Fair Value Measurements

Fair value under GAAP is defined as the price that would be received to sell an asset or paid to transfer a liability (an exit price) in an orderly transaction between market participants on the measurement date.

Fair Value Hierarchy. The following describes the hierarchy of valuation inputs (Levels 1, 2, and 3) used to measure fair value and the primary valuation methodologies used by Northern Trust for financial instruments measured at fair value on a recurring basis. Observable inputs reflect market data obtained from sources independent of the reporting entity; unobservable inputs reflect the entity’s own assumptions about how market participants would value an asset or liability based on the best information available. GAAP requires an entity measuring fair value to maximize the use of observable inputs and minimize the use of unobservable inputs and establishes a fair value hierarchy of inputs. Financial instruments are categorized within the hierarchy based on the lowest level input that is significant to their valuation. Northern Trust’s policy is to recognize transfers into and transfers out of fair value levels as of the end of the reporting period in which the transfer occurred. No transfers between fair value levels occurred during the years ended December 31, 2018, or 2017.

Level 1 – Quoted, active market prices for identical assets or liabilities. Northern Trust’s Level 1 assets are comprised of available for sale investments in U.S. treasury securities.

Level 2 – Observable inputs other than Level 1 prices, such as quoted active market prices for similar assets or liabilities, quoted prices for identical or similar assets in inactive markets, and model-derived valuations in which all significant inputs are observable in active markets. Northern Trust’s Level 2 assets include available for sale and trading account debt securities, the fair values of which are determined predominantly by external pricing vendors. Prices received from vendors are compared to other vendor and third-party prices. If a security price obtained from a pricing vendor is determined to exceed pre-determined tolerance levels that are assigned based on an asset type’s characteristics, the exception is researched and, if the price is not able to be validated, an alternate pricing vendor is utilized, consistent with Northern Trust’s pricing source hierarchy. As of December 31, 2018, Northern Trust’s available for sale debt securities portfolio included 1,479 Level 2 securities with an aggregate market value of $31.7 billion. All 1,479 debt securities were valued by external pricing vendors. As of December 31, 2017, Northern Trust’s available for sale debt securities portfolio included 1,436 Level 2 debt securities with an aggregate market value of $28.0 billion. All 1,436 debt securities were valued by external pricing vendors. Trading account debt securities, which totaled $0.3 million and $0.5 million as of December 31, 2018, and December 31, 2017, respectively, were all valued using external pricing vendors.

Northern Trust has established processes and procedures to assess the suitability of valuation methodologies used by external pricing vendors, including reviews of valuation techniques and assumptions used for selected securities. On a daily basis, periodic quality control reviews of prices received from vendors are conducted which include comparisons to prices on similar security types received from multiple pricing vendors and to the previous day’s reported prices for each security. Predetermined tolerance level exceptions are researched and may result in additional validation through available market information or the use of an alternate pricing vendor. Quarterly, Northern Trust reviews documentation from third-party pricing vendors regarding the valuation processes and assumptions used in their valuations and assesses whether the fair value levels assigned by Northern Trust to each security classification are appropriate. Annually, valuation inputs used within third-party pricing vendor valuations are reviewed for propriety on a sample basis through a comparison of inputs used to comparable market data, including security classifications that are less actively traded and security classifications comprising significant portions of the portfolio.

Level 2 assets and liabilities also include derivative contracts which are valued internally using widely accepted income-based models that incorporate inputs readily observable in actively quoted markets and reflect the contractual terms of the contracts. Observable inputs include foreign exchange rates and interest rates for foreign exchange contracts; credit spreads, default probabilities, and recovery rates for credit default swap contracts; interest rates for interest rate swap contracts and forward contracts; and interest rates and volatility inputs for interest rate option contracts. Northern Trust evaluates the impact of counterparty credit risk and its own credit risk on the valuation of its derivative instruments. Factors considered include the likelihood of default by Northern Trust and its counterparties, the remaining maturities of the instruments, net exposures after giving effect to master netting arrangements or similar agreements, available collateral, and other credit enhancements in determining the appropriate fair value of derivative instruments. The resulting valuation adjustments have not been considered material.

