Summary of CHEMICAL FINANCIAL CORP

Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations

The following is management's discussion and analysis of certain significant factors that have affected the Corporation's financial condition and results of operations during the periods included in the consolidated financial statements included in this filing.

Critical Accounting Policies

The Corporation's consolidated financial statements are prepared in accordance with U.S. generally accepted accounting principles (GAAP) and follow general practices within the industry in which the Corporation operates. Application of these principles requires management to make estimates, assumptions and complex judgments that affect the amounts reported in the financial statements and accompanying notes. These estimates, assumptions and judgments are based on information available as of the date of the financial statements; accordingly, as this information changes, the financial statements could reflect different estimates, assumptions and judgments. Actual results could differ significantly from those estimates. Certain policies inherently have a greater reliance on the use of estimates, assumptions and judgments and, as such, have a greater possibility of producing results that could be materially different than originally reported. Management has identified the determination of the allowance for loan losses, pension plan accounting, income and other taxes, and the evaluation of goodwill impairment to be the accounting areas that require the most subjective or complex judgments, and as such, could be most subject to revision as new or additional information becomes available or circumstances change, including overall changes in the economic climate and/or market interest rates. Therefore, management considers them to be critical accounting policies and discusses them directly with the Audit Committee of the board of directors. The Corporation's significant accounting policies are more fully described in Note 1 to the audited consolidated financial statements contained in the Corporation's Annual Report on Form 10-K for the year ended December 31, 2008 and the more significant assumptions and estimates made by management are more fully described in "Management's Discussion and Analysis of Financial Condition and Results of Operations - Critical Accounting Policies" in the Corporation's Annual Report on Form 10-K for the year ended December 31, 2008. There have been no material changes to those policies or the estimates made pursuant to those policies during the most recent quarter.

Summary

The Corporation's net income was $2.5 million, or $0.10 per diluted share, in the third quarter of 2009, compared to a net loss of $1.0 million, or $0.04 per diluted share, in the third quarter of 2008. The increases in net income and earnings per share were primarily the result of a decrease in the provision for loan losses that was partially offset by an increase in other operating expenses.

Return on average assets in the third quarter of 2009 was 0.24%, compared to
(0.11)% in the third quarter of 2008, on an annualized basis. Return on average equity in the third quarter of 2009 was 2.0%, compared to (0.8)% in the third quarter of 2008, on an annualized basis.

Total assets were $4.27 billion as of September 30, 2009, up $480.3 million, or 12.7%, from $3.79 billion at September 30, 2008, and up $394.1 million, or 10.2%, from $3.87 billion at December 31, 2008.

Total loans were $3.00 billion as of September 30, 2009, an increase of $75.1 million, or 2.6%, from September 30, 2008, and an increase of $21.8 million, or 0.7%, from December 31, 2008. The increase in total loans from both September 30, 2008 and December 31, 2008 was attributable to an increase in consumer loans being partially offset by lower real estate residential loans.

At September 30, 2009, shareholders' equity was 11.2% of total assets and $20.06 per outstanding share of common stock. Shareholders' equity of $479.3 million as of September 30, 2009 decreased $4.0 million, or 0.8%, from June 30, 2009 and $12.3 million, or 2.5%, from December 31, 2008. The decrease in shareholders' equity during the three and nine months ended September 30, 2009 was primarily attributable to cash dividends paid to shareholders, which exceeded net income during the three and nine months ended September 30, 2009.

Balance Sheet

Total Assets

Total assets were $4.27 billion as of September 30, 2009, an increase of $394.1 million, or 10.2%, from total assets of $3.87 billion as of December 31, 2008 and an increase of $480.3 million, or 12.7%, from total assets of $3.79 billion as of September 30, 2008. The increase in total assets from December 31, 2008 was primarily attributable to increases in investment securities and short-term investments that were funded by increased deposits. The increase in total assets from September 30, 2008 was primarily attributable to increases in total loans, investment securities and short-term investments that were funded by increased deposits.

Interest-earning assets were $4.05 billion at September 30, 2009, an increase of $488.7 million, or 13.7%, from December 31, 2008. The increase in interest-earning assets between December 31, 2008 and September 30, 2009 was primarily attributable to the increases in investment securities and short-term investments that were funded by increased deposits.

