-----BEGIN PRIVACY-ENHANCED MESSAGE----- Proc-Type: 2001,MIC-CLEAR Originator-Name: webmaster@www.sec.gov Originator-Key-Asymmetric: MFgwCgYEVQgBAQICAf8DSgAwRwJAW2sNKK9AVtBzYZmr6aGjlWyK3XmZv3dTINen TWSM7vrzLADbmYQaionwg5sDW3P6oaM5D3tdezXMm7z1T+B+twIDAQAB MIC-Info: RSA-MD5,RSA, Tr7Zg0XCGcN2rsJNbpMWkwAgujAA1a2kzXT1pXlcUoiono4tcC0Fhi7jNFAg6qC2 LUpWrgpIhjJrEOyf9PJHtw== 0000905729-99-000059.txt : 19990323 0000905729-99-000059.hdr.sgml : 19990323 ACCESSION NUMBER: 0000905729-99-000059 CONFORMED SUBMISSION TYPE: 10-K PUBLIC DOCUMENT COUNT: 11 CONFORMED PERIOD OF REPORT: 19981231 FILED AS OF DATE: 19990322 FILER: COMPANY DATA: COMPANY CONFORMED NAME: CHEMICAL FINANCIAL CORP CENTRAL INDEX KEY: 0000019612 STANDARD INDUSTRIAL CLASSIFICATION: STATE COMMERCIAL BANKS [6022] IRS NUMBER: 382022454 STATE OF INCORPORATION: MI FISCAL YEAR END: 1231 FILING VALUES: FORM TYPE: 10-K SEC ACT: SEC FILE NUMBER: 000-08185 FILM NUMBER: 99570162 BUSINESS ADDRESS: STREET 1: 333 E MAIN ST CITY: MIDLAND STATE: MI ZIP: 48640 BUSINESS PHONE: 5176313310 10-K 1 =========================================================================== SECURITIES AND EXCHANGE COMMISSION Washington, D.C. 20549 FORM 10-K FOR ANNUAL AND TRANSITION REPORTS PURSUANT TO SECTIONS 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 [X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 FOR THE FISCAL YEAR ENDED DECEMBER 31, 1998 OR [ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 FOR THE TRANSITION PERIOD FROM _______ TO _______ Commission File Number 0-8185 CHEMICAL FINANCIAL CORPORATION (Exact Name of Registrant as Specified in its Charter) MICHIGAN 38-2022454 (State or Other Jurisdiction of (I.R.S. Employer Identification No.) Incorporation or Organization) 333 E. MAIN STREET MIDLAND, MICHIGAN 48640 (Address of Principal Executive Offices) (Zip Code) Registrant's Telephone Number, Including Area Code: (517) 839-5350 Securities Registered Pursuant to Section 12(g) of the Act: COMMON STOCK, $1 PAR VALUE (Title of Class) Indicate by check mark whether the registrant: (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes __X__ No _____ Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of registrant's knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K ( ) The aggregate market value of the voting stock held by non-affiliates of the registrant as of February 19, 1999, was $344,232,372. The number of shares outstanding of the registrant's Common Stock, $1 par value, at February 19, 1999, was 13,506,385. DOCUMENTS INCORPORATED BY REFERENCE Portions of the registrant's Annual Report to Shareholders for the year ended December 31, 1998, are incorporated by reference in Parts I and II (Items 1 and 5-8). Portions of the registrant's definitive Proxy Statement for its April 19, 1999, annual shareholders' meeting are incorporated by reference in Part III (Items 10-13). =========================================================================== PART I FORWARD-LOOKING STATEMENTS This report contains forward-looking statements that are based on management's beliefs, assumptions, current expectations, estimates and projections about the financial services industry, the economy, and about Chemical Financial Corporation itself. Words such as "anticipates," "believes," "estimates," "judgement," "expects," "forecasts," "intends," "is likely," "plans," "predicts," "projects," variations of such words and similar expressions are intended to identify such forward-looking statements. Assessments that Chemical Financial Corporation and/or its information and non-information technology systems are Year 2000 "compliant" or "ready" are statements of belief as to the outcome of future events based in part on information provided by vendors and other third parties that Chemical Financial Corporation has not independently verified. These statements are not guarantees of future performance and involve certain risks, uncertainties and assumptions ("Future Factors") that are difficult to predict with regard to timing, extent, likelihood and degree of occurrence. Therefore, actual results and outcomes may materially differ from what may be expressed or forecasted in such forward-looking statements. Furthermore, Chemical Financial Corporation undertakes no obligation to update, amend or clarify forward-looking statements, whether as a result of new information, future events or otherwise. Future Factors include, but are not limited to, changes in interest rates and interest rate relationships; demand for products and services; the degree of competition by traditional and non-traditional competitors; changes in banking regulations; changes in tax laws; changes in prices, levies and assessments; the impact of technological advances and issues, including Year 2000 issues; governmental and regulatory policy changes; the outcomes of pending and future litigation and contingencies; trends in customer behavior as well as their ability to repay loans; and changes in the national economy. These are representative of the Future Factors that could cause a difference between an ultimate actual outcome and a preceding forward-looking statement. ITEM 1. BUSINESS. Chemical Financial Corporation ("Chemical" or the "Corporation") is a bank holding company. Chemical was organized under Michigan law in August 1973, and is headquartered in Midland, Michigan. Chemical was substantially inactive until June 30, 1974, when it acquired its lead subsidiary bank, Chemical Bank and Trust Company ("CB&T"), pursuant to a reorganization in 2 which the former shareholders of CB&T became shareholders of Chemical. As of December 31, 1998, Chemical owned all of the outstanding stock of ten commercial banks and a data processing company, all located in Michigan. The main offices of Chemical's ten banking subsidiaries are located in Midland, Bay City, Big Rapids, Cadillac, Caro, Clare, Grayling, Marshall, Owosso and Stanton. Chemical's business is concentrated in a single industry segment - commercial banking. Chemical's subsidiaries offer a full range of commercial banking and fiduciary services. These include accepting deposits, business and personal checking accounts, savings and individual retirement accounts, time deposit instruments, electronically accessed banking products, residential and commercial real estate financing, commercial lending, consumer financing, debit cards, safe deposit services, automated teller machines, access to insurance and investment products, money transfer services, corporate and personal trust services and other banking services. The principal markets for these financial services are the communities within Michigan in which Chemical's subsidiaries are located and the areas immediately surrounding these communities. As of December 31, 1998, Chemical and its subsidiaries served these markets through 86 banking offices in 55 communities, located in 24 counties, generally across the mid-section of Michigan. In addition to the full service banking offices, the subsidiary banks operated 85 automated teller machines, both on and off bank premises, as of December 31, 1998. CB&T, which has its headquarters in Midland, is Chemical's lead subsidiary bank and accounted for 32% of total deposits and 28% of total loans of Chemical and its subsidiaries on a consolidated basis as of December 31, 1998. Chemical's banking subsidiaries' primary loan product, historically, has been residential real estate mortgages. As of December 31, 1998, these loans totaled $429 million, or 48%, of consolidated total loans. During 1998 and 1997, Chemical's subsidiaries' generally sold residential real estate mortgages with fifteen year and greater original terms in the secondary mortgage market. During 1996, residential mortgage loans with an original term of fifteen years and less were kept in the Corporation's own loan portfolio, and those with original terms greater than fifteen years were sold in the secondary mortgage market. Chemical originated $117.6 million of residential mortgage loans during 1998 which were sold in the secondary mortgage market, compared to $38.8 million and $12.3 million in residential mortgage loans originated and sold during 1997 and 1996, respectively. The significant increase in 1998 was attributable to the decline in residential mortgage rates and the resultant increases in the refinancing of these mortgages. 3 The principal sources of revenues for Chemical are interest and fees on loans, which accounted for 54% of total revenues in 1998, 1997 and 1996. Interest on investment securities is also a significant source of revenue, accounting for 31% of total revenues in 1998 and 33% in 1997 and 1996. Chemical has no foreign loans, assets or activities. No material part of the business of Chemical or its subsidiaries is dependent upon a single customer or very few customers, the loss of which would have a materially adverse effect on Chemical. The business of banking is highly competitive. In addition to competition from other commercial banks, banks face significant competition from nonbank financial institutions. Savings associations and credit unions compete aggressively with commercial banks for deposits and loans, and credit unions and finance companies are particularly significant factors in the consumer loan market. Banks compete for deposits with a broad range of other types of investments, the most significant of which, over the past few years, have been mutual funds and annuities. Insurance companies and investment firms are also significant competitors for customer deposits. In response to this increased competition for customers' bank deposits, the Corporation expanded its sales and marketing efforts of mutual fund and annuity investment products during 1996. The Corporation's subsidiary banks, through "CFC Investment Centers," offer an array of mutual funds, annuity products and market securities through alliances with Security First Group and BISYS Brokerage Services. The CFC Investment Centers offer customers a complete spectrum of investment products and service capabilities. In addition, the Trust Department of Chemical Bank and Trust Company offers customers a variety of investment products and services. The principal methods of competition for financial services are price (interest rates paid on deposits, interest rates charged on borrowings and fees charged for services) and service (convenience and quality of services rendered to customers). Banks and bank holding companies are extensively regulated. Chemical's subsidiary banks are all chartered under the laws of the State of Michigan and supervised and regulated by the Financial Institutions Bureau of the Michigan Department of Consumer and Industry Services. Three of Chemical's banks are members of the Federal Reserve System and are also supervised, examined and regulated by the Federal Reserve System. The other seven state non-member banks are also regulated by the Federal Deposit Insurance Corporation ("FDIC"). Chemical, as a bank holding company, is regulated by the Federal Reserve System. Deposits of all of Chemical's bank subsidiaries are insured by the FDIC to the extent provided by law. State banks and bank holding companies are governed by both federal and state laws which significantly limit their business activities in a number of respects. Examples of such limitations include: (1) prior approval of the Board of Governors of the Federal Reserve System ("Federal Reserve 4 Board"), and in some cases various other governing agencies, is required for bank holding companies to acquire control of any additional banks or branches, (2) the business activities of bank holding companies and their subsidiaries are limited to banking and to other activities which are determined by the Federal Reserve Board to be closely related to banking, and (3) transactions between bank holding company subsidiary banks are significantly restricted by banking laws and regulations. Chemical is a legal entity separate and distinct from its subsidiary banks and data processing subsidiary. Chemical's primary source of revenues results from dividends paid to it by its subsidiaries. Federal and state banking laws and regulations limit the extent to which Chemical's subsidiary banks can lend or otherwise supply funds to Chemical or certain of its affiliates and also place certain restrictions on the amount of dividends the subsidiary banks of Chemical may pay to Chemical. Banks are subject to a number of federal and state laws and regulations which have a material impact on their business. These include, among others, minimum capital requirements, state usury laws, state laws relating to fiduciaries, the Truth In Lending Act, the Truth in Savings Act, the Equal Credit Opportunity Act, the Fair Credit Reporting Act, the Expedited Funds Availability Act, the Community Reinvestment Act, electronic funds transfer laws, redlining laws, antitrust laws, environmental laws and privacy laws. These laws and regulations can have a significant effect on the operating results of banks. Under Federal law, the FDIC has the authority to impose special assessments on insured depository institutions to repay FDIC borrowings from the United States Treasury or other sources, and to establish semiannual assessment rates on Bank Insurance Fund ("BIF") member banks, so as to maintain the BIF at the designated reserve ratio defined by law. On January 1, 1994, the FDIC implemented a system of risk-based premiums for deposit insurance, pursuant to which the premiums paid by a depository institution are based on the probability that the BIF will incur a loss in respect of that institution. FDIC expense was $.2 million in 1998 and 1997 and $.1 million in 1996. In 1998 and 1997, the Corporation paid the minimum rate of $.01296 per $100 of deposits insured by the BIF and $.0644 per $100 of deposits insured by the Savings Association Insurance Fund ("SAIF"). During 1996, the FDIC's minimum assessment rate for BIF insured deposits was reduced to $2000. Deposits held by well-capitalized banks and insured by the SAIF were assessed at a rate of $.23 per $100 of insured deposits in 1996. In addition, during 1996, SAIF insured deposits, held on March 31, 1995, were assessed a one-time charge of $.657 per $100 of deposits to recapitalize the SAIF to its required reserve ratio. The Corporation's liability for this special assessment was approximately $30,000. 5 The recapitalization of the SAIF was accomplished through the enactment of The Deposit Insurance Funds Act of 1996 (the "Funds Act") on September 30, 1996. This legislation, in addition to requiring the one-time special assessment to the FDIC to capitalize the SAIF to its required reserve ratio, authorizes the Financing Corporation ("FICO") to impose periodic assessments on depository institutions that are members of the BIF, in addition to institutions that are members of the SAIF. The purpose of these periodic assessments is to spread the cost of the interest payments on the outstanding FICO bonds over a larger number of institutions. Until the change in the law, only SAIF-member institutions bore the cost of funding these interest payments. The FICO assessment on BIF insured deposits for years 1997-1999 was established at 1.296 cents for every $100 of domestic deposits. For this same period, the SAIF insured institutions' FICO assessment rate was established at 6.44 cents for every $100 of domestic deposits. Beginning in the year 2000 until 2017, the FICO assessment for both BIF and SAIF insured deposits was established at 2.43 cents for every $100 of domestic deposits. Federal law also contains a "cross-guarantee" provision that could result in insured depository institutions owned by Chemical being assessed for losses incurred by the FDIC in connection with assistance provided to, or the failure of, any other insured depository institution owned by Chemical. Under Federal Reserve Board policy, Chemical is expected to act as a source of financial strength to each subsidiary bank and to commit resources to support each subsidiary bank. Banks are subject to the provisions of the Community Reinvestment Act of 1977 ("CRA"). Under the terms of the CRA, the appropriate federal bank regulatory agency is required, in connection with its examination of a bank, to assess such bank's record in meeting the credit needs of the community served by that bank, including low- and moderate-income neighborhoods. The regulatory agency's assessment of the bank's record is made available to the public. Further, such assessment is required of any bank which has applied to: (1) obtain deposit insurance coverage for a newly chartered institution, (2) establish a new branch office that will accept deposits, (3) relocate an office, or (4) merge or consolidate with, or acquire the assets or assume the liabilities of, a federally regulated financial institution. In the case of a bank holding company applying for approval to acquire a bank or other bank holding company, the Federal Reserve Board will assess the CRA compliance record of each subsidiary bank of the applicant bank holding company, and such compliance records may be the basis for denying the application. The Riegle-Neal Interstate Banking and Branching Efficiency Act of 1994 (the "Riegle-Neal Act") substantially changed the geographic constraints applicable to the banking industry. The Riegle-Neal Act allows bank holding companies to acquire banks located in any state in the United 6 States without regard to geographic restrictions or reciprocity requirements imposed by state law. Effective June 1, 1997, the Riegle-Neal Act also allowed banks to establish interstate branch networks through acquisitions of other banks. The establishment of DE NOVO interstate branches or the acquisition of individual branches of a bank in another state (rather than the acquisition of an out-of-state bank in its entirety) is allowed by the Riegle-Neal Act only if specifically authorized by state law. Michigan permits both U.S. and non-U.S. banks to establish branch offices in Michigan. The Michigan Banking Code permits, in appropriate circumstances and with the approval of the Commissioner of the Financial Institutions Bureau, (1) acquisition of Michigan banks by FDIC-insured banks, savings banks or savings and loan associations located in other states, (2) sale by a Michigan bank of branches to an FDIC-insured bank, savings bank or savings and loan association located in a state in which a Michigan bank could purchase branches of the purchasing entity, (3) consolidation of Michigan banks and FDIC-insured banks, savings banks or savings and loan associations located in other states having laws permitting such consolidation, (4) establishment of branches in Michigan by FDIC-insured banks located in other states, the District of Columbia or U.S. territories or protectorates having laws permitting a Michigan bank to establish a branch in such jurisdiction, and (5) establishment by foreign banks of branches located in Michigan. In March 1996, the Corporation consolidated its bank subsidiary headquartered in Standish, Michigan (Chemical Bank Huron) with its bank subsidiary headquartered in Bay City, Michigan (Chemical Bank Bay Area). On May 1, 1996, the Corporation merged with State Savings Bancorp, Inc. ("SSBI") in Caro, Michigan. SSBI operated one bank, State Savings Bank of Caro, with offices in Caro and Fairgrove, Michigan. The Corporation issued 689,062 shares (adjusted for the 5% stock dividends paid December 30, 1996 and December 30, 1997 and the 5 for 4 stock split paid December 16, 1998) of the Corporation's common stock in exchange for all of the common stock of SSBI. The merger was accounted for as a "pooling of interests." As of May 1, 1996, SSBI had assets of approximately $65 million. On December 31, 1996, the Corporation through CB&T acquired Arbury & Stephenson, Inc., an insurance agency headquartered in Midland, Michigan. The merger was effected through an exchange of shares of the Corporation's common stock. In March 1997, the Corporations subsidiary headquartered in Owosso, Michigan (Chemical Bank Key State) sold its branch banking building in Okemos, Michigan. The loans and deposits of the Okemos branch were transferred to Chemical Bank Key State's branch banking office in Lansing, Michigan. 7 In November 1998, the Corporation's subsidiary headquartered in Marshall, Michigan (Chemical Bank South) purchased a branch banking office in Albion, Michigan from Great Lakes National Bank Michigan. The branch had total deposits of approximately $11 million as of the acquisition date. Chemical Bank South consolidated its existing banking operations at 1408 N. Eaton Street in Albion into the newly acquired location. The nature of the business of Chemical's subsidiaries is such that they hold title to numerous parcels of real property. These properties are primarily owned for branch offices; however, Chemical and its subsidiaries may hold properties for other business purposes, as well as on a temporary basis for properties taken in or in lieu of foreclosure to satisfy loans in default. Under current state and federal laws, present and past owners of real property may be exposed to liability for the cost of clean up of environmental contamination on or originating from those properties, even if they are wholly innocent of the actions that caused the contamination. These liabilities can be material and can exceed the value of the contaminated property. At December 31, 1998, Chemical was the fifth largest bank holding company headquartered in Michigan, measured by total assets, and together with its subsidiaries employed a total of 1006 full-time equivalent employees. The following table summarizes the book value of investment securities as of December 31:
1998 1997 1996 -------- -------- -------- (In thousands) Investment securities available for sale: U.S. Government and agency securities $444,361 $474,706 $422,629 States of the U.S. and municipal securities -- -- -- Mortgage-backed securities 1,583 2,351 2,850 Other securities 43,032 17,116 16,308 -------- -------- -------- Total investment securities available for sale 488,976 494,173 441,787 Investment securities held to maturity: U.S. Government and agency securities 190,957 201,801 168,958 States of the U.S. and municipal securities 41,593 46,707 42,096 Mortgage-backed securities 312 501 679 Other securities 7,985 2,011 2,019 -------- -------- -------- 8 Total investment securities held to maturity 240,847 251,020 213,752 -------- -------- -------- Total investment securities $729,823 $745,193 $655,539 ======== ======== ========
The information under the following captions in the registrant's Annual Report to Shareholders for the year ended December 31, 1998, further describes the business of Chemical and is here incorporated by reference:
CAPTION PAGES ------- ----- Table 2. Average Balances, Tax Equivalent Interest and Effective Yields and Rates 31 Table 3. Volume and Rate Variance Analysis 33 Note C- Investment Securities 18 Table 8. Maturities and Yields of Investment Securities at December 31, 1998 38 Table 4. Summary of Loans and Loan Loss Experience 33 Table 5. Comparison of Loan Maturities and Interest Sensitivity 35 Table 6. Summary of Nonperforming Loans 35 Note D - Loans 19 Table 7. Allocation of the Allowance For Possible Loan Losses 36 Management's Discussion and Analysis, subheadings "Net Interest Income," "Loans," "Nonperforming Loans," "Provision For Possible Loan Losses" and "Liquidity and Interest Sensitivity" 30-41 Table 10. Maturity Distribution of Time Deposits of $100,000 or More 39 Financial Highlights 1
ITEM 2. PROPERTIES. The executive offices of Chemical, the main office of CB&T and Chemical's data processing subsidiary are located in a three story, approximately 74,000 square foot, office building in downtown Midland, which is 100% owned by CB&T. Chemical's subsidiary banks conduct business from a total of 86 banking offices as of December 31, 1998. These offices are located in or in the vicinity of the cities in which the banks have their main offices. Of the banking offices, 83 are owned by the subsidiary banks and 3 are leased from independent parties with remaining lease terms of one year to eleven years. This leased property is considered insignificant. 9 ITEM 3. LEGAL PROCEEDINGS. Chemical's subsidiaries are parties, as plaintiff or defendant, to a number of legal proceedings, none of which is considered material, and all of which arose in the ordinary course of their operations. ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS. Not applicable. SUPPLEMENTAL ITEM. EXECUTIVE OFFICERS OF THE REGISTRANT. Biographical information concerning Chemical's executive officers who are not directors or nominated for election to the Board of Directors is presented below. Executive officer appointments are made or reaffirmed annually at the organizational meeting of the Board of Directors. At its regular meetings, the Board may also make other executive officer appointments. Bruce M. Groom, age 57, is Senior Vice President and Trust Officer of CB&T. He joined CB&T on April 29, 1985 as Senior Vice President and was promoted to Senior Trust Officer in May 1986. Mr. Groom has served on the Board of Chemical Bank Central, a wholly owned subsidiary of Chemical, since February 1989. Mr. Groom is an attorney. Mr. Groom is a member of the Management Committee of Chemical. Lori A. Gwizdala, age 40, is Senior Vice President, Chief Financial Officer and Treasurer of Chemical. She joined Chemical as Controller on January 1, 1985 and was named Chief Financial Officer in May 1987, Senior Vice President in February 1991 and Treasurer in April 1994. Ms. Gwizdala has served as Secretary to the Board of Directors of CFC Data Corp since May 1986, a director of Chemical Bank Bay Area since January 1993 and a director of Chemical Bank Thumb Area since July 1996, all of which are wholly owned subsidiaries of Chemical. Ms. Gwizdala is a certified public accountant. Ms. Gwizdala is a member of the Management Committee of Chemical. William C. Lauderbach, age 56, is Senior Vice President and Investment Officer of CB&T. He joined CB&T as a Trust Officer on July 2, 1973, was promoted to Vice President and Trust Officer in March 1980, Investment Officer in January 1985 and Senior Vice President in February 1991. Mr. Lauderbach has served on the Board of Directors of Chemical Bank South, a wholly owned subsidiary of Chemical, since 1989. Mr. Lauderbach is a member of the Management Committee of Chemical. 10 David B. Ramaker, age 43, is Chief Executive Officer and President of CB&T and Executive Vice President and Secretary of Chemical. He joined CB&T as Vice President on November 20, 1989. Mr. Ramaker became President of Chemical Bank Key State, a wholly owned subsidiary of Chemical in October 1993. Mr. Ramaker became President and member of the Board of Directors of CB&T in September 1996 and Executive Vice President and Secretary to the Board of Chemical and Chief Executive Officer of CB&T on January 1, 1997. Mr. Ramaker has served as a director of Chemical Bank Key State since October 1993. Mr. Ramaker was appointed to the following Boards of Directors of wholly owned subsidiaries of Chemical in December 1996: Chemical Bank Montcalm, Chemical Bank Central (also Chairman), Chemical Bank North (also Chairman), and Chemical Bank West (also Chairman). During 1998, Mr. Ramaker was appointed Chairman of the Board of Directors of Chemical Bank Montcalm and of Chemical Bank Bay Area, wholly owned subsidiaries of Chemical. Mr. Ramaker is a member of the Management Committee of Chemical. 11 PART II ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS. The information under the heading "Stock Price Ranges and Cash Dividends Per Share" on page 10 of the registrant's Annual Report to Shareholders for the year ended December 31, 1998, is here incorporated by reference. ITEM 6. SELECTED FINANCIAL DATA. The information under the caption "Financial Highlights" on page 1 and the sub-heading "Financial Highlights" of "Management's Discussion and Analysis" on pages 28 through 30 of the registrant's Annual Report to Shareholders for the year ended December 31, 1998, is here incorporated by reference. ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS. The information under the heading "Management's Discussion and Analysis" on pages 28 through 43 (inclusive) of the registrant's Annual Report to Shareholders for the year ended December 31, 1998, is here incorporated by reference. ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK. The information under the heading "Liquidity and Interest Sensitivity" on pages 37 through 41 (inclusive) of the registrant's Annual Report to Shareholders for the year ended December 31, 1998, is here incorporated by reference. ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA. The financial statements, notes, and independent auditors' report on pages 11 through 27 (inclusive) of the registrant's Annual Report to Shareholders for the year ended December 31, 1998, is here incorporated by reference. The information under the caption "Selected Quarterly Financial Information (Unaudited)" on page 10 of the registrant's Annual Report to Shareholders for the year ended December 31, 1998, is here incorporated by reference. 12 ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE. Not applicable. 13 PART III ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT. The information set forth under the captions "Nominees for Election to Serve Until the Annual Meeting of Shareholders in 2000" on pages 3 through 4 and "Section 16(a) Beneficial Ownership Reporting Compliance" on page 17 in the registrant's definitive Proxy Statement for its April 19, 1999 annual meeting of shareholders is here incorporated by reference. ITEM 11. EXECUTIVE COMPENSATION. The information set forth under the caption "Compensation of Executive Officers and Directors" on pages 8 through 13 in the registrant's definitive Proxy Statement for its April 19, 1999, annual meeting of shareholders is here incorporated by reference. ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT. The information set forth under the caption "Voting Securities" on pages 5 through 7 in the registrant's definitive Proxy Statement for its April 19, 1999, annual meeting of shareholders is here incorporated by reference. ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS. The information set forth under the caption "Certain Relationships and Related Transactions" on page 17 in the registrant's definitive Proxy Statement for its April 19, 1999, annual meeting of shareholders is here incorporated by reference. 14 PART IV ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K. (a) (1) FINANCIAL STATEMENTS. The following financial statements and independent auditors' report of Chemical Financial Corporation and its subsidiaries are filed as part of this report: Consolidated Statement of Financial Position-December 31, 1998 and 1997 Consolidated Statement of Income for each of the three years in the period ended December 31, 1998 Consolidated Statement of Cash Flows for each of the three years in the period ended December 31, 1998 Consolidated Statement of Changes in Shareholders' Equity for each of the three years in the period ended December 31, 1998 Notes to Consolidated Financial Statements Report of Independent Auditors dated January 19, 1999 The financial statements, the notes to financial statements, and the independent auditors' report listed above are incorporated by reference in Item 8 of this report from the corresponding portions of the registrant's Annual Report to Shareholders for the year ended December 31, 1998. (2) FINANCIAL STATEMENT SCHEDULES. None (3) EXHIBITS. The following exhibits are filed as part of this report: NUMBER EXHIBIT 3.1 RESTATED ARTICLES OF INCORPORATION. Previously filed as Exhibit 3.1 to the registrant's Quarterly Report on Form 10-Q for the quarter ended June 30, 1998. Here incorporated by reference. 3.2 BYLAWS. 4 LONG-TERM DEBT. The registrant has outstanding long-term debt which at the time of this report does not exceed 10% of the registrant's total consolidated assets. The registrant agrees to furnish copies of the agreements defining the rights of holders of such long-term debt to the Securities and Exchange Commission upon request. 15 NUMBER EXHIBIT 10.1 CHEMICAL FINANCIAL CORPORATION STOCK INCENTIVE PLAN OF 1997. Previously filed as Appendix A to the registrant's Definitive Proxy Statement with respect to its Annual Meeting of Shareholders held on April 21, 1997. Here incorporated by reference. 10.2 AMENDED AWARD AND STOCK OPTION PLAN OF 1987. Previously filed as Exhibit 10(a) to the registrant's Annual Report on Form 10-K for the fiscal year ended December 31, 1993, filed with the Commission on March 24, 1994. Here incorporated by reference. 10.3 PLAN FOR DEFERRAL OF DIRECTORS' FEES. Previously filed as Exhibit 10(c) to the registrant's Form S-4 Registration Statement No. 33-64944 filed with the Commission on June 24, 1993. Here incorporated by reference. 10.4 CHEMICAL FINANCIAL CORPORATION SUPPLEMENTAL PENSION PLAN. 10.5 RETIREMENT AGREEMENT. 11 STATEMENT REGARDING COMPUTATION OF PER SHARE EARNINGS. 13 1998 ANNUAL REPORT TO SHAREHOLDERS. 21 SUBSIDIARIES OF THE REGISTRANT. 23 CONSENT OF INDEPENDENT AUDITORS. 27 FINANCIAL DATA SCHEDULE FOR THE YEAR ENDED DECEMBER 31, 1998. 99.1 CHEMICAL FINANCIAL CORPORATION 401(K) PLAN FINANCIAL STATEMENTS, NOTES AND SCHEDULES. 99.2 CHEMICAL FINANCIAL CORPORATION 1992 STOCK PURCHASE PLAN FOR SUBSIDIARY DIRECTORS FINANCIAL STATEMENTS AND NOTES. These agreements are management contracts or compensation plans or arrangements required to be filed as Exhibits to this Form 10-K. Chemical will furnish a copy of any exhibit listed above to any shareholder of the registrant without charge upon written request to Ms. Lori A. Gwizdala, Chief Financial Officer, Chemical Financial Corporation, 333 East Main Street, Midland, Michigan 48640-0569. 16 (b) REPORTS ON FORM 8-K. No reports on Form 8-K were filed during the last quarter of the period covered by this report. 17 SIGNATURES Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized. CHEMICAL FINANCIAL CORPORATION March 22, 1999 S/ ALOYSIUS J. OLIVER Aloysius J. Oliver President and Chief Executive Officer March 22, 1999 S/ LORI A. GWIZDALA Lori A. Gwizdala Senior Vice President, Chief Financial Officer and Treasurer 18 Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the registrant and in the capacities and on the dates indicated. March 22, 1999 S/ ALOYSIUS J. OLIVER Aloysius J. Oliver President and Chief Executive Officer and Director (Principal Executive Officer) March 22, 1999 S/ JAMES A. CURRIE James A. Currie March 22, 1999 S/ MICHAEL L. DOW Michael L. Dow Director March 22, 1999 S/ LORI A. GWIZDALA Lori A. Gwizdala Senior Vice President, Chief Financial Officer and Treasurer (Principal Financial and Accounting Officer) March 22, 1999 S/ TERENCE F. MOORE Terence F. Moore Director March 22, 1999 S/ ALAN W. OTT Chairman of the Board and Director March , 1999 ___________________________________ Frank P. Popoff Director March 22, 1999 S/ LAWRENCE A. REED Lawrence A. Reed Director 19 March 22, 1999 S/ WILLIAM S. STAVROPOULOS William S. Stavropoulos Director 20 EXHIBIT INDEX NUMBER EXHIBIT 3.1 RESTATED ARTICLES OF INCORPORATION. Previously filed as Exhibit 3.1 to the registrant's Quarterly Report on Form 10-Q for the quarter ended June 30, 1998. Here incorporated by reference. 3.2 BYLAWS. 4 LONG-TERM DEBT. The registrant has outstanding long-term debt which at the time of this report does not exceed 10% of the registrant's total consolidated assets. The registrant agrees to furnish copies of the agreements defining the rights of holders of such long-term debt to the Securities and Exchange Commission upon request. 10.1 CHEMICAL FINANCIAL CORPORATION STOCK INCENTIVE PLAN OF 1997. Previously filed as Appendix A to the registrant's Definitive Proxy Statement with respect to its Annual Meeting of Shareholders held on April 21, 1997. Here incorporated by reference. 10.2 AMENDED AWARD AND STOCK OPTION PLAN OF 1987. Previously filed as Exhibit 10(a) to the registrant's Annual Report on Form 10-K for the fiscal year ended December 31, 1993, filed with the Commission on March 24, 1994. Here incorporated by reference. 10.3 PLAN FOR DEFERRAL OF DIRECTORS' FEES. Previously filed as Exhibit 10(c) to the registrant's Form S-4 Registration Statement No. 33-64944 filed with the Commission on June 24, 1993. Here incorporated by reference. 10.4 CHEMICAL FINANCIAL CORPORATION SUPPLEMENTAL PENSION PLAN. 10.5 RETIREMENT AGREEMENT. 11 STATEMENT REGARDING COMPUTATION OF PER SHARE EARNINGS. 13 1998 ANNUAL REPORT TO SHAREHOLDERS. 21 SUBSIDIARIES OF THE REGISTRANT. 23 CONSENT OF INDEPENDENT AUDITORS. 27 FINANCIAL DATA SCHEDULE FOR THE YEAR ENDED DECEMBER 31, 1998. 21 NUMBER EXHIBIT 99.1 CHEMICAL FINANCIAL CORPORATION 401(K) SAVINGS PLAN FINANCIAL STATEMENTS, NOTES AND SCHEDULES. 99.2 CHEMICAL FINANCIAL CORPORATION 1992 STOCK PURCHASE PLAN FOR SUBSIDIARY DIRECTORS FINANCIAL STATEMENTS AND NOTES. 22 EX-3 2 EXHIBIT 3.2 BYLAWS OF CHEMICAL FINANCIAL CORPORATION (AS AMENDED THROUGH OCTOBER 19, 1998) ARTICLE I OFFICES 1.01 PRINCIPAL OFFICE. The principal office of the corporation shall be at such place within the state of Michigan as the Board of Directors shall determine from time to time. 1.02 OTHER OFFICES. The corporation may also have offices at such other places as the Board of Directors from time to time determines or the business of the corporation requires. ARTICLE II SEAL 2.01 SEAL. The corporation shall have a seal in such form as the Board of Directors may from time to time determine. The seal may be used by causing it or a facsimile to be impressed, affixed, reproduced or otherwise. ARTICLE III CAPITAL STOCK 3.01 ISSUANCE OF SHARES. The shares of capital stock of the corporation shall be issued in such amounts, at such times, for such consideration and on such terms and conditions as the Board shall deem advisable, subject to the provisions of the Articles of Incorporation of the corporation and the further provisions of these Bylaws, and subject also to any requirements or restrictions imposed by the laws of the State of Michigan. 3.02 CERTIFICATES FOR SHARES. The shares of the corporation shall be represented by certificates signed by the Chairman of the Board, President or a Vice President and by the Treasurer, Assistant Treasurer, Secretary or Assistant Secretary of the corporation, and may be sealed with the seal of the corporation or a facsimile thereof. The signatures of the officers may be facsimiles if the certificate is countersigned by a transfer agent or registered by a registrar other than the corporation itself or its employee. In case an officer who has signed or whose facsimile signature has been placed upon a certificate ceases to be such officer before the certificate is issued, it may be issued by the corporation with the same effect as if he were such officer at the date of issuance. A certificate representing shares shall state upon its face that the corporation is formed under the laws of the State of Michigan; the name of the person to whom it is issued; the number and class of shares, and the designation of the series, if any, which the certificate represents; the par value of each share represented by the certificate, or a statement that the shares are without par value; and such other provisions as may be required by the laws of the State of Michigan. 3.03 TRANSFER OF SHARES. The shares of the capital stock of the corporation are transferable only on the books of the corporation upon surrender of the certificate therefor, properly endorsed for transfer, and the presentation of such evidences of ownership and validity of the assignment as the corporation may require. 3.04 REGISTERED SHAREHOLDERS. The corporation shall be entitled to treat the person in whose name any share of stock is registered as the owner thereof for purposes of dividends and other distributions in the course of business, or in the course of recapitalization, consolidation, merger, reorganization, sale of assets, liquidation or otherwise and for the purpose of votes, approvals and consents by shareholders, and for the purpose of notices to shareholders, and for all other purposes whatever, and shall not be bound to recognize any equitable or other claim to or interest in such shares on the part of any other person, whether or not the corporation shall have notice thereof, save as expressly required by the laws of the State of Michigan. 3.05 LOST OR DESTROYED CERTIFICATES. Upon the presentation to the corporation of a proper affidavit attesting the loss, destruction or mutilation of any certificate or certificates for shares of stock of the corporation, the Board of Directors shall direct the issuance of a new certificate or certificates to replace the certificates so alleged to be lost, destroyed or mutilated. The Board of Directors may require as a condition precedent to the issuance of new certificates any or all of the following: (a) presentation of additional evidence or proof of the loss, destruction or mutilation claimed; (b) advertisement of loss in such manner as the Board of Directors may direct or approve; (c) a bond or agreement of indemnity, in such form and amount and with such sureties, or without sureties, as the Board of Directors may direct or approve; (d) the order or approval of a court or judge. -2- ARTICLE IV SHAREHOLDERS AND MEETINGS OF SHAREHOLDERS 4.01 PLACE OF MEETINGS. All meetings of shareholders shall be held at the principal office of the corporation or at such other place as shall be determined by the Board of Directors and stated in the notice of meeting. 4.02 ANNUAL MEETING. The annual meeting of the shareholders of the corporation shall be held on the third Monday of the fourth calendar month after the end of the corporation's fiscal year at 2 o'clock in the afternoon. Directors shall be elected at each annual meeting and such other business transacted as may come before the meeting. 4.03 SPECIAL MEETINGS. Special meetings of shareholders may be called by the Board of Directors, the Chairman of the Board (if such office is filled) or the President and shall be called by the President or Secretary at the written request of shareholders holding a majority of the shares of stock of the corporation outstanding and entitled to vote. The request shall state the purpose or purposes for which the meeting is to be called. 4.04 NOTICE OF MEETINGS. Except as otherwise provided by statute, written notice of the time, place and purposes of a meeting of shareholders shall be given not less than 10 nor more than 60 days before the date of the meeting to each shareholder of record entitled to vote at the meeting, either personally or by mailing such notice to his last address as it appears on the books of the corporation. No notice need be given of an adjourned meeting of the shareholders provided the time and place to which such meeting is adjourned are announced at the meeting at which the adjournment is taken and at the adjourned meeting only such business is transacted as might have been transacted at the original meeting. However, if after the adjournment a new record date is fixed for the adjourned meeting a notice of the adjourned meeting shall be given to each shareholder of record on the new record date entitled to notice as provided in this Bylaw. 4.05 RECORD DATES. The Board of Directors, the Chairman of the Board (if such office is filled) or the President may fix in advance a date as the record date for the purpose of determining shareholders entitled to notice of and to vote at a meeting of shareholders or an adjournment thereof, or to express consent or to dissent from a proposal without a meeting, or for the purpose of determining shareholders entitled to receive payment of a dividend or allotment of a right, or for the purpose of any other action. The date fixed shall not be more than 60 nor less than 10 days before the date of the meeting, nor more than 60 days before any other action. In such case only such shareholder as shall be shareholders of record on the date so fixed shall be entitled to notice of and to vote at -3- such meeting or adjournment therefor, or to express consent or to dissent from such proposal, or to receive payment of such dividend or to receive such allotment of rights, or to participate in any other action, as the case may be, notwithstanding any transfer of any stock on the books of the corporation, or otherwise, after any such record date. Nothing in this Bylaw shall affect the rights of a shareholder and his transferee or transferor as between themselves. 4.06 LIST OF SHAREHOLDERS. The Secretary of the corporation or the agent of the corporation having charge of the stock transfer records for shares of the corporation shall make and certify a complete list of the shareholders entitled to vote at a shareholders' meeting or any adjournment thereof. The list shall be arranged alphabetically within each class and series, with the address of, and the number of shares held by, each shareholder; be produced at the time and place of the meeting; be subject to inspection by any shareholder during the whole time of the meeting; and be prima facie evidence as to who are the shareholders entitled to examine the list or vote at the meeting. 