taxable equivalent basis using a federal income tax rate of 35%.

** The change in interest income and interest expense due to both volume and rate has been allocated to the volume and rate changes in proportion to the relationship of the absolute dollar amounts of the change in each.

The following schedule allocates the dollar change in net interest income (FTE) between the portion attributable to changes in the average volume of interest-earning assets and interest-bearing liabilities, including changes in the mix of assets and liabilities, and changes in average interest rates earned and paid, for the nine months ended September 30, 2014, compared to the nine months ended September 30, 2013.

Nine Months Ended September 30, 2014 Compared to Nine Months Ended September 30, 2013 Increase (Decrease) Due to Changes in Average Average Combined Increase/ Volume** Yield/Rate** (Decrease) (In Thousands) Changes in Interest Income on Interest-Earning Assets: Loans $ 17,422 $ (9,890 ) $ 7,532 Taxable investment securities/other assets (702 ) (102 ) (804 ) Tax-exempt investment securities 1,242 (458 ) 784 Interest-bearing deposits with the FRB (315 ) 22 (293 ) Total change in interest income on interest-earning assets 17,647 (10,428 ) 7,219 Changes in Interest Expense on Interest-Bearing Liabilities: Interest-bearing demand deposits 86 37 123 Savings deposits 17 40 57 Time deposits (774 ) (1,556 ) (2,330 ) Short-term borrowings (4 ) (52 ) (56 ) FHLB advances (20 ) (23 ) (43 ) Total change in interest expense on interest-bearing liabilities (695 ) (1,554 ) (2,249 ) Total Change in Net Interest Income (FTE)* $ 18,342 $ (8,874 ) $ 9,468 * Taxable equivalent basis using a federal income tax rate of 35%.

** The change in interest income and interest expense due to both volume and rate has been allocated to the volume and rate changes in proportion to the relationship of the absolute dollar amounts of the change in each.

69 -------------------------------------------------------------------------------- Provision for Loan Losses The provision for loan losses (provision) is an increase to the allowance, as determined by management, to provide for probable losses inherent in the originated loan portfolio and for impairment of pools of acquired loans that results from the Corporation experiencing a decrease in expected cash flows of acquired loans during each reporting period. The provision was $1.5 million in the third quarter of 2014, compared to $3.0 million in the third quarter of 2013 and $1.5 million in the second quarter of 2014.

The Corporation experienced net loan charge-offs of $2.3 million in the third quarter of 2014, compared to $3.7 million in the third quarter of 2013 and $2.2 million in the second quarter of 2014. Net loan charge-offs as a percentage of average loans (annualized) were 0.18% in the third quarter of 2014, compared to 0.33% in the third quarter of 2013 and 0.18% in the second quarter of 2014. Net loan charge-offs in the commercial loan portfolio totaled $0.9 million in the third quarter of 2014, compared to $2.3 million in the third quarter of 2013 and $1.2 million in the second quarter of 2014. The Corporation's commercial loan portfolio's net loan charge-offs were not concentrated in any one industry or borrower. Net loan charge-offs in the consumer loan portfolio totaled $1.3 million in the third quarter of 2014, compared to $1.4 million in the third quarter of 2013 and $1.0 million in the second quarter of 2014.

The Corporation's provision of $1.5 million in the third quarter of 2014 was $0.8 million lower than net loan charge-offs for the quarter. In addition, the provision in the third quarter of 2014 was $1.5 million lower than the third quarter of 2013, although unchanged from the second quarter of 2014. The reduction in the provision for loan losses in the third quarter of 2014, as compared to the third quarter of 2013, was reflective of improvement in the credit quality of the Corporation's loan portfolio including decreases in both net loan charge-offs and nonperforming loans and no significant changes in risk grade categories of the commercial loan portfolio.

The Corporation's provision and net loan charge-offs were $4.6 million and $6.7 million, respectively, for the nine months ended September 30, 2014, compared to $9.0 million and $12.0 million, respectively, for the nine months ended September 30, 2013. The reduction in the Corporation's provision for the first nine months of 2014, as compared to the first nine months of 2013, was due to continued improvement in the credit quality of the Corporation's loan portfolio, including decreases in both net loan charge-offs and nonperforming loans.