Investment Securities

Investment securities at September 30, 2009 totaled $644.9 million, an increase of $97.4 million, or 17.8%, from December 31, 2008. The increase in investment securities was funded by increased customer deposits. The increased funds were partially invested in collateralized mortgage obligations (CMO), primarily variable rate instruments with average maturities of less than three years. CMO investment securities totaled $154.0 million, or 23.9%, of investment securities at September 30, 2009, compared to $37.3 million, or 6.8%, of investment securities at December 31, 2008. Additionally, during the nine months ended September 30, 2009, the Corporation slightly changed the mix of its investment securities portfolio as it re-invested funds from maturing U.S. Treasury, mortgage-backed securities and corporate bonds into state and political subdivisions investment securities, as opportunities in local municipal markets increased due to a reduction in demand nationally for local municipal securities. State and political subdivisions investment securities, which consist primarily of issuers located in the State of Michigan and are general obligations of the issuers, totaled $125.3 million, or 19.4%, of investment securities at September 30, 2009, compared to $90.0 million, or 16.4%, of investment securities at December 31, 2008.

The Corporation's investment securities portfolio had a carrying value of $644.9 million at September 30, 2009, with gross impairment of $9.4 million as of that date. The Corporation concluded that at September 30, 2009 the impairment was temporary.

At September 30, 2009, the Corporation's investment securities portfolio included state and political subdivisions securities with gross impairment of $0.6 million, mortgage-backed securities and collateralized mortgage obligations with combined gross impairment of $0.8 million, corporate bonds with gross impairment of $0.6 million and trust preferred securities with gross impairment of $7.4 million. The Corporation's investment securities portfolio also included U.S. Treasuries which had no gross impairment at September 30, 2009 and government sponsored agency securities which had a relatively small amount of gross impairment at September 30, 2009.

The state and political subdivisions investment securities in the held-to-maturity portfolio totaling $121.5 million at September 30, 2009 were recorded at amortized cost. The majority of these investment securities are from issuers primarily located in the State of Michigan and are primarily general obligations of the issuer, meaning that the issuers' debt obligations are funded by tax collections. Of the total $121.5 million, investment securities totaling $25.7 million, at amortized cost, had gross impairment of $0.6 million at September 30, 2009. The majority of the investment securities with impairment mature beyond 2016 and, due to the steepness of the interest yield curve at September 30, 2009, the Corporation determined that the impairment of $0.6 million at September 30, 2009 was attributable to the change in market interest rates and that the impairment was temporary in nature.

The mortgage-backed securities and collateralized mortgage obligations included in the available-for-sale investment securities portfolio, had a combined amortized cost of $299.8 million and combined gross impairment of $0.8 million at September 30, 2009. Virtually all of the impaired investment securities in these two categories are

backed by an explicit guarantee of the U.S. government. The Corporation assessed the impairment on these investment securities at September 30, 2009 and determined the impairment was attributable to the general decline in market interest rates and volatile prepayment speeds. At September 30, 2009, the Corporation determined that the impairment on these investment securities was temporary in nature.

At September 30, 2009, the Corporation's corporate bond portfolio had an amortized cost of $32.3 million, with gross impairment of $0.6 million on investment securities totaling $4.6 million at fair value. All of the corporate bonds held at September 30, 2009 were of an investment grade, except one single issue investment security from Lehman Brothers Holdings Inc. (Lehman) and two corporate bonds from American General Finance Corporation (AGFC), a wholly-owned subsidiary of American General Finance Inc. (AGFI), which is wholly-owned indirectly by American International Group (AIG). The investment grade ratings obtained for the balance of the corporate bond portfolio indicated that the obligors' capacities to meet their financial commitments were "strong." During the third quarter of 2008, the Corporation recorded a $0.4 million loss related to the write-down of the Lehman bond to fair value as the impairment was deemed to be other-than-temporary and entirely credit related. The Corporation's remaining amortized cost of the Lehman bond was less than $0.1 million at September 30, 2009. The impairment existing at September 30, 2009 was attributable to the two corporate bonds from AGFC with a combined amortized cost/par value of $2.7 million that had impairment of $0.6 million at that date. Both AGFC corporate bonds are senior unsecured obligations. The amortized cost/par value amounts of the two bonds were $0.2 million and $2.5 million with maturity dates of September 1, 2010 and December 15, 2011, respectively.