Level 3 – Valuation techniques in which one or more significant inputs are unobservable in the marketplace. Northern Trust’s Level 3 assets consisted of auction rate securities purchased in 2008 from Northern Trust clients. To estimate the fair value of auction rate securities, Northern Trust uses external pricing vendors that incorporate transaction details and market-based inputs such as past auction results, trades and bids. The significant unobservable inputs used in the fair value measurement are the prices of the securities supported by little market activity and for which trading is limited.

Northern Trust’s Level 3 liabilities consist of swaps that Northern Trust entered into with the purchaser of 1.1 million and 1.0 million shares of Visa Inc. Class B common stock (Visa Class B common shares) previously held by Northern Trust and sold in June 2016 and 2015, respectively. Pursuant to the swaps, Northern Trust retains the risks associated with the ultimate conversion of the Visa Class B common shares into shares of Visa Inc. Class A common stock (Visa Class A common shares), such that the counterparty will be compensated for any dilutive adjustments to the conversion ratio and Northern Trust will be compensated for any anti-dilutive adjustments to the ratio. The swap also requires periodic payments from Northern Trust to the counterparty calculated by reference to the market price of Visa Class A common shares and a fixed rate of interest. The fair value of the swap is determined using a discounted cash flow methodology. The significant unobservable inputs used in the fair value measurement are Northern Trust’s own assumptions about estimated changes in the conversion rate of the Visa Class B common shares into Visa Class A common shares, the date on which such conversion is expected to occur and the estimated growth rate of the Visa Class A common share price. See “Visa Class B Common Shares” under Note 25 — “Contingent Liabilities,” for further information.

Northern Trust believes its valuation methods for its assets and liabilities carried at fair value are appropriate; however, the use of different methodologies or assumptions, particularly as applied to Level 3 assets and liabilities, could have a material effect on the computation of their estimated fair values.

Management of various businesses and departments of Northern Trust (including Corporate Market Risk, Credit Risk Management, Corporate Finance, C&IS and Wealth Management) reviews valuation methods and models for Level 3 assets and liabilities. Fair value measurements are performed upon acquisitions of an asset or liability. Management of the appropriate business or department reviews assumed inputs, especially when unobservable in the marketplace, in order to substantiate their use in each fair value measurement. When appropriate, management reviews forecasts used in the valuation process in light of other relevant financial projections to understand any variances between current and previous fair value measurements. In certain circumstances, third party information is used to support the fair value measurements. If certain third party information seems inconsistent with consensus views, a review of the information is performed by management of the respective business or department to determine the appropriate fair value of the asset or liability.

The following table presents the fair values of Northern Trust’s Level 3 assets and liabilities as of December 31, 2018 and 2017, as well as the valuation techniques, significant unobservable inputs, and quantitative information used to develop significant unobservable inputs for such assets and liabilities as of such dates.

TABLE 46: LEVEL 3 SIGNIFICANT UNOBSERVABLE INPUTS



	DECEMBER 31, 2018
FINANCIAL INSTRUMENT	FAIR VALUE			VALUATION TECHNIQUE	UNOBSERVABLE INPUT	RANGE OF INPUTS
Swaps Related to Sale of Certain Visa Class B Common Shares	$	32.8	million	Discounted Cash Flow	Visa Class A Appreciation	7.0	%	–	11.0%
					Conversion Rate	1.62	x	–	1.64x
					Expected Duration	1.5		–	4.0 years



	DECEMBER 31, 2017
FINANCIAL INSTRUMENT	FAIR VALUE			VALUATION TECHNIQUE	UNOBSERVABLE INPUT	RANGE OF INPUTS
Auction Rate Securities	$	4.3	million	Comparables	Price	$92		–	$100
Swap Related to Sale of Certain Visa Class B Common Shares	$	29.7	million	Discounted Cash Flow	Visa Class A Appreciation	7.0	%	–	11.0%
					Conversion Rate	1.63	x	–	1.65x
					Expected Duration	1.5		–	4.0 years

The following presents assets and liabilities measured at fair value on a recurring basis as of December 31, 2018 and 2017, segregated by fair value hierarchy level.

