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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
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FORM 10-K
[X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
FOR THE FISCAL YEAR ENDED DECEMBER 31, 1998
OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
FOR THE TRANSITION PERIOD FROM TO
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COMMISSION FILE NUMBER 1-4346
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SALOMON SMITH BARNEY HOLDINGS INC.
(EXACT NAME OF REGISTRANT AS SPECIFIED IN ITS CHARTER)
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DELAWARE 22-1660266
(STATE OR OTHER JURISDICTION OF (I.R.S. EMPLOYER
INCORPORATION OR ORGANIZATION) IDENTIFICATION NO.)
388 GREENWICH STREET,
NEW YORK, NEW YORK 10013
(ADDRESS OF PRINCIPAL EXECUTIVE OFFICES) (ZIP CODE)
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(212) 816-6000
(REGISTRANT'S TELEPHONE NUMBER, INCLUDING AREA CODE)
------------------------
REDUCED DISCLOSURE FORMAT
THE REGISTRANT MEETS THE CONDITIONS SET FORTH IN GENERAL INSTRUCTION I
(1)(a) AND (b) OF FORM 10-K AND IS THEREFORE FILING THIS FORM 10-K WITH THE
REDUCED DISCLOSURE FORMAT.
INDICATE BY CHECK MARK WHETHER THE REGISTRANT (1) HAS FILED ALL REPORTS
REQUIRED TO BE FILED BY SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF
1934 DURING THE PRECEDING 12 MONTHS (OR FOR SUCH SHORTER PERIOD THAT THE
REGISTRANT WAS REQUIRED TO FILE SUCH REPORTS), AND (2) HAS BEEN SUBJECT TO SUCH
FILING REQUIREMENTS FOR THE PAST 90 DAYS. YES [X] No [ ]
INDICATE BY CHECK MARK IF DISCLOSURE OF DELINQUENT FILERS PURSUANT TO ITEM
405 OF REGULATION S-K IS NOT CONTAINED HEREIN, AND WILL NOT BE CONTAINED, TO THE
BEST OF REGISTRANT'S KNOWLEDGE, IN DEFINITIVE PROXY OR INFORMATION STATEMENTS
INCORPORATED BY REFERENCE IN PART III OF THIS FORM 10-K OR ANY AMENDMENT TO THIS
FORM 10-K. [X]
BECAUSE THE REGISTRANT IS A WHOLLY OWNED SUBSIDIARY OF CITIGROUP INC., NONE
OF THE REGISTRANT'S OUTSTANDING VOTING STOCK IS HELD BY NONAFFILIATES OF THE
REGISTRANT. AS OF THE DATE HEREOF, 1,000 SHARES OF THE REGISTRANT'S COMMON
STOCK, $.01 PAR VALUE, WERE ISSUED AND OUTSTANDING.
DOCUMENTS INCORPORATED BY REFERENCE: NONE
[COVER PAGE 1 OF 2 PAGES.]
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SECURITIES REGISTERED PURSUANT TO SECTION 12(b) OF THE ACT:
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TITLE OF EACH CLASS NAME OF EACH EXCHANGE ON WHICH REGISTERED
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9 1/2% TRUST PREFERRED STOCK(SM) (TRUPS(SM)) NEW YORK STOCK EXCHANGE
UNITS OF SUBSIDIARY TRUST (AND REGISTRANT'S
GUARANTY WITH RESPECT THERETO)
6.25% EXCHANGEABLE NOTES DUE 2001 NEW YORK STOCK EXCHANGE
6 5/8% NOTES DUE JUNE 1, 2000 NEW YORK STOCK EXCHANGE
SMITH BARNEY S&P 500 EQUITY LINKED NOTES DUE NEW YORK STOCK EXCHANGE AND CHICAGO BOARD
AUGUST 13, 2001 OPTIONS EXCHANGE
SMITH BARNEY S&P 500 EQUITY LINKED NOTES DUE CHICAGO BOARD OPTIONS EXCHANGE
MARCH 11, 2002
NIKKEI 225 INDEX SECURITIES DUE AUGUST 20, NEW YORK STOCK EXCHANGE AND CHICAGO BOARD
2002 OPTIONS EXCHANGE
SENIOR FLOATING INTEREST NOTES (FINS) DUE 2003 NEW YORK STOCK EXCHANGE
(MEDIUM-TERM NOTES, SERIES D)
RESETTABLE EXCHANGEABLE STANDARD & POOR'S 500 AMERICAN STOCK EXCHANGE
INDEX NOTES (SPINS) DUE 2001
7.200% TRUST PREFERRED SECURITIES (TRUPS(R)) NEW YORK STOCK EXCHANGE
OF SUBSIDIARY TRUST (AND REGISTRANT'S
GUARANTY WITH RESPECT THERETO)
EQUITY LINKED NOTES BASED UPON THE DOW JONES CHICAGO BOARD OPTIONS EXCHANGE
INDUSTRIAL AVERAGE(SM) DUE SEPTEMBER 6, 2005
TARGETED GROWTH ENHANCED SECURITIES CHICAGO BOARD OPTIONS EXCHANGE
(TARGETS(SM)) OF SUBSIDIARY TRUST
CALL WARRANTS ON THE 1998 TEN+(SM) INDEX CHICAGO BOARD OPTIONS EXCHANGE
PRINCIPAL-PROTECTED EQUITY LINKED NOTES BASED AMERICAN STOCK EXCHANGE
UPON THE S&P 500(R) INDEX DUE 2005
PRINCIPAL-PROTECTED EQUITY LINKED NOTES BASED CHICAGO BOARD OPTIONS EXCHANGE
UPON THE S&P 500(R) INDEX DUE 2005
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SECURITIES REGISTERED PURSUANT TO SECTION 12(G) OF THE ACT:
NONE
[COVER PAGE 2 OF 2 PAGES.]
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SALOMON SMITH BARNEY HOLDINGS INC.
ANNUAL REPORT ON FORM 10-K
FOR FISCAL YEAR ENDED DECEMBER 31, 1998
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TABLE OF CONTENTS
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FORM 10-K
ITEM NUMBER PAGE
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PART I
1. Business.................................................... 1
2. Properties.................................................. 11
3. Legal Proceedings........................................... 12
4. Submission Of Matters To A Vote Of Security Holders......... 14
PART II
5. Market For Registrant's Common Equity And Related
Stockholder Matters....................................... 14
6. Selected Financial Data..................................... 14
7. Management's Discussion And Analysis Of Financial Condition
And Results Of Operations................................. 14
7a. Quantitative And Qualitative Disclosures About Market
Risk...................................................... 35
8. Financial Statements And Supplementary Data................. 35
9. Changes In And Disagreements With Accountants On Accounting
And Financial Disclosure.................................. 35
PART III
10-13 Omitted Pursuant to General Instruction I
PART IV
14. Exhibits, Financial Statement Schedules, And Reports On Form
8-K....................................................... 36
Exhibit Index............................................... 38
Signatures.................................................. 40
Index to Consolidated Financial Statements and Schedules.... F-1
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PART I
ITEM 1. BUSINESS.
THE COMPANY
Salomon Smith Barney Holdings Inc. ("SSBH") operates through its
subsidiaries in two business segments: (i) Investment Services and (ii) Asset
Management. Salomon Smith Barney provides investment banking, securities and
commodities trading, capital raising, asset management, advisory, research and
brokerage services to its customers, other financial services and executes
proprietary trading strategies on its own behalf. As used in this Form 10-K,
unless the context otherwise requires, "Salomon Smith Barney" and the "Company"
refer to SSBH and its consolidated subsidiaries.
In February 1999, the Company and The Nikko Securities Co., Ltd ("Nikko")
formed a joint venture. Nikko Salomon Smith Barney Limited ("Nikko Salomon Smith
Barney") provides investment banking, sales and trading and research services
for corporate and institutional clients in Japan and other foreign
jurisdictions. Nikko Salomon Smith Barney combines the Japanese institutional
and corporate business of the Company with Nikko's domestic and international
institutional and corporate business. Nikko's retail business and other
activities, including asset management, will remain under Nikko's management.
Nikko Salomon Smith Barney is headquartered in Tokyo and maintains offices and
staff worldwide. Nikko Salomon Smith Barney is owned 51% by Nikko and 49% by the
Company.
Citigroup Inc. ("Citigroup"), SSBH's parent, is a diversified holding
company whose businesses provide a broad range of financial services to consumer
and corporate customers around the world. Citigroup's activities are conducted
through Global Consumer, Global Corporate and Investment Bank, Asset Management,
and Investment Activities. The periodic reports of Citigroup provide additional
business and financial information concerning that company and its consolidated
subsidiaries.
The principal offices of the Company are located at 388 Greenwich Street,
New York, New York 10013, telephone number (212) 816-6000. The Company was
incorporated in Delaware in 1960.(1)
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(1) Certain items in this Form 10-K, including certain matters discussed under
Item 7, "Management's Discussion and Analysis of Financial Condition and
Results of Operations" (the "MD&A"), are forward- looking statements. The
matters referred to in such statements could be affected by the risks and
uncertainties involved in the Company's business, including the effect of
economic and market conditions, the level and volatility of interest rates
and currency values, the impact of current or pending legislation and
regulation and the other risks and uncertainties detailed in "Outlook" in
the MD&A.
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INVESTMENT SERVICES
Salomon Smith Barney is a global, full-service investment banking and
securities brokerage firm with more than 514 offices in 26 countries worldwide.
