Fair Value Disclosures

3 Months Ended

Mar. 31, 2020

Fair value disclosures

A. Fair value measurements

The guidance on fair value measurements defines fair value as the exchange price that would be received for an asset or paid to transfer a liability (an exit price) in the principal or most advantageous market for the asset or liability in an orderly transaction between market participants. This guidance also specifies a fair value hierarchy based upon the observability of inputs used in valuation techniques. Observable inputs (highest level) reflect market data obtained from independent sources, while unobservable inputs (lowest level) reflect internally developed market assumptions. In accordance with this guidance, fair value measurements are classified under the following hierarchy:


•	Level 1 – Quoted prices for identical instruments in active markets.


•	Level 2 – Quoted prices for similar instruments in active markets; quoted prices for identical or similar instruments in markets that are not active; and model-derived valuations in which all significant inputs or significant value-drivers are observable in active markets.


•	Level 3 – Model-derived valuations in which one or more significant inputs or significant value-drivers are unobservable.

When available, we use quoted market prices to determine fair value, and we classify such measurements within Level 1. In some cases where market prices are not available, we make use of observable market based inputs to calculate fair value, in which case the measurements are classified within Level 2. If quoted or observable market prices are not available, fair value is based upon valuations in which one or more significant inputs are unobservable, including internally developed models that use, where possible, current market-based parameters such as interest rates, yield curves and currency rates. These measurements are classified within Level 3.

Fair value measurements are classified according to the lowest level input or value-driver that is significant to the valuation. A measurement may therefore be classified within Level 3 even though there may be significant inputs that are readily observable.

Fair value measurement includes the consideration of nonperformance risk. Nonperformance risk refers to the risk that an obligation (either by a counterparty or Caterpillar) will not be fulfilled. For financial assets traded in an active market (Level 1 and certain Level 2), the nonperformance risk is included in the market price. For certain other financial assets and liabilities (certain Level 2 and Level 3), our fair value calculations have been adjusted accordingly.

Investments in debt and equity securities

We have investments in certain debt and equity securities, primarily at Insurance Services, that are recorded at fair value. Fair values for our U.S. treasury bonds and large capitalization value and smaller company growth equity securities are based upon valuations for identical instruments in active markets. Fair values for other government bonds, corporate bonds and mortgage-backed debt securities are based upon models that take into consideration such market-based factors as recent sales, risk-free yield curves and prices of similarly rated bonds.

In addition, Insurance Services has an equity investment in a real estate investment trust (REIT) which is recorded at fair value based on the net asset value (NAV) of the investment and is not classified within the fair value hierarchy.

See Note 8 for additional information on our investments in debt and equity securities.

Derivative financial instruments

The fair value of interest rate contracts is primarily based on models that utilize the appropriate market-based forward swap curves and zero-coupon interest rates to determine discounted cash flows. The fair value of foreign currency and commodity forward, option and cross currency contracts is based on a valuation model that discounts cash flows resulting from the differential between the contract price and the market-based forward rate.

Assets and liabilities measured on a recurring basis at fair value, primarily related to Financial Products, included in our Consolidated Statement of Financial Position as of March 31, 2020 and December 31, 2019 are summarized below:



	March 31, 2020
(Millions of dollars)	Level 1		Level 2		Level 3		Measured at NAV		Total Assets / Liabilities, at Fair Value
Assets
Debt securities
Government debt
U.S. treasury bonds	$	9	$	—	$	—	$	—	$	9
Other U.S. and non-U.S. government bonds	—		47		—		—		47
Corporate bonds
Corporate bonds	—		871		—		—		871
Asset-backed securities	—		86		—		—		86
Mortgage-backed debt securities
U.S. governmental agency	—		378		—		—		378
Residential	—		5		—		—		5
Commercial	—		53		—		—		53
Total debt securities	9		1,440		—		—		1,449
Equity securities
Large capitalization value	139		—		—		—		139
Smaller company growth	23		—		2		—		25
REIT	—		—		—		137		137
Total equity securities	162		—		2		137		301
Derivative financial instruments, net	—		121		—		—		121
Total assets	$	171	$	1,561	$	2	$	137	$	1,871



	December 31, 2019
(Millions of dollars)	Level 1		Level 2		Level 3		Measured at NAV		Total Assets / Liabilities, at Fair Value
Assets
Debt securities
Government debt
U.S. treasury bonds	$	9	$	—	$	—	$	—	$	9
Other U.S. and non-U.S. government bonds	—		54		—		—		54
Corporate bonds
Corporate bonds	—		856		—		—		856
Asset-backed securities	—		62		—		—		62
Mortgage-backed debt securities
U.S. governmental agency	—		331		—		—		331
Residential	—		6		—		—		6
Commercial	—		47		—		—		47
Total debt securities	9		1,356		—		—		1,365
Equity securities
Large capitalization value	187		—		—		—		187
Smaller company growth	29		—		4		—		33
REIT	—		—		—		126		126
Total equity securities	216		—		4		126		346
Derivative financial instruments, net	—		45		—		—		45
Total assets	$	225	$	1,401	$	4	$	126	$	1,756

In addition to the amounts above, Cat Financial impaired loans are subject to measurement at fair value on a nonrecurring basis and are classified as Level 3 measurements. A loan is considered impaired when management determines that collection of contractual amounts due is not probable. In these cases, an allowance for credit losses may be established based either on the present value of expected future cash flows discounted at the receivables’ effective interest rate, the fair value of the collateral for collateral-dependent receivables, or the observable market price of the receivable. In determining collateral value, Cat Financial estimates the current fair market value of the collateral less selling costs. Cat Financial had impaired loans with a fair value of $324 million and $343 million as of March 31, 2020 and December 31, 2019, respectively.