The Corporation performed an assessment of the likelihood that it would collect all of the contractual amounts due under the two AGFC corporate bonds at September 30, 2009. Ratings from Moody's, Standard & Poor's and Fitch were Baa2, BB+ and BB, respectively, at September 30, 2009. AGFC was downgraded by each of these rating services twice during 2008. Additionally Standard & Poor's and Fitch downgraded AGFC on February 9, 2009 and May 15, 2009, respectively, to a level just below investment grade. Moody's current rating, however, is two notches above the investment grade threshold. There have been no changes in ratings since the end of the second quarter of 2009. Management believes that the analyses used by these rating agencies does not include the likelihood of the parent company's (AIG) ability and willingness to provide support to its subsidiary.

The public filing of AGFC's Form 10-Q with the SEC for the period ended June 30, 2009 indicated AGFC had recorded a financial loss of $227 million for the three months ended June 30, 2009; however, AGFC's total equity at June 30, 2009 was $2.3 billion, or 9.6% of total assets. AGFC's own assessment of its financial condition at June 30, 2009 indicated that, after consideration of many factors, although primarily due to its ability to obtain funding from its parent company and its ability to severely reduce originations of finance receivables, AGFC believed it would have adequate liquidity to finance and operate its businesses and repay its obligations for at least the next twelve months. However, it is possible that the actual outcome of one or more of AGFC's significant judgments or estimates could prove to be materially incorrect and AGFC may not have sufficient cash to meet its obligations in the future. A $0.1 million AGFC bond owned by the Corporation that matured on October 15, 2008 was paid in full on the scheduled payment date, as was all 2009 scheduled quarterly and semi-annual interest payments on both AGFC corporate bonds owned by the Corporation.

At September 30, 2009, the Corporation owned $10.5 million at amortized cost of trust preferred securities that had gross impairment of $7.4 million. Of the $10.5 million balance, $10.0 million represented a 100% interest in a trust preferred security (TRUP) of a small non-public bank holding company in Michigan (issuer) that was purchased in the second quarter of 2008. At September 30, 2009, the Corporation determined the fair value of the TRUP was $3.0 million. The fair value measurement was developed based upon market pricing observations of much larger banking institutions in an illiquid market adjusted by risk measurements. The fair value of the TRUP was based on a calculation of discounted cash flows, based upon both observable inputs and appropriate risk adjustments that market participants would make for performance, liquidity and issuer specifics. See the additional discussion of the development of the fair value of the TRUP in Note 2 to the consolidated financial statements.

Management reviewed financial information of the issuer of the TRUP at September 30, 2009. Based on this review, the Corporation concluded that the significant decline in fair value of the TRUP, compared to its amortized cost, was not attributable to materially adverse conditions specifically related to the issuer. The issuer reported net income in 2007, 2008 and the first three quarters of 2009. At September 30, 2009, the issuer had equity capital of $60.1 million

and a liquidity position which included $125.0 million in investment securities held as available-for-sale. Based on the Corporation's analysis at September 30, 2009, it was the Corporation's belief that the issuer appeared to be a financially sound institution with sufficient liquidity to meet its financial obligations in 2009. The TRUP is not independently rated. Industry bank ratings for 2008, obtained from the issuer, indicated the issuer was defined as "sound." Common stock cash dividends were paid throughout 2008 and through the third quarter of 2009 by the issuer and the Corporation understands that the issuer's management anticipates cash dividends to continue to be paid for the remainder of 2009 and beyond. All scheduled interest payments on the TRUP were made on a timely basis in 2008 and through the third quarter of 2009. The principal of $10.0 million of the TRUP matures in 2038, with interest payments due quarterly.

Based on the information provided by the issuer, as of September 30, 2009, it was the Corporation's belief that there had been no material adverse changes in the issuer's financial performance since the TRUP was issued and purchased by the Corporation and no indication that any material adverse trends were developing that would suggest that the issuer would be unable to make all future principal and interest payments under the TRUP. Further, based on the information provided by the issuer, the issuer appeared to be a financially viable financial institution with both the credit quality and liquidity necessary to meet financial obligations in 2009. At September 30, 2009, the Corporation was not aware of any regulatory issues, memorandums of understanding or cease and desist orders that had been issued to the issuer or its subsidiaries. In reviewing all available information regarding the issuer reflecting past performance and its financial and liquidity position, it was the Corporation's belief that the future cash flows of the issuer supported the carrying value of the TRUP at its original cost of $10.0 million at September 30, 2009. There can be no assurance that other-than-temporary impairment losses will not be recognized on TRUPs or on any other investment security in the future. While the fair value of the TRUP was $7.0 million below the Corporation's carrying value (original cost) at September 30, 2009 and the TRUP was impaired, it was the Corporation's assessment that the overall financial condition of the issuer did not indicate other-than-temporary impairment of the TRUP and that the unrealized loss was temporary at September 30, 2009.