4.07 QUORUM. Unless a greater or lesser quorum is required in the Articles of Incorporation or by the laws of the State of Michigan, the shareholders present at a meeting in person or by proxy who, as of the record date for such meeting, were holders of a majority of the outstanding shares of the corporation entitled to vote at the meeting shall constitute a quorum at the meeting. Whether or not a quorum is present, a meeting of shareholders may be adjourned by a vote of the shares present in person or by proxy. When the holders of a class or series of shares are entitled to vote separately on an item of business, this Bylaw applies in determining the presence of a quorum of such class or series for transaction of such item of business. 4.08 PROXIES. A shareholder entitled to vote at a meeting of shareholders or to express consent or dissent without a meeting may authorize other persons to act for him by proxy. A proxy shall be signed by the shareholder or his authorized agent or representative and shall not be valid after the expiration of three years from its date unless otherwise provided in the proxy. A proxy is revocable at the pleasure of the shareholder executing it except as otherwise provided by the laws of the State of Michigan. 4.09 INSPECTORS OF ELECTION. The Board of Directors, in advance of a shareholders' meeting, may appoint one or more inspectors to act at the meeting or any adjournment thereof. If inspectors are not so appointed, the person presiding at the shareholders' meeting may, and on request of a shareholder entitled to vote thereat shall, appoint one or more inspectors. In case a person appointed fails to appear or act, the vacancy may be filled by appointment made by the Board of Directors in advance of the -4- meeting or at the meeting by the person presiding thereat. If appointed, the inspectors shall determine the number of shares outstanding and the voting power of each, the shares represented at the meeting, the existence of a quorum and the validity and effect of proxies, and shall receive votes, ballots or consents, hear and determine challenges and questions arising in connection with the right to vote, count and tabulate votes, ballots or consents, determine the result, and do such acts as are proper to conduct the election or vote with fairness to all shareholders. On request of the person presiding at the meeting or a shareholder entitled to vote thereat, the inspectors shall make and execute a written report to the person presiding at the meeting of any of the facts found by them and matters determined by them. The report shall be prima facie evidence of the facts stated and of the vote as certified by the inspectors. 4.10 VOTING. Each outstanding share is entitled to one vote on each matter submitted to a vote, unless otherwise provided in the Articles of Incorporation. Votes shall be cast in writing, signed by the shareholder or his proxy. When an action, other than the election of directors, is to be taken by a vote of the shareholders, it shall be authorized by a majority of the votes cast by the holders of shares entitled to vote thereon, unless a greater plurality is required by the Articles of Incorporation or by the laws of the State of Michigan. Except as otherwise provided by the Articles of Incorporation, directors shall be elected by a plurality of the votes cast at any election. 4.11 SHAREHOLDER PROPOSALS. Except as otherwise provided by statute, the corporation's Articles of Incorporation or these Bylaws: (a) No matter may be presented for shareholder action at an annual or special meeting of shareholders unless such matter is: (i) specified in the notice of the meeting (or any supplement to the notice) given by or at the direction of the Board of Directors; (ii) otherwise presented at the meeting by or at the direction of the Board of Directors; (iii) properly presented for action at the meeting by a shareholder in accordance with the notice provisions set forth in this Section and any other applicable requirements; or (iv) a procedural matter presented, or accepted for presentation, by the Chairman in his sole discretion. (b) For a matter to be properly presented by a shareholder, the shareholder must have given timely notice of the matter in writing to the Secretary of the corporation. To be timely, the notice must be delivered to or mailed to and received at the principal executive offices of the corporation not less than 120 calendar days prior to the date corresponding to the date of the corporation's proxy statement or notice of -5- meeting released to shareholders in connection with the last preceding annual meeting of shareholders in the case of an annual meeting (unless the corporation did not hold an annual meeting within the last year, or if the date of the upcoming annual meeting changed by more than thirty days from the date of the last preceding meeting, then the notice must be delivered or mailed and received not more than ten days after the earlier of the date of the notice of the meeting or public disclosure of the date of the meeting), and not more than ten days after the earlier of the date of the notice of the meeting or public disclosure of the date of the meeting in the case of a special meeting. The notice by the shareholder must set forth: (i) a brief description of the matter the shareholder desires to present for shareholder action; (ii) the name and record address of the shareholder proposing the matter for shareholder action; (iii) the class and number of shares of capital stock of the corporation that are beneficially owned by the shareholder; and (iv) any material interest of the shareholder in the matter proposed for shareholder action. For purposes of this Section, "public disclosure" means disclosure in a press release reported by the Dow Jones News Service, Associated Press or other comparable national financial news service or in a document publicly filed by the corporation with the Securities and Exchange Commission pursuant to Section 13, 14 or 15 of the Securities Exchange Act of 1934, as amended. (c) Except to the extent that a shareholder proposal submitted pursuant to this Section is not made available at the time of mailing, the notice of the purposes of the meeting shall include the name and address of and the number of shares of the voting security held by the proponent of each shareholder proposal. (d) Notwithstanding the above, if the shareholder desires to require the corporation to include the shareholder's proposal in the corporation's proxy materials, matters and proposals submitted for inclusion in the corporation's proxy materials shall be governed by the solicitation rules and regulations of the Securities Exchange Act of 1934, as amended, including without limitation Rule 14a-8. -6- ARTICLE V DIRECTORS 5.01 NUMBER. The business and affairs of the corporation shall be managed by a Board of not less than five (5) nor more than twenty-five (25) directors as shall be fixed from time to time by the Board of Directors. The directors need not be residents of Michigan or shareholders of the corporation. 5.02 ELECTION, RESIGNATION AND REMOVAL. Directors shall be elected at each annual meeting of the shareholders, each to hold office until the next annual meeting of shareholders and until his successor is elected and qualified, or until his resignation or removal. A director may resign by written notice to the corporation. The resignation is effective upon its receipt by the corporation or a subsequent time as set forth in the notice of resignation. A director or the entire Board of Directors may be removed, with or without cause, by vote of the holders of a majority of the shares entitled to vote at an election of directors. 5.03 VACANCIES. Vacancies in the Board of Directors occurring by reason of death, resignation, removal, increase in the number of directors or otherwise shall be filled by the affirmative vote of a majority of the remaining directors though less than a quorum of the Board of Directors, unless filled by proper action of the shareholders of the corporation. Each person so elected shall be a director for a term of office continuing only until the next election of directors by the shareholders. 5.04 ANNUAL MEETING. The Board of Directors shall meet each year immediately after the annual meeting of the shareholders, or within three (3) days of such time excluding Sundays and legal holidays if such later time is deemed advisable, at the place where such meeting of the shareholders has been held or such other place as the Board may determine, for the purpose of election of officers and consideration of such business that may properly be brought before the meeting; provided, that if less than a majority of the directors appear for an annual meeting of the Board of Directors the holding of such annual meeting shall not be required and the matters which might have been taken up therein may be taken up at any later special or annual meeting, or by consent resolution. 5.05 REGULAR AND SPECIAL MEETINGS. Regular meetings of the Board of Directors may be held at such times and places as the majority of the directors may from time to time determine at a prior meeting or as shall be directed or approved by the vote or written consent of all the directors. Special meetings of the Board may be called by the Chairman of the Board (if such office is filled) or the President and shall be called by the President or Secretary upon the written request of any two directors. -7- 5.06 NOTICES. No notice shall be required for annual or regular meetings of the Board or for adjourned meetings, whether regular or special. Three days' written notice shall be given for special meetings of the Board, and such notice shall state the time, place and purpose or purposes of the meeting. 5.07 QUORUM. A majority of the Board of Directors then in office, or of the members of a committee thereof, constitutes a quorum for the transaction of business. The vote of a majority of the directors present at any meeting at which there is a quorum shall be the acts of the Board or of the committee, except as a larger vote may be required by the laws of the State of Michigan. A member of the Board or of a committee designated by the Board may participate in a meeting by means of conference telephone or similar communications equipment by means of which all persons participating in the meeting can hear each other. Participation in a meeting in this manner constitutes presence in person at the meeting. 5.08 EXECUTIVE AND OTHER COMMITTEES. The Board of Directors may, by resolution passed by a majority of the whole Board, appoint three or more members of the Board as an executive committee to exercise all powers and authorities of the Board in management of the business and affairs of the corporation, provided, however, that such committee shall not have power or authority to: (a) amend the Articles of Incorporation; (b) adopt an agreement of merger or consolidation; (c) recommend to shareholders the sale, lease or exchange of all or substantially all of the corporation's property and assets; (d) recommend to shareholders a dissolution of the corporation or revocation of a dissolution; (e) amend these Bylaws; (f) fill vacancies in the Board; (g) fix the compensation of the directors for serving on the Board or on a committee; or (h) unless expressly authorized by the Board, declare a dividend or authorize the issuance of stock. The Board of Directors from time to time may, by like resolution, appoint such other committees of one or more directors to have such authority as shall be specified by the Board in the resolution making such -8- appointments. The Board of Directors may designate one or more directors as alternate members of any committee who may replace an absent or disqualified member at any meeting thereof. 5.09 DISSENTS. A director who is present at a meeting of the Board of Directors, or a committee thereof of which he is a member, at which action on a corporate matter is taken is presumed to have concurred in that action unless his dissent is entered in the minutes of the meeting or unless he files his written dissent to the action with the person acting as secretary of the meeting before the adjournment thereof or shall forward such dissent by registered mail to the Secretary of the corporation promptly after the adjournment of the meeting. Such right to dissent does not apply to a director who voted in favor of such action. A director who is absent from a meeting of the Board, or a committee thereof of which he is a member, at which any such action is taken is presumed to have concurred in the action unless he files his written dissent with the Secretary of the corporation within a reasonable time after he has knowledge of the action. 5.10 COMPENSATION. The Board of Directors, by affirmative vote of a majority of directors in office and irrespective of any personal interest of any of them, may establish reasonable compensation of directors for services to the corporation as directors or officers. ARTICLE VI NOTICES, WAIVERS OF NOTICE AND MANNER OF ACTING 6.01 NOTICES. All notices of meetings required to be given to shareholders, directors or any committee of directors may be given by mail, telegram, radiogram or cablegram to any shareholder, director or committee member at his last address as it appears on the books of the corporation. Such notice shall be deemed to be given at the time when the same shall be mailed or otherwise dispatched. 6.02 WAIVER OF NOTICE. Notice of the time, place and purpose of any meeting of shareholders, directors or committee of directors may be waived by telegram, radiogram, cablegram or other writing, either before or after the meeting, or in such other manner as may be permitted by the laws of the State of Michigan. Attendance of a person at any meeting of shareholders, in person or by proxy, or at any meeting of directors or of a committee of directors, constitutes a waiver of notice of the meeting except when the person attends the meeting for the express purpose of objecting, at the beginning of the meeting, to the transaction of any business because the meeting is not lawfully called or convened. 6.03 ACTION WITHOUT A MEETING. Any action required or permitted at any meeting of shareholders or directors or committee of directors may be -9- taken without a meeting, without prior notice and without a vote, if all of the shareholders or directors or committee members entitled to vote thereon consent thereto in writing. ARTICLE VII OFFICERS 7.01 NUMBER. The Board of Directors shall elect or appoint a Chairman of the Board, a President, a Secretary, a Treasurer, and one or more Vice Presidents, Assistant Secretaries and/or Assistant Treasurers. The President and Chairman of the Board, if any, shall be members of the Board of Directors. Any two of the above offices, except those of President and Vice President, may be held by the same person, but no officer shall execute, acknowledge or verify an instrument in more than one capacity. 7.02 TERM OF OFFICE, RESIGNATION AND REMOVAL. An officer shall hold office for the term for which he is elected or appointed and until his successor is elected or appointed and qualified, or until his resignation or removal. An officer may resign by written notice to the corporation. The resignation is effective upon its receipt by the corporation or at a subsequent time specified in the notice of resignation. An officer may be removed by the Board with or without cause. The removal of an officer shall be without prejudice to his contract rights, if any. The election or appointment of an officer does not of itself create contract rights. 7.03 VACANCIES. The Board of Directors may fill any vacancies in any office occurring for whatever reason. 7.04 AUTHORITY. All officers, employees and agents of the corporation shall have such authority and perform such duties in the conduct and management of the business and affairs of the corporation as may be designated by the Board of Directors and these Bylaws. ARTICLE VIII DUTIES OF OFFICERS 8.01 CHAIRMAN OF THE BOARD. The Chairman of the Board shall be the chief executive officer of the corporation and shall preside at all meetings of the shareholders and of the Board of Directors at which he is present. He shall see that all orders and resolutions of the Board are carried into effect, and he shall have the general powers of supervision and management usually vested in the chief executive officer of a corporation, including the authority to vote all securities of other corporations and business organizations which are held by the corporation. -10- 8.02 PRESIDENT. The President shall be the chief operating officer of the corporation and shall have the general powers of supervision and management over the day-to-day operations of the corporation. In the absence or disability of the Chairman of the Board, he also shall perform the duties and execute the powers of the Chairman of the Board as set forth in these Bylaws. 8.03 VICE PRESIDENTS. The Vice Presidents, in order of their seniority, shall, in the absence or disability of the President, perform his duties and exercise his powers and shall perform such other duties as the Board of Directors or the President may from time to time prescribe. 8.04 SECRETARY. The Secretary shall attend all meetings of the Board of Directors and of shareholders and shall record all votes and minutes of all proceedings in a book to be kept for that purpose. He shall give or cause to be given notice of all meetings of the shareholders and of the Board of Directors. He shall keep in safe custody the seal of the corporation, and, when authorized by the Board, affix the same to any instrument requiring it, and when so affixed it shall be attested by his signature, or by the signature of the Treasurer or an Assistant Secretary. The Secretary may delegate any of his duties, powers and authorities to one or more Assistant Secretaries, unless such delegation is disapproved by the Board. 8.05 TREASURER. The Treasurer shall have the custody of the corporate funds and securities; shall keep full and accurate accounts of receipts and disbursements in books of the corporation; and shall deposit all moneys and other valuable effects in the name and to the credit of the corporation in such depositories as may be designated by the Board of Directors. He shall render to the President and directors, whenever they may require it, an account of his transactions as Treasurer and of the financial condition of the corporation. The Treasurer may delegate any of his duties, powers and authorities to one or more Assistant Treasurers unless such delegation be disapproved by the Board of Directors. 8.06 ASSISTANT SECRETARIES AND TREASURERS. The Assistant Secretaries, in the order of their seniority, shall perform the duties and exercise the powers and authorities of the Secretary in case of his absence or disability. The Assistant Treasurers, in the order of their seniority, shall perform the duties and exercise the powers and authorities of the Treasurer in case of his absence or disability. The Assistant Secretaries and Assistant Treasurers shall also perform such duties as may be delegated to them by the Secretary and Treasurer, respectively, and also such duties as the Board of Directors may prescribe. -11- ARTICLE IX SPECIAL CORPORATE ACTS 9.01 ORDERS FOR PAYMENT OF MONEY. All checks, drafts, notes, bonds, bills of exchange and orders for payment of money of the corporation shall be signed by such officer or officers or such other person or persons as the Board of Directors may from time to time designate. 9.02 CONTRACTS AND CONVEYANCES. The Board of Directors of the corporation may in any instance designate the officer and/or agent who shall have authority to execute any contract, conveyance, mortgage or other instrument on behalf of the corporation, or may ratify or confirm any execution. When the execution of any instrument has been authorized without specification of the executing officers or agents, the Chairman of the Board, the President or any Vice President, and the Secretary or Assistant Secretary or Treasurer or Assistant Treasurer, may execute the same in the name and on behalf of this corporation and may affix the corporate seal thereto. ARTICLE X BOOKS AND RECORDS 10.01 MAINTENANCE OF BOOKS AND RECORDS. The proper officers and agents of the corporation shall keep and maintain such books, records and accounts of the corporation's business and affairs, minutes of the proceedings of its shareholders, Board and committees, if any, and such stock ledgers and lists of shareholders, as the Board of Directors shall deem advisable, and as shall be required by the laws of the State of Michigan and other states or jurisdictions empowered to impose such requirements. Books, records and minutes may be kept within or without the State of Michigan in a place which the Board shall determine. 10.02 RELIANCE ON BOOKS AND RECORDS. In discharging his duties, a director or an officer of the corporation, when acting in good faith, may rely upon the opinion of counsel for the corporation, upon the report of an independent appraiser selected with reasonable care by the Board, or upon financial statements of the corporation represented to him to be correct by the President or the officer of the corporation having charge of its books of account, or stated in a written report by an independent public or certified public accountant or firm of such accountants fairly to reflect the financial condition of the corporation. -12- ARTICLE XI INDEMNIFICATION 11.01 INDEMNIFICATION. The corporation shall provide indemnification to persons who serve or have served as directors, officers, employees or agents of the corporation, and to persons who serve or have served at the request of the corporation as directors, officers, employees, partners or agents of another foreign or domestic corporation, partnership, joint venture, trust or other enterprise, whether for profit or not, to the fullest extent permitted by the Michigan Business Corporation Act, as the same now exists or may hereafter be amended. ARTICLE XII AMENDMENTS 12.01 AMENDMENTS. The Bylaws of the corporation may be amended, altered or repealed, in whole or in part, by the shareholders or by the Board of Directors at any meeting duly held in accordance with these Bylaws, provided that notice of the meeting includes notice of the proposed amendment, alternative or repeal. -13- EX-10 3 EXHIBIT 10.4 CHEMICAL FINANCIAL CORPORATION SUPPLEMENTAL RETIREMENT INCOME PLAN Adopted May 20, 1985 and as Amended August 15, 1988 and December 21, 1992 1. PURPOSE OF THE PLAN The purpose of the Chemical Financial Corporation Supplemental Retirement Income Plan (the "Plan") is threefold: (i) to reimburse a Corporate Officer of Chemical Financial Corporation (the "Company") for any reduction in his benefit payments under the Chemical Financial Corporation Employees' Pension Plan (the "Pension Plan") which may be caused by the limitations imposed thereon by Section 415 of the Internal Revenue Code (the "415 Limit" or Section 401(a)(17) of the Internal Revenue Code (the "401(a)(17) Limit"); (ii) to provide incentive and reward to such officer through additional retirement income in recognition of this meritorious service and material contribution to the Company's continued growth and development; and (iii) to assist the Company in retaining and attracting high caliber key executives upon whose efforts the future successful and profitable operation of its business is dependent. 2. EFFECTIVE DATE This Plan was approved and adopted by the Board of Directors of Chemical Financial Corporation as of May 20, 1985 and amended as of August 15, 1988 and December 21, 1992. 3. PARTICIPANTS IN THE PLAN The Plan is administered by a committee appointed by the Board of Directors consisting of not less than three members of the Board of Directors (the Compensation Committee). The Plan empowers the Compensation Committee to grant such key employees of the Company and its Subsidiaries as shall be selected from time to time by the Committee, participation rights in the Plan. 4. PENSION PLAN BENEFITS For purposes of this section, "Unrestricted Pension Benefit" means the amount which would have been payable from the Pension Plan if the 415 Limit or 401(a)(17) Limit did not apply, calculated as of the participant's date of retirement based on the applicable optional payment method. "Restricted Benefit Amount" means the amount actually payable from the Pension Plan calculated as of the participant's date of retirement based on the applicable optional payment method. Pension Plan benefits are only available to a participant who is employed by the Company immediately prior to his normal or early retirement from the Company under the terms of the Pension Plan. A participant who retires pursuant to the normal or early retirement provisions of the Pension Plan and elects benefits from the Pension Plan shall, subject to approval by the Committee, receive a monthly supplement from the Plan. The supplement shall be equal to the difference between (i) the Unrestricted Pension Benefit and (ii) the Restricted Benefit Amount, both calculated according to the form of payment elected for his Pension Plan Benefits. In the event the participant's death and payment election from causes a Pension Plan payment to a beneficiary, a portion of the supplement shall be paid to such beneficiary during the period of any related Pension Plan payment. The portion of the supplement to be paid (if any) shall equal the portion of the participant's Pension Plan benefit which is continued for such beneficiary(ies). However, upon a Change in Control (as hereafter defined), each participant or his/her recognized survivor shall be paid the present value of the benefit accrued under the Supplemental Plan in the following manner: a. If an active employee or former employee with a deferred benefit who is eligible to retire, the participant's benefit shall be calculated as if the participant terminated employment and then retired and elected to receive the 100% Joint Annuitant Option benefit as of the last day of the month immediately preceding the Change in Control. b. If an employee or former employee who is not eligible to retire, the participant's benefit shall be calculated as if the participant terminated employment and then elected to receive the lump sum equivalent of a vested deferred benefit as of the last day of the month immediately preceding the Change in Control. All amounts shall be paid in a single lump sum within 90 days of the Change in Control unless the participant consents to another form of payment. For purposes of the Supplemental Plan, a Change in Control shall mean a change in control of a nature that would be required to be reported in response to Item 6(e) of Schedule 14A of Regulation 14A promulgated under the Securities Exchange Act of 1934, as amended (the "Exchange Act"), whether or not the Company is then subject to such reporting requirement; provided that, without limitation, a Change in Control shall be deemed to have occurred if: (i) any individual, partnership, firm, corporation, association, trust, unincorporated organization or other entity, or any syndicate or group deemed to be a person under Section 14(d)(2) of the Exchange Act, is or becomes the "beneficial owner" (as defined in rule 13D-3 of the General Rules and Regulations under the Exchange Act), directly or indirectly, of securities of the Company representing 20 percent or more the of the combined voting power of the Company's then outstanding securities entitled to vote in the election of directors of the Company; or (ii) during any period of two (2) consecutive years (not including any period prior to the adoption of this amendment), individuals who at the beginning of such period constitute the Board of Directors and any new directors whose election by the Board of Directors or nomination for election by the Company's stockholders was approved by a vote of at least three- quarters (3/4) of the directors then still in office who either were directors at the beginning of the period or whose election or nomination for election was previously so approved, cease for any reason to constitute a majority thereof. For purposes of this lump sum payment in the event of a Change in Control, the present value of the accrued benefit shall be calculated using such actuarial assumptions as the Compensation Committee shall adopt from time to time. 5. ADMINISTRATION OF THE PLAN The Plan shall be administered by the Compensation Committee. The Committee shall have all such powers that may be necessary to carry out the provisions of the Plan in the absence of any action by the Board, including without limitation, the power to delegate administrative matters to other persons, to construe and interpret the Plan, to adopt and revise the rules, regulations and forms relating to and consistent with the Plan's terms and to make any other determinations which it deems necessary or advisable for the implementation and administration of the Plan provided, however, that the right and power to amend and/or terminate the Plan are reserved exclusively to the Board. Subject to the foregoing, all decisions and determinations by the Committee shall be final, binding and conclusive as to all parties including, without limitation, the Company, any participant hereunder and all other employees and persons. 6. SOURCE OF BENEFIT PAYMENTS No fund or other assets of the Company shall be segregated and attributable to any benefit payments to be made at a later time, as herein above provided, but rather benefit payments under the Plan shall be made from the general assets of the company at the time any such payment becomes due and payable. Benefit payments under the Plan are to be taken as deductions for income tax purposes in the Company's fiscal year that they are actually made. At such time as any benefit payments are made, it shall be determined by the Company whether any portion thereof is allocable to any affiliates(s) of the Company because of their recipient having also served as a Corporate Officer of such affiliate(s); and, if such is the case, the Company may elect to obtain reimbursement from such affiliate(s) as appropriate, for such allocable portion. No participant or surviving spouse or beneficiary thereof shall have any proprietary rights of any nature whatsoever with respect to any benefit payments, unless and until such time a benefit payment is made to such participant or the surviving spouse or beneficiaries thereof, and then only as to the amount of such payment. 7. NON-ALIENATION OF PAYMENTS Any benefits payable under the Plan shall not be subject in any manner to alienation, sale, transfer, assignment, pledge, attachment, garnishment or encumbrance of any kind, by will, or by inter vivos instrument. Any attempt to alienate, sell, transfer, assign, pledge or otherwise encumber any such payment, whether currently or thereafter payable, shall not be recognized by the Committee or the Company. Any benefit payment due hereunder shall not in any manner be liable for, or subject to, the debts or liabilities of any participant or the surviving spouse or beneficiary thereof, as the case may be. If any such participant, surviving spouse or beneficiary shall attempt to alienate, sell, transfer, assign, pledge or otherwise encumber any benefit payments to be made to that person under the Plan or any part thereof, or if by reason of such person's bankruptcy or other event happening at any time, such payments would devolve upon anyone else or would not be enjoyed by such person, then the Committee, in its discretion, may terminate such person's interest in any such benefit payment, and hold or apply it to or for the benefit of that person, the spouse, children, or other dependents hereof, or any of them, in such manner as the Committee may deem proper. 8. INCOMPETENCY Every person receiving or claiming benefit payments under the Plan shall be conclusively presumed to be mentally competent until the date on which the Committee receives a written notice, in a form and manner acceptable to the Committee, that such person is incompetent and that a guardian, conservator, or other person legally vested with the care of his estate has bee appointed. In the event a guardian or conservator of the estate of any person receiving or claiming benefit payment under the Plan shall be appointed by a court of competent jurisdiction, payments may be made to such guardian or conservator; provided that proper proof of appointment and continuing qualification is furnished in a form and manner acceptable to the Committee. Any such payment so made shall be a complete discharge of any liability therefor. 9. LIMITATION OF RIGHTS AGAINST THE COMPANY Participation in this Plan, or any modifications thereof, or the payments of any benefits hereunder, shall not be construed as giving to any participant any right to be retained in the service of the Company, limiting in any way the right of the Company to terminate such participant's employment at any time, evidencing any agreement or understanding express or implied, that the Company will employ such participant in any particular position or at any particular rate of compensation and/or guaranteeing such participant any right to receive any other form or amount of renumeration from the Company. 10. CONSTRUCTION The Plan shall be construed, administered and governed in all respects under and by the laws of the State of Michigan. Wherever any words are used herein in the masculine, they shall be construed as though they were used in the feminine for all cases where they would so apply; and wherever any words are used herein in the singular or the plural, they shall be construed as though they were used in the plural or the singular, as the case may be, in all cases where they would so apply. The words "hereof", "hereunder" and other similar compounds of the word "here" shall mean and refer to this entire document and not to any particular paragraph. 11. LIABILITY Neither the Company nor any shareholder, director, officer or other employee of the Company or any member of the committee or any other person shall be jointly or severally liable for any act or failure to act hereunder, except for gross negligence or fraud. 12. AMENDMENT OR TERMINATION OF THE PLAN The Company, by action of the Board, reserves the right to amend, modify, terminate or discontinue the Plan at any time; and such action shall be final, binding and conclusive as to all parties, including any participant hereunder, any surviving spouse or beneficiary thereof and all other Company employees and persons. 13. SUCCESSORS AND ASSIGNS The terms and conditions of the Plan, as amended and in effect from time to time, shall be binding upon the successors and assigns of the Company, including without limitation any entity into which the Company may be merged or with which the Company may be consolidated. EX-10 4 EXHIBIT 10.5 RETIREMENT AGREEMENT THIS AGREEMENT is made this 16th day of November, 1998, between ALAN W. OTT ("Mr. Ott") and CHEMICAL FINANCIAL CORPORATION ("Chemical"), and joined in by its subsidiary, CHEMICAL BANK AND TRUST COMPANY ("Chemical Bank"); WHEREAS, Chemical is a bank holding company and a Michigan corporation; and WHEREAS, Chemical believes that its ability to conduct its business successfully is dependent upon retaining key management employees until such time as they retire; and WHEREAS, Mr. Ott has been employed in an important management and chief executive position with Chemical for over 30 years, and the parties desire to continue to maintain a relationship upon the terms and conditions set forth herein; and WHEREAS, Mr. Ott has determined to retire from the active management of Chemical, but has agreed to provide assistance and advice during the transition to a new chief executive; IT IS, THEREFORE, AGREED AS FOLLOWS: 1. RETIREMENT. Effective the close of business December 31, 1996, Mr. Ott resigned and retired from his position as President and Chief Executive Officer of Chemical Financial Corporation and Chief Executive Officer of Chemical Bank. Mr. Ott shall continue to serve as a Director of Chemical and Chemical Bank and Chairman of the Board of Directors of Chemical and Chemical Bank, through January 1, 1999 to December 31, 1999, without compensation for Directors' meetings. Mr. Ott may thereafter continue his service to Chemical for such time and in such role as Chemical and he deem appropriate. 2. COMPENSATION AND BENEFITS. Chemical agrees to pay to Mr. Ott an annual compensation of Fifty Thousand Dollars ($50,000.00), commencing on the first day of January, 1999, for a period of one year or until his death, if earlier. Payments to Mr. Ott will be made on the first business day of each month during the term of this Agreement. Mr. Ott shall be provided group health benefits in accordance with the terms of Chemical's Retiree Medical and Dental Plan. If at any time Chemical terminates any such insurance plan for its retirees, Chemical may also terminate such plan for Mr. Ott; if Chemical substitutes medical and hospitalization insurance plans for its retirees or provides additional medical or hospitalization insurance coverage for its retirees, then such substituted and/or additional insurance coverage shall be made available to Mr. Ott. 3. COVENANT NOT TO COMPETE. Mr. Ott agrees that during the period that payments are being made to him hereunder, he shall not enter into employment or any form of equity ownership of any business which is competitive with the businesses related to, affiliated with, or managed by Chemical; provided, however, that the parties agree that this provision will be limited to a geographic area consisting of a fifty (50) miles radius from each existing business location of Chemical or any business related to, affiliated with, or managed by Chemical. In the event the Board of Directors of Chemical determines that Mr. Ott is in violation of this covenant not to compete, it shall give written notice to him. Mr. Ott shall have a period of ninety (90) days from the date of such notice to cease his competitive activity, and that payments hereunder shall continue during such period. If the competitive activity is not terminated within the ninety (90) day period, further payments hereunder shall cease. In the event of a dispute hereunder, the parties agree to submit their disagreement to arbitration. Nothing in this Section 3 shall be construed to prevent Mr. Ott from acquiring or holding, directly or indirectly, securities of any corporation or other entity the securities of which are listed for trading on any national or regional securities exchange or quoted on any automated quotation system sponsored by the National Association of Securities Dealers, Inc. as long as Mr. Ott's total beneficial ownership in any such corporation or entity does not exceed five percent (5%) of the total securities outstanding of such corporation or entity. 4. NO ASSIGNMENT. This Agreement is personal to each party to this Agreement and no party may assign or delegate any rights or obligations hereunder without first obtaining the written consent of the others. 5. MODIFICATION. This Agreement supersedes all prior agreements with respect to the matters covered hereby, and no modification of this Agreement shall be valid unless it is in writing and signed by Chemical and Mr. Ott. 6. CONSTRUCTION. This Agreement shall be governed and construed in accordance with the laws of the State of Michigan. 7. HEADINGS. The paragraph headings in this Agreement are for convenient reference only, and shall not modify or amend the express terms hereof. 8. SUCCESSORS AND ASSIGNS. This Agreement shall be binding upon, and shall inure to the benefit of, the parties hereto and their respective heirs, personal representatives, successors and assigns. DATED: December 9, 1998 /S/ ALAN W. OTT Alan W. Ott CHEMICAL FINANCIAL CORPORATION DATED: December 9, 1998 /S/ ALOYSIUS J. OLIVER Aloysius J. Oliver Its President & Chief Executive Officer CHEMICAL BANK AND TRUST COMPANY DATED: December 9, 1998 /S/ DAVID B. RAMAKER David B. Ramaker Its President & Chief Executive Officer EX-11 5 EXHIBIT 11 COMPUTATION OF PER SHARE EARNINGS
YEAR ENDED DECEMBER 31 1998 1997 1996 ------- ------- ------- (Amounts in thousands, except per share amounts) BASIC: Average shares outstanding 13,486 13,427 13,388 Net income $26,046 $23,889 $22,003 ======= ======= ======= Net income per common share $ 1.93 $ 1.78 $ 1.64 ======= ======= ======= DILUTED: Average shares outstanding 13,486 13,427 13,388 Net effect of the assumed exercise of stock options-based on the treasury stock method using average market price 150 159 194 ------- ------- ------- 13,636 13,586 13,582 ======= ======= ======= Net income $26,046 $23,889 $22,003 ======= ======= ======= Net income per common share $ 1.91 $ 1.76 $ 1.62 ======= ======= =======
EX-13 6 EXHIBIT 13 1998 SILVER ANNIVERSARY - --------------------------------------------------------------------------- NINETEEN NINETY-EIGHT - ANNUAL REPORT [PICTURE OF QUARTER SPINNING] Chemical Financial Corporation [CHEMICAL LOGO] 1998 HIGHLIGHTS 1998 marked the 24th consecutive year of both increased operating earnings and cash dividends. - 1998 net income was $26.046 million, up 9% over 1997 net income of $23.889 million. - 1998 earnings per share were $1.91, up 8.5% over 1997 earnings per share of $1.76. - Return on average assets was 1.44% in 1998, compared to 1.38% in 1997. - 1998 cash dividends per share were $.77, up 14.6% over 1997 cash dividends per share of $.67. - The Corporation paid a 5 for 4 stock split on December 16, 1998. All per share amounts have been adjusted to reflect the stock split. - The Corporation converted its core operating system in 1998 to a new system as part of its Year 2000 readiness plan. The Corporation's financial position remained strong at December 31, 1998. - Total assets increased $108 million, or 6.1%, during 1998 to $1.873 billion as of December 31, 1998. - Total loans increased $52.7 million, or 6.2%, and total deposits increased $78.4 million, or 5.3%, during 1998. - Shareholders' equity increased $17.9 million, or 8%, during 1998 to $241.8 million as of December 31, 1998 and represented 12.9% of total assets. - The allowance for possible loan losses was $18.1 million, or 2.01% of total loans, compared to total nonperforming loans of $3.1 million, or .35% of total loans as of December 31, 1998. REFERENCE GUIDE 1998 Highlights. . . . . . . . . . . . . . . . . . .Inside Front Cover Financial Highlights . . . . . . . . . . . . . . . . . . . . . . . . 1 Message to Shareholders. . . . . . . . . . . . . . . . . . . . . . . 2 A Quarter Century of Growth and Profitability. . . . . . . . . . . . 4 25 Years in Review . . . . . . . . . . . . . . . . . . . . . . . . . 6 Quarterly Financial Information. . . . . . . . . . . . . . . . . . .10 Consolidated Financial Statements. . . . . . . . . . . . . . . . . .11 Notes to Consolidated Financial Statements . . . . . . . . . . . . .15 Report of Ernst & Young LLP, Independent Auditors. . . . . . . . . .27 Management's Discussion and Analysis . . . . . . . . . . . . . . . .28 Directors and Officers of Affiliates . . . . . . . . . . . . . . . .44 Corporate Directors and Officers . . . . . . . . . . . . . . . . .48 Corporate Information. . . . . . . . . . . . . . . . Inside Back Cover FINANCIAL HIGHLIGHTS
YEARS ENDED DECEMBER 31 1998 1997 1996 1995 1994 - ---------------------------------------------------------------------------------------------------------- OPERATING RESULTS (in thousands) Net interest income $72,487 $69,040 $67,090 $63,687 $63,278 Provision for possible loan losses 964 1,002 1,128 1,065 1,099 Noninterest income 15,610 13,122 12,198 12,359 11,330 Operating expenses 48,307 45,718 45,124 44,629 45,613 Net income 26,046 23,889 22,003 20,489 19,110 PER SHARE DATA Net income Basic $1.93 $1.78 $1.64 $1.53 $1.44 Diluted 1.91 1.76 1.62 1.51 1.42 Cash dividends .77 .67 .58 .49 .41 Book value end-of-period 17.92 16.66 15.47 14.59 12.85 Market value end-of-period 33.50 35.80 30.10 27.94 19.35 AT YEAR END (in thousands) Total assets $1,872,626 $1,765,100 $1,698,774 $1,706,085 $1,658,023 Deposits 1,554,271 1,475,841 1,429,915 1,449,801 1,421,678 Long-term debt 8,000 9,000 10,000 12,080 12,099 Shareholders' equity 241,839 223,925 207,269 194,902 170,680 FINANCIAL RATIOS Return on average total assets 1.44% 1.38% 1.30% 1.24% 1.15% Return on average shareholders' equity 11.3 11.1 10.9 11.0 11.1 Average shareholders' equity to average total assets 12.8 12.5 11.9 11.3 10.4 Cash dividends paid per share to diluted net income per share 40.3 38.2 36.0 32.8 28.8 Allowance for possible loan losses to total loans 2.01 2.05 2.06 2.09 2.01 Tangible equity to assets 12.7 12.5 12.0 11.2 10.1 Adjusted for the 5 for 4 stock split paid December 16, 1998.