Noninterest Income The following summarizes the major components of noninterest income: Three Months Ended Nine Months Ended September 30, September 30, September 30, September 30, 2014 2013 June 30, 2014 2014 2013 (Inthousands) Service charges and fees on deposit accounts $ 5,612 $ 5,690 $ 5,486 $ 16,028 $ 16,420 Wealth management revenue 3,730 3,369 3,958 11,319 10,693 Electronic banking fees 3,428 3,076 3,234 9,774 9,478 Mortgage banking revenue 1,166 1,038 1,491 3,451 4,699 Other fees for customer services 867 814 930 2,588 2,419 Insurance commissions 391 382 518 1,200 1,329 Gain on sale of investment securities - - - - 1,104 Other 157 275 184 508 689 Total noninterest income $ 15,351 $ 14,644 $ 15,801 $ 44,868 $ 46,831 Noninterest income was $15.4 million in the third quarter of 2014, compared to $14.6 million in the third quarter of 2013 and $15.8 million in the second quarter of 2014. Noninterest income in the third quarter of 2014 was $0.7 million higher than the third quarter of 2013, with the increase attributable to modest increases in wealth management revenue and electronic banking fees.

Noninterest income in the third quarter of 2014 was $0.5 million lower than the second quarter of 2014, with the decrease primarily attributable to a $0.4 million reduction in the Corporation's secondary mortgage market indemnification reserve in the second quarter of 2014.

Service charges and fees on deposit accounts, which include overdraft/non-sufficient funds fees, checking account service fees and other deposit account charges, were $5.6 million in the third quarter of 2014, a decrease of $0.1 million, or 1.4%, from the third quarter of 2013 and an increase of $0.1 million, or 2.3%, from the second quarter of 2014.

Overdraft/non-sufficient funds fees included in service charges and fees on deposit accounts were $4.5 million in the third quarter of 2014, compared to $4.6 million in the third quarter of 2013 and $4.4 million in the second quarter of 2014.

70 -------------------------------------------------------------------------------- Wealth management revenue is comprised of investment fees that are generally based on the market value of assets within a trust account, custodial account fees and fees from the sale of investment products. Volatility in the equity and bond markets impacts the market value of trust assets and related investment fees. Wealth management revenue was $3.7 million in the third quarter of 2014, an increase of $0.4 million, or 10.7%, over the third quarter of 2013 and a decrease of $0.2 million, or 5.8%, from the second quarter of 2014. Fees from the sales of investment products totaled $1.0 million in both the third quarter of 2014 and the third quarter of 2013 and $0.9 million in the second quarter of 2014.

Electronic banking fees, which represent income earned by the Corporation from ATM transactions, debit card activity and internet banking fees, were $3.4 million in the third quarter of 2014, an increase of $0.4 million, or 11.4%, from the third quarter of 2013 and an increase of $0.2 million, or 6.0%, from the second quarter of 2014. The increases in electronic banking fees in the third quarter of 2014, compared to both the third quarter of 2013 and the second quarter of 2014, were primarily attributable to lower costs associated with the Corporation's debit card Preferred Rewards program, which are recognized as a reduction to debit card fee income when earned by customers.

Mortgage banking revenue (MBR) includes revenue from originating, selling and servicing residential mortgage loans for the secondary market. MBR was $1.2 million in the third quarter of 2014, an increase of $0.1 million, or 12.3%, from the third quarter of 2013 and a decrease of $0.3 million, or 21.8%, from the second quarter of 2014. During the second quarter of 2014, MBR included a $0.4 million reduction to the Corporation's reserve for probable losses on loans sold in the secondary market. The Corporation sold $45 million of residential mortgage loans in the secondary market in the third quarter of 2014, compared to $45 million in the third quarter of 2013 and $36 million in the second quarter of 2014.

The Corporation sells residential mortgage loans in the secondary market on both a servicing retained and servicing released basis. These sales include the Corporation entering into residential mortgage loan sale agreements with buyers in the normal course of business. The agreements contain provisions that include various representations and warranties regarding the origination, characteristics and underwriting of the mortgage loans. The recourse of the buyer may result in either indemnification of any loss incurred by the buyer or a requirement for the Corporation to repurchase a loan that the buyer believes does not comply with the representations included in the loan sale agreement.

