3. Fair Value Measurements – 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.

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 securities. Their fair values are determined by external pricing vendors, or in limited cases internally, using widely accepted income-based (discounted cash flow) models that incorporate observable current market yield curves and assumptions regarding anticipated prepayments and defaults.

Level 2 assets and liabilities also include derivative contracts which are valued 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 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 consist of auction rate securities purchased in 2008 from Northern Trust clients. To estimate the fair value of auction rate securities, for which trading is limited and market prices are generally unavailable, Northern Trust developed and maintains a pricing model that discounts estimated cash flows over their estimated remaining lives. Significant inputs to the model include the contractual terms of the securities, credit risk ratings, discount rates, forward interest rates, credit/liquidity spreads, and Northern Trust’s own assumptions about the estimated remaining lives of the securities. The significant unobservable inputs used in the fair value measurement are Northern Trust’s own assumptions about the estimated remaining lives of the securities and the applicable discount rates. Significant increases (decreases) in the estimated remaining lives or the discount rates in isolation would result in a significantly lower (higher) fair value measurement. Level 3 liabilities include financial guarantees relating to standby letters of credit and acquisition related contingent consideration liabilities. Northern Trust’s recorded liability for standby letters of credit, reflecting the obligation that Northern Trust has undertaken, is measured as the amount of unamortized fees on these instruments. Fees are determined by applying basis points to the principal amounts of the letters of credit. The significant unobservable inputs used in the fair value measurement are the market fees on the instruments. Significant increases (decreases) in the market fees would result in significantly higher (lower) fair value measurements. The fair values of contingent purchase consideration liabilities are determined using an income-based (discounted cash flow) model that incorporates Northern Trust’s own assumptions about business growth rates and applicable discount rates, which represent unobservable inputs to the model. Significant increases (decreases) in projected growth rates in isolation would result in significantly higher (lower) fair value measurements, while significant increases (decreases) in the discount rate in isolation would result in significantly lower (higher) fair value measurements.

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 Loan Operations, Treasury Risk Management, Credit Policy, Business Practice & Marketing, and Northern Trust Hedge Fund services) determine the valuation policies and procedures for Level 3 assets and liabilities. Each business and department represents a component of Northern Trust’s business units, and reports to management of their respective business units. Generally, valuation policies are reviewed by management of each business or department. Fair value measurements are performed upon acquisitions of an asset or liability. As necessary, the valuation models are reviewed by management of the appropriate business or department, and adjusted for changes in inputs. Management of each business or department reviews the inputs in order to substantiate the unobservable inputs used 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 of department to conclude as to the appropriate fair value of the asset or liability.

The following presents the valuation techniques, significant unobservable inputs, and quantitative information used to develop significant unobservable inputs for Northern Trust’s Level 3 assets and liabilities as of March 31, 2012 and December 31, 2011.


Financial Instrument	Valuation Technique	Unobservable Input	Range of Quantitative Information
Auction Rate Securities	Discounted Cash Flow	Remaining lives Discount rates	2.4 – 8.6 years 3 – 9%
Contingent Consideration	Discounted Cash Flow	Discount rates Business growth rates	10.5% 1 – 10%
Standby Letters of Credit	Market Approach	Market fees	$50.1 million

The following presents assets and liabilities measured at fair value on a recurring basis as of March 31, 2012 and December 31, 2011, segregated by fair value hierarchy level.

(In Millions)

Level 1

Level 2

Level 3

Netting *

Assets/Liabilities
at Fair Value

March 31, 2012

Securities

Available for Sale

U.S. Government

2,766.5

—

2,766.5

Obligations of States and Political Subdivisions

—

15.0

—

15.0

Government Sponsored Agency

—

17,605.3

—

17,605.3

Corporate Debt

—

2,839.7

—

2,839.7

Covered Bonds

—

1,376.4

—

1,376.4

Non-U.S. Government

—

192.2

—

192.2

Supranational Bonds

—

911.1

—

911.1

Residential Mortgage-Backed

—

137.6

—

137.6

Other Asset-Backed

—

2,035.0

—

2,035.0

Certificates of Deposit

—

2,448.5

—

2,448.5

Auction Rate

—

176.3

—

176.3

Other

—

403.2

—

403.2

Total Available for Sale

2,766.5

27,964.0

176.3

—

30,906.8

Trading Account

—

9.3

—

9.3

Total Available for Sale and Trading

2,766.5

27,973.3

176.3

—

30,916.1

Other Assets

Derivatives

Foreign Exchange Contracts

—

3,142.4

—

3,142.4

Interest Rate Swaps

—

323.9

—

323.9

Interest Rate Options

—

0.1

—

0.1

Total Derivatives

—

3,466.4

—

(2,168.9

)