[LOAN COMPOSITION December 31, 1998]
Consumer Installment Loans 18.8% Commercial and Municipal Loans 15.5% Residential Mortgages 45.6% Nonresidential Real Estate Mortgages 10.2% Construction Loans 3.9% Home Equity Loans 6.0%
[BOOK VALUE PER SHARE (December 31) (in dollars) Graph]
94 12.85 95 14.59 96 15.47 97 16.66 98 17.92
[CASH DIVIDENDS PER SHARE (in dollars) Graph]
94 .41 95 .49 96 .58 97 .67 98 .77
1 MESSAGE TO SHAREHOLDERS To Our Shareholders: In our 25th year, Chemical Financial Corporation continued an unbroken series of increases in annual operating income since 1974 and recorded net income of more than $25 million for the first time. Net income for 1998 was $26.046 million, 9.0 percent more than earnings of $23.889 million reported for 1997. Diluted earnings per share were $1.91, an 8.5 percent increase over earnings of $1.76 per share in 1997. At year end 1998, total assets were $1.873 billion, 6.1 percent more than they were one year earlier. Total deposits increased by 5.3 percent during the year to $1.554 billion and total loans went up by 6.2 percent to $898.3 million. Shareholders' equity grew 8.0 percent to stand at $241.8 million as the year ended. This is more than twice the minimum recommended by bank regulators for "well capitalized" organizations. It is interesting to recall that the Company reported net income of $1.3 million for 1974 and ended that year with total assets of $153.4 million. The past 25 years have, indeed, made a difference! The improvement in 1998 earnings is primarily attributable to growth, a significant increase in the gains on the sale of mortgages and our ability to maintain net interest income in spite of declining interest rates. Moreover, our fastest growing deposit category was demand deposits in checking accounts. These tend to be the lowest cost deposit. We also had three highly successful consumer loan promotions during the year. They generated 9,333 new loans totaling $94.5 million in a fiercely competitive environment. [2000 AND BEYOND LOGO] Our shareholders continued to share in our progress. Cash dividends increased 14.6 percent in 1998 and a 5-for-4 stock split was distributed in December. At the time of the split, the Board of Directors announced their intention to pay a quarterly dividend of $.21 per share in 1999. This rate would provide our shareholders with another 9.4 percent increase in dividends paid. We are just as proud of our record of increasing dividend payments every year for 25 years as we are of our record of improving operating income in each of those years. In September, we announced a stock repurchase program. Management was authorized to purchase up to 100,000 shares of the Corporation's common stock. The stock acquired under the program is used in connection with the employee benefit plans and for other general corporate purposes. Because less than one percent of the Company's 13.5 million outstanding shares are involved, the financial impact of this repurchase program is expected to be minimal. Without question, our most significant internal effort in 1998 was working toward ensuring that the Company and its bank subsidiaries are ready for the Year 2000. In February, we converted our principal data processing activities to the new Kirchman Corporation Dimension system as part of our Year 2000 readiness plan. Not only has the Kirchman Corporation certified that this system is designed to be Year 2000 compliant, but its implementation enhanced our customer accounting operations and gave us the ability to improve customer service and expand our product offerings. Chemical Bank and Trust Company, the Corporation's lead subsidiary bank, has agreed to adopt Kirchman's GBQ (Getting Better Quicker) process that is designed to improve customer service by providing front line employees full on-line access to their customers' deposit and loan records. The process is also designed to improve income by better identifying cross-sales opportunities for customer contact employees and helping to control expenses. Although some media outlets have sensationalized the story and raised questions about the ability of banks to deal with Year 2000 issues, we are pleased to report that as of December 31, 1998, all of our information systems that we have identified as critical were on target to be ready for the [NET INCOME PER SHARE (DILUTED) (in dollars) Graph]
94 1.42 95 1.51 96 1.62 97 1.76 98 1.91
[NET INCOME (in thousands of dollars) Graph]
94 19,110 95 20,489 96 22,003 97 23,889 98 26,046
[TOTAL ASSETS (December 31) (in millions of dollars) Graph]
94 1,658 95 1,706 96 1,699 97 1,765 98 1,873
2 first day of business in January 2000 according to our readiness plan. For example, we spent approximately $525,000 in 1998 replacing desktop computers and software that were not Year 2000 compliant and the Trust Department of Chemical Bank and Trust Company converted to new SunGard and Corbel Quantech systems as part of our Year 2000 readiness plan. Chemical Bank South, a banking subsidiary headquartered in Marshall, Michigan acquired the Albion, Michigan branch of Great Lakes National Bank Michigan in November. In connection with this acquisition, Chemical Bank South merged its existing branch at 1408 N. Eaton Street in Albion into the larger facility acquired. We are now in the midst of a significant remodeling project at this new location that will enhance our image in the community just as the acquisition increased our market share. As we have said many times, one of our key corporate strategies is to operate as a group of community banks, not as a large branch network of a single bank. This strategy works well for us because we have been able to attract community leaders in business, the professions and civic affairs to serve as directors of our affiliates. At the Annual Shareholder Meeting in April of 1998, five of them retired in accordance with our Directors Retirement Policy. At Chemical Bank and Trust Company, Stuart Bergstein retired after 22 years of service and Mary Neely ended a 16 year tenure on that bank's board. Donald Clarke retired after serving as a member of the Chemical Bank Michigan board since 1987. David Elow joined the Chemical Bank Key State board in 1983 and served as that bank's Chairman from 1986 until his retirement. Finally, Carl Schuberg retired after 30 years as a member of the Chemical Bank Central board. Lawrence Burks, Vice Chairman of Chemical Bank and Trust Company, retired as a full time employee in April after 25 years of service but continues to serve as a director of that bank. We thank these able people for their many contributions to the advancement of our organization. During the year, we also added ten new affiliate bank directors. The new directors represent a variety of business interests and professions. We look forward to their participation in the deliberations of our affiliate boards and to their advice and counsel. All of us associated with the Company are encouraged that such capable community leaders are willing to join the Chemical Financial family. At the corporate level, Terence F. Moore was appointed to the Corporation's board in January and then elected to a full one-year term at the Annual Meeting. Mr. Moore has been a director of Chemical Bank and Trust Company since 1991 and of CFC Data Corp since 1995. He is President and Chief Executive Officer of MidMichigan Health in Midland, an organization comprising three hospitals, two nursing homes and nine other subsidiaries. [PICTURE OF ALOYSIUS J. OLIVER & ALAN W. OTT] As we begin our 26th year, we remain optimistic about our future prospects. When our principal competitors affiliate with interstate megabanks, our market position is enhanced because we remain a local organization, with decision makers who live and work in the communities we serve. We have the ability to develop products and services tailored specifically to the local needs of our communities and to react quickly to changes in the financial services industry. We express gratitude to our shareholders, directors, officers and employees for participating in the success of Chemical Financial Corporation over the past 25 years. We intend to continue with our strategy that has proven successful in the past and look forward to the new millennium and continued success in the future. Sincerely, /s/ Alan W. Ott Alan W. Ott Chairman of the Board /s/ Aloysius J. Oliver Aloysius J. Oliver President and Chief Executive Officer 3 A QUARTER CENTURY OF GROWTH AND PROFITABILITY On June 30, 1974, Chemical Financial Corporation began operation with total assets of approximately $150 million and a staff of 165 under the direction of Robert B. Bennett, as Chairman and Alan W. Ott, as President and Chief Executive Officer. Messrs. Bennett and Ott held these positions until their retirement in 1986 and 1996, respectively. In 1973, the Company had been incorporated at the urging of Mr. Ott, then President and CEO of Chemical Bank and Trust Company. Following approvals by the shareholders and various state and federal regulators, each share of the bank was exchanged for two new shares of Chemical Financial Corporation common stock. [PICTURES OF ROBERT B. BENNETT AND ALAN W. OTT] [PICTURE OF STOCK CERTIFICATES] [PICTURE OF EMPLOYEE GROWTH RATE FROM 1981 TO 1998] By the end of 1981, the staff of Chemical Financial Corporation and its affiliates had grown to 500+ full-time employees. At the end of 1998, the Corporation had 1006 employees. Thanks to the hard work of these dedicated banking professionals, the Chemical organization has maintained its 25-year focus on customer satisfaction and achieved recognition as one of the premier banking companies in Michigan. [PICTURE OF QUARTERS ACROSS THE PAGE WITH THE YEARS 1974 THROUGH 1986 ABOVE EACH QUARTER] [PICTURE OF CHEMICAL BANK MASTERCARD WITH A LINE POINTING TO THE QUARTER WITH 1977 ABOVE IT] The first two ChemKey Automatic Teller Machines (ATMs) were installed in 1977. Today, the Corporation has a sophisticated online network of 85 machines that process almost 4 million transactions and inquiries each year, not only for Chemical Bank customers, but also for members of other financial institutions as well - a significant source of fee income. Chemical Financial Corporation continues to lead the way with innovative banking services such as ChemConnectsm online banking and ChemKey/ChemCheck debit cards. [PICTURE OF LITTLE TOY HOUSES WITH DOLLAR SIGNS ON THEM WITH A LINE POINTING TO THE QUARTER WITH 1979 ABOVE IT] Chemical Financial Corporation acquired its fifth bank in 1979, Citizens Bank and Trust Company, in Clare, now Chemical Bank Michigan. Over the past 25 years, the acquisition of new banks (17 in all) has been a principal source of growth for the Corporation. Today, the Corporation is one of the leading super community banks in Michigan, with ten bank affiliates and 86 full-service banking offices in 24 counties across mid-Michigan. In 1986, Chemical Financial Corporation became the first bank holding company in Michigan to take advantage of the state's eased restrictions on branch banking when Chemical Bank Albion merged with Chemical Bank Marshall to form one larger, more efficient institution - Chemical Bank South. By taking advantage of additional changes in the Michigan Banking Code over the years, Chemical Financial Corporation has been able to organize its affiliates so all of its customers have a nearby community bank, each with its own officers and board of directors. [PICTURE OF CHEMICAL BANK SOUTH] 4 For the first time, Chemical Financial Corporation reported net income of more than $10 million - a far cry from the $1,319,000 net income reported in 1974. Operating income has increased EVERY SINGLE YEAR since the Corporation began. [PICTURE OF GROWTH OF NET INCOME REPORTED UP TO $10 MILLION WITH A LINE POINTING TO THE QUARTER WITH 1989 ABOVE IT] At the Annual Meeting in April 1994, Gilbert A. Currie retired as Chairman of the Board of Chemical Financial Corporation. Mr. Currie began his association with the Chemical organization in 1956 when he was elected a director of Chemical Bank and Trust Company. He served as Chairman of that bank from 1961 until 1986, when he became Chairman of the Board of Chemical Financial Corporation. "Gil" Currie personified that special combination of progressive thinking and conservative practices that has allowed the organization to compound its successes, year after year. [PICTURE OF GILBERT A. CURRIE WITH A LINE POINTING TO THE QUARTER WITH 1994 ABOVE IT] In its 25th year of doing business, Chemical Financial Corporation earned net income of more than $26 million. This consistent improvement in earnings is the primary reason the Corporation has been able to distribute stock dividends and splits that have enabled one share of Chemical Financial Corporation stock in 1974 to grow to 10.992 shares today. It has also allowed the payment of cash dividends totaling $70.47 on those shares. In 1974, the market value of a single share of Chemical Financial Corporation stock was $38. As of December 31, 1998, the value of 10.992 shares of Chemical Financial Corporation stock was $368.23. [PICTURE OF THE NUMBER 25 ON TOP OF A PILE OF QUARTERS, DIMES AND NICKELS WITH A LINE POINTING TO THE QUARTER WITH 1998 ABOVE IT] [PICTURE OF QUARTERS ACROSS THE PAGE WITH THE YEARS 1987 THROUGH 1998 ABOVE EACH QUARTER] [PICTURE OF CHEMICAL BANK BAY AREA (MANUFACTURERS BANK OF BAY CITY) WITH A LINE POINTING TO THE QUARTER WITH 1987 ABOVE IT] With the purchase of Manufacturers Bank of Bay City in 1987, now known as Chemical Bank Bay Area, Chemical Financial Corporation became one of the ten largest bank holding companies in Michigan, with consolidated total assets exceeding $1 billion. [PICTURE OF 75TH ANNIVERSARY WITH A LINE POINTING TO THE QUARTER WITH 1992 ABOVE IT] Chemical Financial Corporation's lead bank, Chemical Bank and Trust Company, celebrated its 75th Anniversary in March 1992. Originally known as Chemical State Savings Bank, it opened in 1917 as a "savings bank," which, under the banking laws of that era, meant it could pay interest on savings accounts and lend money for home mortgages. For much of its history, the bank has advertised itself as the bank for everybody. This philosophy of doing business has guided the operations of all Chemical Financial Corporation affiliate banks for the past 25 years. 5 25 YEARS IN REVIEW When the directors of Chemical Bank and Trust Company incorporated a holding company in 1973, they had two primary goals: steady asset growth and consistent earnings improvement. Their goals extended to provide customers with superior service and innovative products, give employees an opportunity for professional development and career advancement, and provide the shareholders with returns on their investment. Looking at the Corporation's record, these goals have been achieved. - --------------------------------------------------------------------------- CHEMICAL BANK HAS TWO PRIMARY GOALS: STEADY ASSET GROWTH AND CONSISTENT EARNINGS IMPROVEMENT. - --------------------------------------------------------------------------- In 1972, the Michigan legislature amended the state's Banking Code to allow for the formation of multi-bank holding companies. Allowing banks to affiliate under one corporate umbrella allowed affiliated banks to be more responsive to their customers while achieving efficiencies that enhanced profitability. [PICTURE OF ARTICLES OF INCORPORATION OF CHEMICAL FINANCIAL CORPORATION] Not long after the new law became effective, Alan W. Ott, who had become President and Chief Executive Officer of Chemical Bank and Trust Company in 1972, led the project of organizing a holding company, and in 1973 the new company was incorporated. The formation of the new company resulted in the exchange of Chemical Bank and Trust Company stock for new shares of Chemical Financial Corporation on June 30, 1974. Chemical Financial Corporation began operations with one subsidiary bank, approximately $150 million in assets and 165 employees. A key decision made at this time was to transfer the bank's data processing subsidiary to a separate subsidiary and rename it CFC Data Corp. Over the next 25 years, the Corporation acquired 16 more commercial banks. Figure 1 lists those acquisitions and the year in which each occurred. FIGURE 1
BANK ACQUISITIONS - ------------------------------------------------------- Chemical Bank and Trust Company, Midland 1974 The Bank of Albion 1975 AuGres State Bank 1977 Gladwin County Bank, Beaverton 1977 National Bank of Marshall 1978 Citizens Bank and Trust Company, Clare 1979 First National Bank of Lake City 1980 Montcalm Central Bank, Stanton 1981 The Pinney State Bank, Cass City 1982 Northern National Bank, Grayling 1984 Manufacturers Bank of Bay City 1987 First National Bank & Trust, Big Rapids 1988 Huron County Bank, Harbor Beach 1989 The Peoples State Bank of Caro 1989 Cass City State Bank 1989 Key State Bank, Owosso 1993 State Savings Bank of Caro 1996
Many of these transactions were mergers that triggered an accounting method called "pooling of interests." As a consequence, the Corporation's financial statements for previous years were restated as if the new affiliate had always been a subsidiary of the Corporation. The total assets originally reported by the Corporation at the end of each year, however, more accurately reflect the growth achieved as a result of mergers and acquisitions. 6 FIGURE 2 TOTAL ASSETS REPORTED AT YEAR END 1974 -1998
1974 $153,484,000 1977 1980 1983 1986 1989 1992 1995 1998 $1,872,626,000
FIGURE 3 REPORTED ANNUAL NET INCOME 1974 - 1998
1974 $1,319,000 1977 1980 1983 1986 1989 1992 1995 1998 $26,046,000
Figure 2 shows the growth in total assets reported by Chemical Financial Corporation over the past 25 years. Figure 3 shows the growth in net income reported since the Corporation was formed. The Corporation's operating income has increased every single year since 1974. - --------------------------------------------------------------------------- WHILE GROWTH WAS THE MOST IMPORTANT FACTOR IN THE CORPORATION'S RECORD OF UNINTERRUPTED INCREASES IN EARNINGS, THE CONTINUOUS EFFORT TO IMPROVE OPERATING EFFICIENCY HAS ALSO PLAYED A KEY ROLE IN MAKING UNINTERRUPTED INCREASES IN EARNINGS POSSIBLE - --------------------------------------------------------------------------- While growth was the most important factor in the Corporation's record of uninterrupted increases in earnings, a continuous effort to improve operating efficiency has also played a key role in making this record possible. There have been three main components to this effort. The first has been to consolidate all data processing. As technology has evolved and CFC Data Corp's capabilities have expanded, CFC Data Corp has become a vital contributor to the improved efficiency of the subsidiary banks. The second has been the development of a small corporate staff. Functions such as financial accounting, auditing, loan review, investments and marketing are the responsibility of professionals on the corporate staff. The net result has been to give the affiliate banks better staff support services at a lower overall cost. The third component has been the consolidation of affiliates that were in contiguous or overlapping markets to gain greater operating efficiencies while continuing to provide first-rate customer service. This process began in 1986 when Chemical Bank Albion was merged into Chemical Bank Marshall. The combined institution was renamed Chemical Bank South. This merger was one of the first of its kind in the state of Michigan following enactment of a new law easing the restrictions on branch banking in the state. Federal law and the Banking Code gradually eliminated most restrictions on branch banking. Today, they allow one institution to have branches anywhere in the state and, in many cases, in other states as well. 7 Chemical Financial Corporation has determined that it cannot maintain its level of customer service through a statewide network of branches. At the same time, however, it has determined that it is possible to provide quality service wherever it does business through a limited number of affiliates. This approach gives all of the Corporation's customers access to senior bank officers who live and work nearby. It also puts major decisions, including lending approvals, in the hands of local directors who are familiar with the people, businesses and communities most affected by their decisions. Since 1985, Chemical Financial Corporation has undertaken four affiliate consolidations and reorganized two existing affiliates through mergers into two new banks organized by the Corporation. Figure 4 shows these intra- company consolidations. FIGURE 4 INTRA-COMPANY CONSOLIDATIONS - --------------------------------------------------------------------------- 1985 Chemical Bank West was organized and Chemical Bank Lake City merged into it 1986 Chemical Bank Albion merged into Chemical Bank Marshall and was renamed Chemical Bank South 1987 Chemical Bank Huron was organized and Chemical Bank AuGres merged into it 1988 Chemical Bank Cass City merged into Chemical Bank Bay Area 1992 Chemical Bank Gladwin County merged into Chemical Bank Michigan 1996 Chemical Bank Huron merged into Chemical Bank Bay Area [PICTURE OF A LITTLE BOY SITTING ON AN INFORMATION CENTER DESK TOUCHING THE BOTTOM OF A PIGGY BANK THAT A WOMAN WHO IS SITTING AT THE DESK IS HOLDING AND A MAN STANDING BEHIND THE LITTLE BOY] In a related effort to improve customer service and efficiency, the Corporation has made Chemical Bank and Trust Company the sole provider of trust services among its affiliates. Through agency agreements with all of the other nine affiliates, the Trust Department of Chemical Bank and Trust Company offers a wide range of sophisticated trust services wherever a Chemical Financial Corporation affiliate does business. The Trust Department now has more than $1.3 billion in assets and has become a significant source of fee income that is increasing each year, demonstrating the success of this approach. As new laws and changes in regulations have opened new lines of business to banks and their holding companies, Chemical Financial Corporation has seized the opportunities that have presented themselves. Banks, but not holding companies, may now operate insurance agencies in Michigan. Chemical Bank and Trust Company formed a new subsidiary, CFC Title Services, Inc. in 1996 as the first step in a successful move into the title insurance business. At the end of that year, the Corporation acquired Arbury & Stephenson, Inc., an independent insurance agency located in Midland. Through this agency, now known as Chemical Financial Insurance Agency, the Corporation is gradually expanding its efforts to market casualty and life insurance. Ultimately, the goal is to offer insurance of all types throughout the 24-county area served by Chemical Banks. 8 Chemical Financial Corporation has also moved into the marketing of mutual funds, market securities and annuities through a partnership with Security First Group and BISYS Brokerage Services and now operates five CFC Investment Centers. Security First provides customers with annuities and BISYS provides them with mutual funds and market securities. The Corporation's management felt that a partnership with outside experts was the best way to move into these highly specialized areas and introduce a new sales culture into the organization. Banking is a people business. It always has been and always will be. Technology has made many clerical and administrative tasks unnecessary; however, the operation of a successful financial institution is still the consequence of strong leadership working with capable officers and employees. Chemical Financial Corporation's continuous growth and constant improvement in earnings would not have been possible if it were not for the skill, dedication and foresight of the men and women who have been members of the Chemical Financial family during the past 25 years. - --------------------------------------------------------------------------- THE OPERATION OF A SUCCESSFUL FINANCIAL INSTITUTION IS STILL THE CONSEQUENCE OF STRONG LEADERSHIP WORKING WITH CAPABLE OFFICERS AND EMPLOYEES. - --------------------------------------------------------------------------- The 14 people who have served on the Chemical Financial Corporation board of directors since 1974 have brought a rare combination of innovative thinking and conservative practices to the board deliberations. Figure 5 lists all of the current and former members of the Chemical Financial Corporation board of directors. - --------------------------------------------------------------------------- THE COMPOUND AVERAGE ANNUAL RATE OF RETURN ON STOCK HELD FOR 25 YEARS, EXCLUDING CASH DIVIDENDS, HAS BEEN 9.51 PERCENT - --------------------------------------------------------------------------- The Corporation has been fortunate to have such highly qualified directors. It has also employed a great many good people who have made major contributions to the advancement of Chemical Financial Corporation since 1974. Although it would be impossible to name them all here, their work and their accomplishments are duly noted and gratefully acknowledged. The approach of Chemical Financial Corporation's organizers was to do well so that it would be possible to provide the Corporation's shareholders with a return on their investment. As the record indicates, that has happened. When the first shares of Chemical Financial Corporation were issued in 1974, they had an initial market value of $38.00 per share. Thanks to 17 stock dividends and splits since then, each of those shares had grown to 10.992 shares at the end of 1998. Based on the closing price on December 31, 1998, the market value of those 10.992 shares was $368.23. Put another way, the cost basis of one share of Chemical Financial Corporation stock after the exchange in 1974 was $3.46 per share as of December 31, 1998, adjusted for all subsequent stock dividends and splits. Therefore, the compound average annual rate of return on Chemical Financial Corporation stock held for 25 years, excluding cash dividends, has been 9.51 percent. In addition, over the 25-year period, each of the 10.992 shares has received cash dividends of $6.41, or a total cash payment on each initial share of $70.46. Viewed in retrospect, Chemical Financial Corporation's 25-year history is not filled with notable events or great suspense. Rather, it is a record of constantly compounding success made possible by careful planning and diligent execution. It is also the story of the development of super community banking. Today, super community banks are the backbone of the financial services industry in smaller cities and towns across America. The ability of the Corporation and its affiliates to adapt to changing circumstances and foresee opportunities has allowed it to achieve increased performance, year after year, as it also became one of the premier super community banks in the country. Those who were responsible for the organization of Chemical Financial Corporation 25 years ago should be pleased with the results of their efforts. FIGURE 5 CURRENT AND FORMER DIRECTORS OF CHEMICAL FINANCIAL CORPORATION
Robert B. Bennett Michael L. Dow* Keith R. McKennon Frank P. Popoff* Gilbert A. Currie Carl A. Gerstacker Terence F. Moore* Lawrence A. Reed* James A. Currie* I. Frank Harlow Aloysius J. Oliver* William S. Stavropoulos* Herbert H. Lyon Alan W. Ott* *Current director
9 QUARTERLY FINANCIAL INFORMATION STOCK PRICE RANGES AND CASH DIVIDENDS PER SHARE
1998 1997 HIGH LOW CASH DIVIDEND HIGH LOW CASH DIVIDEND - ---------------------------------------------------------------------------------------------------------- First quarter $ 36.40 $ 31.10 $.192 $ 28.76 $ 23.62 $.160 Second quarter 35.50 32.20 .192 27.43 24.00 .160 Third quarter 33.95 26.10 .192 32.48 25.90 .175 Fourth quarter 34.25 28.20 .192 36.00 29.71 .175 - ---------------------------------------------------------------------------------------------------------- $.768 $.670 ========================================================================================================== Adjusted for the 5 for 4 stock split paid December 16, 1998.