Repurchase demands and loss indemnifications received by the Corporation are reviewed by a senior officer on a loan-by-loan basis to validate the claim made by the buyer. The Corporation maintains a reserve for probable losses expected to be incurred from loans previously sold in the secondary market. This contingent liability is based on trends in repurchase and indemnification requests, actual loss experience, information requests, known and inherent risks in the sale of loans in the secondary market and current economic conditions.

For the nine months ended September 30, 2014, the Corporation incurred loan losses and buyer indemnification expenses of $0.3 million related to nine residential mortgage loans that had been previously sold in the secondary market. During the three years preceding 2014, the Corporation incurred loan losses and buyer indemnification expenses totaling $0.6 million related to ten residential mortgage loans that had been previously sold in the secondary market. The Corporation was also required to repurchase ten residential mortgage loans totaling $1.0 million in 2011 and 2012 that had been previously sold in the secondary market as it was determined that these loans did not meet the original qualifications for sale in the secondary market. These ten loans were all performing and their fair values approximated the repurchase price at the repurchase date. Accordingly, the Corporation did not incur a loss at the time of repurchase on any of these loans. The Corporation records losses resulting from the repurchase of loans previously sold in the secondary market, as well as adjustments to estimates of future probable losses, as part of its MBR in the period incurred. The Corporation's reserve for probable losses was $1.1 million at both September 30, 2014 and June 30, 2014, $1.6 million at December 31, 2013 and $1.1 million at September 30, 2013.

Noninterest income was $44.9 million in the nine months ended September 30, 2014, compared to $46.8 million in the nine months ended September 30, 2013.

Noninterest income in the nine months ended September 30, 2013 included nonrecurring income of $1.5 million mostly attributable to available-for-sale investment securities gains. Excluding this nonrecurring income, noninterest income in the nine months ended September 30, 2014 was $0.4 million lower than the nine months ended September 30, 2013, with the decrease largely attributable to a $1.4 million, or 23%, decline in mortgage banking revenue and related title insurance revenue. In addition, service charges and fees on deposit accounts were $0.4 million, or 2.4%, lower in the nine months ended September 30, 2014, compared to the nine months ended September 30, 2013, while wealth management revenue was $0.6 million, or 5.9%, higher in the nine months ended September 30, 2014, compared to the nine months ended September 30, 2013.

71 -------------------------------------------------------------------------------- Operating Expenses The following summarizes the major categories of operating expenses: Three Months Ended Nine Months Ended September 30, September 30, September 30, September 30, 2014 2013 June 30, 2014 2014 2013 (In thousands) Salaries and wages $ 20,608 $ 19,800 $ 20,138 $ 60,279 $ 58,189 Employee benefits 4,277 4,265 4,722 13,650 13,873 Occupancy 3,629 3,406 3,638 11,641 10,449 Equipment and software 3,772 3,354 3,792 11,025 10,251 Outside processing and service fees 3,074 2,614 2,877 8,619 8,273 Professional fees 937 909 1,032 3,262 2,837 FDIC insurance premiums 1,064 1,061 1,063 3,188 3,253 Postage and express mail 1,056 784 722 2,657 2,205 Advertising and marketing 1,165 540 874 2,715 2,201 Training, travel and other employee expenses 553 587 643 1,824 1,786 Telephone 457 464 476 1,400 1,483 Intangible asset amortization 445 467 446 1,336 1,444 Supplies 455 421 415 1,315 1,253 Donations 214 593 417 997 1,476 Credit-related expenses 52 (511 ) 202 620 637 FHLB prepayment fees - - - - 753 Other 944 791 968 2,781 2,180 Total operating expenses $ 42,702 $ 39,545 $ 42,425 $ 127,309 $ 122,543 Operating expenses were $42.7 million in the third quarter of 2014, compared to $39.5 million in the third quarter of 2013 and $42.4 million in the second quarter of 2014. Operating expenses included nonrecurring transaction-related expenses attributable to the pending acquisition of Northwestern of $1.3 million in the third quarter of 2014 and $0.7 million in the second quarter of 2014.