1,297.5

Other Liabilities

Derivatives

Foreign Exchange Contracts

—

3,109.2

—

3,109.2

Interest Rate Swaps

—

222.9

—

222.9

Interest Rate Options

—

0.1

—

0.1

Credit Default Swaps

—

0.2

—

0.2

Total Derivatives

—

3,332.4

—

(2,111.7

)

1,220.7

Other

Standby Letters of Credit

—

50.1

—

50.1

Contingent Consideration

—

58.6

—

58.6

Total Other

—

108.7

—

108.7

Northern Trust has elected to net derivative assets and liabilities when legally enforceable master netting agreements exist between Northern Trust and the counterparty. As of March 31, 2012, derivative assets and liabilities shown above also include reductions of $350.3 million and $293.1 million, respectively, as a result of cash collateral received from and deposited with derivative counterparties.


(In Millions)	Level 1		Level 2		Level 3		Netting *			Assets/Liabilities at Fair Value
December 31, 2011
Securities
Available for Sale
U.S. Government	$	4,029.4	$	—	$	—	$	—		$	4,029.4
Obligations of States and Political Subdivisions		—		15.8		—		—			15.8
Government Sponsored Agency		—		16,771.4		—		—			16,771.4
Corporate Debt		—		2,676.7		—		—			2,676.7
Covered Bonds		—		754.9		—		—			754.9
Non-U.S. Government		—		173.7		—		—			173.7
Supranational Bonds		—		972.1		—		—			972.1
Residential Mortgage-Backed		—		163.8		—		—			163.8
Other Asset-Backed		—		1,604.8		—		—			1,604.8
Certificates of Deposit		—		2,418.1		—		—			2,418.1
Auction Rate		—		—		178.3		—			178.3
Other		—		433.5		—		—			433.5

Total Available for Sale		4,029.4		25,984.8		178.3		—			30,192.5

Trading Account		—		8.0		—		—			8.0

Total Available for Sale and Trading	$	4,029.4	$	25,992.8	$	178.3	$	—		$	30,200.5

Other Assets
Derivatives
Foreign Exchange Contracts	$	—	$	3,087.3	$	—	$	—		$	3,087.3
Interest Rate Swaps		—		338.3		—		—			338.3
Credit Default Swaps		—		0.7		—		—			0.7

Total Derivatives		—		3,426.3		—		(2,243.7	)		1,182.6

Other Liabilities
Derivatives
Foreign Exchange Contracts	$	—	$	2,991.6	$	—	$	—		$	2,991.6
Interest Rate Swaps		—		231.9		—		—			231.9
Credit Default Swaps		—		0.1		—		—			0.1

Total Derivatives		—		3,223.6		—		(2,281.0	)		942.6

Other
Standby Letters of Credit		—		—		43.8		—			43.8
Contingent Consideration		—		—		56.8		—			56.8

Total Other		—		—		100.6		—			100.6

Northern Trust has elected to net derivative assets and liabilities when legally enforceable master netting agreements exist between Northern Trust and the counterparty. As of December 31, 2011, derivative assets and liabilities shown above also include reductions of $220.1 million and $257.4 million, respectively, as a result of cash collateral received from and deposited with derivative counterparties.

The following tables present the changes in Level 3 assets and liabilities for the three months ended March 31, 2012 and 2011.


(In Millions)	Auction Rate Securities
Three Months Ended March 31	2012			2011
Fair Value at January 1	$	178.3		$	367.8
Total Gains and (Losses) for the Period
Included in Earnings		(1.5	)		4.4
Included in Other Comprehensive Income		(0.2	)		(6.4	)
Purchases, Issues, Sales, and Settlements
Sales		—			(1.5	)
Settlements		(0.3	)		(79.0	)

Fair Value at March 31	$	176.3		$	285.3


(In Millions)	Other Liabilities *
Three Months Ended March 31	2012			2011
Fair Value at January 1	$	100.6		$	58.6
Total (Gains) and Losses for the Period
Included in Earnings		2.3			(1.6	)
Included in Other Comprehensive Income		0.4			—
Purchases, Issues, Sales, and Settlements
Issues		5.5			2.5
Settlements		(0.1	)		(10.3	)

Fair Value at March 31	$	108.7		$	49.2

*	Balances relate to standby letters of credit and contingent consideration liabilities.