TABLE 47: RECURRING BASIS HIERARCHY LEVELING



	DECEMBER 31, 2018
(In Millions)	LEVEL 1		LEVEL 2		LEVEL 3		NETTING			ASSETS/ LIABILITIES AT FAIR VALUE
Debt Securities
Available for Sale
U.S. Government	$	5,185.3	$	—	$	—	$	—		$	5,185.3
Obligations of States and Political Subdivisions	—		655.9		—		—			655.9
Government Sponsored Agency	—		22,424.6		—		—			22,424.6
Non-U.S. Government	—		142.2		—		—			142.2
Corporate Debt	—		2,294.7		—		—			2,294.7
Covered Bonds	—		829.3		—		—			829.3
Sub-Sovereign, Supranational and Non-U.S. Agency Bonds	—		2,096.2		—		—			2,096.2
Other Asset-Backed	—		2,657.7		—		—			2,657.7
Commercial Mortgage-Backed	—		587.2		—		—			587.2
Other	—		15.7		—		—			15.7

Total Available for Sale	5,185.3		31,703.5		—		—			36,888.8

Trading Account	—		0.3		—		—			0.3

Total Available for Sale and Trading Debt Securities	5,185.3		31,703.8		—		—			36,889.1

Other Assets
Derivative Assets
Foreign Exchange Contracts	—		2,466.1		—		—			2,466.1
Interest Rate Contracts	—		96.1		—		—			96.1
Other Financial Derivatives ⁽¹⁾	—		1.3		—		—			1.3

Total Derivative Assets	—		2,563.5		—		(1,357.1		)	1,206.4

Other Liabilities
Derivative Liabilities
Foreign Exchange Contracts	—		2,262.5		—		—			2,262.5
Interest Rate Contracts	—		93.1		—		—			93.1
Other Financial Derivatives ⁽²⁾	—		—		32.8		—			32.8

Total Derivative Liabilities	$	—	$	2,355.6	$	32.8	$	(1,796.3	)	$	592.1

Note: Northern Trust has elected to net derivative assets and liabilities when legally enforceable master netting arrangements or similar agreements exist between Northern Trust and the counterparty. As of December 31, 2018, derivative assets and liabilities shown above also include reductions of $134.5 million and $573.7 million, respectively, as a result of cash collateral received from and deposited with derivative counterparties.

(1) This line consists of a total return swap contract.

(2) This line consists of swaps related to the sale of certain Visa Class B common shares.



	DECEMBER 31, 2017
(In Millions)	LEVEL 1		LEVEL 2		LEVEL 3		NETTING			ASSETS/ LIABILITIES AT FAIR VALUE
Debt Securities
Available for Sale
U.S. Government	$	5,700.3	$	—	$	—	$	—		$	5,700.3
Obligations of States and Political Subdivisions	—		746.4		—		—			746.4
Government Sponsored Agency	—		18,676.6		—		—			18,676.6
Non-U.S. Government	—		177.2		—		—			177.2
Corporate Debt	—		2,993.0		—		—			2,993.0
Covered Bonds	—		875.6		—		—			875.6
Sub-Sovereign, Supranational and Non-U.S. Agency Bonds	—		1,820.0		—		—			1,820.0
Other Asset-Backed	—		2,291.3		—		—			2,291.3
Auction Rate	—		—		4.3		—			4.3
Commercial Mortgage Backed	—		435.1		—		—			435.1
Other	—		22.3		—		—			22.3
Total Available for Sale	5,700.3		28,037.5		4.3		—			33,742.1

Trading Account	—		0.5		—		—			0.5

Total Available for Sale and Trading Debt Securities	5,700.3		28,038.0		4.3		—			33,742.6