Excluding these nonrecurring expenses, operating expenses in the third quarter of 2014 were $1.9 million, or 4.7%, higher than the third quarter of 2013, with the increase primarily attributable to higher employee compensation and credit-related expenses. Excluding nonrecurring expenses, operating expenses in the third quarter of 2014 were $0.3 million lower than the second quarter of 2014.

Salaries and wages of $20.6 million in the third quarter of 2014 increased $0.8 million, or 4.1%, over the third quarter of 2013 due primarily to merit and market-driven salary adjustments that took effect at the beginning of 2014.

Salaries and wages in the third quarter of 2014 increased $0.5 million, or 2.3%, from the second quarter of 2014 due largely to one additional business day included in the third quarter of 2014. Performance-based compensation expense was $2.2 million in both the third quarter of 2014 and the second quarter of 2014, compared to $2.5 million in the third quarter of 2013.

Employee benefit costs were $4.3 million in both the third quarter of 2014 and the third quarter of 2013, compared to $4.7 million in the second quarter of 2014. The decrease in employee benefit costs of $0.4 million, or 9.4%, in the third quarter of 2014, compared to the second quarter of 2014, was attributable to lower group health costs.

Occupancy expenses of $3.6 million in the third quarter of 2014 increased $0.2 million, or 6.5%, over the third quarter of 2013, although remained unchanged compared to the second quarter of 2014.

Equipment and software expenses included nonrecurring transaction-related expenses of $0.2 million in the third quarter of 2014 and $0.4 million in the second quarter of 2014. Excluding these nonrecurring expenses, equipment and software expense of $3.6 million in the third quarter of 2014 was $0.2 million higher than both the third quarter of 2013 and the second quarter of 2014.

Outside processing and service fees included nonrecurring transaction-related expenses of $0.3 million in the third quarter of 2014. Excluding these nonrecurring expenses, outside processing and service fees of $2.7 million in the third quarter of 2014 were $0.1 million higher than the third quarter of 2013 and $0.1 million lower than the second quarter of 2014.

72 -------------------------------------------------------------------------------- Professional fees included nonrecurring transaction-related expenses of $0.1 million in the third quarter of 2014 and $0.2 million in the second quarter of 2014. Excluding these nonrecurring expenses, professional fees of $0.8 million in the third quarter of 2014 were $0.1 million, or 8.1%, lower than the third quarter of 2013, although remained unchanged compared to the second quarter of 2014.

Postage and express mail expenses included nonrecurring transaction-related expenses of $0.1 million in the third quarter of 2014. Excluding these nonrecurring expenses, postage and express mail expenses of $0.9 million in the third quarter of 2014 were $0.2 million higher than both the third quarter of 2013 and the second quarter of 2014, with the increase due to a higher volume of customer mailings that occurred during the third quarter of 2014.

Advertising and marketing expenses included nonrecurring transaction-related expenses of $0.5 million in the third quarter of 2014. Excluding these nonrecurring expenses, advertising and marketing expenses of $0.7 million in the third quarter of 2014 were $0.1 million, or 26%, higher than the third quarter of 2013 and $0.2 million, or 20%, lower than the second quarter of 2014, with the fluctuations due to the timing and seasonality of the Corporation's marketing campaigns.

Credit-related expenses are comprised of other real estate (ORE) net costs and loan collection costs. ORE net costs are comprised of costs to carry ORE, such as property taxes, insurance and maintenance costs, fair value write-downs after a property is transferred to ORE and net gains/losses from the disposition of ORE. Loan collection costs include legal fees, appraisal fees and other costs recognized in the collection of loans with deteriorated credit quality and in the process of foreclosure. Credit-related expenses of $0.1 million in the third quarter of 2014 were $0.6 million higher than the third quarter of 2013 and $0.2 million lower than the second quarter of 2014. Lower net gains on the sales of ORE properties in the third quarter of 2014, compared to the third quarter of 2013, were partially offset by lower ORE operating costs and loan collection costs. The decrease in credit-related costs in the third quarter of 2014, compared to the second quarter of 2014, was attributable to a combination of slightly higher net gains on sales of ORE properties and slightly lower loan collection costs. The Corporation recognized net gains on the sale of ORE properties of $0.6 million in the third quarter of 2014, compared to $1.3 million in the third quarter of 2013 and $0.5 million in the second quarter of 2014. ORE operating costs and loan collection costs, combined, were $0.6 million in the third quarter of 2014, compared to $0.7 million in both the third quarter of 2013 and second quarter of 2014.