For the period ended March 31, 2012, there were no transfers into or out of Level 3 assets or liabilities. Unrealized losses related to auction rate securities and contingent consideration liabilities are included in net unrealized gains on securities available for sale and in foreign currency translation adjustments, respectively, within the consolidated statement of comprehensive income.

The following tables provide the amounts and locations within the consolidated statement of income of gains and losses recognized in connection with changes in Level 3 assets and liabilities for the three months ended March 31, 2012 and 2011.


2012
	Operating Income (Expense)			Interest Income		Investment Security Gains (Losses)
Total gains or losses included in earnings *	$	(2.3	)	$	0.1	$	(1.6	)


2011
	Operating Income (Expense)		Interest Income		Investment Security Gains (Losses)
Total gains or losses included in earnings **	$	1.6	$	4.3	$	0.1

Changes in unrealized gains or losses included in earnings for assets and liabilities held at period-end include operating expense of $2.3 million. There were no changes in unrealized gains or losses included in earnings for assets or liabilities held at the end of the period that were included in interest income or investment security gains or losses.

Changes in unrealized gains or losses included in earnings for assets and liabilities held at period-end include operating income of $1.6 million. There were no changes in unrealized gains or losses included in earnings for assets or liabilities held at the end of the period that were included in interest income or investment security gains or losses.

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.

The following provides information regarding those assets measured at fair value on a nonrecurring basis at March 31, 2012 and 2011, segregated by fair value hierarchy level.


(In Millions)	Level 1		Level 2		Level 3		Total Fair Value
March 31, 2012
Loans (1)	$	—	$	—	$	25.5	$	25.5
Other Real Estate Owned (2)		—		—		1.4		1.4

Total Assets at Fair Value	$	—	$	—	$	26.9	$	26.9

March 31, 2011
Loans (1)	$	—	$	—	$	80.7	$	80.7
Other Real Estate Owned (2)		—		—		13.9		13.9

Total Assets at Fair Value	$	—	$	—	$	94.6	$	94.6

(1)

In accordance with Accounting Standard Codification (ASC) Subtopic 310-10, Northern Trust recorded individually impaired loans at fair value and reduced by $9.5 million the level of specific reserves on these loans during the three months ended March 31, 2012. An additional $3.1 million of specific reserves was provided during the three months ended March 31, 2011 to reduce the fair value of these loans.

(2)

In accordance with ASC Subtopics 310-40 and 360-10, Northern Trust recorded Other Real Estate Owned (OREO) at fair value and subsequently charged $0.1 million and $0.3 million through other operating expenses during the three months ended March 31, 2012 and 2011, respectively, to reduce the fair values of these OREO properties.

The fair values of real-estate loan collateral and OREO properties 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 their realizable value. Other loan collateral is valued using a market approach, adjusted for asset specific characteristics, and in limited instances, third party valuations are used. Other loan collateral typically consists of accounts receivable, inventory and equipment.

The following table provides the valuation techniques, significant unobservable inputs, and quantitative information used to develop the significant unobservable inputs for Northern Trust’s Level 3 assets and liabilities that are not measured at fair value on a recurring basis as of March 31, 2012 and December, 2011.


Financial Instrument	Valuation Technique	Unobservable Input	Range of Quantitative Information
Loans	Market Approach	Discount to reflect realizable value	15 – 30%
OREO	Market Approach	Discount to reflect realizable value	15 – 30%

Fair Value of Financial Instruments. GAAP requires disclosure of the estimated fair value of certain financial instruments and the methods and significant assumptions used to estimate fair value. It excludes from this requirement nonfinancial assets and liabilities, as well as a wide range of franchise, relationship, and intangible values that add value to Northern Trust. Accordingly, the required fair value disclosures provide only a partial estimate of the fair value of Northern Trust. Financial instruments recorded at fair value on Northern Trust’s consolidated balance sheet are discussed above. The following methods and assumptions were used in estimating the fair values of financial instruments that are not carried at fair value.

Held to Maturity Securities. The fair values of held to maturity securities were modeled by external pricing vendors or, in limited cases, modeled internally, using widely accepted models which are based on an income approach that incorporates current market yield curves and assumptions regarding anticipated prepayments and defaults.