Chemical Financial Corporation common stock is traded on The NASDAQ Stock Market under the symbol CHFC. The above table sets forth the range of bid prices for Chemical Financial Corporation common stock for the periods indicated. These quotations reflect inter-dealer prices, without retail markup, markdown, or commission, and may not necessarily represent actual transactions. As of December 31, 1998, there were 13,496,230 shares of Chemical Financial Corporation common stock issued and outstanding held by approximately 4,200 shareholders of record. The earnings of the Corporation's subsidiary banks are the principal source of funds to pay cash dividends. Consequently, cash dividends are dependent upon the earnings, capital needs, regulatory constraints, and other factors affecting each individual bank. See Note H to the Consolidated Financial Statements for a discussion of such limitations. Management expects the Corporation to declare and pay comparable regular quarterly cash dividends on its common shares in 1999. SELECTED QUARTERLY FINANCIAL INFORMATION (UNAUDITED) (In thousands, except per share data)
1998 1997 FIRST SECOND THIRD FOURTH FIRST SECOND THIRD FOURTH QUARTER QUARTER QUARTER QUARTER QUARTER QUARTER QUARTER QUARTER - ---------------------------------------------------------------------------------------------------------------------- Interest income $29,824 $30,460 $30,776 $30,573 $28,193 $29,096 $30,131 $29,899 Interest expense 12,348 12,447 12,491 11,860 11,457 11,850 12,583 12,389 Net interest income 17,476 18,013 18,285 18,713 16,736 17,246 17,548 17,510 Provision for possible loan losses 219 260 234 251 329 219 219 235 Investment securities gains -- 8 -- -- -- -- 1 -- Income before income taxes 8,564 9,208 9,794 11,260 8,235 8,329 8,785 10,093 Net income 5,779 6,179 6,529 7,559 5,526 5,624 5,906 6,833 Net income per share Basic .43 .46 .48 .56 .41 .42 .44 .51 Diluted .42 .46 .48 .55 .41 .41 .43 .51
The net income per share amounts have been restated to reflect the 5 for 4 stock split paid December 16, 1998. 10 CONSOLIDATED FINANCIAL STATEMENTS CONSOLIDATED STATEMENT OF INCOME
YEARS ENDED DECEMBER 31 1998 1997 1996 - ---------------------------------------------------------------------------------------------------------- (In thousands, except per share data) INTEREST INCOME Interest and fees on loans $ 74,039 $ 69,873 $ 67,470 Interest on investment securities: Taxable 40,602 40,554 38,882 Tax-exempt 2,072 2,160 2,189 - ---------------------------------------------------------------------------------------------------------- TOTAL INTEREST ON SECURITIES 42,674 42,714 41,071 Interest on federal funds sold 4,809 4,699 4,575 Interest on deposits with unaffiliated banks 111 33 136 - ---------------------------------------------------------------------------------------------------------- TOTAL INTEREST INCOME 121,633 117,319 113,252 INTEREST EXPENSE Interest on deposits 47,050 46,320 44,284 Interest on short-term borrowings 1,503 1,363 1,163 Interest on long-term debt 593 596 715 - ---------------------------------------------------------------------------------------------------------- TOTAL INTEREST EXPENSE 49,146 48,279 46,162 - ---------------------------------------------------------------------------------------------------------- NET INTEREST INCOME 72,487 69,040 67,090 Provision for possible loan losses 964 1,002 1,128 - ---------------------------------------------------------------------------------------------------------- NET INTEREST INCOME after provision for possible loan losses 71,523 68,038 65,962 NONINTEREST INCOME Trust department income 3,554 3,210 2,897 Service charges on deposit accounts 5,487 5,314 5,382 Other charges and fees for customer services 4,515 3,813 3,199 Gains on sales of loans 1,536 239 137 Other 518 546 583 - ---------------------------------------------------------------------------------------------------------- TOTAL NONINTEREST INCOME 15,610 13,122 12,198 OPERATING EXPENSES Salaries, wages and employee benefits 28,895 27,280 26,964 Occupancy 4,372 4,362 4,261 Equipment 2,988 3,091 2,884 Other 12,052 10,985 11,015 - ---------------------------------------------------------------------------------------------------------- TOTAL OPERATING EXPENSES 48,307 45,718 45,124 - ---------------------------------------------------------------------------------------------------------- INCOME BEFORE INCOME TAXES 38,826 35,442 33,036 Federal income taxes 12,780 11,553 11,033 - ---------------------------------------------------------------------------------------------------------- NET INCOME $ 26,046 $ 23,889 $ 22,003 ========================================================================================================== NET INCOME PER SHARE Basic $ 1.93 $ 1.78 $ 1.64 Diluted 1.91 1.76 1.62 CASH DIVIDENDS PER SHARE .77 .67 .58
See notes to consolidated financial statements. 11 CONSOLIDATED STATEMENT OF FINANCIAL POSITION
DECEMBER 31 1998 1997 - ----------------------------------------------------------------------------------------------------------- (Dollars in thousands) ASSETS Cash and demand deposits due from banks $ 98,483 $ 95,794 Federal funds sold 113,150 49,750 Interest bearing deposits with unaffiliated banks 5,000 -- Investment securities: Available for sale (at estimated market value) 488,976 494,173 Held to maturity (estimated market value - $244,430 in 1998 and $253,459 in 1997) 240,847 251,020 - ----------------------------------------------------------------------------------------------------------- Total investment securities 729,823 745,193 Loans 898,293 845,600 Less: Allowance for possible loan losses 18,071 17,359 - ----------------------------------------------------------------------------------------------------------- Net loans 880,222 828,241 Premises and equipment 20,215 20,416 Accrued income 14,195 14,573 Other assets 11,538 11,133 - ----------------------------------------------------------------------------------------------------------- TOTAL ASSETS $1,872,626 $1,765,100 =========================================================================================================== LIABILITIES AND SHAREHOLDERS' EQUITY Deposits: Noninterest-bearing $ 272,388 $ 237,763 Interest-bearing 1,281,883 1,238,078 - ----------------------------------------------------------------------------------------------------------- Total deposits 1,554,271 1,475,841 Short-term borrowings: Treasury tax and loan notes payable to the U.S. Treasury 5,137 11,206 Securities sold under agreements to repurchase 48,113 30,990 - ----------------------------------------------------------------------------------------------------------- Total short-term borrowings 53,250 42,196 Interest payable and other liabilities 15,266 14,138 Long-term debt 8,000 9,000 - ----------------------------------------------------------------------------------------------------------- Total liabilities 1,630,787 1,541,175 Shareholders' equity: Common stock, $1 par value ($10 par value at December 31, 1997): Authorized 18,000,000 shares (15,000,000 at December 31, 1997) Issued and outstanding 13,496,230 shares in 1998 and 10,753,011 shares in 1997 13,496 107,530 Surplus 184,384 87,086 Retained earnings 40,892 27,904 Accumulated other comprehensive income 3,067 1,405 - ----------------------------------------------------------------------------------------------------------- Total shareholders' equity 241,839 223,925 - ----------------------------------------------------------------------------------------------------------- TOTAL LIABILITIES AND SHAREHOLDERS' EQUITY $1,872,626 $1,765,100 ===========================================================================================================
See notes to consolidated financial statements. 12 CONSOLIDATED STATEMENT OF CASH FLOWS
YEARS ENDED DECEMBER 31 1998 1997 1996 - ------------------------------------------------------------------------------------------------------------------- (In thousands) OPERATING ACTIVITIES Net income $ 26,046 $ 23,889 $ 22,003 Adjustments to reconcile net income to net cash provided by operating activities: Provision for possible loan losses 964 1,002 1,128 Gains on sales of loans (1,536) (239) (137) Provision for depreciation and amortization 2,946 2,741 2,793 Gain on sale of branch office building -- (256) -- Net amortization of investment securities 405 1,789 2,546 Net decrease in accrued income and other assets 475 491 2,244 Net increase (decrease) in interest payable and other liabilities 967 (113) 158 - ------------------------------------------------------------------------------------------------------------------- NET CASH PROVIDED BY OPERATING ACTIVITIES 30,267 29,303 30,735 INVESTING ACTIVITIES Cash and cash equivalents assumed in acquisition of branch office 9,588 -- -- Net (increase) decrease in interest bearing deposits with unaffiliated banks (5,000) 1,134 1,847 Proceeds from maturities of investment securities available for sale 255,153 119,934 109,233 Proceeds from sales of investment securities available for sale -- -- 522 Purchases of investment securities available for sale (247,675) (171,209) (191,055) Proceeds from maturities of investment securities held to maturity 101,991 122,742 200,557 Purchases of investment securities held to maturity (91,946) (160,468) (45,625) Proceeds from sales of loans 118,566 39,060 12,558 Net loan originations, excluding sales (170,567) (77,631) (60,564) Proceeds from sale of branch office building -- 900 -- Purchases of premises and equipment (1,790) (2,902) (2,349) - ------------------------------------------------------------------------------------------------------------------- NET CASH PROVIDED BY (USED IN) INVESTING ACTIVITIES (31,680) (128,440) 25,124 FINANCING ACTIVITIES Net increase (decrease) in demand deposits, NOW accounts and savings accounts 67,408 59,944 (24,845) Net increase (decrease) in certificates of deposit and other time deposits (197) (14,018) 4,959 Net increase in short-term borrowings 11,054 4,863 2,110 Principal payments on long-term debt (1,000) (1,000) (2,080) Cash dividends paid (10,359) (9,003) (7,771) Proceeds from stock purchase plan 295 259 264 Proceeds from exercise of stock options 338 386 339 Repurchases of common stock (37) (467) (1,035) - ------------------------------------------------------------------------------------------------------------------- NET CASH PROVIDED BY (USED IN) FINANCING ACTIVITIES 67,502 40,964 (28,059) - ------------------------------------------------------------------------------------------------------------------- INCREASE (DECREASE) IN CASH AND CASH EQUIVALENTS 66,089 (58,173) 27,800 Cash and cash equivalents at beginning of year 145,544 203,717 175,917 - ------------------------------------------------------------------------------------------------------------------- CASH AND CASH EQUIVALENTS AT END OF YEAR $ 211,633 $ 145,544 $ 203,717 =================================================================================================================== SUPPLEMENTAL DISCLOSURES OF CASH FLOW INFORMATION Interest paid on deposits, short-term borrowings and long-term debt $ 49,229 $ 48,390 $ 46,685 Federal income taxes paid 14,180 11,545 11,106
See notes to consolidated financial statements. 13 CONSOLIDATED STATEMENT OF CHANGES IN SHAREHOLDERS' EQUITY
Years Ended December 31, 1998, 1997 and 1996 ACCUMULATED OTHER COMMON RETAINED COMPREHENSIVE STOCK SURPLUS EARNINGS INCOME TOTAL - ------------------------------------------------------------------------------------------------------------------- (Dollars in thousands) BALANCES AT JANUARY 1, 1996 $96,944 $56,918 $39,665 $1,375 $194,902 Stock dividend - 5% 4,859 13,301 (18,160) -- -- Comprehensive income: Net income for 1996 -- -- 22,003 -- -- Net change in unrealized gains (losses) on securities available for sale, net of taxes of $(858) -- -- -- (1,557) -- Comprehensive income -- -- -- -- 20,446 Cash dividends paid -- -- (7,771) -- (7,771) Shares issued upon exercise of employee stock options (including related tax benefit) 436 (92) -- -- 344 Shares issued from stock purchase plan 74 165 -- -- 239 Shares issued for acquisition of insurance agency 88 56 -- -- 144 Repurchase of 41,343 shares (303) (732) (1,035) - ------------------------------------------------------------------------------------------------------------------- BALANCES AT DECEMBER 31, 1996 102,098 69,616 35,737 (182) 207,269 Stock dividend 5% 5,120 17,599 (22,719) -- -- Comprehensive income: Net income for 1997 -- -- 23,889 -- -- Net change in unrealized gains (losses) on securities available for sale, net of taxes of $854 -- -- -- 1,587 -- Comprehensive income -- -- -- -- 25,476 Cash dividends paid -- -- (9,003) -- (9,003) Shares issued upon exercise of employee stock options (including related tax benefit) 374 12 -- -- 386 Shares issued from stock purchase plan 73 191 -- -- 264 Repurchase of 17,718 shares (135) (332) -- -- (467) - ------------------------------------------------------------------------------------------------------------------- BALANCES AT DECEMBER 31, 1997 107,530 87,086 27,904 1,405 223,925 Change in common stock par value to $1 per share (97,058) 97,058 -- -- -- Stock split - 5 for 4 2,699 -- (2,699) -- -- Comprehensive income: Net income for 1998 -- -- 26,046 -- -- Net change in unrealized gains (losses) on securities available for sale, net of taxes of $894 -- -- -- 1,662 -- Comprehensive income -- -- -- -- 27,708 Cash dividends paid -- -- (10,359) -- (10,359) Shares issued upon exercise of employee stock options (including related tax benefit) 252 86 -- -- 338 Shares issued from stock purchase plan 74 190 -- -- 264 Repurchase of 1,250 shares (1) (36) -- -- (37) - ------------------------------------------------------------------------------------------------------------------- BALANCES AT DECEMBER 31, 1998 $13,496 $184,384 $40,892 $3,067 $241,839 ===================================================================================================================
See notes to consolidated financial statements. 14 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS NOTE A - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES The accounting and reporting policies of Chemical Financial Corporation and its subsidiaries conform to generally accepted accounting principles and prevailing practices within the banking industry. Management makes estimates and assumptions that affect the amounts reported in the financial statements and accompanying footnotes. Actual results could differ from these estimates. Significant accounting policies of Chemical Financial Corporation (the Corporation) and its subsidiaries are described below: BASIS OF PRESENTATION AND PRINCIPLES OF CONSOLIDATION: The consolidated financial statements of the Corporation include the accounts of the parent company and its subsidiaries, all of which are wholly-owned. All significant income and expenses are recorded on the accrual basis. Intercompany accounts and transactions have been eliminated in preparing the consolidated statements. CASH AND CASH EQUIVALENTS: For purposes of reporting cash flows, cash and cash equivalents include cash on hand, amounts due from unaffiliated banks and federal funds sold. Generally, federal funds are sold for one-day periods. INVESTMENT SECURITIES AVAILABLE FOR SALE: Investment securities available for sale include those securities which might be sold as part of the Corporation's management of interest rate and prepayment risk, in response to changes in interest rates, or a desire to increase liquidity. Investment securities available for sale are stated at estimated market value, with the aggregate unrealized gains and losses, net of income taxes, classified as a component of accumulated other comprehensive income. Realized gains and losses from the sale of investment securities available for sale are determined using the specific identification method and are classified as noninterest income in the consolidated statement of income. Premiums and discounts on securities available for sale, as well as on securities held to maturity, are amortized over the estimated lives of the related securities. INVESTMENT SECURITIES HELD TO MATURITY: Designation as an investment security held to maturity is made at the time of acquisition and is based on the Corporation's intent and ability to hold the security to maturity. Securities held to maturity are stated at cost adjusted for the amortization of premium and accretion of discount to maturity. LOANS: Loans are stated at their principal amount outstanding. Loan performance is reviewed regularly by loan review personnel, loan officers and senior management. Loan interest income is recognized on the accrual basis. A loan is placed in the nonaccrual category when principal or interest is past due 90 days or more, unless the loan is both well secured and in the process of collection, or when in the opinion of management, there is sufficient reason to doubt the collectability of future principal or interest. Interest previously accrued, but not collected, is reversed and charged against interest income at the time the loan is placed in nonaccrual status. The subsequent recognition of interest income on a nonaccrual loan is then recognized only to the extent cash is received and where future collection of principal is probable. Loans are returned to accrual status when principal and interest payments are brought current and collectability is no longer in doubt. Interest income on restructured loans is recognized according to the terms of the restructure, subject to the above described nonaccrual policy. Nonperforming loans are comprised of those loans accounted for on a nonaccrual basis, accruing loans contractually past due 90 days or more as to interest or principal payments, and other loans for which the terms have been renegotiated to provide for a reduction of interest or principal because of a deterioration in the financial position of the borrower. A loan is considered to be impaired when it is probable that payment of principal and interest will not be made in accordance with the contractual terms of the loan agreement. Impaired loans are carried at the present value of expected cash flows discounted at the loan's effective interest rate or at the fair value of the collateral, if the loan is collateral dependent. Smaller-balance homogeneous loans are evaluated for impairment in total. Such loans include residential first mortgage loans secured by one-to-four family residences, residential construction loans, and other consumer installment loans. Commercial loans and commercial mortgage loans are evaluated individually for impairment. A portion of the allowance for possible loan losses may be allocated to impaired loans. ALLOWANCE FOR LOAN LOSSES: The allowance for possible loan losses is maintained at a level that, in management's judgment, is considered to be adequate to provide for potential loan losses. Management's evaluation of the adequacy of the allowance is based on a continuing review of the loan portfolio, actual loan loss experience, risk characteristics of the loan portfolio, current and prospective financial condition of the borrowers, balance of the loan portfolio, loan growth, and current and prospective economic conditions. Loans which are deemed uncollectible are charged off and deducted from continued on next page 15 NOTE A - CONTINUED the allowance. The provision for loan losses and recoveries on loans previously charged off are added to the allowance. MORTGAGE BANKING OPERATIONS: The origination of mortgage loans is an integral component of the business of the Corporation. The Corporation generally sells the longer term fixed interest rate residential mortgage loans that it originates in the secondary market. These longer term fixed interest rate residential mortgage loans are generally held for sale thirty days or less, and book value approximates market value. The Corporation has retained the servicing rights on all loans that it sold in the secondary market. Servicing income is recognized in noninterest income when received and expenses are recognized when incurred. Statement of Financial Accounting Standards No. 125, "Accounting for Transfers and Servicing of Financial Assets and Extinguishments of Liabilities" (SFAS 125), was adopted prospectively January 1, 1997. SFAS 125 requires that an asset be recognized for the rights to service mortgage loans, including those rights that are created by the origination of mortgage loans which are sold with the servicing rights retained by the originator. The recognition of the asset results in an increase in the gains recognized upon the sale of the underlying loans. The Corporation amortizes the mortgage servicing right asset in proportion to, and over the life of, the estimated net future servicing income. SFAS 125 additionally requires periodic evaluation of the fair market value of the asset. Any impairment is recognized as a valuation allowance. PREMISES AND EQUIPMENT: Premises and equipment are stated at cost less accumulated depreciation. Premises and equipment are depreciated over the useful lives of the assets. Depreciation is computed on the straight-line method. The estimated useful lives are generally 25 to 35 years for buildings and 3 to 7 years for equipment. A summary of premises and equipment at December 31 follows:
1998 1997 - ------------------------------------------------------------------------ (In thousands) Bank premises $ 29,239 $ 28,649 Equipment 12,278 11,257 - ------------------------------------------------------------------------ 41,517 39,906 Less: Accumulated depreciation 21,302 19,490 - ------------------------------------------------------------------------ Total $ 20,215 $ 20,416 ========================================================================
INTANGIBLE ASSETS: Goodwill, representing the cost of investments in subsidiaries in excess of the fair value of identifiable net assets at acquisition, is being amortized over twenty years. Other acquired intangible assets, such as those associated with acquired core deposits, are being amortized over periods between five and fifteen years. STOCK OPTIONS: In 1996, the Corporation adopted Statement of Financial Accounting Standards No. 123, "Accounting for Stock-Based Compensation" (SFAS 123). Under the provisions of this statement, the Corporation elected to continue to apply Accounting Principles Board Opinion No. 25, "Accounting for Stock Issued to Employees" (APB 25) in measuring and recognizing compensation expense for its stock option plan and to disclose the pro forma effect of applying the fair value method required by SFAS 123. Under APB 25, no compensation expense is recognized as a result of options awarded to employees under stock option plans. Information on the Corporation's stock- based compensation plans is included in Note J. INCOME TAXES: The Corporation files a consolidated federal income tax return and is responsible for the payment of any tax liability of the consolidated organization. Income tax expense is based on income and expenses, as reported in the financial statements. When income and expenses are recognized in different periods for tax purposes, applicable deferred taxes are provided for in the financial statements. EARNINGS PER SHARE: In 1997, the Corporation adopted Statement of Financial Accounting Standards No. 128, "Earnings per Share" (SFAS 128). This statement simplified the standard for computing earnings per share. Basic earnings per share for the Corporation is computed by dividing net income by the weighted average number of common shares outstanding during the period. Diluted earnings per share for the Corporation is computed by dividing net income by the sum of the weighted average number of common shares outstanding and the dilutive effect of common stock equivalents outstanding during the period. The Corporation's common stock equivalents consist of common stock issuable under the assumed exercise of stock options granted under the Corporation's stock option plans, using the treasury stock method. The following table summarizes the number of shares used in the denominator of the basic and diluted earnings per share computations:
1998 1997 1996 - ------------------------------------------------------------------------------------------- Denominator for basic earnings per share 13,486,159 13,426,583 13,387,824 Denominator for diluted earnings per share 13,636,337 13,585,980 13,582,253
16 COMPREHENSIVE INCOME: On January 1, 1998, the Corporation adopted Statement of Financial Accounting Standards, No. 130, "Reporting Comprehensive Income" (SFAS 130). SFAS 130 established standards for the reporting of comprehensive income and its components. Comprehensive income includes net income and certain adjustments to equity required under generally accepted accounting principles which result from transactions other than with shareholders. The Corporation elected to display comprehensive income as a component in the statement of shareholders' equity. OPERATING SEGMENT: On January 1, 1998, Statement of Financial Accounting Standards No. 131, "Disclosures about Segments of an Enterprise and Related Information" (SFAS 131), became effective. SFAS 131 established standards for the reporting of information about operating segments and related disclosures about products and services, geographic areas and major customers. The Corporation is a bank holding company that operates ten commercial banks and a data processing company, each as a separate subsidiary of the Corporation. All ten of the Corporation's commercial bank subsidiaries operate as community banks and offer a full range of commercial banking and fiduciary products and services to the residents and business customers of their geographical market areas. The products and services offered by the commercial bank subsidiaries are consistent throughout the Corporation, as is the pricing of these products and services. These services include personal and business checking accounts, savings and individual retirement accounts, time deposit instruments, electronically accessed banking products, residential and commercial real estate financing, commercial lending, consumer financing, debit cards, safe deposit services, automated teller machines, access to insurance and investment products, money transfer services, corporate and personal trust services and other banking services. Each of the Corporation's commercial bank subsidiaries operates in a separate geographical area within the state of Michigan. The geographical area served by each of these subsidiaries is generally the twenty-five mile radius surrounding its headquarters. All marketing of products and services throughout the Corporation's ten subsidiary banks is uniform, as many of the markets served by these subsidiaries overlap. The distribution of products and services is uniform throughout the Corporation's commercial bank subsidiaries and is achieved primarily through retail branch banking offices, automated teller machines and electronically accessed banking products. All ten commercial bank subsidiaries are state chartered commercial banks, and operate under the same banking regulations. The data processing subsidiary primarily performs data processing functions for the Corporation's ten commercial banking subsidiaries. It is management's opinion that the Corporation operates in a single operating segment - commercial banking. The Corporation's primary sources of revenues are from its investment securities and loan products. The following table summarizes the Corporation's revenue from its specific loan products for the years ended December 31:
1998 1997 1996 - --------------------------------------------------------------------------------------- (In thousands) Interest income and fee revenue Commercial loans $ 11,689 $ 10,747 $ 11,148 Real estate mortgage loans - commercial 8,312 8,332 8,328 Real estate mortgage loans - residential 35,520 35,120 33,167 Real estate construction loans 2,757 2,165 1,679 Consumer loans 15,761 13,509 13,148 - --------------------------------------------------------------------------------------- Total $ 74,039 $ 69,873 $ 67,470 =======================================================================================
COMMON STOCK: On December 16, 1998, the Corporation paid a 5 for 4 stock split, effected in the form of a 25% stock dividend. All per share data and share amounts, where applicable, included in the consolidated financial statements and in the related notes thereto have been retroactively adjusted to reflect the split. RECLASSIFICATION: Certain amounts in the 1997 and 1996 financial statements have been reclassified to conform with the 1998 presentation. NOTE B - ACQUISITIONS During the three years ended December 31, 1998, the Corporation made the following acquisitions: On November 20, 1998, Chemical Bank South, a wholly owned banking subsidiary of the Corporation headquartered in Marshall, Michigan, acquired a branch banking office in Albion, Michigan from Great Lakes National Bank Michigan. The branch banking office had approximately $11 million of deposits as of that date. The transaction was accounted for by the purchase method of accounting. The amount of the purchase price assigned to core deposit intangibles was $1.3 million. In conjunction with the acquisition, Chemical Bank South consolidated its banking operations at 1408 N. Eaton Street in Albion with the newly acquired branch banking office. On December 31, 1996, the Corporation acquired Arbury & Stephenson, Inc., an insurance agency headquartered in Midland, Michigan. The merger was effected through an exchange of shares of the Corporation's common stock. On May 1, 1996, the Corporation merged with State Savings Bancorp, Inc. (SSBI) in Caro, Michigan. SSBI operated one bank, State Savings Bank of Caro, with offices in Caro and Fairgrove. The Corporation issued 689,062 shares of the Corporation's common stock in exchange for all of the common stock of SSBI. The merger was accounted for as a "pooling of interests." As of May 1, 1996, SSBI had assets of approximately $65 million. 17 NOTE C - INVESTMENT SECURITIES The following is a summary of the amortized cost and estimated market value of investment securities available for sale and investment securities held to maturity at December 31, 1998 and 1997:
AVAILABLE FOR SALE INVESTMENT SECURITIES GROSS GROSS ESTIMATED AMORTIZED UNREALIZED UNREALIZED MARKET COST GAINS LOSSES VALUE (In thousands) DECEMBER 31, 1998 - ---------------------------------------------------------------------------------------------------------- U.S. Treasury and agency securities $ 440,479 $ 4,073 $ 191 $ 444,361 Mortgage-backed securities 1,554 29 -- 1,583 Other debt securities 38,043 197 8 38,232 - ---------------------------------------------------------------------------------------------------------- Total debt securities 480,076 4,299 199 484,176 Equity securities 4,181 619 -- 4,800 - ---------------------------------------------------------------------------------------------------------- Total $ 484,257 $ 4,918 $ 199 $ 488,976 ========================================================================================================== DECEMBER 31, 1997 - ---------------------------------------------------------------------------------------------------------- U.S. Treasury and agency securities $ 473,000 $ 2,090 $ 384 $ 474,706 Mortgage-backed securities 2,310 42 1 2,351 Other debt securities 15,133 18 78 15,073 - ---------------------------------------------------------------------------------------------------------- Total debt securities 490,443 2,150 463 492,130 Equity securities 1,574 469 -- 2,043 - ---------------------------------------------------------------------------------------------------------- Total $ 492,017 $ 2,619 $ 463 $ 494,173 ==========================================================================================================
HELD TO MATURITY INVESTMENT SECURITIES GROSS GROSS ESTIMATED AMORTIZED UNREALIZED UNREALIZED MARKET COST GAINS LOSSES VALUE (In thousands) DECEMBER 31, 1998 - ---------------------------------------------------------------------------------------------------------- U.S. Treasury and agency securities $ 190,957 $ 2,526 $ 30 $ 193,453 States of the U.S. and political subdivisions 41,593 1,076 28 42,641 Mortgage-backed securities 312 4 1 315 Other debt securities 7,985 36 -- 8,021 - ---------------------------------------------------------------------------------------------------------- Total $ 240,847 $ 3,642 $ 59 $ 244,430 ========================================================================================================== DECEMBER 31, 1997 U.S. Treasury and agency securities $ 201,801 $ 1,695 $ 1 $ 203,495 States of the U.S. and political subdivisions 46,707 958 227 47,438 Mortgage-backed securities 501 9 3 507 Other debt securities 2,011 12 4 2,019 - ---------------------------------------------------------------------------------------------------------- Total $ 251,020 $ 2,674 $ 235 $ 253,459 ==========================================================================================================
The amortized cost of U.S. Treasury and U.S. agencies, states of the U.S. and political subdivisions and all other securities at December 31, 1996 were $592,191,000, $42,096,000 and $21,532,000, respectively, whereas the estimated market values of these three categories of investments at December 31, 1996 were $592,355,000, $43,044,000 and $21,882,000, respectively. The amortized cost and estimated market value of debt and equity securities at December 31, 1998, by contractual maturity for both available for sale and held to maturity investment securities follows:
AVAILABLE FOR SALE ESTIMATED AMORTIZED MARKET COST VALUE - ---------------------------------------------------------------------------- (In thousands) Due in one year or less $ 244,323 $ 245,724 Due after one year through five years 234,199 236,869 Mortgage-backed securities 1,554 1,583 Equity securities 4,181 4,800 - ---------------------------------------------------------------------------- Total $ 484,257 $ 488,976 ============================================================================
HELD TO MATURITY ESTIMATED AMORTIZED MARKET COST VALUE - ---------------------------------------------------------------------------- (In thousands) Due in one year or less $ 94,410 $ 95,128 Due after one year through five years 133,950 136,322 Due after five years through ten years 10,456 10,871 Due after ten years 1,719 1,794 Mortgage-backed securities 312 315 - ---------------------------------------------------------------------------- Total $ 240,847 $ 244,430 ============================================================================
Investment securities with a book value of $233.6 million at December 31, 1998 were pledged to collateralize public fund deposits and for other purposes as required by law; at December 31, 1997, the corresponding amount was $177.8 million. Recognized gains on investment securities were $8,000, $1,000 and $15,000 in 1998, 1997 and 1996, respectively. 18 NOTE D - LOANS The following summarizes loans as of December 31:
1998 1997 - ----------------------------------------------------------------------- (In thousands) Commercial and agricultural $ 139,051 $ 120,696 Real estate construction 35,039 31,143 Real estate mortgage 520,972 536,938 Consumer 203,231 156,823 - ----------------------------------------------------------------------- Total $ 898,293 $ 845,600 =======================================================================
The Corporation's subsidiary banks have extended loans to directors and officers, and their associates, of the Corporation and of the Corporation's significant subsidiaries. The loans were made in the ordinary course of business at normal terms, including interest rates and collateralization, prevailing at the time, and did not involve more than the normal risk of collectability. The aggregate loans outstanding to the directors and officers of the Corporation and its significant subsidiaries totaled $18,495,000 at December 31, 1998 and $19,183,000 at December 31, 1997. During 1998, there were $25,978,000 of new loans and other additions, while repayments and other reductions totaled $26,666,000. Changes in the Allowance for Possible Loan Losses were as follows for the years ended December 31:
1998 1997 1996 - ---------------------------------------------------------------------------------------- (In thousands) Balance at beginning of year $17,359 $16,607 $15,886 Provision charged to operations 964 1,002 1,128 Loan charge-offs (549) (620) (691) Loan recoveries 297 370 284 - ---------------------------------------------------------------------------------------- Net loan charge-offs (252) (250) (407) - ---------------------------------------------------------------------------------------- Balance at end of year $18,071 $17,359 $16,607 ========================================================================================
Nonaccrual and renegotiated loans aggregated $1.8 million and $1.9 million at December 31, 1998 and December 31, 1997, respectively. Interest income totaling $79,172 was recorded on the nonaccrual loans in 1998. Additional interest income of $144,870 would have been recorded during 1998 on these loans had they been current in accordance with their original terms. The Corporation had no impaired loans as of December 31, 1998 and 1996. The Corporation had $328,000 of impaired loans as of December 31, 1997. An impairment allowance was not required on any of these loans. The impaired loan balances represented loans for which their fair value exceeded the recorded investment in the loan, based on fair value of the related collateral. NOTE E - FEDERAL INCOME TAXES The provision for federal income taxes is less than that computed by applying the federal statutory income tax rate of 35% primarily due to tax- exempt interest on investments and loans as shown in the following analysis for the years ended December 31:
1998 1997 1996 - ---------------------------------------------------------------------------------------- (In thousands) Tax at statutory rate $13,589 $12,405 $11,563 Changes resulting from: Tax-exempt income (878) (887) (884) Other 69 35 354 - ---------------------------------------------------------------------------------------- Total federal income tax expense $12,780 $11,553 $11,033 ========================================================================================
The provision for federal income taxes consisted of the following for the years ended December 31:
1998 1997 1996 - ---------------------------------------------------------------------------------------- (In thousands) Current $14,537 $11,503 $11,291 Deferred (benefit) (1,757) 50 (258) - ---------------------------------------------------------------------------------------- Total $12,780 $11,553 $11,033 ========================================================================================
Deferred income taxes reflect the net tax effects of temporary differences between the carrying amounts of assets and liabilities for financial reporting purposes and the amounts used for income tax purposes. Significant temporary differences which comprise the deferred tax assets and liabilities of the Corporation were as follows as of December 31:
1998 1997 - ---------------------------------------------------------------------------- (In thousands) Deferred tax assets: Allowance for possible loan losses $5,437 $4,786 Employee benefit plans 1,601 1,138 Expense accruals not yet tax deductible 1,459 1,184 Other 549 423 - ---------------------------------------------------------------------------- Total deferred tax assets 9,046 7,531 Deferred tax liabilities: Investment securities available for sale 1,651 756 Tax over book depreciation 621 610 Other 603 856 - ---------------------------------------------------------------------------- Total deferred tax liabilities 2,875 2,222 - ---------------------------------------------------------------------------- Net deferred tax assets $6,171 $5,309 ============================================================================
Federal income tax expense applicable to gains on securities transactions was $3,000 in 1998 and $5,000 in 1996, and is included in federal income taxes on the consolidated statement of income. 19 NOTE F - PENSION AND POSTRETIREMENT BENEFITS The Corporation has a noncontributory defined benefit pension plan ("Plan") covering all of its salaried employees. Normal retirement benefits are based on years of service and the employee's average annual pay of the five highest consecutive years during the ten years preceding retirement. The Corporation's funding strategy has been to contribute annually the maximum amount that can be deducted for federal income tax purposes. Contributions are intended to provide not only for benefits attributed to service to date but also for those expected to be earned in the future. Plan assets consist primarily of listed stocks, U.S. Government securities and common stock of the Corporation (154,042 shares at December 31, 1998). The following table sets forth the change in the benefit obligation and plan assets of the Plan:
1998 1997 - ------------------------------------------------------------------------------- (In thousands) Change in benefit obligation Benefit obligation at beginning of year $30,022 $25,648 Service cost 1,563 1,339 Interest cost 2,073 1,897 Net actuarial loss 1,269 1,948 Benefits paid (1,026) (810) - ------------------------------------------------------------------------------- Benefit obligation at end of year $33,901 $30,022 =============================================================================== Change in plan assets: Fair value of plan assets at beginning of year $44,043 $34,880 Actual return on plan assets 6,202 8,774 Contributions by the Corporation -- 1,199 Benefits paid (1,026) (810) - ------------------------------------------------------------------------------- Fair value of plan assets at end of year $49,219 $44,043 =============================================================================== Overfunded status of the plan $15,318 $14,021 Unrecognized net actuarial gain (12,111) (10,099) Unrecognized net transition asset (451) (628) Unrecognized prior service cost (126) (154) - ------------------------------------------------------------------------------- Prepaid benefit cost $ 2,630 $ 3,140 ===============================================================================
Net periodic pension cost of the Plan consisted of the following for the years ended December 31:
1998 1997 1996 - ----------------------------------------------------------------------------------------- (In thousands) Service cost $ 1,563 $ 1,339 $ 1,405 Interest cost 2,073 1,897 1,753 Expected return on plan assets (2,921) (2,532) (2,272) Amortization of transition amount (177) (177) (177) Amortization of prior service cost (28) (28) (28) - ----------------------------------------------------------------------------------------- Pension expense $ 510 $ 499 $ 681 =========================================================================================
Weighted-average assumptions as of December 31:
1998 1997 1996 - ------------------------------------------------------------------------------------------ Discount rate used in determining projected benefit obligation 6.75% 7.00% 7.50% Expected return on assets 8% 8% 8% Rate of compensation increase 5% 5% 6%
In addition to the Corporation's defined benefit pension plan, the Corporation provides postretirement medical and dental (to age 65) benefits to salaried employees. Eligibility for such benefits is age 55 with at least ten years of service with the Corporation or its subsidiaries. Retirees are required to make contributions toward the cost of their benefits based on their years of credited service and age at retirement. Retiree contributions are adjusted annually. The accounting for these postretirement benefits anticipates changes in future cost-sharing features such as retiree contributions, deductibles, copayments and coinsurance. The Corporation reserves the right to amend, modify or terminate these benefits at any time. The following table sets forth changes in the Corporation's postretirement benefit obligation:
1998 1997 - ------------------------------------------------------------------------------- (In thousands) Change in benefit obligation: Benefit obligation at beginning of year $4,274 $3,222 Service cost 192 148 Interest cost 287 267 Net actuarial (gain) loss (306) 723 Benefits paid, net of retiree contributions 25 (86) - ------------------------------------------------------------------------------- Benefit obligation at end of year $4,472 $4,274 =============================================================================== Unfunded status of the plan $4,472 $4,274 Unrecognized net actuarial loss (75) (380) Unrecognized prior service cost 8 12 - ------------------------------------------------------------------------------- Accrued postretirement benefit cost $4,405 $3,906 ===============================================================================
Net periodic postretirement benefit cost consisted of the following for the years ended December 31:
1998 1997 1996 - ------------------------------------------------------------------------------------------- (In thousands) Service cost $ 192 $ 148 $ 139 Interest cost 287 267 216 Amortization of prior service cost (4) (4) (4) - ------------------------------------------------------------------------------------------- Net periodic postretirement benefit cost $ 475 $ 411 $ 351 ===========================================================================================
The weighted-average discount rate used in determining the accumulated postretirement benefit obligation was 6.75% and 7.0% at December 31, 1998 and December 31, 1997, respectively. For measurement purposes, the annual rates of increase in the per capita cost of covered health care benefits and dental benefits for 1999 were assumed at 7.73% and 6.34%, respectively. These rates were assumed to decrease gradually to 5% in 2003 and remain at that level thereafter. 20 The assumed health care and dental cost trend rates have a significant effect on the amounts reported. A one-percentage-point change in these rates would have the following effects:
1-PERCENTAGE- 1-PERCENTAGE- POINT INCREASE POINT DECREASE - ----------------------------------------------------------------------- (In thousands) Effect on total of service and interest cost components in 1998 $102 $(79) Effect on postretirement benefit obligation as of December 31, 1998 $839 $(738)
NOTE 6 - LONG-TERM DEBT Long-term debt consisted of the following obligation:
DECEMBER 31 1998 1997 - ------------------------------------------------------------------------------ (In thousands) Chemical Financial Corporation: Term note payable to unaffiliated bank (5.76% at December 31, 1998) $8,000 $9,000 ==============================================================================
Principal payments on the term note payable are due as follows: $5,000,000 in June 2002 and $3,000,000 in June 2003. The Corporation, at its option, reduced this debt by $1,000,000 during both 1998 and 1997. Interest on the term note payable is computed based upon one of three alternative interest rate methods, which is elected by the Corporation at the beginning of each interest period for 1, 3, 6 or 12 month intervals. The three alternative interest rate methods are based upon the prime rate of the unaffiliated bank, the Eurodollar rate or the domestic certificate of deposit rate of the unaffiliated bank. The loan agreement includes various restrictions and covenants pertaining to capital, earnings and additional indebtedness and is secured by the stock of two of the Corporation's subsidiary banks. NOTE H - RESTRICTED ASSETS AND DIVIDEND LIMITATIONS OF SUBSIDIARY BANKS Banking regulations require that banks maintain cash reserve balances in vault cash, with the Federal Reserve Bank or with certain other qualifying banks. The aggregate average amount of such legal balances required to be maintained by the Corporation's subsidiary banks was $18.3 million for the year ended December 31, 1998. During 1998, the Corporation's subsidiary banks satisfied their legal reserve requirements almost exclusively by maintaining average vault cash balances in excess of their legal reserve requirements. Federal and state banking regulations place certain restrictions on the transfer of assets in the form of dividends, loans or advances from the bank subsidiaries to the Corporation. At December 31, 1998, substantially all of the assets of the bank subsidiaries were restricted from transfer to the Corporation in the form of loans or advances. Dividends from its bank subsidiaries are the principal source of funds for the Corporation. Under the most restrictive of these regulations, the aggregate amount of dividends which can be paid by the Corporation's bank subsidiaries to the parent company, without obtaining prior approval from bank regulatory agencies, was $71 million at January 1, 1999. Dividends paid to the Corporation by its banking subsidiaries totaled $12 million in 1998, $11.3 million in 1997 and $20.3 million in 1996. In addition to the statutory limits, the Corporation also considers the overall financial and capital position of each subsidiary prior to making any cash dividend decisions. 21 NOTE I - CAPITAL The Corporation and its subsidiary banks are subject to various regulatory capital requirements administered by the federal banking agencies. Under these capital requirements, the subsidiary banks must meet specific capital guidelines that involve quantitative measures of assets, liabilities and certain off-balance sheet items as calculated under regulatory accounting practices. In addition, capital amounts and classifications are subject to qualitative judgements by the regulators. Failure to meet minimum capital requirements can initiate certain mandatory - and possibly additional discretionary - actions by regulators that, if undertaken, could have a direct material effect on the Corporation's financial statements. Quantitative measures established by regulation to ensure capital adequacy require minimum ratios of Total and Tier I capital to risk-weighted assets and of Tier I capital to average assets ("Leverage ratio"). These capital guidelines assign risk weights to on- and off-balance sheet items in arriving at total risk-weighted assets. Minimum capital levels are based upon perceived risk of various asset categories and certain off-balance sheet instruments. At December 31, 1998 and 1997, the Corporation's and each of its banking subsidiaries' capital ratios exceeded the quantitative capital ratios required for an institution to be considered "well-capitalized." The table below, "Capital Analysis," compares the Corporation's and each of its significant subsidiaries' actual capital amounts and ratios with the quantitative measures established by regulation to ensure capital adequacy at December 31, 1998.