Salomon Smith Barney provides a full range of financial advisory, research and
capital raising services to corporations, governments and individuals. The
firm's 10,800 Financial Consultants, located in approximately 450 offices across
the United States, service over 5.7 million client accounts, representing over
$770 billion in assets.
INVESTMENT BANKING AND TRADING
Salomon Smith Barney's global investment banking services encompass a full
range of capital market activities, including the underwriting and distribution
of debt and equity securities for United States and foreign corporations and for
state, local and other governmental and government sponsored authorities. The
Company frequently acts as an underwriter or private placement agent in
corporate and public securities offerings and provides alternative financing
options. It also provides financial advice to investment banking clients on a
wide variety of transactions including mergers and acquisitions, divestitures,
leveraged buyouts, financial restructurings and a variety of cross-border
transactions.
Salomon Smith Barney executes securities and commodity futures brokerage
transactions on all major United States securities and futures exchanges and
major international exchanges on behalf of customers and for its own account.
The Company's significant capital base and extensive distribution capabilities
also enable it to provide liquidity to investors across a broad range of markets
and financial instruments, and to execute capital-intensive transactions on
behalf of its customers and for its own account. It executes transactions in
large blocks of exchange-listed stocks, usually with institutional investors,
and often acts as principal to facilitate these transactions. It makes markets,
buying and selling as principal, in over 1,329 equity securities traded on the
NASDAQ system. Additionally, the firm makes markets in convertible and preferred
stocks, warrants and other equity securities.
Salomon Smith Barney also engages in principal transactions in fixed income
securities. Through its subsidiaries, it is a major dealer in government
securities in New York, London, Frankfurt and Tokyo. Salomon Smith Barney makes
inter-dealer markets and trades as principal in corporate debt and equity
securities, including those of United States and foreign corporate issuers,
United States and foreign government and agency securities, mortgage-related
securities, whole loans, municipal and other tax-exempt securities, commercial
paper and other money market instruments as well as emerging market debt
securities and foreign exchange. It also enters into repurchase and reverse
repurchase agreements to provide financing for itself and its customers, and
engages in securities lending and borrowing transactions.
Salomon Smith Barney is a major participant in the over-the-counter ("OTC")
market for derivative instruments involving a wide range of products, including
interest rate, equity and
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currency swaps, caps and floors, options, warrants and other derivative
products. It also creates and sells various types of structured securities. The
Company's ability to execute transactions is enhanced by its established
presence in international capital markets, its use of information technology and
quantitative risk management tools, its research capabilities, and its knowledge
and experience in various derivative markets.
Salomon Smith Barney also trades for its own account in various markets
throughout the world, and uses many different strategies involving a broad
spectrum of financial instruments and derivative products. Historically, these
trading strategies have primarily involved the fixed income securities of the
G-7 countries, but they also involve the trading of fixed income securities
globally (including emerging markets) as well as currencies and equities.
Because these trading strategies are often designed with time horizons of one
year or more, profits or losses reported in interim periods can be volatile and
may not reflect the ultimate success or failure of these strategies. For a
discussion of certain of the risks involved in Salomon Smith Barney's securities
trading and investment activities, and the firm's strategies to manage these
risks, see Item 7, "Management's Discussion and Analysis of Financial Condition
and Results of Operations."
RETAIL BROKERAGE AND RELATED SERVICES
The Private Client Division provides investment advice and financial
planning and brokerage services for almost six million client accounts,
primarily through the network of Salomon Smith Barney Financial Consultants. A
significant portion of Salomon Smith Barney's revenues is generated from the
commissions that it earns as a broker for its clients in the purchase and sale
of securities. Financing customers' securities transactions through secured
margin lending provides Salomon Smith Barney with an additional source of
income. While credit losses may arise as a result of this financing activity, to
date such losses have not been material. The Financial Consultants also sell
proprietary mutual funds and a large number of mutual funds sponsored and
managed by others, and Salomon Smith Barney receives commissions and other sales
and services revenues from these activities.
Qualified Salomon Smith Barney Financial Consultants also offer individual
insurance products, primarily variable annuities. Some of these products, such
as Travelers Life and Annuity's Vintage Life(R) and Vintage Annuity(R), single
premium variable annuity and universal life products, 401(k) Blueprint(R) and
Travelers Target Maturity(R), a market value-adjusted fixed annuity, are
manufactured by other subsidiaries of Citigroup.
The Company's Corporate Client Group provides retirement plan services and
stock plan services to a wide variety of corporations. These services involve
the management of defined benefit and defined contribution plan products such as
401(k) plans, as well as the provision of administrative and brokerage services
for sponsors of and participants in stock option and other stock-based benefit
plans.
In addition to more traditional brokerage services, Salomon Smith Barney
Financial Consultants also deliver the programs and services offered by Salomon
Smith Barney's Consulting Group
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("CG"). CG sponsors a number of different "wrap fee" programs, in which CG and
Salomon Smith Barney typically provide a range of services, such as an analysis
of the client's financial situation, investment needs and risk tolerance;
recommendations and ongoing monitoring of the performance and suitability of the
investment manager(s) retained; and securities execution, custody, reporting and
recordkeeping. In such programs, the client generally pays a single bundled fee
for these services. CG also offers "wrap fee" programs in which separate
accounts are managed by selected, specially trained Salomon Smith Barney
Financial Consultants. Assets in the Financial Consultant managed programs at
December 31, 1998, totaled $16.5 billion, as compared to $11.6 billion and $7.9
billion at year-end 1997 and 1996, respectively.
In addition, CG provides traditional investment management consulting
services to institutions, including assisting clients in formulating investment
objectives and policies and in selecting investment management firms for the
day-to-day management of client portfolios. As of December 31, 1998, the Company
provided consulting services with respect to externally managed client assets
aggregating approximately $59.0 billion, excluding the TRAK(R) program described
below, as compared to approximately $49.2 billion at December 31, 1997 and
approximately $37.5 billion at December 31, 1996.
Salomon Smith Barney's TRAK(R) program provides clients with
non-discretionary asset allocation advice based on the client's identification
of investment objectives and risk tolerances. TRAK(R) clients include both
individuals and institutions, including participant-directed 401(k) plans.
Clients can choose to allocate assets among the CG Capital Markets funds, a
series of 14 mutual funds each corresponding to a particular asset class and
investment style, or from among the selected fund offerings of 40 no-load or
load-waived mutual fund families (including Smith Barney proprietary funds)
corresponding to the same asset class and investment style criteria. At December
31, 1998, TRAK(R) assets exceeded $12.8 billion, as compared to approximately
$10.5 billion at December 31, 1997 and approximately $7.2 billion at December
31, 1996. Salomon Smith Barney also offers a separate offshore TRAK(R) program
to non-resident alien clients, which includes client investment in a series of
asset class/investment style funds domiciled outside the United States.
TRUST SERVICES
Certain subsidiaries of Citigroup are chartered as trust companies and
provide a full range of fiduciary services with a particular emphasis on
personal trust services. Another Citigroup subsidiary offers a broad range of
trustee services for qualified retirement plans, with particular emphasis on the
401(k) plan market. Each of these trust companies is subject to supervision by
either federal or state banking authorities, as appropriate based upon the
jurisdiction in which such trust company is chartered, and uses the distribution
network of Salomon Smith Barney to market its services. Salomon Smith Barney
provides certain advisory and support services to the trust companies and
receives fees for such services. Certain subsidiaries of SSBH also operate a
private trust services business that is licensed as a bank and trust company in
the Cayman Islands.
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PHIBRO AND OTHER
Phibro conducts a global commodities dealer business through its principal
offices in Westport (Connecticut), London and Singapore. Commodities traded
include crude oil, refined oil products, natural gas, electricity, metals and
various soft commodities. During 1998, Phibro continued its downsizing effort to
significantly reduce the scope of some of its activities. Phibro makes extensive
use of futures markets and is a participant in the OTC derivatives market. Its
principal competitors are major integrated oil companies, other commodity
trading companies, certain investment banks and other financial institutions.
As a dealer, Phibro's strategy is to focus on taking positions in
commodities on a longer-term horizon while also engaging in counterparty flow
business on a short-term basis. Phibro's operating results are subject to a high
degree of volatility, particularly on a quarterly basis, due to the predominance
of directional positions in commodities that have a longer-term horizon until
realization. Thus, results are better evaluated over the longer term.
For a summary of the Company's operations by geographic area, see Note 7 of
Notes to Consolidated Financial Statements.
DERIVATIVES AND RISK MANAGEMENT
Derivative instruments are contractual commitments or payment exchange
agreements between counterparties that "derive" their value from some underlying
asset, index, interest rate or exchange rate. The Company enters into various
bilateral financial contracts involving future settlement, which are based upon
a predetermined principal or par value (referred to as the "notional" amount).
Such instruments include swaps, swap options, caps and floors, futures
contracts, forward purchase and sale agreements, option contracts and warrants.
Derivatives activities, like Salomon Smith Barney's other ongoing business
activities, give rise to market, credit and operational risks, although the
Company also uses derivative instruments to manage these risks in its other
businesses. For a more complete discussion of Salomon Smith Barney's use of
derivative financial instruments and certain of the related risks, see Item 7,
"Management's Discussion and Analysis of Financial Condition and Results of
Operations" and Notes 4, 5, 9, 17 and 18 of Notes to Consolidated Financial
Statements.