Loans (Excluding Lease Receivables). The fair value of the loan portfolio was estimated using an income approach (discounted cash flow) that incorporates current market rates offered by Northern Trust as of the date of the consolidated financial statements. The fair values of all loans were adjusted to reflect current assessments of loan collectability.

Federal Reserve and Federal Home Loan Bank Stock. The fair values of Federal Reserve and Federal Home Loan Bank stock are equal to their carrying values which represent redemption value.

Affordable Housing Investments. The fair values of these instruments were estimated using a revised income approach (discounted cash flow) methodology that incorporates current market rates. Previously, their carrying values were considered to approximate fair value.

Savings Certificates and Other Time Deposits. The fair values of these instruments were estimated using an income approach (discounted cash flow) that incorporates market interest rates currently offered by Northern Trust for deposits with similar maturities.

Senior Notes, Subordinated Debt, and Floating Rate Capital Debt. Fair values were determined using a market approach based on quoted market prices, when available. If quoted market prices were not available, fair values were based on quoted market prices for comparable instruments.

Federal Home Loan Bank Borrowings. The fair values of these instruments were estimated using an income approach (discounted cash flow) that incorporates market interest rates available to Northern Trust.

Loan Commitments. The fair values of loan commitments represent the estimated costs to terminate or otherwise settle the obligations with a third party.

Financial Instruments Valued at Carrying Value. Due to their short maturity, the carrying values of certain financial instruments approximated their fair values. These financial instruments include cash and due from banks; federal funds sold and securities purchased under agreements to resell, interest-bearing deposits with banks, federal reserve deposits and other interest-bearing assets; client security settlement receivables; non-U.S. offices interest-bearing deposits; federal funds purchased; securities sold under agreements to repurchase; and other borrowings (includes term federal funds purchased, and other short-term borrowings). As required by GAAP, the fair values required to be disclosed for demand, noninterest-bearing, savings, and money market deposits must equal the amounts disclosed in the consolidated balance sheet, even though such deposits are typically priced at a premium in banking industry consolidations.

The following tables summarize fair values of financial instruments.


(In Millions)	March 31, 2012
	Book Value		Fair Value
	Book Value		Total		Level 1		Level 2		Level 3
Assets
Cash and Due from Banks	$	4,280.3	$	4,280.3	$	4,280.3	$	—	$	—
Federal Funds Sold and Resell Agreements		290.9		290.9		—		290.9		—
Interest-Bearing Deposits with Banks		18,871.3		18,871.3		—		18,871.3		—
Federal Reserve Deposits and Other Interest-Bearing		2,228.0		2,228.0		—		2,228.0		—
Securities
Available for Sale ⁽¹⁾		30,906.8		30,906.8		2,766.5		27,964.0		176.3
Held to Maturity		709.7		727.2		—		727.2		—
Trading Account		9.3		9.3		—		9.3		—
Loans (excluding Leases)
Held for Investment		27,845.6		27,957.9		—				27,957.9
Held for Sale		0.1		0.1		—		—		0.1
Client Security Settlement Receivables		985.3		985.3		—		985.3		—
Other Assets
Federal Reserve and Federal Home Loan Bank Stock		172.9		172.9		—		172.9		—
Affordable Housing Investments		280.5		306.60		—		306.60		—
Rabbi Trust Investments		122.6		122.6		83.6		39.0		—
Liabilities
Deposits
Demand, Noninterest-Bearing, Savings and Money Market	$	34,263.8	$	34,263.8	$	34,263.8	$	—	$	—
Savings Certificates and Other Time		3,093.8		3,101.3		—		3,101.3		—
Non U. S. Offices Interest-Bearing		36,575.4		36,575.4		—		36,575.4		—
Federal Funds Purchased		1,973.7		1,973.7		—		1,973.7		—
Securities Sold under Agreements to Repurchase		284.0		284.0		—		284.0		—
Other Borrowings		1,103.0		1,103.0		—		1,103.0		—
Senior Notes		2,122.6		2,192.2		—		2,192.2		—
Long Term Debt (excluding Leases)
Subordinated Debt		1,036.6		1,055.5		—		1,055.5		—
Federal Home Loan Bank Borrowings		705.0		723.7		—		723.7		—
Floating Rate Capital Debt		277.0		232.3		—		232.3		—
Other Liabilities
Standby Letters of Credit		50.1		50.1		—		—		50.1
Contingent Consideration		58.6		58.6		—		—		58.6
Loan Commitments		28.9		28.9		—		—		28.9
Derivative Instruments
Asset/Liability Management
Foreign Exchange Contracts
Assets	$	14.6		14.6	$	—	$	14.6	$	—
Liabilities		45.6		45.6		—		45.6		—
Interest Rate Swaps
Assets		141.8		141.8		—		141.8		—
Liabilities		45.9		45.9		—		45.9		—
Credit Default Swaps
Assets		—		—		—		—		—
Liabilities		0.2		0.2		—		0.2		—
Forward Contracts
Assets		—		—		—		—		—
Liabilities		—		—		—		—		—
Client-Related and Trading
Foreign Exchange Contracts
Assets		3,127.8		3,127.8		—		3,127.8		—
Liabilities		3,063.6		3,063.6		—		3,063.6		—
Interest Rate Swaps
Assets		182.1		182.1		—		182.1		—
Liabilities		177.0		177.0		—		177.0		—
Interest Rate Options
Assets		0.1		0.1		—		0.1		—
Liabilities		0.1		0.1		—		0.1		—