At September 30, 2009, the Corporation expected to fully recover the entire amortized cost basis of each impaired investment security in its investment securities portfolio and not incur any credit losses associated with its impaired investment securities. Furthermore, as of September 30, 2009, the Corporation did not have the intent to sell any of its impaired investment securities and believed that it was more likely than not that the Corporation would not have to sell any of its impaired investment securities before a full recovery of amortized cost.

Loans

The Corporation's subsidiary bank is a full-service commercial bank and, therefore, the acceptance and management of credit risk is an integral part of the Corporation's business. At September 30, 2009, the Corporation's loan portfolio was $3.0 billion and consisted of loans to commercial borrowers
(commercial, real estate commercial and real estate construction-commercial)
totaling $1.46 billion, or 48% of total loans, loans to consumer borrowers for the purpose of acquiring residential real estate (real estate residential and real estate construction-residential) totaling $772 million, or 26% of total loans, and loans to consumer borrowers secured by various types of collateral totaling $774 million, or 26% of total loans, at that date. Loans at fixed interest rates comprised approximately 80% of the Corporation's loan portfolio at September 30, 2009 and December 31, 2008.

The Corporation maintains loan policies and credit underwriting standards as part of the process of managing credit risk. Underwriting standards are designed to promote relationship banking rather than transactional banking. These standards include providing loans generally only within the Corporation's market areas. The Corporation's lending markets generally consist of communities across the middle to southern and western sections of the lower peninsula of Michigan. The Corporation's lending market areas do not include the southeastern portion of Michigan. The Corporation has no foreign loans or any loans to finance highly leveraged transactions. The Corporation's lending philosophy is implemented through strong administrative and reporting controls. The Corporation maintains a centralized independent loan review function, which monitors asset quality of the loan portfolio.

Total loans at September 30, 2009 of $3.0 billion were up $21.8 million, or 0.7%, from total loans at December 31, 2008, and up $75.1 million, or 2.6%, from total loans at September 30, 2008. A summary of the changes in the loan portfolio by category follows.

Commercial loans consist primarily of loans to varying types of businesses, municipalities and nonprofit organizations for the purpose of supporting working capital and operational needs and term financing of equipment. Repayment of such loans is generally provided through operating cash flows of the business, although the Corporation also generally secures commercial loans with equipment, real estate, personal guarantees of the owner or other sources of repayment.

Commercial loans were $575.1 million at September 30, 2009, a decrease of $12.5 million, or 2.1%, from December 31, 2008. The decrease in commercial loans was attributable to both seasonal reductions of short-term lines of credit and less customer demand for new financing. Commercial loans represented 19.1% of the Corporation's loan portfolio at September 30, 2009, compared to 19.7% at December 31, 2008.

The average size of commercial loan transactions is generally relatively small, which decreases the risk of loss within the commercial loan portfolio due to the lack of loan concentration. The Corporation's loan portfolio to commercial borrowers, defined as commercial, real estate commercial and real estate construction-commercial loans, is well diversified across business lines and has no concentration in any one industry. The total loan portfolio to commercial borrowers of $1.46 billion at September 30, 2009 included 74 loan relationships of $2.5 million or greater. These 74 borrowing relationships totaled $401.3 million and represented 27.5% of the loan portfolio to commercial borrowers at September 30, 2009. Further, at September 30, 2009, only five of these borrowing relationships were $10 million or higher, totaling $68.3 million, or 4.7%, of the loan portfolio to commercial borrowers as of that date. These five loans were performing at September 30, 2009.

Real estate commercial loans include loans that are secured by real estate occupied by the borrower for ongoing operations, non-owner occupied real estate leased to one or more tenants and vacant land that has been acquired for investment or future land development. Real estate commercial loans were $782.6 million at September 30, 2009, a decrease of $3.8 million, or 0.5%, from December 31, 2008. Real estate commercial loans represented 26.1% of the Corporation's loan portfolio at September 30, 2009, compared to 26.4% at December 31, 2008. Loans secured by owner occupied properties, non-owner occupied properties and vacant land comprised approximately 74%, 22% and 4%, respectively, of the Corporation's real estate commercial loans outstanding at September 30, 2009.