COMPETITION
The businesses in which Salomon Smith Barney is engaged are highly
competitive. The principal factors affecting competition in the investment
banking and brokerage industry are the quality and ability of professional
personnel and the relative prices of services and products offered. In addition
to competition from other investment banking firms, both domestic and
international, and securities brokerage companies and discount and on-line
securities brokerage operations, including regional firms in the United States,
there has been increasing competition from other sources, such as commercial
banks, insurance companies and other major companies that have entered the
investment banking and securities brokerage industry, in many cases
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through acquisitions. Certain of those competitors may have greater capital and
other resources than the Company.
ASSET MANAGEMENT
The Asset Management segment is comprised of two primary asset management
business platforms: Salomon Brothers Asset Management and the Smith Barney Asset
Management division of Salomon Smith Barney Inc. These companies offer a broad
range of asset management products and services from global investment centers,
including mutual funds, closed-end funds, managed accounts and unit investment
trusts.
Clients include private and public retirement plans, endowments,
foundations, banks, central banks, insurance companies, other corporations,
government agencies, high net worth and other individuals. Client relationships
may be introduced through the cross-marketing and distribution opportunities
within the Citigroup structure, through Asset Management's own sales force or
through independent sources.
The Company receives ongoing fees, generally stated as a percentage of the
client's assets, from asset management clients. At December 31, 1998, client
assets managed by Salomon Smith Barney Asset Management were approximately
$186.0 billion, as compared to approximately $152.5 billion at December 31, 1997
and approximately $126.5 billion at December 31, 1996. These amounts include
separately managed accounts with assets of approximately $68.3 billion at
December 31, 1998, $54.1 billion at December 31, 1997 and $44.5 billion at
December 31, 1996.
The following table shows the aggregate assets in, and number of, mutual
funds managed by the Company at December 31 for each of the last three years.
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MUTUAL FUND ASSETS UNDER MANAGEMENT
DECEMBER 31,
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1998 1997 1996
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(DOLLARS IN BILLIONS)
NO. OF NO. OF NO. OF
FUNDS ASSETS FUNDS ASSETS FUNDS ASSETS
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Money market.............................. 14 $ 58.6 15 $46.6 13 $41.6
Mutual funds.............................. 128 55.4 114 48.6 111 38.1
Annuities................................. 32 3.7 26 3.2 25 2.3
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Total........................... 174 $117.7 155 $98.4 149 $82.0
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SMITH BARNEY ASSET MANAGEMENT
At December 31, 1998, Smith Barney Asset Management sponsored 70 mutual
funds (open-end investment companies), including taxable and tax-exempt money
market funds, equity funds, taxable fixed income funds and tax-exempt fixed
income funds sold primarily through Salomon Smith Barney Financial Consultants
and the Primerica Financial Services sales force, affiliates of the Company.
Smith Barney Asset Management also serves as the primary investment manager to
twelve closed-end investment companies, the shares of which are listed for
trading on one or more securities exchanges. In addition, at December 31, 1998,
Smith Barney Asset Management managed 27 mutual fund portfolios serving as
funding vehicles for variable annuity contracts, including certain variable
annuities and other individual products of the Travelers Life and Annuity unit
of Citigroup, which are sold by Salomon Smith Barney Financial Consultants.
Smith Barney Asset Management also sponsors and manages 18 mutual funds
domiciled outside the United States, which are offered to Salomon Smith Barney's
non-resident alien client base as well as to the general public.
Smith Barney Asset Management also provides separate account discretionary
and non-discretionary investment management services to a wide variety of
individual and institutional clients, including private and public retirement
plans, endowments, foundations, banks, central banks, insurance companies, other
corporations and governmental agencies. Client relationships may be introduced
either through Salomon Smith Barney's network of Financial Consultants or
independently of that network.
Smith Barney Asset Management also sponsors and oversees the portfolios of
a large number of unit investment trusts, which are unmanaged investment
companies, the portfolios of which are generally static. Such unit investment
trusts may hold domestic and foreign equity and debt securities, including
municipal bonds. Certain trusts are sponsored and overseen solely by Smith
Barney Asset Management; other trusts are jointly sponsored through a syndicate
of major broker-dealers of which Smith Barney is a member. At December 31, 1998,
outstanding unit trust assets held by Smith Barney's clients were approximately
$13.2 billion, as compared to approximately $11.8 billion at December 31, 1997
and approximately $8.6 billion at December 31, 1996.
SALOMON BROTHERS ASSET MANAGEMENT
Salomon Brothers Asset Management provides separate account discretionary
and non-discretionary investment management services to pension funds,
investment companies, endowments, foundations, banks, central banks, insurance
companies, other corporations, governmental agencies and individuals. Client
relationships may be introduced through traditional independent consultant
evaluations as well as through the individual and institutional client
relationships of the Company's broker-dealer subsidiaries.
At December 31, 1998, Salomon Brothers Asset Management sponsored 16 mutual
funds, including taxable and tax-exempt money market funds, equity funds,
taxable fixed income funds
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and tax-exempt fixed income funds sold primarily through dealer agreements with
a variety of national and regional brokerage firms, including Salomon Smith
Barney Inc. Salomon Brothers Asset Management serves as investment manager to
these mutual funds, as well as to 5 mutual portfolios serving as funding
vehicles for variable annuity contracts as well as to 11 closed-end investment
companies, the shares of which are listed for trading on one or more securities
exchanges. Salomon Brothers Asset Management also manages 15 mutual funds
domiciled outside the United States, which are offered to Salomon Smith Barney's
non-resident alien client base as well as to the general public.
COMPETITION
Competitors of the mutual funds and asset management groups include a large
number of mutual fund management and sales companies, asset management firms and
banks. Competition in mutual fund sales and investment management is based on
investment performance, service to clients and product design.
OTHER INFORMATION
REGULATION
Certain of SSBH's subsidiaries are subject to various securities and
commodities regulations and capital adequacy requirements promulgated by the
regulatory and exchange authorities of the jurisdictions in which they operate.
Some subsidiaries are registered as broker-dealers and as investment advisers
with the U.S. Securities and Exchange Commission (the "SEC") and as futures
commission merchants and as commodity pool operators with the Commodity Futures
Trading Commission ("CFTC"). Certain of SSBH's subsidiaries are also members of
the New York Stock Exchange, Inc. (the "NYSE") and other principal United States
securities exchanges, as well as the National Association of Securities Dealers,
Inc. ("NASD") and the National Futures Association ("NFA"), a not-for-profit
membership corporation designated as a registered futures association by the
CFTC. The Company's primary broker-dealer subsidiaries, Salomon Smith Barney
Inc. ("SSB") and The Robinson-Humphrey Company, LLC ("R-H"), are registered as
broker-dealers in all 50 states, the District of Columbia and Puerto Rico, and
in addition are registered as investment advisers in certain states that require
such registration. SSB is also a registered broker-dealer in Guam. SSB is also a
reporting dealer to the Federal Reserve Bank of New York and a member of the
principal United States futures exchanges. SSB and R-H are subject to extensive
regulation, primarily for the benefit of their customers, including minimum
capital requirements, which are promulgated and enforced by, among others, the
SEC, the CFTC, the NFA, the NYSE, various self-regulatory organizations of which
these subsidiaries are members and the securities administrators of the 50
states, the District of Columbia and Puerto Rico and, in the case of SSB, Guam.
The SEC and the CFTC also require certain registered broker-dealers (including
SSB) to maintain records concerning certain financial and securities activities
of affiliated companies that may be material to the broker-dealer, and to file
certain financial and other information regarding such affiliated companies.
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Salomon Smith Barney's operations abroad are conducted through various
subsidiaries, principally Salomon Brothers International Limited ("SBIL") in
London, Nikko Salomon Smith Barney in Tokyo and Salomon Brothers AG ("SBAG") in
Frankfurt. Its activities in the United Kingdom, which include investment
banking, trading, brokerage and asset management services, are subject to the
Financial Services Act 1986, which regulates organizations that conduct
investment businesses in the United Kingdom (including imposing capital and
liquidity requirements), and to the rules of the Securities and Futures
Authority and the Investment Management Regulatory Organisation. Nikko Salomon
Smith Barney is a registered foreign securities company in Japan and, as such,
its activities in Japan are subject to Japanese law applicable to non-Japanese
securities firms and are regulated by the Japanese Ministry of Finance and
Financial Supervisory Agency. SBAG is a German bank, principally engaged in
securities trading and investment banking and is regulated by Germany's Banking
Supervisory Authority. These and other subsidiaries of SSBH are also members of
various securities and commodities exchanges and are subject to the rules and
regulations of those exchanges. Salomon Smith Barney's other offices are also
subject to the jurisdiction of local financial services regulatory authorities.
In connection with the mutual funds business, SSBH and its subsidiaries
must comply with regulations of a number of regulatory agencies and
organizations, including the SEC, the NASD and regulatory agencies in the
United Kingdom and Germany. SSBH is the direct or indirect parent of
investment advisers registered and regulated under the Investment Advisers Act
of 1940 and the Investment Company Act of 1940. Under those Acts, the advisory
contracts between SSBH's investment adviser subsidiaries and the mutual funds
they serve ("Affiliated Funds") would automatically terminate upon an assignment
of such contracts by the investment adviser. Such an assignment would be
presumed to have occurred if any party were to acquire more than 25% of
Citigroup's voting securities. In that event, consent to the assignment from the
shareholders of the Affiliated Funds involved would be needed for the advisory
relationships to continue. In addition, the Company's registered investment
advisers and the Affiliated Funds are subject to certain restrictions in their
dealings with each other. For example, SSB may act as broker to an Affiliated
Fund in a transaction involving an exchange-traded security only when that fund
maintains procedures that govern, among other things, the execution price of the
transaction and the commissions paid; it may not, however, conduct principal
transactions with an Affiliated Fund. Further, an Affiliated Fund may acquire
securities during the existence of an underwriting where SSB is a principal
underwriter only in certain limited situations.