CAPITAL ANALYSIS RISK-BASED CAPITAL LEVERAGE TIER I TOTAL AMOUNT RATIO AMOUNT RATIO AMOUNT RATIO - ------------------------------------------------------------------------------------------------------------ (Dollars in millions) Corporation's capital $239 13% $235 27% $246 29% Required capital minimum 55 3 34 4 68 8 Required capital "well capitalized" definition 92 5 51 6 85 10 Chemical Bank and Trust Company's capital 85 14 85 35 88 36 Required capital minimum 19 3 10 4 20 8 Required capital "well capitalized" definition 31 5 15 6 24 10 Chemical Bank Michigan's capital 30 12 29 28 31 30 Required capital minimum 7 3 4 4 8 8 Required capital "well capitalized" definition 12 5 6 6 10 10 Chemical Bank Bay Area's capital 25 12 25 24 26 25 Required capital minimum 6 3 4 4 8 8 Required capital "well capitalized" definition 10 5 6 6 10 10 Chemical Bank Thumb Area's capital 22 12 21 28 22 29 Required capital minimum 5 3 3 4 6 8 Required capital "well capitalized" definition 9 5 5 6 8 10
22 NOTE J - STOCK OPTIONS The Chemical Financial Corporation stock option plan provides for grants of options, incentive stock options, stock appreciation rights, or a combination thereof. At December 31, 1998, there were a total of 522,391 shares available for the granting of future awards under the Corporation's 1997 plan. The plan provides that the option price shall not be less than the fair market value of common stock at the date of grant, options become exercisable between one and five years from the date of grant as determined by the Compensation Committee of the Board of Directors, all awards expire no later than ten years and one day after the date of grant, and options granted may be designated nonstatutory options or incentive stock options. The Corporation does not record expense as a result of the grant or exercise of stock options. Options granted may include an appreciation right that entitles the grantee to receive a number of shares of common stock without payment to the Corporation, calculated by dividing the difference between the option price and the market price of the total number of shares in the option at the expiration date of the option, by the market price of a single share. As of December 31, 1998, there were no outstanding options with stock appreciation rights. The activity in the Corporation's stock option plans during the three years ended December 31, 1998, was as follows:
WEIGHTED AVERAGE NUMBER OF EXERCISE SHARES PRICE - ---------------------------------------------------------------------------------------------- Outstanding - January 1, 1996 436,421 $13.92 Activity during 1996: Granted 133,610 26.30 Exercised (89,285) 12.35 Cancelled (1,106) 21.37 - ---------------------------------------------------------------------------------------------- Outstanding - December 31, 1996 479,640 17.58 Activity during 1997: Granted 8,859 31.14 Exercised (58,745) 11.10 Cancelled (3,182) 26.30 - ---------------------------------------------------------------------------------------------- Outstanding - December 31, 1997 426,572 18.68 Activity during 1998: Granted 125,000 33.25 Exercised (57,967) 12.19 Cancelled (1,738) 26.19 - ---------------------------------------------------------------------------------------------- Outstanding - December 31, 1998 491,867 $23.12 ==============================================================================================
The following table summarizes information about stock options outstanding at December 31, 1998:
OPTIONS OUTSTANDING OPTIONS EXERCISABLE - ------------------------------------------------------------------------------------------------ WEIGHTED WEIGHTED AVERAGE RANGE OF AVERAGE NUMBER EXERCISE AVERAGE EXERCISE NUMBER EXERCISE OUTSTANDING PRICE LIFE PRICES EXERCISABLE PRICE - ------------------------------------------------------------------------------------------------ 57,914 $ 9.71 0.97 $9.14 - $ 9.91 57,914 $ 9.71 68,780 12.29 2.17 12.29 68,780 12.29 231,314 23.92 6.22 19.47 - 26.30 188,454 23.54 8,859 31.14 8.82 31.14 5,578 31.14 125,000 33.25 9.82 33.25 -- -- - ------------------------------------------------------------------------------------------------ 491,867 $23.12 6.00 $9.14 - $33.25 320,726 $18.76 ================================================================================================ Weighted average remaining contractual life in years.
The Corporation does not recognize compensation cost in accounting for its stock option plans. If the Corporation had elected to recognize compensation cost for options granted in 1998, 1997 and 1996, based on the fair value of the options granted at the grant date, net income and earnings per share would have been reduced to the pro forma amounts indicated below (in thousands, except per share amounts):
1998 1997 1996 - ------------------------------------------------------------------------------- Net income - as reported $26,046 $23,889 $22,003 Net income - pro forma 25,923 23,551 21,958 Diluted earnings per share - as reported 1.91 1.76 1.62 Diluted earnings per share - pro forma 1.90 1.73 1.62 Basic earnings per share - as reported 1.93 1.78 1.64 Basic earnings per share - pro forma 1.92 1.75 1.64
The weighted average fair values of options granted during 1998, 1997 and 1996 were $6.96, $7.41 and $5.98 per share, respectively. The fair value of each option grant is estimated on the date of grant using the Black-Scholes option-pricing model with the following assumptions:
1998 1997 1996 - -------------------------------------------------------------------------------- Expected dividend yield 2.2% 2.2% 2.2% Expected stock volatility 16.9% 16.9% 13.0% Risk-free interest rate 4.78% 5.88% 6.13% Expected life of options - in years 6.5 6.5 6.3
23 NOTE K - COMMITMENTS AND OTHER MATTERS Commitments to extend credit are agreements to lend to a customer as long as there is no violation of any condition established in the contract. Commitments generally have fixed expiration dates or other termination clauses. Historically, the majority of the commitments have not been drawn upon and, therefore, do not necessarily represent future cash requirements. The Corporation evaluates each customer's creditworthiness on a case-by- case basis. The amount of collateral obtained, if deemed necessary, by the Corporation upon extension of credit is based on management's credit evaluation of the borrower. Collateral held varies but may include accounts receivable, inventory, property, plant and equipment and income producing commercial properties. Standby letters of credit are conditional commitments issued generally by the Corporation to guarantee the performance of a customer to a third party. Both arrangements have credit risk essentially the same as that involved in extending loans to customers and are subject to the Corporation's normal credit policies. The Corporation at any point in time also has approved but undisbursed loans. The majority of these undisbursed loans will convert to a booked loan within a three month period. Loan commitments, standby letters of credit and undisbursed loans were $114 million, $4.7 million and $58.4 million, respectively, at December 31, 1998 and $105.7 million, $4.9 million and $35.7 million, respectively, at December 31, 1997. The majority of the loan commitments and standby letters of credit outstanding as of December 31, 1998 expire one year from their contract date, except for $11.3 million which extend for more than five years. The Corporation's loan commitments, standby letters of credit and undisbursed loans have been estimated to have no realizable fair value, as historically the majority of the loan commitments have not been drawn upon and generally the Corporation does not receive fees in connection with these agreements. The Corporation has lease commitments on certain computer software that will require annual lease payments of approximately $412,000 per year through 2002. There were no other material lease rental payments or noncancelable lease commitments outstanding at December 31, 1998. Expenses included in the category of other operating expenses which were in excess of 1% of interest and noninterest income during the three year period ended December 31, 1998, were as follows: Stationery and supplies expense of $1,520,000 in 1998, $1,504,000 in 1997 and $1,644,000 in 1996. NOTE L - DISCLOSURES ABOUT FAIR VALUE OF FINANCIAL INSTRUMENTS Statement of Financial Accounting Standards No. 107, "Disclosures About Fair Value of Financial Instruments" (SFAS 107), requires disclosures about the estimated fair values of the Corporation's financial instruments. The Corporation utilized quoted market prices, where available, to compute the fair value of its financial instruments. In cases where quoted market prices were not available, the Corporation used present value methods to estimate the fair values of its financial instruments. These estimates of fair value are significantly affected by the assumptions made and, accordingly, do not necessarily indicate amounts which could be realized in a current market exchange. It is also the Corporation's general practice and intent to hold the majority of its financial instruments until maturity and, therefore, the Corporation does not expect to realize the estimated amounts disclosed. The following methods and assumptions were used by the Corporation in estimating its fair value disclosures for financial instruments: CASH AND CASH EQUIVALENTS: The carrying amounts reported in the consolidated statement of financial position for cash and federal funds sold approximate those assets' fair values. INTEREST-BEARING DEPOSITS WITH UNAFFILIATED BANKS: The carrying amounts reported in the consolidated statement of financial position for interest bearing deposits with unaffiliated banks approximate those assets' fair values. INVESTMENT SECURITIES: Fair values for investment securities are based on quoted market prices. LOANS RECEIVABLE: For variable interest rate loans that reprice frequently and have no significant change in credit risk, fair values are based on carrying values. The fair values for fixed interest rate loans are estimated using discounted cash flow analysis, using interest rates currently being offered for loans with similar terms to borrowers of similar credit quality. The resulting amounts are adjusted to estimate the effect of declines in the credit quality of borrowers since the loans were originated. 24 DEPOSIT LIABILITIES: The fair values of accounts without defined maturities, such as interest- and noninterest-bearing checking, savings and money fund accounts are equal to the amounts payable on demand. As of December 31, 1998 and December 31, 1997, the Corporation had total deposits without defined maturities totaling $1,006,971,000 and $934,676,000, respectively, for which SFAS 107 defined their fair values to be equal to their carrying amounts. Fair values for fixed interest rate certificates of deposit and other time deposits are based on the discounted value of contractual cash flows, using interest rates currently being offered for deposits of similar remaining maturities. The fair values for variable interest rate certificates of deposit and other time deposits approximate their carrying amounts. SHORT-TERM BORROWINGS: The carrying amounts of borrowings under repurchase agreements and other short-term borrowings approximate their fair values. LONG-TERM DEBT: The carrying amount of the Corporation's variable rate long-term debt approximates fair value. COMMITMENTS TO EXTEND CREDIT, STANDBY LETTERS OF CREDIT AND UNDISBURSED LOANS: The Corporation's loan commitments, standby letters of credit and undisbursed loans have no carrying amount and have been estimated to have no realizable fair value. Historically, a majority of the loan commitments have not been drawn upon and, generally, the Corporation does not receive fees in connection with these commitments. Estimates of fair value have not been made for items which are not defined by SFAS 107 as financial instruments, including such items as the Corporation's core deposit intangibles, mortgage servicing rights and the value of its trust and data processing operations. The Corporation believes it is impractical to estimate a representative fair value for these types of assets, even though management believes they add significant value to the Corporation. The following is a summary of previously described financial instruments reported in the consolidated statement of financial position for which fair values differ from carrying amounts as of December 31:
1998 1997 CARRYING FAIR CARRYING FAIR AMOUNT VALUE AMOUNT VALUE - ---------------------------------------------------------------------------------------------------- (In thousands) ASSETS: Investment securities $729,823 $733,406 $745,193 $747,632 Loans 880,222 892,812 828,241 842,582 LIABILITIES: Time deposits 547,300 549,792 541,165 540,745
25 NOTE M - PARENT COMPANY ONLY FINANCIAL INFORMATION Condensed financial statements of Chemical Financial Corporation (parent company) follow: CONDENSED STATEMENT OF FINANCIAL POSITION
DECEMBER 31 1998 1997 - ---------------------------------------------------------------------------------------------------------- (In thousands) ASSETS Cash on deposit at subsidiary bank $ 15,246 $ 15,228 Investment securities available for sale 3,701 1,806 Investments in bank subsidiaries 234,616 218,146 Investment in non-bank subsidiary 1,978 1,984 Goodwill 2,008 2,314 Other assets 1,391 1,662 - ---------------------------------------------------------------------------------------------------------- Total Assets $258,940 $241,140 ========================================================================================================== LIABILITIES AND SHAREHOLDERS' EQUITY Liabilities: Long-term debt $ 8,000 $ 9,000 Other liabilities 9,101 8,215 - ---------------------------------------------------------------------------------------------------------- Total Liabilities 17,101 17,215 Shareholders' equity 241,839 223,925 - ---------------------------------------------------------------------------------------------------------- Total Liabilities and Shareholders' Equity $258,940 $241,140 ==========================================================================================================
CONDENSED STATEMENT OF INCOME
YEARS ENDED DECEMBER 31 1998 1997 1996 - ---------------------------------------------------------------------------------------------------------- (In thousands) INCOME Cash dividends from bank subsidiaries $11,968 $11,348 $20,304 Cash dividends from non-bank subsidiary 656 102 360 Interest received from subsidiary bank 663 677 660 Other income 82 12 163 - ---------------------------------------------------------------------------------------------------------- Total Income 13,369 12,139 21,487 EXPENSES Interest on long-term debt 593 596 715 Operating expenses 2,088 1,818 1,500 Amortization of goodwill 305 305 305 - ---------------------------------------------------------------------------------------------------------- Total Expenses 2,986 2,719 2,520 - ---------------------------------------------------------------------------------------------------------- INCOME BEFORE INCOME TAXES AND EQUITY IN UNDISTRIBUTED NET INCOME OF SUBSIDIARIES 10,383 9,420 18,967 Federal income tax benefit 738 658 470 - ---------------------------------------------------------------------------------------------------------- 11,121 10,078 19,437 Equity in undistributed net income of: Bank subsidiaries 14,931 13,392 2,465 Non-bank subsidiary (6) 419 101 - ---------------------------------------------------------------------------------------------------------- Net Income $26,046 $23,889 $22,003 ==========================================================================================================
CONDENSED STATEMENT OF CASH FLOWS
YEARS ENDED DECEMBER 31 1998 1997 1996 - ----------------------------------------------------------------------------------------------------------- (In thousands) OPERATING ACTIVITIES Net income $26,046 $23,889 $22,003 Equity in undistributed net income of subsidiaries (14,925) (13,811) (2,566) Other 1,385 281 349 - ----------------------------------------------------------------------------------------------------------- Net Cash Provided by Operations 12,506 10,359 19,786 INVESTING ACTIVITIES Purchases of investment securities available for sale (1,725) (1,266) -- - ----------------------------------------------------------------------------------------------------------- Net Cash Used for Investing Activities (1,725) (1,266) -- FINANCING ACTIVITIES Capital contribution to bank subsidiary -- -- (9,000) Principal payments on long-term debt (1,000) (1,000) (2,000) Repurchases of common stock (37) (467) (1,035) Proceeds from subsidiary directors' stock purchase plan 295 259 264 Proceeds from exercise of stock options 338 386 339 Cash dividends paid (10,359) (9,003) (7,771) - ----------------------------------------------------------------------------------------------------------- Net Cash Used in Financing Activities (10,763) (9,825) (19,203) - ----------------------------------------------------------------------------------------------------------- Increase (Decrease) in Cash 18 (732) 583 Cash at beginning of year 15,228 15,960 15,377 - ----------------------------------------------------------------------------------------------------------- Cash at End of Year $15,246 $15,228 $15,960 ===========================================================================================================
26 REPORT OF ERNST & YOUNG LLP, INDEPENDENT AUDITORS To the Board of Directors Chemical Financial Corporation We have audited the accompanying consolidated statement of financial position of Chemical Financial Corporation and subsidiaries as of December 31, 1998 and 1997, and the related consolidated statements of income, changes in shareholders' equity, and cash flows for each of the three years in the period ended December 31, 1998. These financial statements are the responsibility of the Corporation's management. Our responsibility is to express an opinion on these financial statements based on our audits. We conducted our audits in accordance with generally accepted auditing standards. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion. In our opinion, the financial statements referred to above present fairly, in all material respects, the consolidated financial position of Chemical Financial Corporation and subsidiaries at December 31, 1998 and 1997, and the consolidated results of their operations and their cash flows for each of the three years in the period ended December 31, 1998 in conformity with generally accepted accounting principles. /s/ Ernst & Young LLP Detroit, Michigan January 19, 1999 27 MANAGEMENT'S DISCUSSION AND ANALYSIS FINANCIAL HIGHLIGHTS The following discussion and analysis is intended to cover the significant factors affecting Chemical Financial Corporation's (the Corporation) consolidated statements of financial position and income, included herein. It is designed to provide shareholders with a more comprehensive review of the operating results and financial position of the Corporation than could be obtained from an examination of the financial statements alone. This discussion should be read in conjunction with the financial highlights on page 1, and the consolidated financial statements and notes thereto beginning on page 11. On December 16, 1998, the Corporation paid a 5 for 4 stock split to shareholders of record on December 2, 1998. All per share amounts, and shares outstanding where appropriate, have been adjusted for this stock split. MERGERS AND ACQUISITIONS The primary method of expansion into new banking markets has been through acquisitions of other financial institutions and bank branches. The following is a summary of the Corporation's merger and acquisition activity during the three-year period ended December 31, 1998. On November 20, 1998, the Corporation acquired a branch banking office in Albion, Michigan from Great Lakes National Bank Michigan. The branch had total deposit liabilities of $11 million as of that date and was consolidated with an existing affiliate. On December 31, 1996, the Corporation acquired Arbury & Stephenson, Inc. (A&S), a property and casualty insurance agency headquartered in Midland, Michigan. The merger was effected through an exchange of shares of the Corporation's common stock. A&S was merged into an insurance subsidiary of the Corporation's lead bank and offers a variety of personal and corporate insurance products, through the "Chemical Financial Insurance Agency." On May 1, 1996, the Corporation acquired State Savings Bancorp, Inc. (SSBI), headquartered in Caro, Michigan. SSBI operated one bank, State Savings Bank of Caro, with offices in Caro and Fairgrove. The Corporation issued 689,062 shares of the Corporation's common stock for all of the outstanding stock of SSBI. As of May 1, 1996, SSBI had total assets of approximately $65 million. NET INCOME Net income in 1998 was $26.046 million, or $1.91 per share, compared to net income of $23.889 million, or $1.76 per share in 1997. Net income in 1998 represented a 9% increase over 1997 net income, while 1998 earnings per share represented an 8.5% increase over 1997 earnings per share. Net operating income has increased at an average annual compound rate of 7.5% during the five year period ended December 31, 1998, while operating earnings per share has grown at an average annual compound rate of 7.2% over that same period. The Corporation's return on average assets was 1.44% in 1998, 1.38% in 1997 and 1.30% in 1996. The Corporation's return on average shareholders' equity was 11.3% in 1998, 11.1% in 1997 and 10.9% in 1996. DEPOSITS Total deposits as of December 31, 1998 were $1.554 billion, up $78 million, or 5.3%, from total deposits of $1.476 billion as of December 31, 1997. The majority of the growth in deposits during 1998 was in the noninterest- bearing and interest-bearing checking account products offered by the Corporation. This growth was primarily achieved through enhanced cross- selling efforts by bank personnel. Total deposits increased $46 million, or 3.2%, during 1997. The 1997 increase was attributable to the transfer of Trust Department assets from a nonaffiliated financial services organization to a new money market savings account at the Corporation's lead subsidiary bank, Chemical Bank and Trust Company. This new account provides Trust Department customers a market interest yield with the added benefit of being covered by deposit insurance provided by the Federal Deposit Insurance Corporation, as well as being secured by U. S. Treasury securities. The growth of the Corporation's deposits continues to be impacted by competition for customer deposits from other investment products. Mutual funds and various annuity products are clearly the two most significant products in competition for customer deposits. These products are sold by a wide spectrum of organizations, including nonbank financial institutions and other institutions, such as brokerage and insurance companies. In response to this increased competition for customers' bank deposits, the Corporation expanded its sales and marketing efforts of mutual fund and annuity investment products during 1996. The Corporation's subsidiary banks, through "CFC Investment Centers," offer a broad array of mutual funds, annuity products and market securities through alliances with Security First Group and BISYS Brokerage Services. CFC Investment Centers offer customers a complete spectrum of investment products and service capabilities, backed by strong technical innovations. During 1998, customers purchased $16 million of annuity and mutual fund investments through the CFC Investment Centers. In addition, the Trust Department of Chemical Bank and Trust Company offers customers a number of investment products and services. Two of these products are "ChemVest Advantage," which provides customers with professional assistance in spreading their funds among a variety of 28 TABLE 1. FIVE-YEAR INCOME STATEMENT TAX EQUIVALENT BASIS AS A PERCENTAGE OF AVERAGE TOTAL ASSETS
YEARS ENDED DECEMBER 31 1998 1997 1996 1995 1994 - --------------------------------------------------------------------------------------------------------------------------- INTEREST INCOME Interest and fees on loans 4.12% 4.06% 4.01% 3.90% 3.75% Interest on investment securities 2.42 2.54 2.49 2.49 2.26 Interest on short-term investments .27 .27 .28 .30 .21 - --------------------------------------------------------------------------------------------------------------------------- TOTAL INTEREST INCOME 6.81 6.87 6.78 6.69 6.22 INTEREST EXPENSE Interest on deposits 2.61 2.68 2.62 2.62 2.20 Interest on short-term borrowings .08 .08 .07 .09 .07 Interest on long-term debt .03 .03 .04 .05 .04 - --------------------------------------------------------------------------------------------------------------------------- TOTAL INTEREST EXPENSE 2.72 2.79 2.73 2.76 2.31 - --------------------------------------------------------------------------------------------------------------------------- NET INTEREST INCOME 4.09 4.08 4.05 3.93 3.91 Provision for possible loan losses .05 .06 .07 .06 .07 NONINTEREST INCOME Trust department income .20 .19 .17 .16 .16 Service charges and fees .55 .53 .51 .52 .46 Gains on sales of loans .08 .01 .01 .03 .01 Other .03 .03 .03 .03 .05 - --------------------------------------------------------------------------------------------------------------------------- TOTAL NONINTEREST INCOME .86 .76 .72 .74 .68 OPERATING EXPENSES Salaries, wages and benefits 1.60 1.58 1.60 1.55 1.53 Occupancy expense .24 .25 .25 .24 .24 Equipment expense .17 .18 .17 .17 .17 Other .67 .64 .65 .74 .80 - --------------------------------------------------------------------------------------------------------------------------- TOTAL OPERATING EXPENSES 2.68 2.65 2.67 2.70 2.74 - --------------------------------------------------------------------------------------------------------------------------- INCOME BEFORE INCOME TAXES 2.22 2.13 2.03 1.91 1.78 Federal income taxes .71 .67 .65 .59 .54 Tax equivalent adjustment .07 .08 .08 .08 .09 - --------------------------------------------------------------------------------------------------------------------------- NET INCOME 1.44% 1.38% 1.30% 1.24% 1.15% =========================================================================================================================== AVERAGE TOTAL ASSETS In thousands $1,804,022 $1,726,960 $1,688,214 $1,654,640 $1,659,360 =========================================================================================================================== Taxable equivalent basis using a federal income tax rate of 35%.
institutional mutual funds and "ChemSelect-IRA," which allows customers to choose their own asset allocation and risk tolerance among a variety of mutual funds without any sales charges or transaction fees. As of December 31, 1998, these two Trust Department investment products had balances totaling $28 million. ASSETS Total assets of the Corporation were $1.873 billion as of December 31, 1998, up $108 million, or 6.1%, over total assets of $1.765 billion as of December 31, 1997. CASH DIVIDENDS Cash dividends paid per share in 1998 of $.77 represented a 14.6% increase over cash dividends paid per share in 1997 of $.67. The Corporation has paid regular cash dividends every quarter since it was organized as a bank holding company in 1973. The Corporation's annual cash dividends per share over the past five years, adjusted for all stock dividends and stock splits, were as follows:
1998 1997 1996 1995 1994 - --------------------------------------------------------------------------------------------- Annual Dividend $.77 $.67 $.58 $.49 $.41
Cash dividends per share in 1997 represented a 15.5% increase over cash dividends per share in 1996, while cash dividends per share in 1996 represented a 17.6% increase over cash dividends paid in 1995. The compound annual growth rate of the Corporation's cash dividends per share over the past five and ten year periods ended December 31, 1998, was 15.9% and 12.3%, respectively. The earnings of the Corporation's subsidiaries are the principal source of funds to pay cash dividends to shareholders. Cash dividends are dependent upon the earnings of the Corporation's subsidiaries, as well as capital requirements, regulatory restraints and other factors affecting each of the Corporation's subsidiary banks. continued on next page 29 FINANCIAL HIGHLIGHTS - CONTINUED BUSINESS OF THE CORPORATION The Corporation is a bank holding company with its business concentrated in a single industry segment - commercial banking. The Corporation, through its ten banking subsidiaries, offers a full range of commercial banking services. These banking services include accepting deposits, business and personal checking accounts, savings and individual retirement accounts, time deposit instruments, electronically accessed banking products, residential and commercial real estate financing, commercial lending, consumer financing, debit cards, safe deposit box services, money transfer services, automated teller machines, access to insurance products and corporate and personal trust services. The Corporation also has a data processing subsidiary. This subsidiary provides data processing services to the Corporation's ten subsidiary banks and to outside customers. The data processing services provided to the Corporation's subsidiaries represented 87% of total revenue of the data processing subsidiary in 1998, 84% in 1997 and 76% in 1996. The principal markets for the Corporation's commercial banking services are communities within Michigan in which the Corporation's subsidiaries are located and the areas immediately surrounding these communities. As of December 31, 1998, the Corporation served 55 communities through 86 banking offices in 24 counties, located generally across the mid-section of Michigan's lower peninsula. In addition to the banking offices, the Corporation operated 85 automated teller machines, both on and off bank premises, as of December 31, 1998. The principal sources of revenues for the Corporation are interest and fees on loans, which accounted for 54% of total revenues in 1998, 1997 and 1996. Interest on investment securities is also a significant source of revenue, accounting for 31% of total revenues in 1998 and 33% of total revenues in 1997 and 1996. Chemical Bank and Trust Company (CB&T), the Corporation's largest subsidiary and lead bank headquartered in Midland, Michigan, represented 28% of total loans and 32% of total deposits as of December 31, 1998. CB&T broadened the insurance products offered to its customers through further entry into the insurance industry. On December 31, 1996, CB&T acquired a small property and casualty insurance agency in Midland, Michigan. In January 1997, a title insurance company formed by CB&T began operations. NET INTEREST INCOME Interest income is the total amount earned on funds invested in loans, investment securities and money market instruments, such as federal funds sold. Interest expense is the amount of interest paid on interest-bearing checking accounts, savings and time deposits, as well as on short- and long-term debt. Net interest income, on a fully taxable equivalent (FTE) basis, is the difference between interest income and interest expense and reflects adjustments made to the yields on tax-exempt assets in order to analyze tax-exempt income and fully taxable income on a comparable basis. The net interest margin is net interest income (FTE) as a percentage of average earning assets. Net interest spread is the difference between the average yield on earning assets and the average cost of interest-bearing liabilities. The single most important component in analyzing the results of the Corporation's operations is net interest income. Net interest income (FTE) comprised 82.5% of net revenues in 1998, compared to 84.3% in 1997 and 84.9% in 1996. Net interest income is influenced by a variety of factors, including changes in the volume of earning assets, changes in the mix of earning assets and interest-bearing liabilities, the proportion of earning assets that are funded by noninterest-bearing liabilities (demand deposits) and equity capital, market rates of interest and variations in interest sensitivity in the differing types of interest-earning assets and interest- bearing liabilities. Some of these factors are controlled to a certain extent by management policies and actions. However, conditions beyond management's control also have an impact on changes in net interest income. These conditions include changes in market interest rates, the strength of credit demands by customers, competition from other financial institutions, the growth of deposit accounts at nonbank financial competitors and the continued growth in annuity and mutual fund investments. Table 2 presents for 1998, 1997 and 1996 the average daily balances of the Corporation's major assets and liabilities, interest income and expense on a FTE basis, average interest rates earned and paid on the Corporation's assets and liabilities, net interest income (FTE), net interest spread (FTE) and net interest margin. Net interest income (FTE) in 1998 was $73.839 million, up $3.435 million, or 4.9%, over 1997 net interest income (FTE) of $70.404 million. The increase in net interest income during 1998 was primarily attributable to increases in average loans, noninterest- bearing deposits and shareholders' equity. During 1998, average loans increased $59 million, or 7.2%, average noninterest-bearing deposits increased $26 million, or 11.6%, and average shareholders' equity increased $14 million, or 6.5%. 30 TABLE 2. AVERAGE BALANCES, TAX EQUIVALENT INTEREST AND EFFECTIVE YIELDS AND RATES* (Dollars in Thousands)
YEARS ENDED DECEMBER 31 1998 1997 1996 TAX EFFECTIVE TAX EFFECTIVE TAX EFFECTIVE AVERAGE EQUIVALENT YIELD/ AVERAGE EQUIVALENT YIELD/ AVERAGE EQUIVALENT YIELD/ BALANCE INTEREST RATE BALANCE INTEREST RATE BALANCE INTEREST RATE - ---------------------------------------------------------------------------------------------------------------------------------- ASSETS Earning Assets: Loans $ 879,886 $ 74,390 8.45% $ 820,451 $ 70,198 8.56% $ 792,209 $ 67,767 8.55% Taxable investment securities 683,567 40,602 5.94 672,347 40,554 6.03 661,401 38,882 5.88 Non-taxable investment securities 39,389 3,073 7.80 40,129 3,199 7.97 39,542 3,249 8.22 Federal funds sold 88,883 4,809 5.41 86,045 4,699 5.46 86,721 4,575 5.28 Interest-bearing deposits with unaffiliated banks 2,055 111 5.40 415 33 7.95 1,905 136 7.14 - ---------------------------------------------------------------------------------------------------------------------------------- Total interest income/ total earning assets 1,693,780 122,985 7.26 1,619,387 118,683 7.33 1,581,778 114,609 7.25 Less: Allowance for possible loan losses (17,762) (17,032) (16,296) Other assets: Cash and due from banks 82,481 78,216 75,828 Premises and equipment 19,804 19,838 20,303 Accrued income and other assets 25,719 26,551 26,601 - ---------------------------------------------------------------------------------------------------------------------------------- Total Assets $1,804,022 $1,726,960 $1,688,214 ================================================================================================================================== LIABILITIES AND EQUITY Interest-Bearing Liabilities: Interest-bearing demand deposits 237,799 5,191 2.18% $ 233,004 $ 5,408 2.32% $ 234,900 $ 5,359 2.28% Savings deposits 472,212 12,876 2.73 442,195 11,545 2.61 430,783 10,305 2.39 Time deposits 549,414 28,983 5.28 556,259 29,361 5.28 553,993 28,260 5.17 Short-term borrowed funds 41,727 1,503 3.60 34,271 1,363 3.98 31,455 1,163 3.70 Long-term debt 8,994 593 6.59 9,236 596 6.45 10,976 715 6.51 - ---------------------------------------------------------------------------------------------------------------------------------- Total interest expense/total interest-bearing liabilities 1,310,146 49,146 3.75 1,274,965 48,279 3.79 1,262,107 46,162 3.66 Noninterest-bearing deposits 247,275 221,652 209,500 - ---------------------------------------------------------------------------------------------------------------------------------- Total deposits and borrowed funds 1,557,421 1,496,617 1,471,607 Accrued expenses and other liabilities 16,556 14,386 15,182 Shareholders' equity 230,045 215,957 201,425 - ---------------------------------------------------------------------------------------------------------------------------------- Total Liabilities and Equity $1,804,022 $1,726,960 $1,688,214 ================================================================================================================================== Interest Spread (Average yield earned minus average rate paid) 3.51% 3.54% 3.59% ================================================================================================================================== Net Interest Income (FTE) $ 73,839 $ 70,404 $ 68,447 ================================================================================================================================== Net Interest Margin (Net interest income (FTE)/Total average earning assets) 4.36% 4.35% 4.33% ================================================================================================================================== Taxable equivalent basis using a federal income tax rate of 35%. Nonaccrual loans are included in average balances reported and are used to calculate yields.
Average interest rates earned and paid on the Corporation's assets and liabilities did not change significantly during 1998, resulting in modest changes in the Corporation's net interest spread and net interest margin during 1998. During 1998, the average yield on interest earning assets decreased 7 basis points to 7.26%, while the average cost of interest-bearing liabilities decreased 4 basis points to 3.75%. These decreases resulted in a 3 basis point decrease in the net interest spread to 3.51%, while the net interest margin increased 1 basis point during 1998 to 4.36%. The slight decrease in both the average yield on earning assets and the average rate paid on interest-bearing liabilities was attributable to the overall decline in market interest rates. continued on next page 31 NET INTEREST INCOME - CONTINUED Net interest income (FTE) increased $1.957 million, or 2.9%, during 1997. The increase in net interest income during 1997 was also primarily attributable to increases in average loans, noninterest-bearing deposits and shareholders' equity. During 1997, average loans increased $28 million, or 3.6%, average noninterest-bearing deposits increased $12 million, or 5.8%, and average shareholders' equity increased $14.5 million, or 7.2%. Average interest rates earned and paid on the Corporation's assets and liabilities did not change significantly during 1997. The net interest spread decreased 5 basis points during 1997 to 3.54%, while the net interest margin increased 2 basis points to 4.35%. Net interest income (FTE) increased $3.34 million, or 5.1%, in 1996. This increase was primarily attributable to an increase in loans and an increase in the average yield of investment securities. During 1996, average loans increased $48 million, or 6.4%, while the average yield on investment securities increased 34 basis points. The net interest spread increased 8 basis points during 1996 to 3.59%, while the net interest margin increased 13 basis points to 4.33%. Table 3 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. During 1998, the increase in the volume and change in the mix of interest- earning assets and interest-bearing liabilities accounted for a $5.31 million increase in net interest income (FTE), while changes in average interest rates earned and paid on assets and liabilities resulted in a $1.875 million decrease in net interest income. The increase due to changes in the volume and mix of interest-earning assets and interest-bearing liabilities was primarily attributable to the increases in average loans, noninterest-bearing deposits and shareholders' equity. The decrease due to changes in interest rates was primarily attributable to the refinancing of real estate loans during 1998 as mortgage interest rates declined. The increase in net interest income (FTE) in 1997 of $1.957 million, or 2.9%, was mostly attributable to increases in the volume and change in the mix of interest-earning assets and interest-bearing liabilities; primarily due to a $28 million, or 3.6%, increase in average loans. LOANS The Corporation's ten banking subsidiaries are full service community banks, therefore the acceptance and management of credit risk is an integral part of the Corporation's business. The Corporation maintains a conservative loan policy and strict credit underwriting standards. These standards include the granting of loans only within the Corporation's market areas. The Corporation's lending markets generally consist of small cities across mid-Michigan. The Corporation has no foreign loans nor any loans to finance highly leveraged transactions. The Corporation's lending philosophy is implemented through strong administrative and reporting controls at the subsidiary bank level, with additional oversight at the holding company level. The Corporation maintains a centralized independent loan review function at the holding company level, which monitors asset quality at each of the Corporation's subsidiary banks. The Corporation experiences competition for commercial loans from larger regional banks located both in and outside the Corporation's market areas, and from other community banks located both within and in the areas surrounding the Corporation's lending markets. The Corporation experiences competition for consumer loans from larger regional banks, community banks, local credit unions and finance companies. The Corporation's competition for residential mortgage loans includes community banks, larger regional banks, savings associations, credit unions and mortgage companies. The competition for residential mortgage loans has increased over the last few years as mortgage lending companies have expanded their marketing efforts. The Corporation's loan portfolio is well diversified geographically, as well as along industry lines, and, therefore, is reasonably sheltered from adverse economic impact in any one industry or geographic area. An additional strength of the Corporation's loan portfolio is that as of December 31, 1998, approximately 54% of the loan portfolio was comprised of credits granted to consumers in the form of residential mortgage loans, home equity loans and lines of credit secured by first and second mortgages. Total loans as of December 31, 1998 were $898.3 million, an increase of $52.7 million, or 6.2%, over total loans of $845.6 million as of December 31, 1997. The increase in total loans during 1998 was primarily attributable to increases in commercial and consumer loans. Commercial loans increased 15.2%, while consumer loans increased 29.6% during 1998. Commercial loans totaled $139 million as of December 31, 1998, an increase of $18.4 million, or 15.2%, over total commercial loans as of December 31, 1997 of $120.7 million. The growth in the commercial loan portfolio during 1998 was the result of enhanced sales and marketing efforts within the Corporation's market areas. Commercial loans decreased $1.9 million, or 1.5%, in 1997 and $2.3 million, or 1.8%, during 1996. Commercial loans represented approximately 16%, 14% and 15% of total loans outstanding as of December 31, 1998, 1997 and 1996, respectively. 32 TABLE 3. VOLUME AND RATE VARIANCE ANALYSIS (In Thousands)
1998 COMPARED TO 1997 1997 COMPARED TO 1996 INCREASE (DECREASE) INCREASE (DECREASE) DUE TO CHANGES IN COMBINED DUE TO CHANGES IN COMBINED AVERAGE AVERAGE INCREASE AVERAGE AVERAGE INCREASE VOLUME YIELD/RATE (DECREASE) VOLUME YIELD/RATE (DECREASE) - -------------------------------------------------------------------------------------------------------------------------------- CHANGES IN INTEREST INCOME ON EARNING ASSETS: Loans $5,565 $(1,373) $4,192 $2,179 $ 252 $2,431 Taxable investment securities 671 (623) 48 650 1,022 1,672 Non-taxable investment securities (58) (68) (126) 48 (98) (50) Federal funds sold 154 (44) 110 (36) 160 124 Interest-bearing deposits with unaffiliated banks 92 (14) 78 (103) -- (103) - -------------------------------------------------------------------------------------------------------------------------------- Total change in interest income on earning assets 6,424 (2,122) 4,302 2,738 1,336 4,074 CHANGES IN INTEREST EXPENSE ON INTEREST-BEARING LIABILITIES: Interest-bearing demand deposits 303 (520) (217) (43) 92 49 Savings deposits 909 422 1,331 279 961 1,240 Time deposits (359) (25) (384) 117 630 747 Short-term borrowed funds 277 (137) 140 109 91 200 Long-term debt (16) 13 (3) (112) (7) (119) - -------------------------------------------------------------------------------------------------------------------------------- Total change in interest expense on interest-bearing liabilities 1,114 (247) 867 350 1,767 2,117 - -------------------------------------------------------------------------------------------------------------------------------- TOTAL INCREASE (DECREASE) IN NET INTEREST INCOME (FTE) $5,310 $(1,875) $3,435 $2,388 $ (431) $1,957 ================================================================================================================================ The changes in net interest income (FTE) due to both volume and rate have been allocated to volume and rate changes in proportion to the relationship of the absolute dollar amounts of the change in each. Taxable equivalent basis using a federal income tax rate of 35%.
