CHFC 2017 Annual Report

Interest rate swaps are entered into in order to economically hedge the effect of changes and to mitigate the impact of fluctuations in interest rate volatility to manage exposures that arise from business activities that result in the receipt or payment of future known and uncertain cash amounts. These derivatives are designated as cash flow hedges. Accordingly, the effective portion of changes in the fair value of interest rate swaps are recorded in accumulated other comprehensive income on the Consolidated Statement of Financial Condition and is subsequently reclassified into earnings in the period that the hedged forecasted transaction affects earnings. Any ineffective portion of the change in fair value of the derivatives is recognized directly in earnings. The Corporation expects the hedges to remain highly effective during the remaining terms of the swaps. Interest rate swaps, are valued based on quoted prices for similar assets in an active market with inputs that are observable. The Corporation utilizes interest rate derivatives to provide a service to certain qualifying customers to help facilitate their respective risk management strategies, customer-initiated derivatives. Therefore, these derivatives are not used to manage interest rate risk in the Corporation's assets or liabilities. The Corporation generally takes offsetting positions with dealer counterparties to mitigate the valuation risk of the customer-initiated derivatives. Income primarily results in the spread between the customer derivatives and offsetting dealer positions. The gains or losses derived from changes in fair value are recognized in current earnings during the period of change in other noninterest income on theConsolidated Statements of Income. TheCorporation calculates a credit valuation adjustment by applying a credit spread for the counterparty or the Corporation, as appropriate, to the total expected exposure of the derivative after considering collateral and other master netting arrangements. The Corporation additionally has written and purchased option derivatives consisting of instruments to facilitate an equity- linked time deposit product (the "Power Equity CD"). The Power Equity CD is a time deposit that provides the purchaser a guaranteed return of principal at maturity plus a potential equity return (a written option), while the Corporation receives a known streamof funds based on the equity return (a purchased option). The written and purchased options are mirror derivative instruments which are carried at fair value on the Consolidated Statements of Financial Position. Premises and Equipment Land is carried at cost. Premises and equipment are stated at cost less accumulated depreciation. Depreciation is computed using the straight-line method with useful lives ranging from 25 to 40 years for buildings and three to ten years for all other depreciable assets. Maintenance and repairs are charged to expense as incurred. Other Real Estate Owned and Repossessed Assets Other real estate owned ("ORE") and repossessed assets represent property acquired by the Corporation as part of an acquisition or subsequently through the loan foreclosure or repossession process, or any other resolution activity that results in partial or total satisfaction of problem loans. ORE is primarily comprised of commercial and residential real estate properties, including vacant land and development properties, obtained in partial or total satisfaction of loan obligations. The acquired properties are recorded at fair value at the date of acquisition. Losses arising at the time of acquisition of properties not acquired as part of an acquisition are charged against the allowance for loan and lease losses. Foreclosed properties are initially recorded at the lower of cost, or the estimated fair value of the property, less estimated costs to sell, based upon the property's appraised value at the date of transfer to ORE and management's estimate of the fair value of the collateral, establishing a new cost basis. Any difference between the net realizable value of the property and the carrying value of the loan is charged to the allowance for loan losses. Subsequently, all other real estate owned is valued at the lower of cost or fair value, less estimated costs to sell, based on periodic valuations performed by management, with any difference between the net realizable value of the property and the carrying value of the loan charged to the allowance for loan losses. If fair value declines subsequent to foreclosure, a valuation allowance is recorded through expense. Subsequent write-downs, for amounts not expected to be recovered, in the carrying value of other real estate owned and repossessed asset properties that may be required are expensed as incurred. Improvements to the properties may be capitalized if the improvements contribute to the overall value of the property. Improvement amounts may not be capitalized in excess of the net realizable value of the property. Any gains or losses realized at the time of disposal are reflected in other noninterest expense on the Consolidated Statements of Income. Other real estate owned and repossessed assets totaling $8.8 million and $17.2 million at December 31, 2017 and 2016, respectively, was included in "Interest receivable and other assets" in the Consolidated Statements of Financial Position. Goodwill Goodwill is not amortized, but rather is subject to impairment tests annually or more frequently if triggering events occur and indicate potential impairment. The Corporation's annual goodwill impairment assessment was performed as of October 31, Chemical Financial Corporation Notes to Consolidated Financial Statements December 31, 2017 90