SSB and R-H are members of the Securities Investor Protection Corporation
("SIPC"), which, in the event of liquidation of a broker-dealer, provides
protection for customers' securities accounts held by the firm of up to $500,000
for each eligible customer, subject to a limitation of $100,000 for claims for
cash balances. In addition, SSBH has purchased additional coverage of up to $150
million for eligible customers, approximately $50 million of which is from a
subsidiary of Citigroup.
Citigroup, SSBH's parent, is a bank holding company subject to the Bank
Holding Company Act of 1956 (the "BHCA"). For a discussion of the BHCA and its
application to the Company, see Note 2 of Notes to Consolidated Financial
Statements.
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<PAGE> 13
President Clinton's recent budget proposal (the "Budget Proposal")
contains a number of tax provisions that could adversely impact Salomon Smith
Barney, for example, provisions relating to tax-exempt interest obligations.
The Budget Proposal, which is in its early stages of consideration, has not yet
been introduced as part of any legislation in Congress. It is unclear which if
any of the President's proposals will become law.
Capital Requirements
As registered broker-dealers, SSB and R-H are subject to the SEC's net
capital rule, Rule 15c3-1 (the "Net Capital Rule"), promulgated under the
Exchange Act. These companies compute net capital under the alternative method
of the Net Capital Rule, which requires the maintenance of minimum net capital,
as defined. A member of the NYSE may be required to reduce its business if its
net capital is less than 4% of aggregate debit balances (as defined) and may
also be prohibited from expanding its business or paying cash dividends if
resulting net capital would be less than 5% of aggregate debit balances.
Furthermore, the Net Capital Rule does not permit withdrawal of equity or
subordinated capital if the resulting net capital would be less than 5% of such
debit balances.
The Net Capital Rule also limits the ability of broker-dealers to transfer
large amounts of capital to parent companies and other affiliates. Under the Net
Capital Rule, equity capital cannot be withdrawn from a broker-dealer without
the prior approval of the SEC in certain circumstances, including when net
capital after the withdrawal would be less than (i) 120% of the minimum net
capital required by the Net Capital Rule, or (ii) 25% of the broker-dealer's
securities position "haircuts," i.e., deductions from capital of certain
specified percentages of the market value of securities to reflect the
possibility of a market decline prior to disposition. In addition, the Net
Capital Rule requires broker-dealers to notify the SEC and the appropriate self-
regulatory organization two business days before a withdrawal of excess net
capital if the withdrawal would exceed the greater of $500,000 or 30% of the
broker-dealer's excess net capital, and two business days after a withdrawal
that exceeds the greater of $500,000 or 20% of excess net capital. Finally, the
Net Capital Rule authorizes the SEC to order a freeze on the transfer of capital
if a broker-dealer plans a withdrawal of more than 30% of its excess net capital
and the SEC believes that such a withdrawal would be detrimental to the
financial integrity of the firm or would jeopardize the broker-dealer's ability
to pay its customers.
Compliance with the Net Capital Rule could limit those operations of the
Company that require the intensive use of capital, such as underwriting and
trading activities and the financing of customer account balances, and also
could restrict SSBH's ability to withdraw capital from its broker-dealer
subsidiaries, which in turn could limit SSBH's ability to pay dividends and make
payments on its debt.
SSB had net capital, computed in accordance with the Net Capital Rule, of
$3.195 billion, which exceeded the minimum net capital requirement by $2.841
billion. For further discussion of capital requirements related to the Company's
principal regulated subsidiaries, see Note 12 of Notes to Consolidated Financial
Statements.
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<PAGE> 14
GENERAL BUSINESS FACTORS
In the judgment of the Company, no material part of the business of the
Company and its subsidiaries is dependent upon a single customer or group of
customers, the loss of any one of which would have a materially adverse effect
on the Company, and no one customer or group of affiliated customers accounts
for as much as 10% of the Company's consolidated revenues.
At December 31, 1998, the Company had approximately 34,930 full-time and
1,363 part-time employees.
SOURCE OF FUNDS
For a discussion of the Company's sources of funds and maturities of the
long-term debt of the Company and its subsidiaries, see Item 7, "Management's
Discussion and Analysis of Financial Condition and Results of
Operations -- Liquidity and Capital Resources," and Notes 8 and 9 of Notes to
Consolidated Financial Statements.
TAXATION
For a discussion of tax matters affecting the Company and its operations,
see Note 14 of Notes to Consolidated Financial Statements.
ITEM 2. PROPERTIES.
The Company's principal executive offices are located in New York City. In
addition, the Company owns two office buildings in New York City, which total
approximately 627,000 square feet. The Company also owns an office building in
Rutherford, New Jersey, totaling approximately 249,000 square feet and an office
building in Tampa, Florida, totaling approximately 135,000 square feet. In
addition, the Company owns an office building in London, England, that contains
approximately 212,760 net square feet. The building is subject to a mortgage
that becomes due in 2007, but which may be prepaid without premium at any time
with notice. Most of the Company's other offices are located in leased premises,
the leases for which expire at various times.
The Company leases two buildings located at 388 and 390 Greenwich Street,
New York and totaling approximately 2,300,000 square feet, through March, 2003.
The Company has a purchase option with respect to these properties. The Company
also leases approximately 1,018,000 square feet of office space at Seven World
Trade Center in New York City, through 2010.
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<PAGE> 15
The Company believes that these facilities are adequate for the purposes
for which they are used and are well maintained. For further information
concerning leases, see Note 10 of Notes to Consolidated Financial Statements.
ITEM 3. LEGAL PROCEEDINGS.
This section describes the major pending legal proceedings, other than
ordinary routine litigation incidental to the business, to which the Company or
its subsidiaries is a party or to which any of their property is subject.
In September 1992, Harris Trust and Savings Bank (as trustee for Ameritech
Pension Trust ("APT"), Ameritech Corporation, and an officer of Ameritech filed
suit against Salomon Brothers Inc. ("SBI") and Salomon Brothers Realty
Corporation ("SBRC") in the U.S. District Court for the Northern District of
Illinois (Harris Trust Savings Bank, not individually but solely as trustee for
the Ameritech Pension Trust, Ameritech Corporation and John A. Edwardson v.
Salomon Brothers Inc and Salomon Brothers Realty Corp.). The second amended
complaint alleges that three purchases by APT from defendants of participation
interests in net cash flow or resale proceeds of three portfolios of motels
owned by Motels of America, Inc. ("MOA"), as well as a fourth purchase by APT of
a similar participation interest with respect to a portfolio of motels owned by
Best Inns, Inc. ("Best"), violated the Employee Retirement Income Security Act
("ERISA"), and that the purchase of the participation interests for the third
MOA portfolio and for the Best portfolio violated the Racketeer Influenced and
Corrupt Organization Act ("RICO") and state law. SBI had acquired the
participation interests in transactions in which it purchased as principal
mortgage notes issued by MOA and Best to finance purchases of motel portfolios;
95% of three such interests and 100% of one such interest were sold to APT for
purchase prices aggregating approximately $20.9 million. Plaintiffs' second
amended complaint seeks (a) judgment on the ERISA claims for the purchase prices
of the four participation interests (approximately $20.9 million), for
rescission and for disgorgement of profits, as well as other relief, and (b)
judgment on the claims brought under RICO and state law in the amount of $12.3
million, with damages trebled to $37 million on the RICO claims and punitive
damages in excess of $37 million on certain of the state law claims as well as
other relief. The court dismissed the RICO, breach of contract, and unjust
enrichment claims. The court also found that defendants did not qualify as an
ERISA fiduciary and dismissed the claims based on that allegation. Defendants
moved for summary judgment on the sole remaining claim. The motion was denied,
and defendants appealed to the U.S. Court of Appeals for the Seventh Circuit.
Defendants are awaiting a decision.
Both the Department of Labor and the Internal Revenue Service have advised
SBI that they were or are reviewing the transactions in which APT acquired such
participation interests. With respect to the Internal Revenue Service review,
SSBH, SBI and SBRC have consented to extensions of time for the assessment of
excise taxes that may be claimed to be due with respect to the transactions for
the years 1987, 1988 and 1989. In August 1996, the IRS sent SSBH, SBI and SBRC
what appeared to be draft "30-day letters" with respect to the transactions and
SSBH, SBI and SBRC were given an opportunity to comment on whether the IRS
should issue 30-day
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<PAGE> 16
letters, which would actually commence the assessment process. In October 1996,
SSBH, SBI and SBRC submitted a memorandum setting forth reasons why the IRS
should not issue 30-day letters with respect to the transactions.
In December 1996, a complaint seeking unspecified monetary damages was
filed by Orange County, California against numerous brokerage firms, including
Smith Barney, in the U.S. Bankruptcy Court for the Central District of
California (County of Orange et al. v. Bear Stearns & Co. Inc. et al.).
Plaintiff alleges, among other things, that defendants recommended and sold to
plaintiff unsuitable securities and that such transactions were outside the
scope of plaintiff's statutory and constitutional authority (ultra vires).
Defendants' motion for summary judgment was granted with respect to the ultra
vires claims in February 1999. The court allowed the filing of an amended
complaint asserting claims based on alleged breaches of fiduciary duty.