TABLE 4. SUMMARY OF LOANS AND LOAN LOSS EXPERIENCE (Dollars in Thousands)
YEARS ENDED DECEMBER 31 1998 1997 1996 1995 1994 - ------------------------------------------------------------------------------------------------------------------- Distribution of Loans: Commercial and agricultural loans $ 139,051 $ 120,696 $ 122,584 $ 124,861 $ 128,923 Real estate construction loans 35,039 31,143 24,791 16,195 19,255 Real estate mortgage loans 520,972 536,938 510,193 472,454 465,721 Consumer loans 203,231 156,823 150,085 147,068 146,964 - ------------------------------------------------------------------------------------------------------------------- Total loans outstanding at year end $ 898,293 $ 845,600 $ 807,653 $ 760,578 $ 760,863 =================================================================================================================== Summary of Changes in the Allowance for Possible Loan Losses: Allowance for possible loan losses at beginning of year $ 17,359 $ 16,607 $ 15,886 $ 15,295 $ 14,583 Loans charged off: Commercial and agricultural (111) (114) (250) (433) (317) Real estate construction -- -- -- -- -- Real estate mortgage -- (26) (55) (3) (76) Consumer (438) (480) (386) (230) (237) - ------------------------------------------------------------------------------------------------------------------- Total loan charge-offs (549) (620) (691) (666) (630) Recoveries of loans previously charged off: Commercial and agricultural 118 193 92 60 58 Real estate construction -- -- -- -- -- Real estate mortgage 29 10 24 28 40 Consumer 150 167 168 104 145 - ------------------------------------------------------------------------------------------------------------------- Total loan recoveries 297 370 284 192 243 - ------------------------------------------------------------------------------------------------------------------- Net loan charge-offs (252) (250) (407) (474) (387) Provision for loan losses 965 1,002 1,128 1,065 1,099 - ------------------------------------------------------------------------------------------------------------------- Allowance for possible loan losses at year end $ 18,071 $ 17,359 $ 16,607 $ 15,886 $ 15,295 =================================================================================================================== Ratio of net charge-offs during the year to average loans outstanding .03% .03% .05% .06% .05% =================================================================================================================== Ratio of allowance for possible loan losses at year end to total loans outstanding at year end 2.01% 2.05% 2.06% 2.09% 2.01% ===================================================================================================================
continued on next page 33 LOANS - CONTINUED Real estate mortgage loans, including real estate construction loans, comprise the majority of the Corporation's loan portfolio. As of December 31, 1998, 1997 and 1996, total real estate mortgage loans, including real estate construction loans, were $556 million, $568.1 million and $535 million, respectively. Real estate mortgage loans, including real estate construction loans, decreased $12.1 million, or 2.1%, during 1998, due primarily to refinancing of customers with balloon mortgage loans to longer term fixed interest rate mortgages. These longer term mortgages were sold in the secondary mortgage lending market. The volume of mortgage loans refinanced during 1998 was higher than historical prepayment percentages due to the decline in interest rates on longer term residential mortgage loans. Real estate mortgage loans, including real estate construction loans, increased $33.1 million, or 6.2%, during 1997, and $46.3 million, or 9.5%, during 1996. Real estate mortgage loans, including real estate construction loans, as a percentage of total loans, were 62% as of December 31, 1998, compared to 67% as of December 31, 1997 and 66% as of December 31, 1996. Approximately 82% of the total real estate mortgage loan portfolio was secured by residential real estate as of December 31, 1998 and 1997. The Corporation manages the interest rate risk on the residential real estate mortgage loan portfolio through the promotion of balloon mortgage products. As of December 31, 1998, balloon and other variable rate residential mortgage loans represented approximately 50% of the total residential mortgage loan portfolio, repriceable three, five or eight years from the mortgage origination date. The eight-year balloon product was introduced during 1996. The Corporation originated $118 million of long-term fixed interest rate residential mortgage loans during 1998, which were sold in the secondary mortgage market. This compares with $39 million of residential mortgage loans originated during 1997 and $12 million of residential mortgage loans originated during 1996, which were sold in the secondary mortgage market. During both 1998 and 1997, it was the Corporation's practice to generally sell residential mortgage loans with original maturities of fifteen years and longer in the secondary market. In 1996, it was the Corporation's general practice to sell only those residential real estate mortgage loans with original maturities greater than fifteen years in the secondary market. The significant increase in the volume of long-term fixed interest rate residential loans being originated in 1998 can be attributed to the health of the economy and the decrease in mortgage interest rates. During 1998, interest rates on longer term residential mortgages decreased approximately 100 basis points from 1997 levels. The decline in mortgage interest rates resulted in an increased volume in the long-term fixed interest rate mortgage loan products by customers seeking new residential mortgage loans and qualifying customers refinancing balloon mortgages. As of December 31, 1998, the Corporation was servicing $181 million of residential mortgage loans that had been originated by the Corporation in its market areas and subsequently sold in the secondary mortgage market. Consumer loans totaled $203.2 million as of December 31, 1998, compared to $156.8 million as of December 31, 1997 and $150.1 million as of December 31, 1996. Consumer loans represented approximately 23% of total loans outstanding as of December 31, 1998, and 19% as of December 31, 1997 and 1996. Consumer loans increased $46.4 million, or 29.6%, during 1998. The increase in 1998 was attributable to three consumer loan promotions. These promotions were limited time offers of consumer loans at special interest rates to qualifying borrowers. These three loan promotions generated approximately $94 million of new consumer loans during 1998. The 1998 consumer loan promotions were the Corporation's affiliate banks' eighth year of offering special interest rates on consumer loans during promotion periods. Historically, the average life of the Corporation's consumer loan portfolio has been approximately three years. This short average life and the success of the consumer loan promotions have resulted in significant reductions each year in consumer loan balances through loan payments and payoffs. Consequently, during each of the last three years, the consumer loan portfolio did not increase by the amount of new loans generated during the loan promotion periods in these years. Table 5 presents the maturity distribution of commercial and agricultural loans, real estate construction and nonresidential real estate mortgage loans. These loans represented approximately 29% of total loans as of December 31, 1998 and 1997. The percentage of these loans maturing within one year was 55% at December 31, 1998, compared to 49% at December 31, 1997. The percentage of these loans maturing beyond five years remained low at 9% as of December 31, 1998, compared to 12% at December 31, 1997. Of those loans with maturities beyond one year, the percentage of loans with variable interest rates was 20% at December 31, 1998, compared to 30% at December 31, 1997. The decline in the percentage of variable rate loans with maturities beyond one year has continued as a result of a strong customer demand to convert variable interest rate loans to fixed interest rates as interest rates have decreased. It is management's opinion that these loan maturities and the mix between loans with fixed and variable interest rates remain at acceptable levels to provide the Corporation sufficient flexibility in maintaining a balance between interest rate- sensitive assets and liabilities. 34 TABLE 5. COMPARISON OF LOAN MATURITIES AND INTEREST SENSITIVITY (Dollars in thousands)
AS OF DECEMBER 31, 1998 AS OF DECEMBER 31, 1997 DUE IN DUE IN - ---------------------------------------------------------------------------------------------------------------------------------- 1 YEAR 1 TO 5 OVER 5 1 YEAR 1 TO 5 OVER 5 OR LESS YEARS YEARS TOTAL OR LESS YEARS YEARS TOTAL - ---------------------------------------------------------------------------------------------------------------------------------- Loan Maturities: Commercial and agricultural $ 81,076 $ 46,837 $11,138 $139,051 $ 75,885 $40,005 $ 4,806 $120,696 Real estate construction 24,367 6,470 4,202 35,039 19,669 6,435 5,039 31,143 Nonresidential real estate mortgage 39,513 43,693 8,469 91,675 25,351 49,084 20,747 95,182 - ---------------------------------------------------------------------------------------------------------------------------------- Total $144,956 $ 97,000 $23,809 $265,765 $120,905 $ 95,524 $30,592 $247,021 ================================================================================================================================== Percent of Total 55% 36% 9% 100% 49% 39% 12% 100% ==================================================================================================================================
AS OF DECEMBER 31, 1998 AS OF DECEMBER 31, 1997 - ---------------------------------------------------------------------------------------------------------------------------------- Interest Sensitivity: Above loans maturing after one year which have: Fixed interest rates $ 96,761 80% $ 88,256 70% Variable interest rates 24,048 20 37,860 30 - ---------------------------------------------------------------------------------------------------------------------------------- Total $120,809 100% $126,116 100% ==================================================================================================================================
NONPERFORMING LOANS Nonperforming loans include loans accounted for on a nonaccrual basis, accruing loans contractually past due 90 days or more as to interest or principal payments and other loans whose terms have been renegotiated to provide for a reduction of interest or principal because of a deterioration in the financial position of the borrower. The Corporation's practice is to immediately charge to the allowance for possible loan losses specifically identified credit losses. This determination is made for each loan at the time of transfer to nonperforming status, after giving consideration to collateral value and the borrower's ability to repay the loan principal. Nonaccrual loans were $1.79 million as of December 31, 1998, compared to $1.78 million as of December 31, 1997 and $1.34 million as of December 31, 1996. Nonaccrual loans as a percentage of total loans were .20%, .21% and .17%, as of December 31, 1998, 1997 and 1996, respectively. Accruing loans past due 90 days or more were $1.32 million as of December 31, 1998, compared to $1.13 million as of December 31, 1997 and $.54 million as of December 31, 1996. Total nonperforming loans were $3.1 million, or .35% of total loans, as of December 31, 1998; compared to $3.05 million, or .36% of total loans, as of December 31, 1997 and $1.9 million, or .23% of total loans, as of December 31, 1996. PROVISION FOR POSSIBLE LOAN LOSSES The provision for possible loan losses ("provision") is the amount added to the allowance for possible loan losses ("allowance") on a monthly basis to absorb potential loan losses. The allowance is maintained at a level considered by management to be adequate to absorb loan losses inherent in the loan portfolio. This evaluation is based on a continuous review of the loan portfolio, both individually and by category, and includes consideration of changes in the TABLE 6. SUMMARY OF NONPERFORMING LOANS (In thousands)
DECEMBER 31 1998 1997 1996 1995 1994 - ------------------------------------------------------------------------------------------------------------------------ Loans accounted for on a nonaccrual basis $ 1,785 $ 1,783 $ 1,341 $ 1,658 $ 2,682 Accruing loans contractually past due 90 days or more as to interest or principal payments: Commercial, agricultural 39 447 7 118 95 Real estate construction -- -- -- -- -- Real estate mortgage 1,145 557 271 747 182 Consumer 132 121 261 104 91 - ------------------------------------------------------------------------------------------------------------------------ 1,316 1,125 539 969 368 Renegotiated loans -- 139 -- 84 148 - ------------------------------------------------------------------------------------------------------------------------ Total $ 3,101 $ 3,047 $ 1,880 $ 2,711 $ 3,198 ======================================================================================================================== Interest income totaling $79,172 was recorded on the nonaccrual loans in 1998.
Additional interest income of $144,870 would have been recorded during 1998 on these loans had they been current in accordance with their original terms. continued on next page 35 PROVISION FOR POSSIBLE LOAN LOSSES - CONTINUED TABLE 7. ALLOCATION OF THE ALLOWANCE FOR POSSIBLE LOAN LOSSES (Dollars in thousands)
DECEMBER 31 1998 1997 1996 1995 1994 PERCENT PERCENT PERCENT PERCENT PERCENT OF LOANS OF LOANS OF LOANS OF LOANS OF LOANS IN EACH IN EACH IN EACH IN EACH IN EACH CATEGORY CATEGORY CATEGORY CATEGORY CATEGORY TO TO TO TO TO ALLOWANCE TOTAL ALLOWANCE TOTAL ALLOWANCE TOTAL ALLOWANCE TOTAL ALLOWANCE TOTAL AMOUNT LOANS AMOUNT LOANS AMOUNT LOANS AMOUNT LOANS AMOUNT LOANS - --------------------------------------------------------------------------------------------------------------------------------- Commercial and agri- cultural loans $ 5,562 15.5% $ 4,975 14.3% $ 5,351 15.1% $ 5,510 16.5% $ 4,959 16.9% Real estate construc- tion loans 701 3.9 623 3.7 496 3.1 324 2.1 385 2.5 Real estate mort- gage loans 5,470 58.0 5,638 63.5 5,612 63.2 5,052 62.1 4,990 61.3 Consumer loans 4,065 22.6 3,673 18.5 3,487 18.6 3,381 19.3 3,401 19.3 Not allocated 2,273 2,450 1,661 1,619 1,560 - --------------------------------------------------------------------------------------------------------------------------------- Total $18,071 100% $17,359 100% $16,607 100% $15,886 100% $15,295 100% =================================================================================================================================
type and volume of the loan portfolio, actual loan loss experience, the present and prospective financial condition of borrowers, industry and geographic exposures within the portfolio, current and prospective economic conditions, and special factors affecting specific business sectors. This evaluation process is reviewed by the Corporation's centralized independent loan review personnel, who monitor the credit quality of the Corporation's loan portfolio using uniform procedures and reporting systems. The provision was approximately $1 million in both 1998 and 1997, and $1.13 million in 1996. The Corporation experienced net loan losses of approximately $.25 million in both 1998 and 1997, and $.41 million in 1996. The Corporation's provision exceeded actual net loan losses by $.71 million in 1998, $.75 million in 1997 and $.72 million in 1996. The Corporation's allowance increased to $18.07 million as of December 31, 1998 and represented 2.01% of total loans, compared to 2.05% at December 31, 1997 and 2.06% at December 31, 1996. The allocation of the allowance in Table 7 is based upon ranges of estimates and is not intended to imply either limitations on the usage of the allowance or exactness of the specific amounts. The entire allowance is available to absorb any future loan charge-offs without regard to the categories in which the loan losses are classified. NONINTEREST INCOME Noninterest income is derived primarily from trust services, deposit account fees, fees for other customer services and gains on the sale of residential mortgage loans. Noninterest income totaled $15.61 million in 1998, compared to $13.12 million in 1997 and $12.20 million in 1996. Noninterest income increased $2.49 million, or 19%, in 1998 and $.924 million, or 7.6%, in 1997, over the prior year. The 1998 increase was primarily attributable to increases in Trust Department income, increases in other charges and fees for customer services, and increased gains from the sale of residential mortgage loans in the secondary market. Income from Trust Department activities increased $.344 million, or 10.7%, in 1998, and $.313 million, or 10.8%, in 1997, over the prior year. The 1998 and 1997 increases reflect higher fee income resulting from an expanded customer base, increases in custodial accounts and increased asset values due to favorable market performance. Noninterest income from other charges and fees for customer services was $4.515 million in 1998, compared to $3.813 million in 1997 and $3.199 million in 1996. The increases of $.702 million, or 18%, in 1998, and $.614 million, or 19%, in 1997, were primarily attributable to increases in ATM fee revenues from nondeposit customers of the Corporation's affiliate banks, and increased fee income generated from the sale of annuity and mutual fund investment products, property and casualty insurance and title insurance. Gains on the sale of residential mortgage loans were $1.54 million in 1998, compared to $.24 million in 1997 and $.14 million in 1996. The $1.3 million increase in 1998 was due to the Corporation selling significantly more residential mortgage loans in the secondary market in 1998 than in 1997. During 1998, the Corporation sold $118 million of residential mortgage loans in the secondary market, compared to $39 million in 1997 and $12 million in 1996. The significant increase in the volume of residential mortgage loans being sold during 1998 was attributable to both the health of the economy, which created more residential mortgage loan activity, and also the reduction of residential mortgage loan interest rates. The reduction in interest rates increased both the refinancing of long-term fixed interest rate mortgage loans and the election of long-term fixed interest rate mortgage loan products over the balloon mortgage loan products on new residential mortgage loans. It was the Corporation's general practice during 1998 and 1997 to sell residential mortgage loans 36 with terms of fifteen years or greater in the secondary mortgage market. Gains on the sale of residential mortgage loans were significantly lower in 1996, as the Corporation elected to keep those loans with amortizations of fifteen years or less that it originated in its own loan portfolio. Those loans with amortizations greater than fifteen years were sold in the secondary mortgage market. OPERATING EXPENSES Total operating expenses were $48.31 million in 1998, $45.72 million in 1997 and $45.12 million in 1996. Total operating expenses as a percentage of total average assets was 2.68% in 1998, 2.65% in 1997 and 2.67% in 1996. The Corporation's efficiency ratio, defined as total operating expenses divided by the sum of net interest income and noninterest income was 55% in 1998, compared to 56% in 1997 and 57% in 1996. Total operating expenses increased $2.59 million, or 5.7%, in 1998, compared to increases of $.6 million, or 1.3%, in 1997 and $.5 million, or 1.1%, in 1996 over the prior year. The lower increase in operating expenses in 1997 was primarily due to other operating expenses in 1996 including nonrecurring costs associated with the acquisition of State Savings Bancorp, Inc. The lower increase in operating expenses in 1996 was due to the significant reduction in Federal Deposit Insurance Corporation (FDIC) expense between 1995 and 1996. FDIC expense was $.1 million in 1996, compared to $1.6 million in 1995. Salaries, wages and employee benefits remain the largest component of operating expenses. These expenses totaled $28.90 million in 1998, $27.28 million in 1997 and $26.96 million in 1996. Salaries, wages and employee benefits expense increased $1.6 million, or 5.9%, in 1998. Full-time equivalent employees were 1006 at December 31, 1998, compared to 1003 at December 31, 1997 and 1000 at December 31, 1996. Salaries, wages and employee benefits expense increased $.32 million, or 1.2%, in 1997. The Corporation was able to maintain 1997 personnel costs at approximately 1996 levels by achieving a 3.1% reduction in employee benefits cost, while salaries and wages increased 2.3%. Personnel expenses accounted for 60% of operating expenses during 1998, 1997 and 1996. Occupancy and equipment expense totaled $7.36 million in 1998, $7.45 million in 1997 and $7.15 million in 1996. Occupancy and equipment expense decreased 1.2% in 1998 and increased 4.3% in 1997. Other operating expenses totaled $12.05 million in 1998, $10.99 million in 1997 and $11.02 million in 1996. The increase in 1998 of $1.06 million, or 9.7%, was partially attributable to expenses incurred in the conversion of the Corporation's core data processing system in 1998 to a new system, which has been certified by its vendor to be Year 2000 compliant. INCOME TAXES The Corporation's effective federal income tax rate was 32.9% in 1998, 32.6% in 1997 and 33.4% in 1996, compared to the statutory rate of 35% in each of these years. The small changes in the Corporation's effective federal income tax rate reflect the changes each year in the proportion of interest income exempt from federal taxation, tax credits, nondeductible interest expense and other nondeductible expenses relative to pretax income. Tax-exempt income (FTE), net of related nondeductible interest expense, totaled $3.9 million in 1998, 1997 and 1996. Tax-exempt income (FTE) as a percentage of total interest income (FTE) was 3.4%, 3.5% and 3.6% in 1998, 1997 and 1996, respectively. Income before income taxes (FTE) was $40.18 million in 1998, $36.81 million in 1997 and $34.39 million in 1996. LIQUIDITY AND INTEREST SENSITIVITY The Corporation manages its liquidity to ensure that it has the ability to meet the cash withdrawal needs of its depositors, provide funds for borrowers and at the same time ensure that the Corporation's own cash requirements are met. The Corporation accomplishes these goals through the management of liquidity at two levels - the parent company and the banking subsidiaries. The parent company's sources of funds have been dividends from subsidiaries, borrowings from unaffiliated banks and proceeds from equity issuances. During the three-year period ended December 31, 1998, the parent company's primary source of funds was subsidiary dividends. The parent company manages its liquidity position to provide the cash necessary to pay dividends to shareholders, service debt, invest in subsidiaries, enter new banking markets, pursue investment opportunities and satisfy other operating requirements. Federal and state banking laws place certain restrictions on the amount of dividends that a bank may pay to its parent company. Such restrictions have not had, and are not expected to have, any material effect on the Corporation's ability to meet its cash obligations or impede its ability to manage its liquidity needs. At January 1, 1999, the Corporation's bank subsidiaries could dividend $71 million to the parent company and remain "well capitalized" under the regulatory "risk-based" capital guidelines; without obtaining regulatory approval. In addition to the funds available from subsidiaries, the parent company had $15.2 million in cash on hand as of December 31, 1998. The subsidiary banks manage liquidity to insure adequate funds are available to meet the cash flow needs of depositors and borrowers. The subsidiary banks' most readily available sources of liquidity are federal funds sold, investment securities classified as available for sale and investment securities classified as held to maturity maturing continued on next page 37 LIQUIDITY AND INTEREST SENSITIVITY - CONTINUED TABLE 8. MATURITIES AND YIELDS OF INVESTMENT SECURITIES AT DECEMBER 31, 1998 (Dollars in Thousands)
MATURING AFTER ONE AFTER FIVE TOTAL TOTAL WITHIN BUT WITHIN BUT WITHIN AFTER CARRYING MARKET ONE YEAR FIVE YEARS TEN YEARS TEN YEARS VALUE VALUE - ---------------------------------------------------------------------------------------------------------------------------------- AMOUNT YIELD AMOUNT YIELD AMOUNT YIELD AMOUNT YIELD AMOUNT YIELD - ---------------------------------------------------------------------------------------------------------------------------------- AVAILABLE FOR SALE: U.S. Treasury and agencies $229,886 5.83% $214,474 5.56% -- -- -- -- $444,360 5.62% $444,360 Other securities 15,838 5.88 22,395 5.68 $ 583 6.53% $5,800 5.96% 44,616 5.85 44,616 - ---------------------------------------------------------------------------------------------------------------------------------- Total Investment Securities Available for Sale 245,724 5.83 236,869 5.57 583 6.53 5,800 5.96 488,976 5.71 488,976 HELD TO MATURITY: U.S. Treasury and agencies 79,654 6.10 111,303 5.92 -- -- -- -- 190,957 5.96 193,453 States of the U.S. and political subdivisions 9,754 6.88 19,664 7.73 10,456 7.99 1,719 8.27 41,593 7.62 42,641 Other securities 5,002 6.04 3,165 6.09 45 8.00 85 5.56 8,297 6.01 8,336 - ---------------------------------------------------------------------------------------------------------------------------------- Total Investment Securities Held to Maturity 94,410 6.18 134,132 6.19 10,501 7.99 1,804 8.14 240,847 6.28 244,430 - ---------------------------------------------------------------------------------------------------------------------------------- Total Investment Securities $340,134 5.93% $371,001 5.79% $11,084 7.91% $7,604 6.52% $729,823 5.90% $733,406 ================================================================================================================================== Yields are weighted by amount and time to contractual maturity and are on a taxable equivalent basis using a 35% federal income tax rate. Based on final contractual maturity.
within one year. These sources of liquidity are supplemented by new deposits and by loan payments received from customers. As of December 31, 1998, the Corporation held $113 million in federal funds sold, $489 million in investment securities available for sale and $94 million in other investment securities maturing within one year. These short-term assets represented approximately 45% of total deposits as of December 31, 1998. Historically, the Corporation's investment securities portfolio has been very short-term in nature, with the average life of the portfolio consistently being less than two years. As of December 31, 1998, 46.6% of the Corporation's investment securities portfolio, or $340 million in investment securities, will mature during 1999, and another $303 million in investment securities, or 41.6% of the investment securities portfolio, will mature during 2000. The combination of the 1999 and 2000 scheduled maturities results in 88% of the Corporation's investment securities portfolio maturing within two years of December 31, 1998. As of December 31, 1997, 68% of the investment securities portfolio was scheduled to mature within two years. The maturity analysis of the investment securities portfolio is summarized in Tables 8 and 9. TABLE 9. MATURITY ANALYSIS OF INVESTMENT SECURITIES (as a % of total portfolio)
DECEMBER 31 1998 1997 1996 - -------------------------------------------------------------------------------------- Maturity: Under 1 year 46.6% 33.7% 35.1% 1-5 years 50.8 63.4 61.4 5-10 years 1.5 2.0 2.6 Over 10 years 1.1 .9 .9 - -------------------------------------------------------------------------------------- Total 100% 100% 100% ======================================================================================
Table 10 presents the maturity distribution of time deposits of $100,000 or more at the end of each of the last three years. Historically, the Corporation has not utilized time deposits of $100,000 or more as a source of liquidity. Time deposits of $100,000 or more and the percentage of these deposits to total deposits increased slightly during 1998 to $96.3 million, or 6.2% of total deposits, as of December 31, 1998, compared to $85.1 million, or 5.8% of total deposits, as of December 31, 1997 and $108.4 million, or 7.6% of total deposits, as of December 31, 1996. The percentage of time deposits of $100,000 or more with a maturity of less than three months was 70% at December 31, 1998 and 1997, and 77% at December 31, 1996. As the Corporation does not utilize these deposits as a source of liquidity, it is able to invest the funds generated from these deposits in investments of similar maturity. The management of net interest income must address two objectives. It must consider the liquidity needs of the Corporation and interest rate risk. Interest rate risk arises in the normal course of the Corporation's business due to differences in the repricing and maturity characteristics of rate sensitive assets and liabilities. 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 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. Interest rate sensitivity management aims at achieving reasonable stability in both 38 TABLE 10. MATURITY DISTRIBUTION OF TIME DEPOSITS OF $100,000 OR MORE (Dollars in thousands)
DECEMBER 31 1998 1997 1996 AMOUNT PERCENT AMOUNT PERCENT AMOUNT PERCENT - ----------------------------------------------------------------------------------------------------------- Maturity: Within 3 months $66,976 70% $59,482 70% $ 83,851 77% Within 3 to 6 months 18,468 19 12,371 15 14,893 14 Within 6 to 12 months 6,497 7 6,677 8 5,894 5 Over 12 months 4,329 4 6,550 7 3,760 4 - ----------------------------------------------------------------------------------------------------------- Total $96,270 100% $85,080 100% $108,398 100% ===========================================================================================================
net interest income and the net interest margin through periods of changing interest rates. 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. It is necessary to analyze projections of net interest income based upon the repricing characteristics of the Corporation's earning assets and interest-bearing deposits and the varying magnitude by which interest rates may change on loans, investments and interest-bearing deposit accounts. The Corporation's interest rate sensitivity is managed through policies and risk limits approved by the Boards of Directors of the Corporation and its subsidiary banks, and an Asset and Liability Committee (ALCO). The ALCO, which is comprised of executive and senior management from various areas of the Corporation, including finance, lending, investments and deposit gathering, meets regularly to execute asset and liability management strategies. The ALCO establishes and monitors guidelines on the sensitivity of earnings to changes in interest rates. The goal of the ALCO process is to manage the balance sheet to provide the maximum level of net interest income and minimal impact on earnings from major interest rate changes, while maintaining a high quality balance sheet and acceptable levels of interest rate and liquidity risk. The Corporation has not used and does not intend to use interest rate swaps or other derivative financial instruments in the management of interest rate risk. The Corporation held no derivative financial instruments as of December 31, 1998. Management has the ability to adjust interest rates on non-maturing deposit accounts to achieve an approximately neutral interest sensitivity position within a one-year time period. Interest rate sensitivity is managed by a number of techniques, as no single interest rate risk measurement tool satisfies both objectives. The primary techniques utilized by the Corporation are asset and liability repricing schedules, commonly referred to as static gap analysis, and simulation analysis. Table 11 includes the Corporation's interest-earning assets and interest- bearing liabilities as of December 31, 1998, categorizing each into the earliest time period of their repricing or maturity, and summarizes the Corporation's interest rate repricing static gaps for selected repricing/maturity periods. TABLE 11. SCHEDULE OF RATE SENSITIVE ASSETS AND LIABILITIES BY REPRICING OR MATURITY DATE AT DECEMBER 31, 1998 (Dollars in thousands)
1-180 181-365 OVER 1 DAYS DAYS YEAR TOTAL - ---------------------------------------------------------------------------------------------------------- INTEREST-EARNING ASSETS: Loans $229,273 $107,878 $561,142 $ 898,293 Other interest-earning assets 276,784 181,500 389,689 847,973 - ---------------------------------------------------------------------------------------------------------- Total interest-earning assets $506,057 $289,378 $950,831 $1,746,266 ========================================================================================================== INTEREST-BEARING LIABILITIES: Non-maturing deposits $123,844 -- $610,739 $ 734,583 Time deposits 297,170 $114,615 135,515 547,300 - ---------------------------------------------------------------------------------------------------------- Total interest-bearing deposits 421,014 114,615 746,254 1,281,883 Other interest-bearing liabilities 53,250 8,000 -- 61,250 - ---------------------------------------------------------------------------------------------------------- Total interest-bearing liabilities $474,264 $122,615 $746,254 $1,343,133 ========================================================================================================== Gap $31,793 $166,763 $204,577 $ 403,133 Cumulative gap $31,793 $198,556 $403,133 Cumulative rate sensitive ratio 1.07 1.33 1.30 Cumulative gap as a percentage of total earning assets 1.8% 11.4% 23.1%
continued on next page 39 LIQUIDITY AND INTEREST SENSITIVITY - CONTINUED Total interest-earning assets exceeded interest-bearing liabilities by $403 million as of December 31, 1998. This difference was funded through noninterest-bearing deposits and shareholders' equity. Table 11 shows that total assets maturing or repricing within one year exceeded liabilities maturing or repricing within one year by $198.6 million, or 11.4% of total earning assets, as of December 31, 1998. The computation of static gap does not address the fact that the repricing of certain categories of assets and liabilities is subject to competitive and other influences that are beyond the control of the Corporation. As a result, certain assets and liabilities mature or reprice in periods other than in their contractual period. The distribution of the Corporation's deposits with no contractual maturity was based on historical analysis and management's current assumptions as to the repricing of these funds. Accordingly, as of December 31, 1998, $610.7 million of deposits with no contractual maturity ("non-maturing deposits") that are repriceable daily at the Corporation's discretion, were included in the over-1-year repricing category. These accounts are believed by management to be predominately noninterest-rate sensitive. Table 11 illustrates that as of December 31, 1998, the Corporation's cumulative rate sensitive ratio (rate sensitive assets to rate sensitive liabilities) in the 1-180 day repricing category was 1.07, and 1.33 in the cumulative one-year (1-365 days) repricing category. Static gap sensitivity varies from time frame to time frame; however, asset and liability management and the ability to adjust interest rates on non-maturing deposit accounts enables the Corporation to achieve reasonable stability in net interest income through periods of changing interest rates. The Corporation recognizes the limitations of static gap analysis as a tool in managing interest rate risk and, therefore, utilizes other methods, including simulation analysis. Simulation analysis is used to project the potential effects of various interest rate environments on the balance sheet mix and net interest income. Simulation analysis involves the analysis of net interest income, and the corresponding quantification of interest rate risk that is attributable to changes in interest rate levels and relationships, asset and liability mixes and loan prepayment characteristics. 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 pricing behavior. Assumptions based on historical pricing relationships, experience and anticipated market reactions are applied to certain core deposit and loan categories to reflect changes in interest rate costs and yields relative to changes in market interest rates. A process is maintained where management evaluates "base" net interest income under what it believes to be the most likely interest rate environment. This "base" net interest income is then evaluated against numerous interest rate scenarios, including increasing and decreasing market interest rates by 100 basis points evenly over the next year. This measurement of interest rate risk exposure on net interest income at year-end 1998, projected over the succeeding twelve months, indicates a nearly neutral interest rate sensitivity position during 1999. TABLE 12. FINANCIAL INSTRUMENTS (Dollars in thousands)
OUTSTANDING OUTSTANDING PRINCIPAL AMOUNT MATURING IN: DECEMBER 31, 1998 DECEMBER 31, 1997 1999 2000 2001 2002 2003 THEREAFTER TOTAL FAIR VALUE TOTAL FAIR VALUE - ------------------------------------------------------------------------------------------------------------------------------- RATE SENSITIVE ASSETS: Fixed interest rate loans $246,058 $155,845 $121,612 $88,762 $29,502 $160,628 $802,407 $814,997 $724,544 $726,526 Average inter- est rate 7.82% 7.94% 7.92% 7.89% 7.71% 7.67% 7.83% 8.11% Variable interest rate loans $ 58,573 $ 16,050 $ 4,715 $ 2,786 $ 1,567 $ 12,195 $ 95,886 $ 95,886 $121,056 $121,056 Average inter- est rate 8.91% 8.66% 8.81% 8.63% 8.69% 8.62% 8.81% 9.35% Fixed interest rate securities $340,134 $303,259 $ 57,331 $ 4,743 $ 5,671 $ 18,685 $729,823 $733,406 $745,193 $747,632 Average inter- est rate 5.85% 5.96% 5.23% 7.53% 6.90% 7.11% 5.89% 6.13% Other interest- earning assets $118,150 -- -- -- -- -- $118,150 $118,150 $ 49,750 $ 49,750 Average inter- est rate 4.76% -- -- -- -- -- 4.76% 5.49% RATE SENSITIVE LIABILITIES: Noninterest-bear- ing deposits $ 10,896 $ 10,460 $ 10,041 $ 9,640 $ 9,254 $222,097 $272,388 $272,388 $237,763 $237,763 Interest-bear- ing demand and savings deposits $ 29,383 $ 28,208 $ 27,080 $25,996 $24,957 $598,959 $734,583 $734,583 $696,913 $696,913 Average inter- est rate 2.36% 2.36% 2.36% 2.36% 2.36% 2.36% 2.36% 2.67% Time deposits $411,785 $ 77,166 $ 45,453 $ 8,105 $ 955 $ 3,836 $547,300 $549,792 $541,165 $540,745 Average inter- est rate 4.99% 5.38% 5.33% 5.72% 5.44% 5.43% 5.09% 5.38% Fixed interest rate borrowings $ 1,761 -- -- -- -- -- $ 1,761 $ 1,761 $ 12,954 $ 12,954 Average inter- est rate 4.80% -- -- -- -- -- 4.80% 2.66% Variable interest rate borrowings $ 51,489 -- -- $ 5,000 $ 3,000 -- $ 59,489 $ 59,489 $ 38,242 $ 38,242 Average inter- est rate 3.30% -- -- 5.76% 5.76% -- 3.63% 5.02%
40 Table 12 provides additional information about the Corporation's financial instruments used for purposes other than trading that are sensitive to changes in interest rates. For loans, securities, deposits, and borrowings with contractual maturities, the table presents principal cash flows and related weighted average interest rates by contractual maturities. For interest- and noninterest-bearing demand and savings deposits that have no contractual maturity, the table presents estimated principal cash flows based on the Corporation's historical experience and management's judgement, as applicable, concerning customers' most likely withdrawal behaviors, and weighted average interest rates as of December 31, 1998. The fair market value of loans was estimated using discounted cash flow analysis, using interest rates currently being offered for loans with similar terms to borrowers of similar credit quality. Weighted average variable rates on loans were based on the implied forward rates in the yield curve at December 31, 1998. The fair market value of time deposits was estimated using discounted cash flow analysis, using interest rates currently being paid on time deposits with similar terms. Table 12 excludes loan commitments. A discussion of the Corporation's loan commitments is included in this Annual Report in Note K to the financial statements. CAPITAL Capital provides the foundation for future growth and expansion. The major component of capital is shareholders' equity. Shareholders' equity was $241.84 million as of December 31, 1998, an increase of $17.91 million, or 8%, from total shareholders' equity as of December 31, 1997. The increase in 1998 was derived almost exclusively from earnings retention of $15.69 million. The ratio of shareholders' equity to total assets was 12.9% at December 31, 1998, compared to 12.7% at December 31, 1997 and 12.2% at December 31, 1996. The Corporation's tangible equity ratio was 12.7%, 12.5% and 12.0% as of December 31, 1998, 1997 and 1996, respectively. Under the regulatory "risk-based" capital guidelines in effect for both banks and bank holding companies, minimum capital levels are based upon perceived risk in the Corporation's various asset categories. These guidelines assign risk weights to on-and-off balance sheet items in arriving at total risk-adjusted assets. Regulatory capital is divided by the computed total of risk-adjusted assets to arrive at the risk-based capital ratios. The Corporation's capital ratios exceeded the minimum levels prescribed by the Federal Reserve Board, as of December 31, 1998, as shown in the following table.