Operating expenses were $127.3 million in the nine months ended September 30, 2014, compared to $122.5 million in the nine months ended September 30, 2013.

Operating expenses in the nine months ended September 30, 2014 included nonrecurring transaction-related expenses attributable to the pending acquisition of Northwestern of $2.2 million, while operating expenses in the nine months ended September 30, 2013 included nonrecurring expenses of $0.8 million attributable to the Corporation's prepayment of its FHLB advances.

Excluding these nonrecurring expenses, operating expenses in the nine months ended September 30, 2014 were $3.3 million, or 2.7%, higher than the nine months ended September 30, 2013, with the increase primarily attributable to higher salaries and wages, group health costs and occupancy expenses, which were partially offset by lower pension expenses and donations.

Income Tax Expense The Corporation's effective federal income tax rate was 30.8% for the third quarter of 2014, compared to 29.9% and 30.4% for the third quarter of 2013 and the second quarter of 2014, respectively. The fluctuations in the Corporation's effective federal income tax rate reflect changes each year in the proportion of interest income exempt from federal taxation, nondeductible interest expense and other nondeductible expenses relative to pretax income and tax credits. The Corporation recorded income tax expense for the nine-month periods ended September 30, 2014 and 2013 using its estimate of the effective income tax rate expected for the full year and applied that rate on a year-to-date basis.

Liquidity Liquidity measures the ability of the Corporation to meet current and future cash flow needs in a timely manner. Liquidity risk is the adverse impact on net interest income if the Corporation was unable to meet its cash flow needs at a reasonable cost.

Liquidity is managed to ensure stable, reliable and cost-effective sources of funds are available to satisfy deposit withdrawals and lending and investment opportunities. The ability of a financial institution to meet its current financial obligations is a function of its balance sheet structure, its ability to liquidate assets and its access to alternative sources of funds. The Corporation manages its funding needs by maintaining a level of liquid funds through its asset/liability management process. The Corporation's largest sources of liquidity on a consolidated basis are the deposit base that comes from consumer, business and municipal customers within the Corporation's local markets, principal payments on loans, maturing investment securities, cash held at the FRB and unpledged investment securities available-for-sale. Total deposits increased $339 million during the three months ended September 30, 2014 and $241 million during the twelve months ended September 30, 2014. The Corporation's loan-to-deposit ratio was 92.8% at September 30, 2014, compared to 96.2% at June 30, 2014, 90.7% at December 31, 2013 and 87.1% at 73 -------------------------------------------------------------------------------- September 30, 2013. The Corporation had $248 million of cash deposits held at the FRB at September 30, 2014, compared to $1 million at June 30, 2014, $180 million at December 31, 2013 and $357 million at September 30, 2013. The increase in interest-bearing balances at the FRB during the third quarter of 2014 was largely attributable to a seasonal increase in municipal customer deposits, while the decrease during the twelve months ended September 30, 2014 was attributable to the Corporation utilizing some of the liquidity from its excess funds held at the FRB to partially fund loan growth. At September 30, 2014, the Corporation had unpledged investment securities available-for-sale with an amortized cost of $43 million and available unused wholesale sources of liquidity, including FHLB advances and borrowings from the discount window of the FRB.

Chemical Bank is a member of the FHLB and as such has access to short-term and long-term advances from the FHLB that are generally secured by residential mortgage first lien loans. The Corporation's borrowing availability from the FHLB, based on its FHLB capital stock and subject to certain requirements, was $343 million at September 30, 2014. Chemical Bank can also borrow from the FRB's discount window to meet short-term liquidity requirements. These borrowings are required to be secured by investment securities and/or certain loan types, with each category of assets carrying various borrowing capacity percentages. At September 30, 2014, Chemical Bank maintained an unused borrowing capacity of $32 million with the FRB's discount window based upon pledged collateral as of that date. Chemical Bank also had the ability to borrow an additional $75 million of federal funds from a third-party financial institution at September 30, 2014. It is management's opinion that the Corporation's borrowing capacity could be expanded, if deemed necessary, as Chemical Bank has additional borrowing capacity available at the FHLB that could be used if it increased its investment in FHLB capital stock, and Chemical Bank has a significant amount of additional assets that could be used as collateral at the FRB's discount window.