In June 1998, complaints were filed in the U.S. District Court for the
Eastern District of Louisiana in two actions (Board of Liquidations, City Debt
of the City of New Orleans v. Smith Barney Inc. et ano. and The City of New
Orleans v. Smith Barney Inc. et ano.), in which the City of New Orleans seeks a
declaratory judgment that Smith Barney Inc. and another underwriter are
responsible for any damages that the City may incur in the event the Internal
Revenue Service denies tax exempt status to the City's General Obligation
Refunding Bonds Series 1991. The Company filed a motion to dismiss the
complaints in September 1998, and the complaints were subsequently amended. The
Company has filed a motion to dismiss the amended complaints.
In November 1998, a purported class action complaint was filed in the
United States District Court for the Middle District of Florida (Dwight Brock as
Clerk for Collier County v. Merrill Lynch, et al.). The complaint alleges that,
pursuant to a nationwide conspiracy, 17 broker-dealer defendants, including SSB,
charged excessive mark-ups in connection with advanced refunding transactions.
The Company intends to contest this complaint vigorously.
ENVIRONMENTAL MATTERS
In July 1996, the City and County of Denver ("Denver") enacted an ordinance
imposing a substantial fee on any radioactive waste or radium-contaminated
material disposed of in the City of Denver. Under this ordinance, Denver
assessed a subsidiary of Salomon, the S.W. Shattuck Chemical Company, Inc.
("Shattuck"), $9.35 million for certain disposal already carried out. Shattuck
sued to enjoin imposition of the fee on constitutional grounds. The United
States also sued, seeking to enjoin imposition of the fee on constitutional
grounds. Denver counterclaimed and moved to add SSBH as a defendant for past
costs. These cases have been consolidated before the U.S. District Court in
Colorado, which granted Shattuck's motion for a preliminary injunction enjoining
Denver from enforcing the ordinance during the pendency of the litigation. The
parties have reached a settlement.
The Company and various subsidiaries have also been named as defendants in
various matters incident to and typical of the businesses in which they are
engaged. These include numerous civil actions, arbitration proceedings and other
matters in which the Company's broker-dealer subsidiaries have been named,
arising in the normal course of business out of activities as a
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<PAGE> 17
broker and dealer in securities, as an underwriter of securities, as an
investment banker or otherwise. In the opinion of the Company's management, none
of these actions is expected to have a material adverse effect on the
consolidated financial condition of the Company and its subsidiaries.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS.
Pursuant to General Instruction I of Form 10-K, the information required by
Item 4 is omitted.
PART II
ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS.
All of the outstanding common stock of the Company is owned by Citigroup.
ITEM 6. SELECTED FINANCIAL DATA.
Pursuant to General Instruction I of Form 10-K, the information required by
Item 6 is omitted.
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS.
In 1998, the Company recorded income from continuing operations, including
the Citigroup restructuring charge and credits relating to the restructuring
charge booked in the fourth quarter of 1997, of $818 million compared to $1,145
million and $1,865 million for the years ended December 31, 1997 and 1996,
respectively. Income from continuing operations in 1997 includes the
restructuring charge booked in connection with the merger of Salomon and Smith
Barney (see Notes 1 and 2 to the consolidated financial statements for further
discussion of the restructuring charges). Revenues, net of interest expense were
$9.2 billion in 1998 compared to $10.9 billion and $10.7 billion in 1997 and
1996, respectively.
Gain on sale of subsidiaries and affiliates in 1996 includes a pre-tax gain
of $48 million related to the sale of the Company's indirect wholly owned
subsidiary The Mortgage Corporation Limited, which originated and serviced
residential mortgages in the United Kingdom. This gain has not been allocated to
either of the Company's operating segments.
The Company's 1996 results also reflect losses from discontinued
operations, including a $290 after-tax loss related to the sale of Basis
Petroleum. As discussed in the "Discontinued Operations" section that follows,
Basis Petroleum is reflected as a discontinued operation in this report.
14
<PAGE> 18
Following is a discussion of the results of operations of the Company's two
operating segments, Investment Services and Asset Management.
RESULTS OF OPERATIONS
INVESTMENT SERVICES
<TABLE>
<CAPTION>
DOLLARS IN MILLIONS
YEAR ENDED DECEMBER 31, 1998 1997 1996
- ------------------------ ------ ------ ------
<S> <C> <C> <C>
Revenues:
Commissions............................................ $3,202 $2,956 $2,600
Investment banking..................................... 2,281 2,082 1,975
Principal transactions................................. (116) 2,500 3,024
Asset management and administration fees............... 1,308 997 777
Other.................................................. 172 119 140
------ ------ ------
Total noninterest revenues............................... 6,847 8,654 8,516
------ ------ ------
Net interest and dividends............................. 1,456 1,533 1,515
------ ------ ------
Revenues, net of interest expense........................ 8,303 10,187 10,031
------ ------ ------
Noninterest expenses:
Compensation and benefits.............................. 5,672 5,891 5,429
Other operating and administrative expenses............ 2,006 1,983 1,847
Restructuring charge, net.............................. (274) 838 --
------ ------ ------
Total noninterest expense................................ 7,404 8,712 7,276
------ ------ ------
Income from continuing operations before income taxes.... 899 1,475 2,755
------ ------ ------
Income taxes............................................. 333 538 1,096
------ ------ ------
Income from continuing operations........................ $ 566 $ 937 $1,659
====== ====== ======
</TABLE>
The Company's investment services segment recorded income from continuing
operations for 1998, including the Citigroup restructuring charge and the
credits related to the restructuring charge booked in the fourth quarter of
1997, of $566 million compared to $937 million and $1,659 million for the years
ended December 31, 1997 and 1996, respectively. Income from continuing
operations in 1997 includes the restructuring charge booked in connection with
the merger of Salomon and Smith Barney (see Notes 1 and 2 to the consolidated
financial statements for further discussion of the restructuring charges).
15
<PAGE> 19
Revenues, net of interest in 1998 declined 18% to $8.3 billion, primarily
due to a decline in principal transaction revenue from fixed income and global
arbitrage activities offset to an extent by increases in commissions, asset
management and administration fees and investment banking revenues. Revenues,
net of interest in 1997 were $10.2 billion, a 2% improvement over the $10.0
billion in 1996, primarily reflecting increases in commissions and asset
management and administration fees, offset by a decline in principal transaction
revenues from fixed income trading and the global arbitrage business.
Commission revenues increased 8% in 1998 to $3.2 billion, from $3.0 billion
in 1997 and $2.6 billion in 1996. The 1998 and 1997 increases reflect growth in
sales of listed and over-the-counter ("OTC") securities. The 1997 results also
reflect higher commissions from mutual funds activity, as well as increased
insurance and annuity sales.
Investment banking revenues were $2.28 billion in 1998 compared to $2.08
billion in 1997 and $1.98 billion in 1996. The increases in 1998 and 1997
reflect revenue growth in unit trust, public finance, and high grade debt
underwritings, and mergers and acquisitions. This was offset somewhat by a
decline in equity underwritings. Investment banking revenues in 1998 were
favorably impacted by an increase in private placement fees, offset by a decline
in high yield underwritings. Investment banking revenues in 1997 were also
favorably impacted by increased high yield underwriting revenues. For 1998, the
Company was ranked #1 in the industry in municipal underwritings, and #2 in
domestic and #3 in global debt and equity underwriting, according to Securities
Data Corp.
Principal transaction revenues declined to a loss of ($116) million in
1998. Decreases in fixed income trading results include losses due to risk
reductions in the U.S. fixed income arbitrage business, and losses in other
global arbitrage. These decreases were offset to an extent by an increase in
equity trading results. Fixed income trading results were adversely impacted by
significant dislocations in the global fixed income markets, including greatly
reduced liquidity and widening credit spreads. Also included in fixed income
results are Russian-related credit losses. In 1997 principal transaction
revenues decreased to $2.5 billion compared to $3.0 billion in 1996. This was
the result of a decrease in long-term fixed income trading strategies, partially
offset by an increase in customer sales and trading. Also contributing to the
1997 decline was increased volatility in the global equity markets and a loss on
risk arbitrage positions in British Telecommunications PLC and MCI
Communications Corporation, partially offset by improved results in long-term
equity strategies.
Asset management and administration fees were $1.31 billion in 1998
compared to $997 million in 1997 and $777 million in 1996. The investment
services segment includes results from assets managed by the Company's Financial
Consultants as well as assets that are externally managed by the consulting
group. Assets under fee-based management in these two categories increased
significantly over the three-year period, causing the corresponding increase in
revenue.
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<PAGE> 20
Total assets under fee-based management were as follows:
<TABLE>
<CAPTION>
DOLLARS IN BILLIONS
AT DECEMBER 31, 1998 1997 1996
- ------------------- ------ ------ ------
<S> <C> <C> <C>
Money market funds....................................... $ 58.6 $ 46.6 $ 41.6
Mutual funds............................................. 59.1 51.8 40.4
Managed accounts......................................... 68.3 54.1 44.5
------ ------ ------
Salomon Smith Barney Asset Management.................... 186.0 152.5 126.5
Financial Consultant managed accounts*................... 16.5 11.6 7.9
------ ------ ------
Total internally managed accounts........................ 202.5 164.1 134.4
Consulting Group externally managed assets*.............. 71.9 59.7 44.1
------ ------ ------
Total assets under fee-based management.................. $274.4 $223.8 $178.5
====== ====== ======
</TABLE>
- ---------------
* Related results included in Investment Services segment.