RISK BASED LEVERAGE CAPITAL RATIOS RATIO TIER 1 TOTAL - ------------------------------------------------------------------------------------ Chemical Financial Corporation's capital ratios 13% 27% 29% Regulatory capital ratios "well capitalized" definition 5 6 10 Regulatory capital ratios minimum requirements 3 4 8
The Corporation's Tier 1 and Total regulatory capital ratios are significantly above the regulatory minimum and "well capitalized" levels due to the Corporation holding $460 million of investment securities and other assets, which are assigned a 0% risk rating, $446 million of investment securities and other assets, which are assigned a 20% risk rating, and $453 million of loans secured by first liens on residential real estate properties and other assets, which are assigned a 50% risk rating. These three categories of assets represented 72% of the Corporation's total assets as of December 31, 1998. As of December 31, 1998, all of the Corporation's banking subsidiaries exceeded the minimum capital ratios required of a "well-capitalized" institution, as defined in the final rule under the Federal Deposit Insurance Corporation Improvement Act of 1991. OUTLOOK The Corporation's philosophy is that it intends to be a "family" of community banks, which operates under the direction of local Boards of Directors, a holding company management team and a Corporate Board of Directors. The Corporation strives to remain a quality sales and service organization and is dedicated to sustained profitability through the preservation of the community banking concept, in an ever-changing and increasingly competitive environment. The Corporation believes it has designed its policies regarding asset/liability management, liquidity, lending, investment strategy and expense control to provide for the safety and soundness of the organization, continued earnings growth and the avoidance of wide fluctuations in earnings from one year to the next. The Corporation has managed its operations successfully, and offsets its lower than peer net interest margin, which results from its conservative lending and investment policies, with lower than peer loan losses and operating expenses. This strategy resulted in an increase in earnings per share of 8.5% and a return on assets of 1.44% during 1998. There are currently no known trends, events or uncertainties that management believes may be reasonably expected to have a material effect on the Corporation's financial performance. 41 YEAR 2000 READINESS DISCLOSURE During the third quarter of 1996, the Corporation formed a Year 2000 project team and began developing its plan to prepare for the Year 2000. The project began with a process to identify information technology and non-information technology systems that required modification for the Year 2000. A Year 2000 Plan was developed with goals and target dates. This plan includes communicating with third party vendors and suppliers, and obtaining certifications of compliance from third party software and service providers. During the early planning process, the Corporation was notified by the vendor of its core operating system that the core operating system used by the Corporation was not Year 2000 compliant and that it would not be modified to become Year 2000 compliant. The Corporation performed an extensive evaluation of replacement operating systems and in July 1997 chose to convert its core operating system to a new system ("Dimension") offered by its existing vendor. The vendor of the new core operating system has certified to the Corporation that its Dimension system is Year 2000 compliant and guarantees that Dimension software has been designed to accurately store and calculate all dates for the current and future millennia. The Dimension software was created as Year 2000 compliant, as opposed to being modified to be Year 2000 compliant. The Dimension software has received a Year 2000 certification by the Information Technology Association of America ("ITAA"). ITAA is the software industry trade group's century date change certification program. The program examines processes and methods used by companies to perform their Year 2000 software calculations and conversions. The certification by ITAA indicates that it is the opinion of ITAA that the processes and methods used by the Kirchman Corporation, which developed the Dimension software, meet the information technology industry's best software development practices for addressing the Year 2000 issue and the Kirchman Corporation has the core capabilities needed to address the Year 2000 issue. The Corporation converted to the new operating system during the first quarter of 1998. The cost of converting to the new operating system was approximately $300,000. In conjunction with the conversion to the new core operating system, the Corporation purchased a new mainframe computer in 1997 at a cost of approximately $1 million, which was capitalized. The existing mainframe computer and core operating system software were fully depreciated prior to 1997. The Corporation continued to assess the impact of the Year 2000 issue on the remainder of its computer-based systems and applications and non- information technology systems throughout 1998. As of December 31, 1998, it is the Corporation's opinion that it is complete with the assessment phase of its Year 2000 Plan. Management believes that, as of December 31, 1998 (i) the conversion to the new core operating system software has been completed, but that some additional testing is necessary; (ii) the core operating system represents approximately 85% of the Corporation's mission critical systems; (iii) all mission critical systems and software have been renovated; and (iv) the Corporation was substantially complete with the testing of its internal mission critical systems and hardware, and was significantly underway with the testing of its other mission critical systems and other software programs. The Corporation's Year 2000 Plan has set March 31, 1999 as the date for all testing to be complete for both internal and external mission critical systems. Based on the testing procedures performed through December 31, 1998, the Corporation was on target to meet its March 31, 1999 completion date. The Corporation replaced computer hardware, primarily desktop computers, and software that were not Year 2000 compliant, in 1998 at a total cost of $525,000, which was capitalized. The Corporation currently anticipates that remaining Year 2000 costs for hardware and software purchases, associated reprogramming, and remedial actions for both information technology and non-information technology will not exceed $250,000 in 1999. As part of the Corporation's Year 2000 Plan, the Trust Department of the Corporation's lead subsidiary bank replaced its computer hardware during 1998. In addition, both of its core operating systems were upgraded during 1998 to be Year 2000 compliant. The Trust Department uses the SunGard Series 7 system for the processing of trust accounting transactions and the Corbel Quantech system for employee benefit recordkeeping transactions. During the fourth quarter of 1998, extensive testing of the two systems used by the Trust Department for Year 2000 compliance was performed and it is management's opinion that all necessary testing had been satisfactorily completed as of December 31, 1998. During 1999, the Trust Department will focus on the Year 2000 compliance of the systems of other third party providers of service to the Trust Department and the progress of those companies and entities in which the fiduciary customers of the Trust Department are invested toward Year 2000 compliance. In accordance with the Corporation's Year 2000 Plan, the Trust Department is developing contingency plans to address Year 2000 issues which may arise after December 31, 1999. The impact of the Year 2000 issues on the Corporation will depend not only on corrective actions that the Corporation takes, but also on the way in which Year 2000 issues are addressed by governmental agencies, businesses and other third parties that provide services or data to, or receive services or data from, the Corporation, or whose financial condition or operational capability is important to the Corporation. To reduce this exposure, the Corporation has initiated formal communication with its significant suppliers and large customers to determine the extent to which the Corporation's interface systems are vulnerable to those third parties' failures to resolve their own Year 2000 issues. The Corporation has received communication from a majority of its third party vendors and suppliers confirming either that the third parties' software systems are Year 2000 compliant or providing the Corporation with a time line of an expected compliance date by mid-1999. The testing of both mission critical and non-critical third party software systems has begun. The Corporation is on schedule to have all testing of third party software systems 42 completed by June 30, 1999. The Corporation is continuing to seek assurances that the systems of other companies on which the Corporation's systems rely will be timely converted or modified. If such modifications and conversions are not completed timely, their inability to correctly recognize the Year 2000 could have an adverse impact on the operations of the Corporation. The Corporation's credit risk associated with borrowers may increase to the extent borrowers fail to adequately address Year 2000 issues. As a result, all of the Corporation's subsidiary banks have identified their material borrowers and have assessed these borrowers' Year 2000 readiness. The material borrowers' Year 2000 readiness will be monitored periodically, based on the level of risk that the Year 2000 has been estimated to pose to the business of each borrower. The Corporation is preparing general contingency plans to address unforeseen Year 2000 issues, including plans in the event that mission critical systems experience difficulties or other significant third parties fail to adequately address Year 2000 issues. Such plans principally involve the operation of systems in an off-line, "limited computerized," environment. This would be accomplished by the manual and desktop computer update of financial records, until problems or difficulties are remedied. The Corporation has determined that it must rely primarily on its software vendors to remedy any unforeseen situations of its mission critical systems in a timely manner. Internal remediation plans are being developed in the remaining information and non-information technology areas. The Corporation is also enhancing its existing business resumption plans to reflect Year 2000 issues. It is developing plans, designed to coordinate the efforts of its personnel and resources, in addressing any Year 2000 difficulties that become evident after December 31, 1999. The Corporation's business resumption plans will include the education of customers about the Year 2000 and explain what the Corporation has done and its plan to be ready for the Year 2000, in order to minimize unwarranted public concerns, and will include the consideration of the additional cash demands of its customers posed by Year 2000 concerns. There can be no assurance that any plans will fully mitigate any such difficulties. Furthermore, there may be certain mission critical third parties, such as utilities or telecommunication companies, where alternative arrangements or other sources are limited or unavailable. The Corporation believes that with the modifications to existing software, the new hardware and software purchases, and the conversion of the Corporation's core operating system, the Year 2000 issue will not pose significant operational problems for its computer systems and that the additional costs to be incurred are not expected to be material to the Corporation's results of operations, liquidity or capital resources. The costs of the project and the date on which the Corporation projects it will complete the Year 2000 modifications, as well as the estimated potential effects on the Corporation's operations of Year 2000 issues, were based on management's best estimates. There can be no guarantee that these estimates will be achieved and actual results could differ materially from those anticipated. Specific factors that might cause differences include, but are not limited to, the ability of other companies on which the Corporation's systems rely to modify or convert their systems to be Year 2000 compliant, the ability to locate and correct all relevant computer codes, the interruption of electronic or telephonic communications, the failure of basic utilities, and similar other uncertainties. This Year 2000 readiness disclosure is in part based upon and repeats information provided to the Corporation by outside sources, including its customers, vendors and outside consultants and other business partners. Although the Corporation believes this outside information is accurate, the Corporation is not the original source of this outside information and has not independently verified the information. OTHER MATTERS This discussion and analysis of financial condition and results of operations, and other sections of this Annual Report, contain forward- looking statements that are based on management's beliefs, assumptions, current expectations, estimates and projections about the financial services industry, the economy, and about the Corporation itself. Words such as "anticipates," "believes," "estimates," "judgement," "expects," "forecasts," "intends," "is likely," "plans," "predicts," "projects," variations of such words and similar expressions are intended to identify such forward-looking statements. In addition, the statements under the caption "Year 2000 Readiness Disclosure" are forward-looking statements. Assessments that the Corporation and/or its information and non-information technology systems are Year 2000 "compliant" or "ready" are statements of belief as to the outcome of future events based in part on information provided by vendors and other third parties that the Corporation has not independently verified. These statements are not guarantees of future performance and involve certain risks, uncertainties and assumptions ("Future Factors") that are difficult to predict with regard to timing, extent, likelihood and degree of occurrence. Therefore, actual results and outcomes may materially differ from what may be expressed or forecasted in such forward-looking statements. Furthermore, the Corporation undertakes no obligation to update, amend or clarify forward-looking statements, whether as a result of new information, future events or otherwise. Future Factors include, but are not limited to, changes in interest rates and interest rate relationships; demand for products and services; the degree of competition by traditional and non-traditional competitors; changes in banking regulations; changes in tax laws; changes in prices, levies and assessments; the impact of technological advances and issues, including Year 2000 issues; governmental and regulatory policy changes; the outcomes of pending and future litigation and contingencies; trends in customer behavior as well as their ability to repay loans; and changes in the national economy. These are representative of the Future Factors that could cause a difference between an ultimate actual outcome and a preceding forward-looking statement. 43 DIRECTORS AND OFFICERS OF AFFILIATES CHEMICAL BANK AND TRUST COMPANY DIRECTORS LAWRENCE E. BURKS Retired Chemical Bank and Trust Co. JAMES A. CURRIE Investor DALE T. DEAN President 4-D Builders Supply, Inc. MICHAEL L. DOW Chairman General Aviation, Inc. DR. DAVID E. FRY President Northwood University RICHARD A. HAZLETON Chairman and Chief Executive Officer Dow Corning Corporation JAMES R. JENKINS Vice President, Secretary and General Counsel Dow Corning Corporation TERENCE F. MOORE President and Chief Executive Officer MidMichigan Health ALOYSIUS J. OLIVER President and CEO Chemical Financial Corporation ALAN W. OTT Chairman Chemical Financial Corporation FRANK P. POPOFF Chairman The Dow Chemical Company DAVID B. RAMAKER President and CEO LAWRENCE A. REED Retired Dow Corning Corporation GARY S. SMITH, M.D. Midland Family Physicians, P.C. WILLIAM S. STAVROPOULOS President and Chief Executive Officer The Dow Chemical Company DIRK D. WALTZ Dirk Waltz Buick-Olds-Jeep, Inc. LAWRENCE J. WASHINGTON, JR. Vice President Human Resources Chemicals and Plastics The Dow Chemical Company HONORARY DIRECTOR DIRK B. WALTZ Retired Dirk Waltz Buick-Olds-Jeep, Inc. ST. LOUIS OFFICE ADVISORY BOARD DANIEL L. DOEPKER President Mid-West Building Distributors, Inc. DOUGLAS F. McKIM Chairman Lodewyk, Nesen & McKim, Inc. LARRY M. NOBLE Senior Vice President DUANE OXENDALE Retired Michigan Livestock Exchange DAVID B. RAMAKER President and CEO WILLIAM C. THIEMKEY, D.O. Physician BRADLY E. VIBBER Senior Vice President and Co-Manager JAMES F. WAGAR Vice Chairman Playbuoy Pontoon Manufacturing, Inc. TINA A. WALLACE Vice President and Co-Manager OFFICERS ALAN W. OTT Chairman DAVID B. RAMAKER President and CEO THOMAS J. ALEXANDER Executive Vice President and Cashier BRUCE M. GROOM Senior Vice President and Senior Trust Officer CHARLES F. KINNEY Senior Vice President WILLIAM C. LAUDERBACH Senior Vice President and Investment Officer W. ROGER MIKUSEK Senior Vice President LARRY M. NOBLE Senior Vice President JUDE T. PATNAUDE Senior Vice President and Trust Officer GLENN W. PIETENPOL Senior Vice President and Trust Officer MARK D. RUHLE Senior Vice President BRADLY E. VIBBER Senior Vice President VICE PRESIDENTS JOANN M. BURGESS ROBERT W. BURNS KIMBERLEE R. BUTCHER ALAN C. CHRISTENSEN TARI E. DETZLER LAWRENCE LaGROW JANET M. McGUIRE ROGER D. NEMETH DARLENE R. SLATER TINA A. WALLACE VICE PRESIDENTS AND TRUST OFFICERS KIRK W. FISHER DANIEL P. McKUNE GUY D. MERRIAM PATRICIA ZIMMERMAN ASSISTANT VICE PRESIDENT AND CONTROLLER JON D. CATLIN ASSISTANT VICE PRESIDENTS CARL R. AHEARN RUTH BOMAN ROBERT O. BURGESS, JR. G. THOMAS CIMBALIK MARY G. GREEN STEPHEN M. HALLEAD SHERRY A. MIZER SELENA NOBLE ROBERT S. RATHBUN MONICA A. SANGER VICTOR L. SCHULTZ RONALD D. SCHWEIGERT BARBARA E. SLAGEL PEGGY L. TUCKER ROBERT J. WALTERS CAROL WIERMAN SHERYL K. WILLIG ASSISTANT VICE PRESIDENTS AND TRUST OFFICERS HERBERT E. HARDY NORMA KENDALL TRUST OFFICERS SHELLY L. CAUFIELD RUDOLPH R. RADOSA, JR. MARK SOVEREEN PICCOLA SWEEBE ASSISTANT TRUST OFFICERS JAN E. GORDON DEBORA RITTENBURG AUDITOR AUDREY J. GRIFFIN ASSISTANT CASHIERS BETH E. BRICK PAMELA J. CARRIER REGINA CURTIS SHERON DEIBERT CHERYL K. MEYERS PATRICIA A. NELLIS MARK J. STEINKE TAMARA J. SWINSON SANDRA TURK KATHY M. WENZEL KEITH A. WENZEL BESSIE T. WILLIAMS SHARON YODER BUILDING AND MAINTENANCE OFFICER CHESTER CANTRELL CHEMICAL FINANCIAL INSURANCE AGENCY VICE PRESIDENT TRICIA LYN SUHR CFC TITLE SERVICES INC. VICE PRESIDENT CHARLOTTE A. ELMORE CFC DATA CORP DIRECTORS THOMAS J. ALEXANDER Executive Vice President and Cashier Chemical Bank and Trust Co. JAMES R. JENKINS Vice President, Secretary and General Counsel Dow Corning Corporation DOMINIC MONASTIERE President and CEO Chemical Bank Bay Area TERENCE F. MOORE President and Chief Executive Officer MidMichigan Health ALOYSIUS J. OLIVER President and CEO Chemical Financial Corporation THOMAS H. PETERSEN Executive Vice President and General Manager OFFICERS ALOYSIUS J. OLIVER President and Treasurer THOMAS H. PETERSEN Executive Vice President and General Manager W. BRIAN BEALL Vice President and Assistant General Manager DAVID D. COBB Vice President Systems Technology LORI A. GWIZDALA Secretary 44 CHEMICAL BANK BAY AREA DIRECTORS GARY E. ANDERSON President Dow Corning Corporation JAMES E. DANEK Executive Vice President LORI A. GWIZDALA Senior Vice President, Chief Financial Officer and Treasurer Chemical Financial Corporation THERON P. HOLLAND Retired DOMINIC MONASTIERE President and CEO DONALD L. PIETZ President PICO, Inc. DAVID B. RAMAKER President and CEO Chemical Bank and Trust Co. DAVID S. RAMSAY Lee/Ramsay Funeral Home ROBERT D. SAROW Attorney at Law Learman, Peters, Sarow & McQuillan GARY D. STEADMAN President Gary D. Steadman, Inc. THOMAS H. TABOR President Herman Hiss & Co. DONALD L. WILTSE Wiltse Chevrolet, Oldsmobile, Buick, Inc. HURON ADVISORY BOARD HOWARD M. BARRIGER Teacher Standish Sterling High School President Barriger Builders RONALD E. CHRISTIE Retired JAMES E. DANEK Executive Vice President KARL N. EDMONDS AuGres Parts & Service GERALD H. HEINRICH Retired THERON P. HOLLAND Retired OTIS L. McKINLEY, D.D.S. Dentist DOMINIC MONASTIERE President and CEO DAVID S. RAMSAY Lee/Ramsay Funeral Home DONALD L. WILTSE Wiltse Chevrolet, Oldsmobile, Buick, Inc. OFFICERS DAVID B. RAMAKER Chairman DOMINIC MONASTIERE President and CEO JAMES E. DANEK Executive Vice President RODNEY R. LOOMIS Senior Vice President VICE PRESIDENT AND CASHIER JANIE L. WILLIAMSON VICE PRESIDENTS CRAIG A. BISHOP DUANA R. McCULLOCH GALE L. MIELENS MARY JO TOPORSKI THOMAS R. WILCOX ASSISTANT VICE PRESIDENTS RONALD D. ERNDT LYNN M. HANSEN SANDRA A. METZGER DEBORAH K. MORGAN SUZANNE E. NEERING AUDITOR DEBBIE L. DEWALD ASSISTANT CASHIERS CHARLOTTE L. ANSPAUGH HOLLY J. BICKHAM MARIA FRANEK JUDITH A. MARCINIAK KATHLEEN C. MARQUARDT BRENDA A. MICHO JEAN M. SAXON KAREN M. SCHAFFER HARRIET L. STOPYAK WILLIAM R. TILLEN CHEMICAL BANK SOUTH DIRECTORS JUDITH A. BOROWITZ President and CEO RONALD J. DeGRAW Attorney Schroeder, DeGraw, Kendall, Mayhall, DeGraw & Dickerson ROBERT W. FRAHM President Bob Frahm Chevrolet-Buick- Pontiac Company EUGENE D. HAMAKER Retired/Consultant Metalab WILLIAM C. LAUDERBACH Senior Vice President and Investment Officer Chemical Bank and Trust Co. PETER T. MITCHELL President Albion College ARLIN E. NESS President Starr Commonwealth Schools ALOYSIUS J. OLIVER President and CEO Chemical Financial Corporation JOYCE J. SPICER Administrative Assistant Albion Division Harvard Industries, Inc. WILLIAM K. STOFFER Chairman and Chief Executive Officer Albion Machine and Tool Co. JEOFFREY A. THORREZ President Concord Manufacturing Co. JACK H. TOWNSEND Chairman and Chief Executive Officer Michigan Kitchen Distributors OFFICERS EUGENE D. HAMAKER Chairman JUDITH A. BOROWITZ President and CEO CAROL R. HAYDEN Vice President and Cashier TERI E. FOGEL Vice President MARVIN N. ITTNER Vice President REBECCA L. VETTEL Vice President ASSISTANT VICE PRESIDENT DIANE M. RAMIREZ AUDITOR ELIZABETH A. WONUS ASSISTANT CASHIERS MELISSA J. HOATH BARBARA A. KEITH DAVID A. SMITH CHEMICAL BANK MONTCALM DIRECTORS JOHN BOOKWALTER Bookwalter Motor Sales, Inc. DONALD BURNS President Montcalm Community College GARY COPP Secretary/Manager Carson City Lumber Co. C. NORMAN CROOKS Farmer SUSAN D. DRAPER Office Manager Lakeview Dental Associates, P.C. THOMAS W. KOHN President and CEO LARRY M. NOBLE Senior Vice President Chemical Bank and Trust Co. DAVID B. RAMAKER President and CEO Chemical Bank and Trust Co. MELVIN SCHNEPP Retired Schnepp Funeral Homes, Inc. OFFICERS DAVID B. RAMAKER Chairman THOMAS W. KOHN President and CEO GLENN L. WOOD Senior Vice President LLOYD D. SCOBY Senior Vice President DARLA BARTLETT Cashier VICE PRESIDENTS DAVID BARKER DIANE BEACH BRUCE COLE ROBERT HILL JEAN SOUTHWARD ASSISTANT VICE PRESIDENTS KAY MEISTER DONNA STRATTON AUDITOR KIMBERLY SIBURT ASSISTANT CASHIERS AMY S. ANDERSEN CONNIE COLLAR LINDA WOLVERTON KAREN YAW 45 CHEMICAL BANK CENTRAL DIRECTORS JACK R. BENEDICT President The Benedict Manufacturing Co. JOHN CURRIE Currie's Amoco BRUCE M. GROOM Senior Vice President and Senior Trust Officer Chemical Bank and Trust Co. KARL W. LINEBAUGH President and CEO RONALD MOHNKE President Mohnke Funeral Home, Inc. LINDA L.H. MYERS Assistant Superintendent Mecosta-Osceola Intermediate School District DAVID L. PORTEOUS Attorney at Law Porteous & White P.C. WILLIAM R. PRUITT Pruitt-Livingston Funeral Home DAVID B. RAMAKER President and CEO Chemical Bank and Trust Co. FRANKLIN C. WHEATLAKE Chairman Wheatlake Enterprises JOSEPH M. WOLSCHLEGER, M.D. Internal Medicine OFFICERS DAVID B. RAMAKER Chairman KARL W. LINEBAUGH President and CEO PHILIP R. KEATING Executive Vice President MARY WITHERS Vice President and Cashier ASSISTANT VICE PRESIDENTS JAMES GARRETT DAVID J. LANGWORTHY JEAN A. MISENAR MARJORIE A. RICHARDS AUDITOR ROBERT D. GAMMONS ASSISTANT CASHIERS KENDA DIESON JANET ROWLAND MARY K. SUCKOW KRISTA TESSEINE CHEMICAL BANK MICHIGAN DIRECTORS ROBERT H. BEACOM Retired Chemical Bank Michigan JOHN M. BICKNELL Retired Retailer DAVID D. CLARKE Crop Farmer VINCENT L. DEMASI Owner Clare Hardware RICHARD DEAN DOHERTY A.J. Doherty Motor Inns, Inc. WAYNE FRUCHEY Retired Fruchey Foods, Inc. JOSEPH F. JOHNSTON Retired Johnston Elevator CHARLES F. KINNEY Senior Vice President Chemical Bank and Trust Co. DENNIS J. LAFLEUR President and CEO MARK D. MANN President Mann Construction, Inc. CLAY MAXWELL Maxwell Seed Farms RICHARD M. MOSER Owner Woods Household Furniture & Appliances BETTY M. MUSSELL Community Volunteer JOSEPH F. MYERS Myers for Tires WILLIAM C. ODYKIRK Ody Enterprises ALOYSIUS J. OLIVER President and CEO Chemical Financial Corporation GUERDON E. SCHUMACHER Retired ALBERT F. WENTWORTH Dairy Farmer OFFICERS ALOYSIUS J. OLIVER Chairman DENNIS J. LAFLEUR President and CEO SENIOR VICE PRESIDENTS JAMES A. ALLEN RODERICK F. BEAMISH RONNIE L. POWELL JAMES P. RAFFENAUD VICE PRESIDENT AND CASHIER STEVEN J. KINGSBURY VICE PRESIDENTS JANET GILLARD TAMMY L. MILLER COMPTROLLER BRENDA J. HAVENS ASSISTANT VICE PRESIDENTS CHARLES AMBLE ROBIN R. GROVE LINDA C. HALL DAVID T. PRAWDZIK SUSAN D. SPEARY LORI STOUT STANLEY L. WARNER AUDITOR HILDA E. FLETCHER ASSISTANT CASHIERS THEOLA CLEVELAND STEPHANIE COOPER ELAINE DUNKLE JUDITH A. GROVE CHRISTINE J. LAWSON TINA M. LEHMANN VERA MARSHALL SUE E. WHITE CHEMICAL BANK NORTH DIRECTORS THOMAS J. ALEXANDER Executive Vice President and Cashier Chemical Bank and Trust Co. WILLIAM L. CAREY Attorney at Law JERRY M. DeWITT Developer ROSE E. DULEY GLEASON Retired Crawford County Library RICHARD D. HACKER Owner Hacker's Yamaha & Honda ROBERT JANSEN Owner Jansen Plumbing & Heating PAUL B. LERG Assistant Superintendent Crawford AuSable Schools DAVID B. RAMAKER President and CEO Chemical Bank and Trust Co. G. JOE SWAIN President and CEO JERRY WALKER Retired Jack Millikin, Inc. OFFICERS DAVID B. RAMAKER Chairman G. JOE SWAIN President and CEO MARK W. FURST Vice President RANDALL A. SEYMOUR Vice President J. ELAINE SWEENEY Vice President and Cashier ASSISTANT VICE PRESIDENTS TAMARA L. KENT SHARON NIEBRZYDOWSKI SHELBY J. NORMAN JANE A. RANDALL ANDREA M. WEISS AUDITOR CAROL D. WHITE ASSISTANT CASHIERS JAY T. DUKE SANDRA L. EGBERS SHARON A. VARISCO 46 CHEMICAL BANK WEST DIRECTORS THOMAS J. ALEXANDER Executive Vice President and Cashier Chemical Bank and Trust Co. RONALD L. BLACKMAN President Blackman Iron & Metal, Inc. NANCY BOWMAN Certified Public Accountant HAROLD CNOSSEN Prosperous Farms WAYNE EVERETT Everett Corporation JOHN GERNAAT Gernaat Family Farms JAMES B. HINKAMP, II Executive Vice President DAVID B. RAMAKER President and CEO Chemical Bank and Trust Co. JOHN A. REISNER President and CEO GERARD WINKLE Van Drie Home Furnishings OFFICERS DAVID B. RAMAKER Chairman JOHN A. REISNER President and CEO JAMES B. HINKAMP, II Executive Vice President KRISTINE E. BOWEN Senior Vice President BARBARA HANCOCK Vice President and Cashier ASSISTANT VICE PRESIDENTS ROXANNE PRINCE SUSAN SCHWAGER AUDITOR NORMA DuVALL ASSISTANT CASHIERS DELLA BEDNARICK DARYL HESSELINK LORIE MORIARTY JUDY MULDER MARY JO SHIVLIE CHEMICAL BANK KEY STATE DIRECTORS WADE V. ALDERMAN President Alderman's Inc. GARY J. GREGORICKA President Viron International MARGARET S. GULICK President and CEO Memorial Healthcare Center JOHN F. HARRISON President and CEO WILLIAM P. HOWE Retired Commercial Contractor MICHAEL G. MAJZEL, JR. Retired Crop Farmer ALOYSIUS J. OLIVER President and CEO Chemical Financial Corporation HERBERT F. PENHORWOOD Retired Industrialist DAVID B. RAMAKER President and CEO Chemical Bank and Trust Co. HOWARD S. SHAND Retired Commercial Mechanical Contractor DAVID R. WAKELAND President Wakeland Oil Company OFFICERS ALOYSIUS J. OLIVER Chairman of the Board JOHN F. HARRISON President and CEO ROBERT L. HARDY Senior Vice President VICE PRESIDENTS JOHN M. CREIGHTON LORI L. EDINGTON JOHN H. LARZELERE VICE PRESIDENT AND CASHIER NITA L. JONES VICE PRESIDENT AND CONTROLLER DONNA S. McAVOY ASSISTANT VICE PRESIDENTS P. JOSEPH DALY MICHELLE M. HOLDEN RANDY L. HORTON DONALD D. LEVI AUDITOR SANDRA A. DuBARNS ASSISTANT CASHIERS BARBARA M. BUCSI JAMES D. JONES SUSAN K. LYNDE JANA L. MOORE CAROL A. ROWELL LINDA K. SOVIS CHEMICAL BANK THUMB AREA DIRECTORS RICHARD C. BIDDINGER Owner Riverside Sales and Engineering Corp. GARY J. CREWS Attorney Ransford and Crews LORI A. GWIZDALA Senior Vice President, Chief Financial Officer and Treasurer Chemical Financial Corporation DOUGLAS H. HERRINGSHAW President and CEO CARL O. HOLMES Chairman MARVIN J. KOCIBA Farm Owner and Operator MICHAEL T. LAETHEM President Laethem Equipment Company KENNETH G. McLAREN Retired Insurance Agency Owner ALOYSIUS J. OLIVER President and CEO Chemical Financial Corporation GERALDINE F. PRIESKORN Vice President Prieskorn Variety Stores, Inc. RICHARD B. RANSFORD President Ransford Funeral Home, Inc. CASS CITY/HARBOR BEACH/BAD AXE ADVISORY BOARD DUANE W. CHIPPI President Cass City Oil & Gas Company RICHARD T. DONAHUE Farm Owner DOUGLAS H. HERRINGSHAW President and CEO MARVIN J. KOCIBA Farm Owner and Operator WILLIAM L. KRITZMAN President and Treasurer Kritzman's, Inc. GERALDINE F. PRIESKORN Vice President Prieskorn Variety Stores, Inc. PATRICIA J. ROGGENBUCK Secretary Helena Valley Farms GLEN H. TOWNLEY Owner Harbor Beach Insurance Agency K. MICHAEL WEAVER Owner Coachlight Pharmacy ROBERT V. WISCHMEYER Plant Manager Agri Sales, Inc. (Cass City) OFFICERS CARL O. HOLMES Chairman DOUGLAS H. HERRINGSHAW President and CEO JAMES E. BOLTON Senior Vice President DENNIS P. GILKEY Senior Vice President ROBERT M. WOLAK Senior Vice President VICE PRESIDENTS MICHAEL F. BOICE FELICIA M. CARR WILLIAM L. CHASE BEVERLY J. PERRY ASSISTANT VICE PRESIDENT AND CASHIER ORVIL A. BEECHER ASSISTANT VICE PRESIDENTS LYNN C. PAVLICHEK LINDA K. SMITH CHERYL D. WILDER CAROLYN M. WYMORE AUDITOR ROSE M. STRUNZ ASSISTANT CASHIERS BETTE M. BURTON SUSAN M. MILLER MARSHA K. MOORE SHERRYL M. SEELEY JANET D. THANE KAREN L. WOOD EXECUTIVE SECRETARY MONALEE McCREA 47 CORPORATE DIRECTORS AND OFFICERS BOARD OF DIRECTORS (from left to right): JAMES A. CURRIE Investor MICHAEL L. DOW Chairman General Aviation, Inc. TERENCE F. MOORE President and Chief Executive Officer MidMichigan Health ALOYSIUS J. OLIVER President and Chief Executive Officer of the Corporation ALAN W. OTT Chairman Retired, Former President and Chief Executive Officer of the Corporation FRANK P. POPOFF Chairman The Dow Chemical Company LAWRENCE A. REED Retired, Former President and Chief Executive Officer Dow Corning Corporation WILLIAM S. STAVROPOULOS President and Chief Executive Officer The Dow Chemical Company [PICTURE OF JAMES A. CURRIE] [PICTURE OF MICHAEL L. DOW] [PICTURE OF TERENCE F. MOORE] [PICTURE OF ALOYSIUS J. OLIVER] [PICTURE OF ALAN W. OTT] [PICTURE OF FRANK P. POPOFF] [PICTURE OF LAWRENCE A. REED] [PICTURE OF WILLIAM S. STAVROPOULOS] [PICTURE OF EXECUTIVE MANAGEMENT (from left to right): LORI A. GWIZDALA, ALOYSIUS J. OLIVER, and DAVID B. RAMAKER] EXECUTIVE OFFICERS ALAN W. OTT Chairman ALOYSIUS J. OLIVER President and Chief Executive Officer DAVID B. RAMAKER Executive Vice President and Secretary LORI A. GWIZDALA Senior Vice President, Chief Financial Officer and Treasurer OFFICERS GLENN SWEENEY Vice President and Corporate Auditor DAVID P. VERMILYE Vice President THEODORE J. GROENING Assistant Vice President and Assistant Financial Officer JOSEPH W. TORRENCE Assistant Vice President and Corporate Human Resources Officer SANDRA BARGERON Assistant Vice President and Auditor ROBERT E. SUTTON Corporate Loan Review and Compliance Officer JONATHAN P. BUSHEY Loan Review Officer CHERYL HASSEN SWARTHOUT Training Officer 48 CORPORATE INFORMATION THE COMPANY Chemical Financial Corporation is a registered bank holding company headquartered in Midland, Michigan, that operates ten bank affiliates with eighty-six banking offices in twenty-four counties located generally across the midsection of Michigan's lower peninsula. Because the Corporation is a bank holding company, its principal operations are conducted by its subsidiaries. All of the Corporation's subsidiary banks are state banks and offer the full range of services normally associated with commercial banking. The Corporation's lead bank is Chemical Bank and Trust Company, headquartered in Midland, Michigan. Trust services are provided by the lead bank directly to customers of the Corporation's other nine subsidiary banks through service agreements with each bank. The Corporation owns a bank-related company, CFC Data Corp, which provides data processing services primarily to the Corporation's subsidiary banks. The Corporation operates an insurance agency and a title services company through subsidiaries of its lead bank. The Corporation serves as controlling shareholder and maintains systems of financial, operational and administrative controls that permit centralized evaluation of subsidiary operations. The Corporation also provides substantive assistance to its subsidiaries in selected functional areas including accounting, operations, marketing, investments, central purchasing, financial planning, internal auditing, loan quality control, training, compliance with regulatory requirements and personnel. STOCK INFORMATION Chemical Financial Corporation common stock is traded on The NASDAQ Stock Market. It is quoted daily in leading financial publications under the NASDAQ National Market Issues heading of the stock tables, NASDAQ symbol: CHFC. As of December 31, 1998, there were five registered market makers of Chemical Financial Corporation common stock: A.G. Edwards & Sons, Inc., Stifel Nicolaus & Co., Roney Capital Markets, Herzog, Heine, Geduld, Inc. and Keefe, Bruyette & Woods, Inc. The approximate number of shareholders of record at December 31, 1998 was 4,200. Analysts, investors, shareholders, and others seeking financial or general information about the Corporation are invited to contact Aloysius J. Oliver, President and Chief Executive Officer, or Lori A. Gwizdala, Senior Vice President and Chief Financial Officer. Telephone (517) 839-5350. SHAREHOLDER ASSISTANCE Inquiries related to shareholder records, change of name, address or ownership of stock, and lost or stolen certificates can be directed to either of the following transfer agents and registrars: Harris Trust and Savings Bank Attention: Shareholder Services 311 West Monroe Street, 11th Floor Chicago, Illinois 60606 Telephone: 1-800-942-5909 Chemical Bank and Trust Company Attention: Co-Transfer Agent 333 East Main Street Midland, Michigan 48640 Telephone: 1-517-839-5236 DIVIDEND REINVESTMENT The Corporation offers a dividend reinvestment program through Harris Trust and Savings Bank, whereby shareholders may reinvest their Chemical Financial Corporation dividends in additional shares of the Corporation's stock. Participating shareholders also may invest up to $3,000 in additional funds each quarter for the purchase of additional shares. Information concerning this optional program is available from either of the transfer agents shown above or the Corporate Office of Chemical Financial Corporation, P.O. Box 569, Midland, Michigan 48640. Telephone (517) 839-5350. DIVIDEND DIRECT DEPOSIT Shareholders of the Corporation may have their dividends deposited into their savings or checking account at any bank that is a member of the National Automated Clearing House (ACH) system. Information describing this service and an authorization form can be requested from either of the transfer agents shown above or the Corporate Office of Chemical Financial Corporation, P.O. Box 569, Midland, Michigan 48640. Telephone (517) 839- 5350. ANNUAL MEETING The annual meeting of the shareholders will be held at the Midland Center for the Arts, 1801 W. St. Andrews Drive, Midland, Michigan, on Monday, April 19, 1999, at 2:00 P.M. CORPORATE INFORMATION Chemical Financial Corporation 333 East Main Street P.O. Box 569 Midland, Michigan 48640 Telephone: (517) 839-5350 Fax Number: (517) 839-5255 Internet: www.chemicalbankmi.com EQUAL OPPORTUNITY EMPLOYERS Chemical Financial Corporation and its subsidiaries are equal opportunity employers. FORM 10-K A COPY OF THE CORPORATION'S ANNUAL REPORT ON FORM 10-K, INCLUDING THE FINANCIAL STATEMENTS AND FINANCIAL STATEMENT SCHEDULES, AS FILED WITH THE SECURITIES AND EXCHANGE COMMISSION, MAY BE OBTAINED WITHOUT CHARGE UPON WRITTEN REQUEST TO LORI A. GWIZDALA, CHIEF FINANCIAL OFFICER OF THE CORPORATION, AT P.O. BOX 569, MIDLAND, MICHIGAN 48640. CHEMICAL FINANCIAL CORPORATION 333 East Main Street P.O. Box 569 Midland, Michigan 48640-0569 Telephone: (517) 839-5350 Fax: (517) 839-5255 WWW.CHEMICALBANKMI.COM [2000 AND BEYOND LOGO] EX-21 7 EXHIBIT 21 SUBSIDIARIES