(1)	Refer to the table located on page 31 for the disaggregation of available-for-sale-securities.


(In Millions)			December 31, 2011
	Book Value		Fair Value
	Book Value		Total		Level 1		Level 2		Level 3
Assets
Cash and Due from Banks	$	4,315.3	$	4,315.3	$	4,315.3	$	—	$	—
Federal Funds Sold and Resell Agreements		121.3		121.3		—		121.3		—
Interest-Bearing Deposits with Banks		16,696.4		16,696.4		—		16,696.4		—
Federal Reserve Deposits and Other Interest-Bearing		13,448.6		13,448.6		—		13,448.6		—
Securities
Available for Sale ⁽¹⁾		30,192.5		30,192.5		4,029.4		25,984.8		178.3
Held to Maturity		799.2		817.1		—		817.1		—
Trading Account		8.0		8.0		—		8.0		—
Loans (excluding Leases)
Held for Investment		27,782.7		27,913.7		—		—		27,913.7
Held for Sale		9.3		9.3		—		—		9.3
Client Security Settlement Receivables		778.3		778.3		—		778.3		—
Other Assets
Federal Reserve and Federal Home Loan Bank Stock		172.9		172.9		—		172.9		—
Affordable Housing Investments		290.8		319.9		—		319.9		—
Rabbi Trust Investments		106.3		106.3		71.4		34.9		—
Liabilities
Deposits
Demand, Noninterest-Bearing, Savings and Money Market	$	43,751.2	$	43,751.2	$	43,751.2	$	—	$	—
Savings Certificates and Other Time		3,058.3		3,065.5		—		3,065.5		—
Non U. S. Offices Interest-Bearing		35,868.0		35,868.0		—		35,868.0		—
Federal Funds Purchased		815.3		815.3		—		815.3		—
Securities Sold under Agreements to Repurchase		1,198.8		1,198.8		—		1,198.8		—
Other Borrowings		931.5		931.5		—		931.5		—
Senior Notes		2,126.7		2,197.3		—		2,197.3		—
Long Term Debt (excluding Leases)
Subordinated Debt		1,033.4		1,040.0		—		1,040.0		—
Federal Home Loan Bank Borrowings		1,055.0		1,082.1		—		1,082.1		—
Floating Rate Capital Debt		276.9		211.6		—		211.6		—
Other Liabilities
Standby Letters of Credit		43.8		43.8		—		—		43.8
Contingent Consideration		56.8		56.8		—		—		56.8
Loan Commitments		28.9		28.9		—		—		28.9
Derivative Instruments
Asset/Liability Management
Foreign Exchange Contracts
Assets	$	25.2		25.2	$	—	$	25.2	$	—
Liabilities		31.8		31.8		—		31.8		—
Interest Rate Swaps
Assets		149.6		149.6		—		149.6		—
Liabilities		47.3		47.3		—		47.3		—
Credit Default Swaps
Assets		0.7		0.7		—		0.7		—
Liabilities		0.1		0.1		—		0.1		—
Client-Related and Trading
Foreign Exchange Contracts
Assets		3,062.1		3,062.1		—		3,062.1		—
Liabilities		2,959.8		2,959.8		—		2,959.8		—
Interest Rate Swaps
Assets		188.7		188.7		—		188.7		—
Liabilities		184.6		184.6		—		184.6		—

(1)	Refer to the table located on page 32 for the disaggregation of available-for-sale-securities.