The Corporation manages its liquidity position to provide the cash necessary to pay dividends to shareholders, invest in new subsidiaries, enter new banking markets, pursue investment opportunities and satisfy other operating requirements. The Corporation's primary source of liquidity is dividends from Chemical Bank.

Federal and state banking laws place certain restrictions on the amount of dividends that a bank may pay to its parent company. During the nine months ended September 30, 2014, Chemical Bank paid $21.6 million in cash dividends to the Corporation, and the Corporation paid cash dividends to shareholders of $21.6 million. During 2013, Chemical Bank paid $24.5 million in dividends to the Corporation and the Corporation paid cash dividends to shareholders of $24.5 million. The earnings of Chemical Bank have been the principal source of funds to pay cash dividends to the Corporation's shareholders. Over the long term, cash dividends to shareholders are dependent upon earnings, capital requirements, regulatory restraints and other factors affecting Chemical Bank.

Market Risk Market risk is the risk of loss arising from adverse changes in the fair value of financial instruments due primarily to changes in interest rates. Interest rate risk is the Corporation's primary market risk and results from timing differences in the repricing of interest rate sensitive assets and liabilities and changes in relationships between rate indices due to changes in interest rates. The Corporation's net interest income is largely dependent upon the effective management of interest rate risk. The Corporation's goal is to avoid a significant decrease in net interest income, and thus an adverse impact on the profitability of the Corporation, in periods of changing interest rates.

Sensitivity of earnings to interest rate changes arises when yields on assets change differently from the interest costs on liabilities. Interest rate sensitivity is determined by the amount of interest-earning assets and interest-bearing liabilities repricing within a specific time period and the magnitude by which interest rates change on the various types of interest-earning assets and interest-bearing liabilities. The management of interest rate sensitivity includes monitoring the maturities and repricing opportunities of interest-earning assets and interest-bearing liabilities. The Corporation's interest rate risk is managed through policies and risk limits approved by the boards of directors of the Corporation and Chemical Bank and an Asset and Liability Committee (ALCO). The ALCO, which is comprised of executive and senior management from various areas of the Corporation and Chemical Bank, including finance, lending, investments and deposit gathering, meets regularly to execute asset and liability management strategies. The ALCO establishes guidelines and monitors the sensitivity of earnings to changes in interest rates. The goal of the ALCO process is to manage the impact on net interest income and the net present value of future cash flows of probable changes in interest rates within authorized risk limits.

The primary technique utilized by the Corporation to measure its interest rate risk is simulation analysis. Simulation analysis forecasts the effects on the balance sheet structure and net interest income under a variety of scenarios that incorporate changes in interest rates, the shape of the Treasury yield curve, interest rate relationships and the mix of assets and liabilities and loan prepayments. These forecasts are compared against net interest income projected in a stable interest rate environment. While many assets and liabilities reprice either at maturity or in accordance with their contractual terms, several balance sheet components demonstrate characteristics that require an evaluation to more accurately reflect their repricing behavior. Key assumptions in the simulation analysis include prepayments on loans, probable calls of investment securities, changes in market conditions, loan volumes and loan pricing, deposit sensitivity and customer preferences. These assumptions are inherently uncertain as they are subject to fluctuation and revision in a dynamic environment. As a result, the simulation analysis cannot precisely forecast the impact of rising and falling interest rates on net interest income.

Actual results will differ from simulated results due to many other 74 -------------------------------------------------------------------------------- factors, including changes in balance sheet components, interest rate changes, changes in market conditions and management strategies.

The Corporation's interest rate sensitivity is estimated by first forecasting the next twelve months of net interest income under an assumed environment of constant market interest rates. The Corporation then compares the results of various simulation analyses to the constant interest rate forecast (base case).

At September 30, 2014, the Corporation projected the change in net interest income during the next twelve months assuming short-term market interest rates were to uniformly and gradually increase or decrease by up to 200 basis points in a parallel fashion over the entire yield curve during the same time period.