B. Fair values of financial instruments

In addition to the methods and assumptions we use to record the fair value of financial instruments as discussed in the Fair value measurements section above, we used the following methods and assumptions to estimate the fair value of our financial instruments:

Cash and short-term investments

Carrying amount approximated fair value.

Restricted cash and short-term investments

Carrying amount approximated fair value. Restricted cash and short-term investments are included in Prepaid expenses and other current assets in the Consolidated Statement of Financial Position.

Finance receivables

Fair value was estimated by discounting the future cash flows using current rates, representative of receivables with similar remaining maturities.

Wholesale inventory receivables

Fair value was estimated by discounting the future cash flows using current rates, representative of receivables with similar remaining maturities.

Short-term borrowings

Carrying amount approximated fair value.

Long-term debt

Fair value for fixed and floating rate debt was estimated based on quoted market prices.

Guarantees

The fair value of guarantees is based upon our estimate of the premium a market participant would require to issue the same guarantee in a stand-alone arms-length transaction with an unrelated party. If quoted or observable market prices are not available, fair value is based upon internally developed models that utilize current market-based assumptions.

Fair values of our financial instruments were as follows:



	Fair Value of Financial Instruments
	March 31, 2020				December 31, 2019
(Millions of dollars)	Carrying Amount		Fair Value		Carrying Amount		Fair Value		Fair Value Levels	Reference
Assets
Cash and short-term investments	$	7,123	$	7,123	$	8,284	$	8,284	1
Restricted cash and short-term investments	$	7	$	7	$	8	$	8	1
Investments in debt and equity securities	$	1,750	$	1,750	$	1,711	$	1,711	1, 2 & 3	Note 8
Finance receivables – net (excluding finance leases ¹)	$	14,076	$	14,149	$	14,473	$	14,613	3	Note 17
Wholesale inventory receivables – net (excluding finance leases ¹)	$	1,104	$	1,071	$	1,105	$	1,076	3
Foreign currency contracts – net	$	129	$	129	$	62	$	62	2	Note 5
Interest rate contracts – net	$	26	$	26	$	—	$	—	2	Note 5
Commodity contracts – net	$	—	$	—	$	3	$	3	2	Note 5

Liabilities
Short-term borrowings	$	4,789	$	4,789	$	5,166	$	5,166	1
Long-term debt (including amounts due within one year)
Machinery, Energy & Transportation	$	9,141	$	11,061	$	9,157	$	11,216	2
Financial Products	$	23,163	$	23,226	$	23,334	$	23,655	2
Interest rate contracts – net	$	—	$	—	$	20	$	20	2	Note 5
Commodity contracts – net	$	34	$	34	$	—	$	—	2	Note 5
Guarantees	$	5	$	5	$	5	$	5	3	Note 11


¹	Represents finance leases and failed sales leasebacks of $7,328 million and $7,800 million at March 31, 2020 and December 31, 2019, respectively.

- Definition

The entire disclosure for the fair value of financial instruments (as defined), including financial assets and financial liabilities (collectively, as defined), and the measurements of those instruments as well as disclosures related to the fair value of non-financial assets and liabilities. Such disclosures about the financial instruments, assets, and liabilities would include: (1) the fair value of the required items together with their carrying amounts (as appropriate); (2) for items for which it is not practicable to estimate fair value, disclosure would include: (a) information pertinent to estimating fair value (including, carrying amount, effective interest rate, and maturity, and (b) the reasons why it is not practicable to estimate fair value; (3) significant concentrations of credit risk including: (a) information about the activity, region, or economic characteristics identifying a concentration, (b) the maximum amount of loss the entity is exposed to based on the gross fair value of the related item, (c) policy for requiring collateral or other security and information as to accessing such collateral or security, and (d) the nature and brief description of such collateral or security; (4) quantitative information about market risks and how such risks are managed; (5) for items measured on both a recurring and nonrecurring basis information regarding the inputs used to develop the fair value measurement; and (6) for items presented in the financial statement for which fair value measurement is elected: (a) information necessary to understand the reasons for the election, (b) discussion of the effect of fair value changes on earnings, (c) a description of [similar groups] items for which the election is made and the relation thereof to the balance sheet, the aggregate carrying value of items included in the balance sheet that are not eligible for the election; (7) all other required (as defined) and desired information.

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