Other Assets
Derivative Assets
Foreign Exchange Contracts	—		2,557.1		—		—			2,557.1
Interest Rate Contracts	—		97.0		—		—			97.0
Other Financial Derivative	—		—		—		—			—
Total Derivatives Assets	—		2,654.1		—		(1,860.0		)	794.1

Other Liabilities
Derivative Liabilities
Foreign Exchange Contracts	—		2,715.1		—		—			2,715.1
Interest Rate Contracts	—		83.5		—		—			83.5
Other Financial Derivative ⁽¹⁾	—		0.7		29.7		—			30.4
Total Derivative Liabilities	$	—	$	2,799.3	$	29.7	$	(1,621.4	)	$	1,207.6

Note: Northern Trust has elected to net derivative assets and liabilities when legally enforceable master netting arrangements or similar agreements exist between Northern Trust and the counterparty. As of December 31, 2017, derivative assets and liabilities shown above also include reductions of $427.6 million and $189.0 million, respectively, as a result of cash collateral received from and deposited with derivative counterparties.

(1) This line consists of swaps related to the sale of certain Visa Class B common shares and a total return swap contract.

The following tables present the changes in Level 3 assets and liabilities for the years ended December 31, 2018 and 2017.

TABLE 48: CHANGES IN LEVEL 3 ASSETS AND LIABILITIES



LEVEL 3 ASSETS	AUCTION RATE SECURITIES
(In Millions)	2018			2017
Fair Value at January 1	$	4.3		$	4.7
Total Gains (Losses):
Included in Other Comprehensive Income ⁽¹⁾	0.1			0.2
Purchases, Issues, Sales, and Settlements
Settlements	(4.4		)	(0.6		)

Fair Value at December 31	$	—		$	4.3

(1) Unrealized gains (losses) are included in net unrealized gains (losses) on debt securities available for sale, within the consolidated statements of comprehensive income.



LEVEL 3 LIABILITIES	SWAPS RELATED TO SALE OF CERTAIN VISA CLASS B COMMON SHARES
(In Millions)	2018			2017
Fair Value at January 1	$	29.7		$	25.2
Total (Gains) Losses:
Included in Earnings ⁽¹⁾	19.8			12.7
Purchases, Issues, Sales, and Settlements
Settlements	(16.7		)	(8.2		)
Fair Value at December 31	$	32.8		$	29.7
Unrealized (Gains) Losses Included in Earnings Related to Financial Instruments Held at December 31 ⁽¹⁾	$	13.3		$	11.4

(1) Gains (losses) are recorded in other operating income (expense) within the consolidated statements of income.

For the years ended December 31, 2018 and 2017 there were no assets or liabilities transferred into or out of Level 3.

Carrying values of assets and liabilities that are not measured at fair value on a recurring basis may be adjusted to fair value in periods subsequent to their initial recognition, for example, to record an impairment of an asset. GAAP requires entities to separately disclose these subsequent fair value measurements and to classify them under the fair value hierarchy.

Assets measured at fair value on a nonrecurring basis at December 31, 2018 and 2017, all of which were categorized as Level 3 under the fair value hierarchy, were comprised of impaired loans whose values were based on real estate and other available collateral, and of OREO properties. Fair values of real estate loan collateral were estimated using a market approach typically supported by third-party valuations and property-specific fees and taxes, and were subject to adjustments to reflect management’s judgment as to realizable value. Other loan collateral, which typically consists of accounts receivable, inventory and equipment, is valued using a market approach adjusted for asset specific characteristics and in limited instances third-party valuations are used.

Collateral-based impaired loans and OREO assets that have been adjusted to fair value totaled $24.9 million and $0.4 million, respectively, at December 31, 2018, and $12.2 million and $0.3 million, respectively, at December 31, 2017. Assets measured at fair value on a nonrecurring basis reflect management’s judgment as to realizable value.

The following table presents the fair values of Northern Trust’s Level 3 assets that were measured at fair value on a nonrecurring basis as of December 31, 2018 and 2017, as well as the valuation technique, significant unobservable inputs, and quantitative information used to develop the significant unobservable inputs for such assets as of such dates.