Additionally, at September 30, 2014, the Corporation projected the change in net interest income of an immediate 400 basis point increase in market interest rates. The Corporation did not project a 400 basis point decrease in interest rates at September 30, 2014 as the likelihood of a decrease of this size was considered unlikely given prevailing interest rate levels. These projections were based on the Corporation's assets and liabilities remaining static over the next twelve months, while factoring in probable calls and prepayments of certain investment securities and residential mortgage and consumer loans. The ALCO regularly monitors the Corporation's forecasted net interest income sensitivity to ensure that it remains within established limits.

A summary of the Corporation's interest rate sensitivity at September 30, 2014 follows: Immediate Gradual Change Change Twelve month interest rate change projection (in basis points) -200 -100 0 +100 +200 +400 Percent change in net interest income vs. constant rates (4.6 )% (2.4 )% - 0.2 % (0.7 )% (3.7 )% At September 30, 2014, the Corporation's model simulations projected that a 100 basis point increase in interest rates would result in a positive variance in net interest income of 0.2% relative to the base case over the next twelve-month period, while 200 and 400 basis point increases in interest rates would result in negative variances in net interest income of 0.7% and 3.7%, respectively, relative to the base case over the next twelve-month period. At September 30, 2014, the Corporation's model simulations also projected that decreases in interest rates of 100 and 200 basis points would result in negative variances in net interest income of 2.4% and 4.6%, respectively, relative to the base case over the next twelve-month period. The likelihood of a decrease in interest rates beyond 100 basis points at September 30, 2014 was considered to be unlikely given prevailing interest rate levels.

The Corporation's model simulations for a 200 basis point increase resulted in a negative variance in net interest income, relative to the base case, primarily due to the Corporation deploying excess cash into fixed-rate loans during the nine months ended September 30, 2014. However, while the model simulations projected a negative variance for a 200 basis point increase, the Corporation's net interest income is still projected to be higher if interest rates were to rise 200 basis points due to the higher yield being earned on the funds deployed into loans and investment securities compared to maintaining these funds at the FRB earning 25 basis points. The Corporation's model simulations for a 100 basis point increase resulted in a positive variance in net interest income, relative to the base case, primarily due to the Corporation maintaining excess cash, which was primarily generated from a seasonal increase in municipal deposits during the third quarter of 2014, at the FRB. The Corporation's model simulations treat excess cash maintained at the FRB as a variable-rate asset.

Future increases in market interest rates are not expected to have a significant immediate favorable impact on the Corporation's net interest income at the time of such increases because of the low percentage of variable interest rate loans in the Corporation's loan portfolio and a large percentage of variable interest rate loans at interest rate floors at September 30, 2014. The percentage of variable interest rate loans, which comprised approximately 24% of the Corporation's loan portfolio at September 30, 2014, has remained relatively consistent during the twelve-month period ended September 30, 2014.

Approximately two-thirds of the Corporation's variable interest rate loans were at an interest rate floor with a majority expected to remain at their floor until they mature or market interest rates rise more than 75 basis points. At its most recent meeting in September 2014, the Federal Open Market Committee (FOMC) did not provide a clear timeline for when it will raise the target range for the federal funds rate, which is currently at between zero and 0.25%. Based on the results of this meeting, the management of the Corporation expects the federal funds rate to remain unchanged until at least the beginning of 2015, and therefore, corresponding increases in other market interest rates that are generally tied to the federal funds rate, such as the prime interest rate, are not expected to increase significantly during 2014.

To reduce the risk of rising interest rates adversely impacting net interest income, the Corporation has positioned its balance sheet to be less liability sensitive by holding some variable rate instruments in its investment securities portfolio. Variable rate investment securities at September 30, 2014 were $198 million, or 22% of total investment securities, compared to $218 million, or 24% of total investment securities, at June 30, 2014, $238 million, or 25% of total investment securities at December 31, 2013 and $250 million, or 25% of total investment securities, at September 30, 2013. The decline in variable rate investment securities during the three and twelve months ended September 30, 2014 is largely due to the Corporation utilizing maturing investment securities to partially fund loan growth.

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