Total noninterest expenses, excluding the net restructuring charge relating
to the merger of Salomon and Smith Barney and the Citigroup restructuring
charge, were $7.7 billion in 1998 compared to $7.9 billion in 1997 and $7.3
billion in 1996. Total expenses were relatively unchanged in 1998 while the 8%
increase in 1997 primarily reflects an increase in production-related
compensation and benefits expense, reflecting increased revenues as well as
higher floor brokerage and other production-related costs. The Company continues
to maintain its focus on controlling fixed expenses.
17
<PAGE> 21
ASSET MANAGEMENT
<TABLE>
<CAPTION>
DOLLARS IN MILLIONS
YEAR ENDED DECEMBER 31, 1998 1997 1996
- ----------------------- ---- ---- ----
<S> <C> <C> <C>
Revenues:
Asset management and administration fees.................. $857 $718 $613
Net interest and dividends and other revenue.............. 47 42 24
---- ---- ----
Revenues, net of interest expense........................... 904 760 637
---- ---- ----
Noninterest expenses:
Compensation and benefits................................. 176 146 129
Other operating and administrative expenses............... 311 269 247
---- ---- ----
Total noninterest expense................................... 487 415 376
---- ---- ----
Income from continuing operations before income taxes....... 417 345 261
---- ---- ----
Income taxes................................................ 165 137 103
---- ---- ----
Income from continuing operations........................... $252 $208 $158
==== ==== ====
</TABLE>
The asset management segment revenues net of interest expense rose 19% to
$904 million in 1998 compared to $760 million in 1997 and $637 million in 1996.
The primary revenue component for the asset management segment is asset
management and administration fees, which were $857 million in 1998, compared to
$718 million in 1997 and $613 million in 1996. The 19% overall increase in 1998
fees reflects broad growth in all asset management products, led by a 27%
increase in revenues from separately managed accounts and an 18% increase in
money market and long-term mutual fund fees. Assets under management for the
segment reached $186 billion at the end of 1998, a 22% increase over 1997 (see
table on preceding page for detail of the segment's assets under fee-based
management). This increase includes the mid-year acquisition of JP Morgan's
Australian asset management business with $5 billion in assets under management.
Other revenues include the net revenue contribution to the asset management
segment for the structuring of unit investment trusts.
Total noninterest expenses were $487 million in 1998 compared to $415
million in 1997 and $376 million in 1996. The 17% increase in 1998 and 10%
increase in 1997 reflect continuing investments in the portfolio management and
sales and marketing infrastructure of the asset management segment to support
sustained business growth.
OUTLOOK
The Company's business is significantly affected by the levels of activity
in the securities markets, which in turn are influenced by the level and trend
of interest rates, the general state of the global economy and the national and
worldwide political environments, among other factors.
18
<PAGE> 22
DISCONTINUED OPERATIONS
In March 1997, the Board of Directors of Salomon Inc approved a non-binding
letter of intent to sell all of the outstanding stock of Basis Petroleum, the
Company's oil refining and marketing business, to Valero Energy Corporation and
a plan of disposition for Basis. Consequently, the Company recorded an after-tax
loss of $290 million in the fourth quarter of 1996. For a description of the
terms of the sale see Note 6 to the consolidated financial statements.
In 1996, Basis and Howell Corporation contributed their respective crude
oil gathering, marketing and transportation activities to form Genesis Energy,
L.P. ("Genesis"). The Company's investment in Genesis was not transferred to
Valero.
Basis Petroleum had an after-tax operating loss of $75 million in 1996.
Basis' 1996 results included an after-tax gain of $37 million ($60 million
pretax) related to a Genesis public offering and an after-tax gain of $14
million ($23 million pretax) related to the reduction of its minimum physical
inventories needed to support its refining operations. In addition, 1996 results
include an after-tax charge of $13 million ($22 million pretax) related to the
shutdown of Basis' chemical processing facility in Houston.
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<PAGE> 23
CAPITAL AND LIQUIDITY MANAGEMENT
Capital is an expensive resource. To maximize the return on equity, it is
essential that the Company deploy its capital in an efficient manner. Liquidity
management is integral to capital management and is especially critical for a
financial institution such as the Company. Access to funding must be assured
under all market conditions. The confidence of creditors and counterparties in
the Company's ability to perform pursuant to its contractual obligations is
important to the Company's continued success.
LIQUIDITY AND CAPITAL RESOURCES
The Company's total assets were $212 billion at December 31, 1998, down
from $277 billion at year-end 1997. Due to the nature of the Company's trading
activities, including its matched book activities, it is not uncommon for the
Company's asset levels to fluctuate from period to period. A "matched book"
transaction involves a security purchased under an agreement to resell (i.e.,
reverse repurchase transaction) and simultaneously sold under an agreement to
repurchase (i.e., repurchase transaction). Financial instruments and commodities
owned and contractual commitments declined during 1998 as a result of decreased
inventory positions in U.S. and Non-U.S. government and agency securities. These
declines can, in large part, be attributed to the risk reduction in the
Company's global arbitrage businesses.
The Company's balance sheet is highly liquid, with the vast majority of its
assets consisting of marketable securities and collateralized short-term
financing agreements arising from securities transactions. The highly liquid
nature of these assets provides the Company with flexibility in financing and
managing its business. The Company monitors and evaluates the adequacy of its
capital and borrowing base on a daily basis in order to allow for flexibility in
its funding, to maintain liquidity, and to ensure that its capital base supports
the regulatory capital requirements of its subsidiaries.
The Company funds its operations through the use of collateralized and
uncollateralized short-term borrowings, long-term borrowings, mandatorily
redeemable securities of subsidiary trusts, and its equity. Collateralized
short-term financing, including repurchase agreements and secured loans, is the
Company's principal funding source. Such borrowings are reported net by
counterparty, when applicable, pursuant to the provisions of Financial
Accounting Standards Board Interpretation 41, Offsetting of Amounts Related to
Certain Repurchase and Reverse Repurchase Agreements ("FIN 41"). Excluding the
impact of FIN 41, short-term collateralized borrowings totaled $121.8 billion at
December 31, 1998. Uncollateralized short-term borrowings provide the Company
with a source of short-term liquidity and are also utilized as an alternative to
secured financing when they represent a cheaper funding source. Sources of
short-term uncollateralized borrowings include commercial paper, unsecured bank
borrowings and letters of credit, deposit liabilities, promissory notes and
corporate loans. Short-term uncollateralized borrowings totaled $12.9 billion at
December 31, 1998.
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<PAGE> 24
The Company has committed uncollateralized revolving lines of credit
totaling $5.0 billion, which it may borrow from at various interest rate options
(LIBOR, CD or base rate), and compensates the banks for the facilities through
facility fees. At December 31, 1998 there were no outstanding borrowings under
these facilities. Under these facilities the Company is required to maintain a
certain level of consolidated adjusted net worth (as defined in the agreement).
At December 31, 1998, this requirement was exceeded by approximately $2.8
billion. The Company also has substantial borrowing arrangements consisting of
facilities that the Company has been advised are available, but where no
contractual lending obligation exists. These arrangements are reviewed on an
ongoing basis to ensure flexibility in meeting the Company's short-term
requirements.
Unsecured term debt is a significant component of the Company's long-term
capital. Term debt totaled $20.2 billion at December 31, 1998, compared with
$19.1 billion at December 31, 1997. The Company utilizes interest rate swaps to
convert the majority of its fixed rate term debt used to fund inventory-related
working capital requirements into variable rate obligations. Term debt issuances
denominated in currencies other than the U.S. dollar that are not used to
finance assets in the same currency are effectively converted to U.S. dollar
obligations through the use of cross-currency swaps and forward currency
contracts. The average remaining maturity of the Company's term debt was 4.0
years at December 31, 1998 and 3.7 years at December 31, 1997. See Note 9 to the
consolidated financial statements for additional information regarding term debt
and an analysis of the impact of interest rate swaps on term debt.
In July 1996, the Company issued $345 million of mandatorily redeemable
securities of subsidiary trusts, which pay interest and fees at an annual rate
of 9.50%. In January 1998, the Company issued $400 million of mandatorily
redeemable securities of subsidiary trusts, which pay interest at an annual rate
of 7.20%. For a detailed description of these securities see Note 11 to the
consolidated financial statements.
The Company's borrowing relationships are with a broad range of banks,
financial institutions and other firms from which it draws funds. The volume of
the Company's borrowings generally fluctuates in response to changes in the
level of the Company's financial instruments, commodities and contractual
commitments, customer balances, the amount of reverse repurchase transactions
outstanding and securities borrowed transactions. As the Company's activities
increase, borrowings generally increase to fund the additional activities.
Availability of financing to the Company can vary depending upon market
conditions, credit ratings, and the overall availability of credit to the
securities industry. The Company seeks to expand and diversify its funding mix
as well as its creditor sources. Concentration levels for these sources,
particularly for short-term lenders, are closely monitored both in terms of
single investor limits and daily maturities.
The Company monitors liquidity by tracking asset levels, collateral and
funding availability to maintain flexibility to meet its financial commitments.
As a policy, the Company attempts to maintain sufficient capital and funding
sources in order to have the capacity to finance itself on a fully
collateralized basis in the event that the Company's access to uncollateralized
financing is temporarily impaired. The Company's liquidity management process
includes a contingency
21
<PAGE> 25
funding plan designed to ensure adequate liquidity even if access to unsecured
funding sources is severely restricted or unavailable. This plan is reviewed
periodically to keep the funding options current and in line with market
conditions. The management of this plan includes an analysis used to determine
the Company's ability to withstand varying levels of stress, which could impact
its liquidation horizons and required margins. In addition, the Company monitors
its leverage and capital ratios on a daily basis.