STATE OR OTHER JURISDICTION NAME OF SUBSIDIARY OF INCORPORATION - --------------------------------- --------------------------- Banking subsidiaries: Chemical Bank and Trust Company Michigan Chemical Bank Michigan Michigan Chemical Bank South Michigan Chemical Bank Thumb Area Michigan Chemical Bank West Michigan Chemical Bank Montcalm Michigan Chemical Bank North Michigan Chemical Bank Bay Area Michigan Chemical Bank Central Michigan Chemical Bank Key State Michigan Non-banking subsidiaries: CFC Data Corp Michigan CFC Financial Services, Inc. (subsidiary of Chemical Bank and Trust Company) - also operates under d/b/a Chemical Financial Insurance Agency Michigan CFC Title Services, Inc. (subsidiary of Chemical Bank and Trust Company) Michigan
EX-23 8 EXHIBIT 23 ERNST & YOUNG LLP CONSENT OF INDEPENDENT AUDITORS We consent to the incorporation by reference in (1) the Registration Statement (Form S-8, Number 33-15064, dated June 17, 1987, pertaining to the Chemical Financial Corporation 1987 Award and Stock Option Plan, (2) the Registration Statement (Form S-8, Number 33-40792, dated May 21, 1991) pertaining to the Chemical Financial Corporation 401(k) Savings Plan and in the related Prospectus, (3) the Registration Statement (Form S-8, Number 33-47356, dated April 28, 1992) pertaining to the Chemical Financial Corporation 1992 Stock Purchase Plan for Subsidiary Directors (4) the Registration Statement (Form S-8, Number 333-38511, dated October 22, 1997) pertaining to the Chemical Financial Corporation 1997 Stock Incentive Plan and (5) the Registration Statement (Form S-8, Number 333-70225), dated January 6, 1999, pertaining to Chemical Financial Corporation 1998 Stock Purchase Plan of our report dated January 19, 1999 with respect to the consolidated financial statements of Chemical Financial Corporation included in the Annual Report (Form 10-K) for the year ended December 31, 1998. We consent to the incorporation by reference of (1) the Registration Statement (Form S-8, Number 33-40792, dated May 21, 1991) pertaining to the Chemical Financial Corporation 401(k) Savings Plan and in the related Prospectus of our report dated February 12, 1999, with respect to the financial statements and schedules of the Chemical Financial Corporation 401(k) Savings Plan included in the Annual Report (Form 10-K) for the year ended December 31, 1998 and (2) the Registration Statement (Form S-8, Number 33-47356, dated April 28, 1992) pertaining to the Chemical Financial Corporation 1992 Stock Purchase Plan for Subsidiary Directors and in the related Prospectus of our report dated February 5, 1999, with respect to the financial statements of the Chemical Financial Corporation 1992 Stock Purchase Plan for Subsidiary Directors included in the Annual Report (Form 10-K) for the year ended December 31, 1998. March 22, 1999 /s/ Ernst & Young LLP EX-27 9 ART. 9 FDS FOR 1998 FORM 10-K
9 THIS SCHEDULE CONTAINS SUMMARY FINANCIAL INFORMATION EXTRACTED FROM THE AUDITED CONSOLIDATED FINANCIAL STATEMENTS OF CHEMICAL FINANCIAL CORPORATION AND SUBSIDIARIES FOR THE PERIOD ENDED DECEMBER 31, 1998 AND IS QUALIFIED IN ITS ENTIRETY BY REFERENCE TO SUCH FINANCIAL STATEMENTS. 1,000 12-MOS DEC-31-1998 JAN-01-1998 DEC-31-1998 98,483 5,000 113,150 0 488,976 240,847 244,430 898,293 18,071 1,872,626 1,554,271 53,250 15,266 8,000 13,496 0 0 228,343 1,872,626 74,039 42,674 4,920 121,633 47,050 49,146 72,487 964 8 48,307 38,826 38,826 0 0 26,046 1.93 1.91 4.36 1,785 1,316 0 0 17,359 549 297 18,071 15,798 0 2,273
EX-99 10 EXHIBIT 99.1 Financial Statements and Schedules Chemical Financial Corporation 401(k) Savings Plan Years ended December 31, 1998 and December 31, 1997 with Report of Independent Auditors ERNST & YOUNG LLP - Suite 1700 - Phone: 313 596 7100 500 Woodward Avenue Detroit, Michigan 48226-3426 REPORT OF INDEPENDENT AUDITORS Administrative Committee Chemical Financial Corporation 401(k) Savings Plan We have audited the accompanying statements of assets available for plan benefits of the Chemical Financial Corporation 401(k) Savings Plan as of December 31, 1998 and 1997 and the related statements of changes in assets available for plan benefits for the years then ended. These financial statements are the responsibility of the Plan's management. Our responsibility is to express an opinion on these financial statements based on our audits. We conducted our audits in accordance with generally accepted auditing standards. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion. In our opinion, the financial statements referred to above present fairly, in all material respects, the assets available for plan benefits of the Plan at December 31, 1998 and 1997, and the changes in its assets available for plan benefits for the years then ended in conformity with generally accepted accounting principles. Our audits were made for the purpose of forming an opinion on the financial statements taken as a whole. The accompanying supplemental schedules of assets held for investment purposes and reportable transactions as of and for the year ended December 31, 1998 are presented for purposes of complying with the Department of Labor's Rules and Regulations for Reporting and Disclosure under the Employee Retirement Income Security Act of 1974, and are not a required part of the financial statements. The fund information in the statements of assets available for plan 2 benefits and the statements of changes in assets available for plan benefits is presented for purposes of additional analysis rather than to present the assets available for plan benefits and changes in assets available for plan benefits of each fund. The supplemental schedules and fund information have been subjected to the auditing procedures applied in our audits of the financial statements and, in our opinion, are fairly stated in all material respects in relation to the financial statements taken as a whole. S/ ERNST & YOUNG LLP February 12, 1999 3 STATEMENT OF ASSETS AVAILABLE FOR BENEFITS, WITH FUND INFORMATION CHEMICAL FINANCIAL CORPORATION 401(k) SAVINGS PLAN DECEMBER 31, 1998
FUND INFORMATION -------------------------------------------------------------------------- CHEMICAL STOCK FINANCIAL CASH AND INTERMEDIATE AND CORPORATION MONEY PARTICIPANT BOND INDEX BOND STOCK MARKET LOAN FUND FUND FUND FUND FUND FUND TOTAL ------------- ------- -------- ----------- -------- ----------- -------- ASSETS: Investments at fair value: Chemical Financial Corporation Common Stock $2,040,820 $2,040,820 Federated Investors Mutual Funds: Short-Intermediate Government Trust $171,343 171,343 Max-Cap Fund $1,923,651 1,923,651 Treasury Obligations Fund 1,866 $239,862 241,728 Fidelity Investments-Puritan Fund $707,512 707,512 Participant loans $38,169 38,169 -------- ---------- -------- ---------- -------- ------- ---------- 171,343 1,923,651 707,512 2,042,686 239,862 38,169 5,123,223 Employee contributions receivable 1,479 13,382 5,097 9,281 1,534 30,773 Cash and accrued income 618 35 964 486 2,103 -------- ---------- -------- ---------- -------- ------- ---------- 4 Assets Available for Plan Benefits $173,440 $1,937,033 $712,609 $2,052,002 $242,360 $38,655 $5,156,099 ======== ========== ======== ========== ======== ======= ==========
See accompanying notes 5 STATEMENT OF ASSETS AVAILABLE FOR BENEFITS, WITH FUND INFORMATION CHEMICAL FINANCIAL CORPORATION 401(k) SAVINGS PLAN DECEMBER 31, 1997
FUND INFORMATION -------------------------------------------------------------------------- CHEMICAL STOCK FINANCIAL CASH AND INTERMEDIATE AND CORPORATION MONEY PARTICIPANT BOND INDEX BOND STOCK MARKET LOAN FUND FUND FUND FUND FUND FUND TOTAL ------------- ------- -------- ----------- -------- ----------- -------- ASSETS: Investments at fair value: Chemical Financial Corporation Common Stock $1,906,118 $1,906,118 Federated Investors Mutual Funds: Short-Intermediate Government Trust $136,904 136,904 Max-Cap Fund $1,253,475 1,253,475 Treasury Obligations Fund 62 56 $ 101 274 $218,049 $3,882 222,424 Fidelity Investments-Puritan Fund 547,145 547,145 Participant loans 39,646 39,646 -------- ---------- -------- ---------- -------- ------- ---------- 136,966 1,253,531 547,246 1,906,392 218,049 43,528 4,105,712 Employee contributions receivable 1,190 11,089 6,877 9,570 1,417 30,143 Cash and accrued income 622 26 16 40 1,012 16 1,732 -------- ---------- -------- ---------- -------- ------- ---------- 6 Assets Available for Plan Benefits $138,778 $1,264,646 $554,139 $1,916,002 $220,478 $43,544 $4,137,587 ======== ========== ======== ========== ======== ======= ==========
See accompanying notes 7 STATEMENT OF CHANGES IN ASSETS AVAILABLE FOR PLAN BENEFITS, WITH FUND INFORMATION CHEMICAL FINANCIAL CORPORATION 401(k) SAVINGS PLAN DECEMBER 31, 1998
FUND INFORMATION -------------------------------------------------------------------------- CHEMICAL CASH AND STOCK FINANCIAL MONEY INTERMEDIATE INDEX AND BOND CORPORATION MARKET PARTICIPANT BOND FUND FUND FUND STOCK FUND FUND LOAN FUND TOTAL ------------- ------- -------- ----------- -------- ----------- -------- Additions: Interest and dividend income $7,472 $38,287 $72,496 $44,156 $10,722 $4,576 $177,709 Employee contributions 29,760 318,881 134,072 232,139 29,822 744,674 -------- ---------- -------- ---------- -------- ------- ---------- 37,232 357,168 206,568 276,295 40,544 4,576 922,383 Deductions: Participants' accounts distributed upon withdrawal (1,115) (24,405) (38,275) (41,646) (70,704) (1,356) (177,501) Net transfers between funds (3,236) (27,593) (33,158) 20,054 52,042 (8,109) 0 Net realized and unrealized appreciation (depreciation) in fair value of investments 1,781 367,217 23,335 (118,703) 273,630 -------- ---------- -------- ---------- -------- ------- ---------- Net increase (decrease) 34,662 672,387 158,470 136,000 21,882 (4,889) 1,018,512 Assets available for plan benefits at beginning of year 138,778 1,264,646 554,139 1,916,002 220,478 43,544 4,137,587 -------- ---------- -------- ---------- -------- ------- ---------- 8 Assets available for plan benefits at end of year $173,440 $1,937,033 $712,609 $2,052,002 $242,360 $38,655 $5,156,099 ======== ========== ======== ========== ======== ======= ==========
See accompanying notes. 9 STATEMENT OF CHANGES IN ASSETS AVAILABLE FOR PLAN BENEFITS, WITH FUND INFORMATION CHEMICAL FINANCIAL CORPORATION 401(k) SAVINGS PLAN DECEMBER 31, 1997
FUND INFORMATION -------------------------------------------------------------------------- CHEMICAL CASH AND STOCK FINANCIAL MONEY INTERMEDIATE INDEX AND BOND CORPORATION MARKET PARTICIPANT BOND FUND FUND FUND STOCK FUND FUND LOAN FUND TOTAL ------------- ------- -------- ----------- -------- ----------- -------- Additions: Interest and dividend income $6,836 $53,219 $41,209 $36,399 $10,985 $3,510 $152,158 Employee contributions 33,744 224,685 162,564 266,581 37,230 724,804 -------- ---------- -------- ---------- -------- ------- ---------- 40,580 277,904 203,773 302,980 48,215 3,510 876,962 Deductions: Participants' accounts distributed upon withdrawal (7,809) (15,066) (17,148) (81,987) (12,196) (467) (134,673) Net transfers between funds (19,600) 87,077 23,017 (47,077) (59,255) 15,838 0 Net realized and unrealized appreciation (depreciation) in fair value of investments 646 205,658 47,158 331,234 584,696 -------- ---------- -------- ---------- -------- ------- ---------- Net increase (decrease) 13,817 555,573 256,800 505,150 (23,236) 18,881 1,326,985 Assets available for plan benefits at beginning of year 124,961 709,073 297,339 1,410,852 243,714 24,663 2,810,602 -------- ---------- -------- ---------- -------- ------- ---------- 10 Assets available for plan benefits at end of year $138,778 $1,264,646 $554,139 $1,916,002 $220,478 $43,544 $4,137,587 ======== ========== ======== ========== ======== ======= ==========
See accompanying notes. 11 NOTES TO FINANCIAL STATEMENTS CHEMICAL FINANCIAL CORPORATION 401(K) SAVINGS PLAN DECEMBER 31, 1998 NOTE A - - DESCRIPTION OF THE PLAN The Chemical Financial Corporation 401(k) Savings Plan (the Plan) is a voluntary, defined-contribution plan covering all eligible employees of Chemical Financial Corporation (the Corporation) and subsidiaries. The Plan provides for the deferral of salaries, wages and bonuses in accordance with Section 401(k) of the Internal Revenue Code. Employees of the Corporation or any of its subsidiaries are eligible for participation upon attaining age 21 and completing one year of service. At December 31, 1998 there were 486 participants in the Plan. Participants are eligible to contribute up to 15% of their annual compensation, up to a maximum of $10,000 in 1998 and $9,500 in 1997. The employer made no contributions to the Plan during 1998 or 1997. The preparation of financial statements in conformity with generally accepted accounting principles requires management to make estimates and assumptions that affect the reported amounts of assets at the date of the financial statements and the reported amounts of changes in assets during the year. Actual results could differ from those estimates. Participants may direct their contributions into an intermediate bond fund, a stock index fund, a stock and bond fund, a money market fund, a Chemical Financial Corporation common stock fund or a combination of these funds, and may elect to change the percentage directed to each fund daily. All participant contributions are fully vested. Participant loans are permitted under the Plan. These loans are subject to a strict set of rules established by laws and regulations. As of December 31, 1998 the Plan had ten participant loans outstanding at interest rates ranging from 7.0%-11.45%. Information about the plan agreement and the vesting and benefit provisions is contained in the Summary Plan Description contained in the Chemical Financial Corporation Employee Handbook and is available along with information regarding investment alternatives from the Plan Administrator and Personnel Departments. 12 The Corporation, acting through its Board of Directors, has the right to amend or terminate the Plan at any time. NOTES TO FINANCIAL STATEMENTS (CONTINUED) NOTE B - - SIGNIFICANT ACCOUNTING POLICIES The financial statements have been prepared under the accrual basis of accounting in accordance with generally accepted accounting principles. Investments are stated at aggregate fair value. Securities traded on a national securities exchange are valued at the last reported sales price on the last business day of the Plan year. Investments traded in the over-the-counter market and listed securities for which no sale was reported on that date are valued at the last reported bid price. Expenses incurred in connection with the operation of the Plan are borne by the Corporation. 13 NOTES TO FINANCIAL STATEMENTS (CONTINUED) NOTE C - - INVESTMENTS During the years ended December 31, 1998 and December 31, 1997 the Plan's net appreciation (depreciation) in the fair value of investments (including investments bought, sold, as well as held during the year) is summarized as follows:
1998 1997 -------- -------- Intermediate Bond Fund $ 1,781 $ 646 Index Fund 367,217 205,658 Stock and Bond Fund 23,335 47,158 Chemical Financial Corporation Common Stock Fund (118,703) 331,234 -------- -------- $273,630 $584,696 ======== ========
The fair value of individual investments that represent 5% or more of the Plan's net assets are as follows:
DECEMBER 31 --------------------------- 1998 1997 ---------- ---------- Federated Investors Mutual Funds: Treasury Obligations Fund $ 241,728 $ 22,424 Max-Cap Fund 1,923,651 1,253,475 Fidelity Investments-Puritan Fund 707,512 547,145 Chemical Financial Corporation Common Stock 2,040,820 1,906,118
14 NOTES TO FINANCIAL STATEMENTS (CONTINUED) NOTE D - - TRANSACTIONS WITH PARTIES-IN-INTEREST THE FOLLOWING IS A SUMMARY OF TRANSACTIONS (AT COST) WITH PARTIES-IN-INTEREST:
CHEMICAL FINANCIAL CORPORATION COMMON STOCK ------------ Balance at January 1, 1997 $994,177 Purchases in 1997 403,695 Sales in 1997 (113,741) Distributions in 1997 (49,978) ---------- Balance at December 31, 1997 $1,234,153 Purchases in 1998 379,041 Sales in 1998 (62,840) Distributions in 1998 (25,846) ---------- Balance at December 31, 1998 $1,524,508 ==========
NOTE E - - INCOME TAX STATUS The Plan has received a determination letter from the Internal Revenue Service dated August 23, 1994, stating that the Plan is qualified under section 401(a) of the Internal Revenue Code (the "Code") and, therefore, the related trust is exempt from taxation. Once qualified, the Plan is required to operate in conformity with the Code to maintain its qualification. The Plan 15 Administrator believes the plan is being operated in compliance with the applicable requirements of the Code and, therefore, believes that the Plan is qualified and the related trust is tax exempt. NOTE F - - PLAN MERGER In May 1996, the Corporation acquired State Savings Bancorp, Inc. During 1997, the participants of the Retirement Plan for the State Savings Bank of Caro were given the option to rollover their account balances into the Plan and, accordingly, approximately $145,000 of such rollover contributions are included as employee contributions in the accompanying financial statements for the year ended December 31, 1997. NOTES TO FINANCIAL STATEMENTS (CONTINUED) NOTE G - - YEAR 2000 READINESS DISCLOSURE (UNAUDITED) The Corporation has modified its internal information technology to be ready for the year 2000 and it is the Corporation's opinion that the conversion of its critical data processing systems and the testing of those systems was complete as of December 31, 1998. The Corporation does not expect the Year 2000 project to have a significant effect on plan operations. 16 EMPLOYEE ID# 38-2022454 PLAN # 002 ITEM 27A -- SCHEDULE OF ASSETS HELD FOR INVESTMENT PURPOSES CHEMICAL FINANCIAL CORPORATION 401(K) SAVINGS PLAN DECEMBER 31, 1998
DESCRIPTION OF INVESTMENT INCLUDING COST PROCEEDS IDENTITY OF ISSUE, BORROWER, LESSOR OR MATURITY DATE, RATE OF INTEREST, OF OF SIMILAR PARTY COLLATERAL, PAR OR MATURITY VALUE COST FAIR VALUE ACQUISITIONS DISPOSITIONS - -------------------------------------- ----------------------------------- --------- ---------- ------------ ------------ Chemical Financial Corporation Common Stock - 60,920 shares Common Stock $1,524,508 $2,040,820 Federated Investors Mutual Funds: Short-Intermediate Government Trust Intermediate Bond Fund- 16,272 shares 169,824 171,343 Max-Cap Fund Index Fund - 75,734 units 1,265,310 1,923,651 Treasury Obligations Fund Money Market Fund - 241,728 shares 241,728 241,728 Fidelity Investments-Puritan Fund Stock and Bond Fund - 35,252 shares 627,869 707,512 ---------- ---------- Total Mutual Funds 2,304,731 3,044,234 ---------- ---------- Participant Loans Ten loans at interest rates ranging from 7.0%-11.45% and maturing 1/31/00-2/28/03 38,169 38,169 $ $ ---------- ---------- ========= ========= TOTAL INVESTMENTS $3,867,408 $5,123,223 ========== ========== Indicates party-in-interest to the Plan There were no investment assets reportable as acquired and disposed of during the year.
17 EMPLOYEE ID# 38-2022454 PLAN # 002 ITEM 27D -- SCHEDULE OF REPORTABLE TRANSACTIONS CHEMICAL FINANCIAL CORPORATION 401(K) SAVINGS PLAN YEAR ENDED DECEMBER 31, 1998
DESCRIPTION OF ASSET EXPENSE VALUE ON (INTEREST RATE AND MATURITY PURCHASE SELLING LEASE INCURRED WITH COST TRANSACTION NET GAIN IDENTITY OF PARTY INVOLVED IN CASE OF A LOAN) PRICE PRICE RENTAL TRANSACTION OF ASSET DATE (LOSS) - -------------------------- ------------------------------ -------- ------- ------ ------------ -------- ----------- -------- Category iii) A series of transactions involving securities of the same issue which, when aggregated, involve an amount in excess of 5% of the current value of plan assets: Chemical Financial Corporation Common Stock: 71 purchases $379,041 $379,041 50 sales 88,686 87,128 ($1,558) Federated Investors Index Fund: 60 purchases 450,235 450,235 21 sales 103,260 147,275 $44,015 Money Market Fund: 184 purchases 712,920 712,920 116 sales 693,616 693,616 - - - 18 Fidelity Investments Stock and Bond Fund: 55 purchases 225,731 225,731 12 sales 81,430 88,699 $7,269
There were no category i), ii) or iv) reportable transactions. 19 EX-99 11 EXHIBIT 99.2 Audited Financial Statements Chemical Financial Corporation 1992 Stock Purchase Plan for Subsidiary Directors December 31, 1998 ERNST & YOUNG LLP - Suite 1700 - Phone: 313 596 7100 500 Woodward Avenue Detroit, Michigan 48226-3426 REPORT OF INDEPENDENT AUDITORS Plan Administrator Chemical Financial Corporation 1992 Stock Purchase Plan for Subsidiary Directors We have audited the accompanying statements of financial condition of the Chemical Financial Corporation 1992 Stock Purchase Plan for Subsidiary Directors as of December 31, 1998 and 1997 and the related statements of income and changes in plan equity for each of the three years in the period ended December 31, 1998. These financial statements are the responsibility of the Plan's administrator. Our responsibility is to express an opinion on these financial statements based on our audits. We conducted our audits in accordance with generally accepted auditing standards. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by the Plan Administrator, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion. In our opinion, the financial statements referred to above present fairly, in all material respects, the financial position of the Chemical Financial Corporation 1992 Stock Purchase Plan for Subsidiary Directors at December 31, 1998 and 1997, and the results of its operations and changes in its plan equity for each of the three years in the period December 31, 1998 in conformity with generally accepted accounting principles. S/ ERNST & YOUNG LLP February 5, 1999 CHEMICAL FINANCIAL CORPORATION 1992 STOCK PURCHASE PLAN FOR SUBSIDIARY DIRECTORS STATEMENTS OF FINANCIAL CONDITION
DECEMBER 31, 1998 1997 -------- -------- ASSETS Cash $ 963 $ 1,139 Common stock receivable of Chemical Financial Corporation, at market value - (9,076 shares at a cost of $300,078 at December 31, 1998 and 9,197 shares at a cost of $263,868 at December 31, 1997) 304,046 329,270 -------- -------- Total assets $305,009 $330,409 ======== ======== LIABILITIES AND PLAN EQUITY Plan equity (51 participants at December 31, 1998 and 46 participants at December 31, 1997) $305,009 $330,409 ======== ========
See accompanying notes. 2 CHEMICAL FINANCIAL CORPORATION 1992 STOCK PURCHASE PLAN FOR SUBSIDIARY DIRECTORS STATEMENTS OF INCOME AND CHANGES IN PLAN EQUITY
YEARS ENDED DECEMBER 31 1998 1997 1996 -------- -------- -------- ADDITIONS Participant contributions $294,650 $258,775 $263,650 Dividend equivalents 3,669 3,501 2,965 Other income 704 1,055 848 -------- -------- -------- 299,023 263,331 267,463 DEDUCTIONS Plan distributions 329,354 291,431 294,346 -------- -------- -------- (30,331) (28,100) (26,883) Net realized appreciation in fair value of investments 4,931 65,402 25,745 -------- -------- -------- Net increase (decrease) (25,400) 37,302 (1,138) Plan equity at beginning of year 330,409 293,107 294,245 -------- -------- -------- Plan equity at end of year $305,009 $330,409 $293,107 ======== ======== ========
See accompanying notes. 3 CHEMICAL FINANCIAL CORPORATION 1992 STOCK PURCHASE PLAN FOR SUBSIDIARY DIRECTORS NOTES TO FINANCIAL STATEMENTS DECEMBER 31, 1998 The Chemical Financial Corporation 1992 Stock Purchase Plan for Subsidiary Directors (the Plan) was implemented by Chemical Financial Corporation (the Corporation) on April 30, 1992. The Plan is designed to provide non-employee directors and advisory directors of the Corporation's subsidiaries, who are neither directors or employees of the Corporation, with a convenient method of acquiring Corporation stock. NOTE 1 - DESCRIPTION OF THE PLAN Subsidiary directors and advisory directors, who elect to participate in the Plan, may elect to contribute to the Plan fifty percent or one hundred percent of their director board fees and/or fifty percent or one hundred percent of their director committee fees, earned as directors or advisory directors of the Corporation's subsidiaries. Participant contributions to the Plan are made by the Corporation's subsidiaries on behalf of each electing participant. Amounts remitted to the Plan are credited to a separate cash account for each participant. As of the last day of each month, each participant's cash account is debited for the purchase of whole shares of the Corporation's stock and credited to a separate participant stock account. The stock purchased under the Plan during the calendar year is issued by the Corporation directly to the participants in the following calendar year, in the month of January. The Plan provides for dividend equivalents to be credited to each participant's cash account, as of the dividend record date of the Corporation's common stock. Dividend equivalents are calculated by multiplying the Corporation's dividend rate by the number of shares of common stock in each participant's stock account, as of the Corporation's dividend record date. The Plan also provides for an appropriate credit to each participant's stock account for stock dividends, stock splits or other distributions of the Corporation's common stock by the Corporation. Fractional shares calculated as a result of the above adjustments are converted to cash based on the market price of the Corporation's common stock, and are credited to each participant's cash account. Plan participants may terminate their participation in the Plan, at any time, by written notice of withdrawal to the Corporation. Participants will cease to be eligible to participate in the Plan when 4 they cease to serve as directors or advisory directors of subsidiaries of the Corporation. Upon withdrawal from the Plan, each participant will receive the shares of common stock of the Corporation in their participant stock account and the cash in their participant cash account. NOTE 1 - DESCRIPTION OF THE PLAN (CONTINUED) As of December 31, 1998, the Plan had 6,186 remaining shares of the Corporation that it was authorized to issue. The 1998 Stock Purchase Plan for Subsidiary Directors ("new plan") was approved by the Board of Directors of the Corporation on December 14, 1998, with the same terms and provisions of the Plan. A common stock receivable for 2,890 shares of the Corporation, with a market value of $96,815, cost basis of $95,245, and cash of $963 were transferred to the new plan on January 1, 1999. The Corporation reserves the right to terminate or amend the Plan at any time, provided, however, that no termination or amendment shall affect or diminish any participant's right to the benefit of contributions made by him/her prior to the date of such amendment or termination. The Plan provides that all expenses of the Plan and its administration shall be paid by the Corporation. The Plan is not qualified under Sections 401(a) or 501(a) of the Internal Revenue Code of 1986, as amended. The Plan does not provide for income taxes because any income is taxable to the participants. Participants in the Plan must treat as taxable income the contributions made to the Plan by the Corporation's subsidiaries on their behalf. Dividend equivalents and any other cash credited to the participants' cash accounts are taxable to the participants for Federal and state income tax purposes in the year such dividend equivalent or cash is credited to the participant cash account. Upon disposition of the common stock of Chemical Financial Corporation purchased under the Plan, participants must treat any gain or loss as long-term or short-term capital gain or loss depending upon when such disposition occurs. 5 CHEMICAL FINANCIAL CORPORATION 1992 STOCK PURCHASE PLAN FOR SUBSIDIARY DIRECTORS NOTES TO FINANCIAL STATEMENTS DECEMBER 31, 1998 NOTE 2 - SUMMARY OF ACCOUNTING POLICIES VALUATION OF COMMON STOCK RECEIVABLE Common stock receivable of Chemical Financial Corporation is recorded at the fair market value of the number of shares receivable at the end of the period. Market value is based on the closing bid price of the Corporation's stock at year end ($33.50 per share at December 31, 1998 and $35.80 per share at December 31, 1997). The number of shares receivable and closing bid prices were adjusted for the 5 for 4 stock split paid on Chemical Financial Corporation common stock on December 16, 1998. INCOME Dividend equivalents and fractional share interests are accrued on the Corporation's dividend or other record date. CONTRIBUTIONS Contributions are accounted for on the accrual basis. 6 CHEMICAL FINANCIAL CORPORATION 1992 STOCK PURCHASE PLAN FOR SUBSIDIARY DIRECTORS NOTES TO FINANCIAL STATEMENTS DECEMBER 31, 1998 NOTE 3 - CONTRIBUTIONS Contributions for participants by the participating companies were as follows:
YEARS ENDED DECEMBER 31 PARTICIPATING COMPANY 1998 1997 1996 -------- -------- -------- Chemical Bank and Trust Co. $ 55,000 $ 70,700 $ 73,025 Chemical Bank Bay Area 34,800 33,100 37,525 Chemical Bank Central 37,150 26,400 22,050 Chemical Bank Thumb Area 34,100 26,650 21,200 Chemical Bank Michigan 32,700 29,750 31,750 Chemical Bank Montcalm 16,200 15,000 19,500 Chemical Bank North 13,575 3,150 4,650 Chemical Bank South 23,425 19,125 19,425 Chemical Bank West 11,700 8,900 8,625 Chemical Bank Key State 33,000 20,000 20,400 CFC Data Corp 3,000 6,000 5,500 -------- -------- -------- Total Contributions $294,650 $258,775 $263,650 ======== ======== ========
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