TABLE 49: LEVEL 3 NONRECURRING BASIS SIGNIFICANT UNOBSERVABLE INPUTS



	DECEMBER 31, 2018
FINANCIAL INSTRUMENT	FAIR VALUE	VALUATION TECHNIQUE	UNOBSERVABLE INPUT	RANGE OF DISCOUNTS APPLIED
Loans	$24.9 million	Market Approach	Discount to reflect realizable value	15.0%	–	30.0%
OREO	$0.4 million	Market Approach	Discount to reflect realizable value	15.0%	–	30.0%



	DECEMBER 31, 2017
FINANCIAL INSTRUMENT	FAIR VALUE	VALUATION TECHNIQUE	UNOBSERVABLE INPUT	RANGE OF DISCOUNTS APPLIED
Loans	$12.2 million	Market Approach	Discount to reflect realizable value	15.0%	–	25.0%
OREO	$0.3 million	Market Approach	Discount to reflect realizable value	15.0%	–	20.0%

The following tables summarize the fair values of all financial instruments.

TABLE 50: FAIR VALUE OF FINANCIAL INSTRUMENTS



	DECEMBER 31, 2018
					FAIR VALUE
(In Millions)	BOOK VALUE		TOTAL FAIR VALUE		LEVEL 1		LEVEL 2		LEVEL 3
ASSETS
Cash and Due from Banks	$	4,581.6	$	4,581.6	$	4,581.6	$	—	$	—
Federal Reserve and Other Central Bank Deposits	30,080.2		30,080.2		—		30,080.2		—
Interest-Bearing Deposits with Banks	4,264.2		4,264.2		—		4,264.2		—
Federal Funds Sold and Securities Purchased under Agreements to Resell	1,165.2		1,165.2		—		1,165.2		—
Debt Securities
Available for Sale (Note)	36,888.8		36,888.8		5,185.3		31,703.5		—
Held to Maturity	14,354.0		14,267.0		101.6		14,165.4		—
Trading Account	0.3		0.3		—		0.3		—
Loans (excluding Leases)
Held for Investment	32,287.0		32,339.2		—		—		32,339.2
Held for Sale	—		—		—		—		—
Client Security Settlement Receivables	1,646.1		1,646.1		—		1,646.1		—
Other Assets
Federal Reserve and Federal Home Loan Bank Stock	300.3		300.3		—		300.3		—
Community Development Investments	606.6		606.6		—		606.6		—
Employee Benefit and Deferred Compensation	202.3		194.5		125.0		69.5		—
LIABILITIES
Deposits
Demand, Noninterest-Bearing, Savings and Money Market	$	37,340.1	$	37,340.1	$	37,340.1	$	—	$	—
Savings Certificates and Other Time	688.7		691.8		—		691.8		—
Non U.S. Offices Interest-Bearing	66,468.0		66,468.0		—		66,468.0		—
Federal Funds Purchased	2,594.2		2,594.2		—		2,594.2		—
Securities Sold Under Agreements to Repurchase	168.3		168.3		—		168.3		—
Other Borrowings	7,901.7		7,904.1		—		7,904.1		—
Senior Notes	2,011.3		1,994.4		—		1,994.4		—
Long-Term Debt
Subordinated Debt	1,112.4		1,089.7		—		1,089.7		—
Floating Rate Capital Debt	277.6		253.5		—		253.5		—
Other Liabilities
Standby Letters of Credit	28.0		28.0		—		—		28.0
Loan Commitments	139.9		139.9		—		—		139.9
DERIVATIVE INSTRUMENTS
Asset/Liability Management
Foreign Exchange Contracts
Assets	$	306.7	$	306.7	$	—	$	306.7	$	—
Liabilities	72.5		72.5		—		72.5		—
Interest Rate Contracts
Assets	30.0		30.0		—		30.0		—
Liabilities	24.5		24.5		—		24.5		—
Other Financial Derivatives
Assets ⁽¹⁾	1.3		1.3		—		1.3		—
Liabilities ⁽²⁾	32.8		32.8		—		—		32.8
Client-Related and Trading
Foreign Exchange Contracts
Assets	2,159.4		2,159.4		—		2,159.4		—
Liabilities	2,190.0		2,190.0		—		2,190.0		—
Interest Rate Contracts
Assets	66.1		66.1		—		66.1		—
Liabilities	68.6		68.6		—		68.6		—

Note: Refer to the table located on page 105 for the disaggregation of available for sale debt securities.