Other
High Yield Portfolio
The Company's activities include trading securities that are less than
investment grade, characterized as "high yield." High yield securities include
corporate debt, convertible debt, preferred and convertible preferred equity
securities rated lower than "triple B-" by internationally recognized rating
agencies, unrated securities with market yields comparable to entities rated
below "triple B-," as well as sovereign debt issued by certain countries in
currencies other than their local currencies and which are not collateralized by
U.S. government securities. For example, high yield securities exclude the
collateralized portion of the Company's holdings of "Brady Bonds," but include
such securities to the extent they are not collateralized. The Company's trading
portfolio of high yield securities owned is carried at market or fair value and
totaled $4.8 billion and $6.8 billion at December 31, 1998 and 1997,
respectively; the largest high yield exposure to one counterparty was $716
million and $785 million at December 31, 1998 and 1997, respectively.
Other
At December 31, 1998, the Company had mark-to-market exposure to hedge
funds of $1,853 million, collateralized by $1,859 million of cash and government
securities, resulting in excess collateral of $6 million. Within these amounts,
certain hedge funds have collateral in excess of the mark-to-market deficit, and
others have deficits in excess of the collateral held. The total exposure to
hedge funds with mark-to-market deficits in excess of collateral held is $36
million. No single hedge fund had a mark-to-market deficit of more than $14
million in excess of collateral held from that hedge fund. Mark-to-market
exposure includes those hedge funds that owe the Company on foreign exchange and
derivative contracts such as swaps, swap options, and other over-the-counter
options and only the uncollateralized portion of receivables on reverse
repurchase and repurchase agreements. This exposure can change significantly as
a result of extreme market movements. The Company has no unsecured loans or loan
commitments to hedge funds. During 1998, the Company made an investment of $300
million in Long-Term Capital Management, LP, a hedge fund, in concert with a
consortium of banks and securities firms.
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DERIVATIVE INSTRUMENTS
Derivatives are an integral element of the world's financial and commodity
markets. Globalization of economic activity has brought more market participants
in contact with foreign exchange and interest rate risk at a time when market
volatility has increased. The Company has developed many techniques using
derivatives to enhance the efficiency of capital and trading risk management.
DERIVATIVE INSTRUMENTS -- OVERVIEW
Derivative instruments are contractual commitments or payment exchange
agreements between counterparties that "derive" their value from some underlying
asset, index, interest rate or exchange rate. The markets for these instruments
have grown tremendously over the past decade. A vast increase in the types of
derivative users and their motivations in using these products has resulted in
an expansion of geographic coverage, transaction volume and liquidity, and the
number of underlying products and instruments.
Derivatives have been used quite successfully by multinational corporations
to hedge foreign currency exposure, by financial institutions to manage gaps in
maturities between assets and liabilities, by investment companies to reduce
transaction costs and take positions in foreign markets without assuming
currency risk, and by non-financial companies to fix the prices of inputs into
the manufacturing process or prices of the products they sell. Derivatives are
also used by investors when, considering such factors as taxes, regulations,
capital, and liquidity, they provide the most efficient means of taking a
desired market position. These are just a few of the business objectives for
which derivatives are used. The list of objectives is large and continues to
grow.
Derivatives are accounted for and settled differently than cash instruments
and their use requires special management oversight. Such oversight should
ensure that management understands the transactions to which it commits the
firms and that the transactions are executed in accordance with sensible
corporate risk policies and procedures.
Derivatives activities, like the Company's other ongoing business
activities, give rise to market, credit, and operational risks. Market risk
represents the risk of loss from adverse market price movements. While market
risk relating to derivatives is clearly an important consideration for
intermediaries such as the Company, such risk represents only a component of the
Company's overall market risk, which arises from activities in non-derivative
instruments as well. Consequently, the scope of the Company's market risk
management procedures extends beyond derivatives to include all financial
instruments and commodities. Credit risk is the loss that the Company would
incur if counterparties failed to perform pursuant to their contractual
obligations. While credit risk is not a principal consideration with respect to
exchange-traded instruments, it is a major factor with respect to
non-exchange-traded OTC instruments. Whenever possible, the Company uses
industry master netting agreements to reduce aggregate credit exposure. Swap and
foreign exchange agreements are documented utilizing counterparty
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master netting agreements supplemented by trade confirmations. Over the past
several years, the Company has enhanced the funding and risk management of its
derivatives activities through the increased use of bilateral security
agreements. The Company, in particular, has been an industry leader in promoting
the use of this risk reduction technique. Based on notional amounts, at both
December 31, 1998 and 1997 approximately 90% of the Company's swap portfolio was
subject to the bilateral exchange of collateral. This initiative, combined with
the success of Salomon Swapco Inc, the Company's triple-A rated derivatives
subsidiary, has greatly strengthened the liquidity profile of the Company's
derivative trading activities. See "Risk Management" for discussions of the
Company's management of market, credit, and operational risks.
NATURE AND TERMS OF DERIVATIVE INSTRUMENTS
The Company and its subsidiaries enter into various bilateral financial
contracts involving future settlement, which are based upon a predetermined
principal or par value (referred to as the "notional" amount). Such instruments
include swaps, swap options, caps and floors, futures contracts, forward
purchase and sale agreements, option contracts and warrants. Transactions are
conducted either through organized exchanges or OTC. For a discussion of the
nature and terms of these instruments see Note 17 to the consolidated financial
statements.
THE COMPANY'S USE OF DERIVATIVE INSTRUMENTS
The Company's use of derivatives can be broadly classified between trading
and non-trading activities. The vast majority of the Company's derivatives use
is in its trading activities, which include market-making activities for
customers and the execution of trading strategies for its own account
("proprietary trading"). The Company's derivative counterparties consist
primarily of other major derivative dealers, financial institutions, insurance
companies, pension funds and investment companies, and other corporations. The
scope of permitted derivatives activities both for trading and non-trading
purposes for each of the Company's businesses is defined by senior management.
Trading Activities
A fundamental activity of the Company is to provide market liquidity to its
customers across a broad range of financial instruments, including derivatives.
The Company also seeks to generate returns by executing proprietary trading
strategies. By their very nature, proprietary trading activities represent the
assumption of risk. However, trading positions are constructed in a manner that
seeks to define and limit risk taking only to those risks that the Company
intends to assume. The most significant derivatives-related activity conducted
by the Company is in fixed-income derivatives, which includes interest rate
swaps, financial futures, swap options, and caps and floors. Other derivative
transactions, such as currency swaps, forwards and options as well as
derivatives linked to equities, are also regularly executed by the Company. The
Company generally earns a spread from market-making transactions involving
derivatives, as it generally does from its market-making activities for
non-derivative transactions. The Company also utilizes derivatives to manage the
market risk inherent in the securities inventories and derivative portfolios it
maintains for market-making purposes as well as its "book" of swap agreements
and
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related transactions with customers. The Company conducts its commodities
dealer activities in organized futures exchanges as well as in OTC forward
markets. The Company executes transactions involving commodities options,
forwards and swaps, much in the same manner as it does in the financial markets.
Non-Trading Activities
The Company also makes use of financial derivatives for non-trading, or end
user, purposes. As an end user, these instruments provide the Company with added
flexibility in the management of its capital and funding costs. Interest rate
swaps are utilized to effectively convert the majority of the Company's
fixed-rate term debt and a portion of its short-term borrowings to variable-rate
obligations. Cross-currency swaps and forward currency contracts are utilized to
effectively convert a portion of its non-U.S. dollar denominated term debt to
U.S. dollar denominated obligations and to minimize the variability in equity
otherwise attributable to exchange rate movements.
For additional derivatives-related disclosures contained in the
consolidated financial statements see the following:
- Note 4 -- Summary of Significant Accounting Policies
- Note 5 -- Principal Transaction Revenues
- Note 9 -- Term Debt
- Note 17 -- Financial Instruments, Commodities and Contractual Commitments
and Related Risks
- Note 18 -- Fair Value Information
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<PAGE> 29
RISK MANAGEMENT
Effective management of the risks inherent in the Company's businesses is
critical. The following section discusses certain of the risks inherent in the
Company's businesses, procedures in place to manage such risks, and initiatives
underway to continue to enhance the Company's management of risk.
MARKET RISK
Market risk represents the potential loss the Company may incur as a result
of absolute and relative price movements in financial instruments, commodities
and contractual commitments due to price volatility, changes in yield curves,
currency fluctuations and changes in market liquidity. The Company manages
aggregate market risk across both on- and off-balance sheet products and,
therefore, separate discussion of market risk for individual products, including
derivatives, is not meaningful. The distinguishing risks relative to derivatives
are credit risk and funding (liquidity) risk, which is roughly equivalent to the
risk of margin calls. Each type of risk can be increased or decreased by market
movements. See "Risk Management -- Credit Risk -- Credit Exposure from
Derivative Activities."
Within the Company's trading businesses, sound management of market risk
has always been a critical consideration. The sections that follow discuss
organizational elements of market risk management, as well as specific risk
management tools and techniques. The Company has sought to institutionalize
these elements across all its businesses. Efforts to further strengthen the
Company's management of market risk are ongoing and the enhancement of risk
management systems and reporting, including the development and utilization of
quantitative tools, is of major importance.
The Company's Risk Management Control Framework
The Company's risk management control framework is based upon the ongoing
participation of senior management, business unit managers and the coordinated
efforts of various support units throughout the firm.