Real estate commercial lending is generally considered to involve a higher degree of risk than real estate residential lending and typically involves larger loan balances concentrated in a single borrower. In addition, the payment experience on loans secured by income-producing properties and vacant land loans are typically dependent on the success of the operation of the related project and are typically affected by adverse conditions in the real estate market and in the economy.

The Corporation generally attempts to mitigate the risks associated with commercial and real estate commercial lending by, among other things, lending primarily in its market areas, lending across industry lines, not developing a concentration in any one line of business and using prudent loan-to-value ratios in the underwriting process.

Real estate construction loans are originated for both business and residential properties, including land development. Land development loans are loans made to residential and commercial developers for infrastructure improvements to create finished marketable lots for residential or commercial construction. Real estate construction loans often convert to a real estate commercial or real estate residential loan at the completion of the construction period; however, most land development loans are originated with the intention that the loans will be paid through the sale of finished properties by the developers within twelve months of the completion date. Real estate construction loans were $118.1 million at September 30, 2009, a decrease of $0.9 million, or 0.7%, from December 31, 2008 and represented 3.9% of the Corporation's loan portfolio as of September 30, 2009 compared to 4.0% as of December 31, 2008. Real estate construction loans to commercial borrowers represented the majority of these loans and were $99.7 million at September 30, 2009, an increase of $10.0 million, or 11.1%, from December 31, 2008. Real estate construction loans also include loans to consumers for the construction of single family residences that are secured by these properties. Real estate construction loans to consumers were $18.4 million at September 30, 2009, a decrease of $10.9 million, or 37.1%, from December 31, 2008.

Real estate construction lending involves a higher degree of risk than real estate commercial lending and real estate residential lending because of the uncertainties of construction, including the possibility of costs exceeding the initial estimates and the need to obtain a tenant or purchaser of the property if it will not be owner-occupied. The Corporation generally attempts to mitigate the risks associated with construction lending by, among other things, lending primarily in its market areas, using prudent underwriting guidelines and closely monitoring the construction process. At September 30, 2009, the Corporation's real estate construction loans to commercial borrowers included $56.9 million of residential development loans. The Corporation's risk in this area has increased since early 2008 as business expansion and development have continued at historically low rates during 2008 and 2009 across all of the Corporation's market areas due to the recessionary economic environment within the State of Michigan. Consequently, the sale of units in residential real estate development projects has slowed significantly, as customer demand significantly decreased, resulting in the inventory of unsold housing units increasing across the State of Michigan. The severe recession in Michigan has resulted in the inability of most developers to sell their finished developed lots and units within their original expected time frames. Accordingly, few of the Corporation's residential development borrowers sold developed lots or units during 2008 and 2009 due to the poor economic environment.

Real estate residential loans consist primarily of one- to four-family residential loans with fixed interest rates of fifteen years or less. The loan-to-value ratio at the time of origination is generally 80% or less. Loans with more than an 80% loan-to-value ratio generally require private mortgage insurance. Real estate residential loans were $753.7 million as of September 30, 2009, a decrease of $85.8 million, or 10.2%, from December 31, 2008. Real estate residential loans represented 25.1% of the Corporation's loan portfolio at September 30, 2009, compared to 28.1% as of December 31, 2008. The decrease in real estate residential loans was attributable to both a significant decline in Michigan's housing market due to the overall economic environment and customers refinancing adjustable rate and balloon mortgages to long-term fixed interest rate loans that the Corporation sold in the secondary market. The Corporation's current general practice is to sell fixed interest rate real estate residential loan originations with maturities of over ten years in the secondary market.

The Corporation's consumer loan portfolio consists of relatively small loan amounts that are spread across many individual borrowers, which minimizes the risk per loan transaction. Collateral values, particularly those of automobiles, recreational vehicles and boats, are negatively impacted by many factors, such as new car promotions, the physical condition of the collateral and even more significantly, overall economic conditions. Consumer loans also include home equity loans, whereby consumers utilize equity in their personal residence, generally through a second mortgage, as collateral to secure the loan.

Consumer loans were $773.9 million at September 30, 2009, an increase of $124.7 million, or 19.2%, from December 31, 2008. Consumer loans represented 25.8% of the Corporation's loan portfolio at September 30, 2009, compared to 21.8% at December 31, 2008. The increase in consumer loans during the nine months ended September 30, 2009 was primarily attributable to an increase in indirect consumer loans, due to a combination of an increased sales effort, new technology to support indirect loan application processing and a reduction in . . .