(1) This line consists of a total return swap contract.

(2) This line consists of swaps related to the sale of certain Visa Class B common shares.



	DECEMBER 31, 2017
					FAIR VALUE
(In Millions)	BOOK VALUE		TOTAL FAIR VALUE		LEVEL 1		LEVEL 2		LEVEL 3
ASSETS
Cash and Due from Banks	$	4,518.1	$	4,518.1	$	4,518.1	$	—	$	—
Federal Reserve and Other Central Bank Deposits	40,479.1		40,479.1		—		40,479.1		—
Interest-Bearing Deposits with Banks	5,611.9		5,611.9		—		5,611.9		—
Federal Funds Sold and Securities Purchased under Agreements to Resell	1,324.3		1,324.3		—		1,324.3		—
Debt Securities
Available for Sale (Note)	33,742.1		33,742.1		5,700.3		28,037.5		4.3
Held to Maturity	13,049.0		13,010.9		35.0		12,975.9		—
Trading Account	0.5		0.5		—		0.5		—
Loans (excluding Leases)
Held for Investment	32,211.1		32,375.8		—		—		32,375.8
Held for Sale	20.9		20.9		—		—		20.9
Client Security Settlement Receivables	1,647.0		1,647.0		—		1,647.0		—
Other Assets
Federal Reserve and Federal Home Loan Bank Stock	223.1		223.1		—		223.1		—
Community Development Investments	415.3		415.3		—		415.3		—
Employee Benefit and Deferred Compensation	183.4		181.5		115.5		66.0		—
LIABILITIES
Deposits
Demand, Noninterest-Bearing, Savings and Money Market	$	45,566.3	$	45,566.3	$	45,566.3	$	—	$	—
Savings Certificates and Other Time	1,152.3		1,153.6		—		1,153.6		—
Non U.S. Offices Interest-Bearing	65,672.2		65,672.2		—		65,672.2		—
Federal Funds Purchased	2,286.1		2,286.1		—		2,286.1		—
Securities Sold Under Agreements to Repurchase	834.0		834.0		—		834.0		—
Other Borrowings	6,051.1		6,052.9		—		6,052.9		—
Senior Notes	1,497.3		1,528.4		—		1,528.4		—
Long-Term Debt (excluding Leases)
Subordinated Debt	1,435.1		1,449.8		—		1,449.8		—
Floating Rate Capital Debt	277.5		260.0		—		260.0		—
Other Liabilities
Standby Letters of Credit	30.3		30.3		—		—		30.3
Loan Commitments	33.1		33.1		—		—		33.1
DERIVATIVE INSTRUMENTS
Asset/Liability Management
Foreign Exchange Contracts
Assets	$	30.1	$	30.1	$	—	$	30.1	$	—
Liabilities	192.6		192.6		—		192.6		—
Interest Rate Contracts
Assets	31.9		31.9		—		31.9		—
Liabilities	19.4		19.4		—		19.4		—
Other Financial Derivatives
Assets	—		—		—		—		—
Liabilities ⁽¹⁾	30.4		30.4		—		0.7		29.7
Client-Related and Trading
Foreign Exchange Contracts
Assets	2,527.0		2,527.0		—		2,527.0		—
Liabilities	2,522.5		2,522.5		—		2,522.5		—
Interest Rate Contracts
Assets	65.1		65.1		—		65.1		—
Liabilities	64.1		64.1		—		64.1		—

Note: Refer to the table located on page 106 for the disaggregation of available for sale debt securities.

(1) This line consists of swaps related to the sale of certain Visa Class B common shares and a total return swap contract.