The Company's risk management efforts include the establishment of
appropriate market and credit risk controls, policies and procedures;
appropriate senior management risk oversight with thorough risk analysis and
reporting; and independent risk management with capabilities to evaluate and
monitor risk limits.
Valuation and Control of Trading Positions
With regard to the Company's trading positions (financial instruments,
commodities and contractual commitments), the Chairman and Chief Executive
Officer determines the appropriate
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<PAGE> 30
risk profile of the Company with assistance from the Risk Management Committee.
This committee is comprised of the Chief Executive Officer, senior business
managers, the Chief Financial Officer, the Chief Risk Officer and the Global
Risk Manager and reviews and recommends appropriate levels of risk, reviews risk
capital allocations, balance sheet and regulatory capital usage by business
units and recommends overall risk policies and controls. Lastly, an independent
Global Risk Management Group provides technical and quantitative analysis of the
market risk associated with trading positions to the Chairman and Chief
Executive Officer and members of the Risk Management Committee on a frequent
basis.
Trading positions are necessary for an active market maker, but can be a
major source of liquidity risk. Monitoring the Company's trading inventory
levels and composition and oversight for pricing is the responsibility of the
Global Risk Management Group and various support units, which monitor trading
positions on a position by position level, and employ specific risk models to
track inventory exposure in credit markets, emerging markets and the mortgage
market. The Company also provides for liquidity risk by imposing markdowns as
the age of the inventory increases. Inventory event risk, both for issuer credit
and emerging markets, is analyzed with the involvement of senior traders,
economists and credit department personnel. Market scenarios for the major
emerging markets are maintained and updated to reflect the event risk for the
emerging market positions. In addition, the Company, as a dealer of securities
in the global capital markets, has risk to issuers of fixed income securities
for the timely payment of principal and interest. Principal risk is reviewed by
the Global Risk Management Group, which identifies and reports major risks
undertaken by the trading businesses. The Credit Department (the "Department")
combines principal risk positions with credit risks resulting from market and
delivery risk to review aggregate exposures by counterparty, industry and
country.
Risk Limits
The Company's trading businesses have implemented business unit limits on
exposure to risk factors. These limits, which are intended to enforce the
discipline of communicating and gaining approval for higher risk positions, are
periodically reviewed by the Global Risk Management Group. Business units may
not exceed risk limits without the approval of the appropriate member of the
Risk Management Committee.
Tools for Risk Management and Reporting
The Company's market risk measurement begins with the identification of
relevant market risk factors. These core risk factors vary from market to
market, and region to region. Risk factors are used in three types of analysis:
stress analysis, scenario analysis and value-at-risk analysis.
Stress Analysis
The Company performs stress analysis by repricing inventory positions for
specified upward and downward moves in risk factors, and computing the revenue
implications of these repricings. Stress analysis is a useful tool for
identifying exposures that appear to be relatively small in the current
environment but grow more than proportionately with changes in risk factors.
Such risk is typical of a number of derivative instruments, including options
sold, many mortgage derivatives and a number of structured products. Stress
analysis provides for the
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<PAGE> 31
measurement of the potential impact of extremely large moves in risk factors,
which, though infrequent, can be expected to occur from time to time.
Scenario Analysis
Scenario analysis is a tool that generates forward-looking "what-if"
simulations for specified changes in market factors. For example, the scenario
analysis simulates the impact of significant changes in domestic and foreign
interest rates. The revenue implications of the specified scenario are
quantified on a business unit and geographic basis.
Value at Risk
Value at risk ("VAR") is a statistical tool for measuring the variability
of trading revenue. The VAR reported reflects a potential range of revenue loss,
over a one-day period, at the "99% confidence level." This level implies that on
99 trading days out of 100, the mark-to-market of the portfolio will likely
result in either (1) an increase in revenue, or (2) a decrease from average
revenue that is less than the VAR estimate; and that on 1 trading day out of
100, the mark-to-market of the portfolio will likely result in a decrease from
average revenue that will likely exceed the VAR estimate.
Value at risk is calculated by performing simulation analysis of the
volatilities and correlations of key underlying market risk factors (e.g.,
interest rates, interest rate spreads, equity prices, foreign exchange rates,
commodity prices, option volatilities) to estimate the range of possible changes
in the market value of the Company's market risk sensitive financial
instruments.
Measuring market risk using statistical risk management models has recently
become the main focus of risk management efforts by many companies whose
earnings are exposed to changes in the fair value of financial instruments.
Management believes that statistical models alone do not provide a reliable
method of monitoring and controlling risk. While VAR models are relatively
sophisticated, they are of limited value for internal risk management in that
they do not capture all of the risks inherent in all positions nor do they give
an indication of which individual exposures could potentially represent large
exposures to the Company.
The following table summarizes the Company's VAR at the 99% confidence
level as of December 31, 1998 and 1997 along with the 1998 average, and the high
and low (based on quarter-end VARs). The VAR relating to non-trading financial
instruments has been excluded from this analysis.
<TABLE>
<CAPTION>
RISK EXPOSURES DECEMBER 31, DECEMBER 31,
($ IN MILLIONS) 1998 1998 AVERAGE 1998 HIGH 1998 LOW 1997*
- --------------- ------------ ------------ --------- -------- ------------
<S> <C> <C> <C> <C> <C>
Interest rate........................... $ 75 $67 $75 $62 $ 57
Equities................................ 15 9 15 5 11
Commodities............................. 11 11 12 9 11
Currency................................ 3 17 26 3 12
Diversification Benefit................. (33) N/A N/A N/A (30)
---- --- --- --- ----
Total................................... $ 71 $70 $73 $66 $ 61
---- --- --- --- ----
</TABLE>
- ---------------
* In 1998, the Company adopted the use of the 99% confidence level rather than
the previously used 95% confidence level, primarily for consistency with
capital guidelines issued by the Federal Reserve Board and other U.S. banking
regulators.
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The quantification of market risk using VAR analysis requires a number of
key assumptions. In calculating VAR at December 31, 1998, the Company used a 99%
confidence interval based upon a normal distribution assumption, over a one-day
period. The standard deviations and correlation assumptions are based upon the
six months of historical data from June 4 through December 4, 1998. In
calculating these standard deviations and correlations, the Company determined
that using six months of data, rather than 12 months or more, more accurately
and conservatively reflected the current volatile market environment. With the
inception of the European Monetary Union ("EMU"), the Company determined that
the correlations within the foreign exchange and swap markets of the European
countries participating in the EMU should be set to 1.0 rather than based upon
historical information. This has been done to better reflect the prospective VAR
to the Company given the positions at December 31, 1998 and the inception of the
EMU. Over 200 risk factors are used in the VAR simulations. VAR reflects the
risk profile of the Company at December 31, 1998 and is not a predictor of
future results.
The following describes the components of market risk:
Interest Rate Risk
Interest rate risk arises from the possibility that changes in interest
rates will affect the value of financial instruments. In connection with the
Company's dealer and proprietary trading activities, including market-making in
OTC derivative contracts, the Company is exposed to interest rate risk, arising
from changes in the level or volatility of interest rates, mortgage prepayment
speeds or the shape and slope of the yield curve. The Company's corporate bond
activities expose it to the risk of loss related to changes in credit spreads.
When appropriate, the Company attempts to hedge its exposure to interest rate
risk by entering into transactions such as interest rate swaps, options, U.S.
and non-U.S. government securities and futures and forwards contracts designed
to mitigate such exposure.
Equity Price Risk
The Company is exposed to equity price risk as a consequence of making
markets in equity securities and equity derivatives. Equity price risk results
from changes in the level or volatility of equity prices, which affect the value
of equity securities, or instruments that derive their value from a particular
stock, a basket of stock or a stock index. The Company attempts to reduce the
risk of loss inherent in its inventory in equity securities by entering into
hedging transactions, including equity options and futures, designed to mitigate
the Company's market risk profile.
Commodity Price Risk
Commodity price risk results from the possibility that the price of the
underlying commodity may rise or fall. Commodity contracts principally relate to
energy and precious metals.
Currency Risk
Currency risk arises from the possibility that changes in foreign exchange
rates will impact the value of financial instruments. When the Company buys or
sells a foreign currency or financial instrument denominated in a currency other
than the U.S. dollar, exposure exists from a net open currency position. Until
the position is covered by selling or buying an equivalent amount of the
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<PAGE> 33
same currency or by entering into a financing arrangement denominated in the
same currency, the Company is exposed to a risk that the exchange rate may move
against it.
CREDIT RISK
Credit risk represents the loss the Company could incur if an issuer or
counterparty is unable or unwilling to perform on its commitments, including the
timely payment of principal and interest or settlement of swap and foreign
exchange transactions, repurchase agreements, securities purchases and sales,
and other contractual obligations. The Company's credit risk management process
considers the many factors that influence the probability of a potential loss,
including, but not limited to, the issuer's or counterparty's financial profile,
its business prospects and reputation, the specific terms and duration of the
transactions, the exposure of the transactions to market risk, macroeconomic
developments and sovereign risk.
Origin of Credit Risk
In the normal course of its operations, the Company and its subsidiaries
enter into various transactions that give rise to credit risk. Credit risk is
generally attributable to one or more of the following risks: market, delivery
and default of principal. Market and delivery risks create credit risk with
respect to transactions with counterparties. Default of principal risk is the
risk of nonpayment of the principal and interest of a security.
The components of market risk such as absolute and relative price
movements, price volatility, changes in yield curves, currency fluctuations, and
changes in market liquidity, result in credit risk when a counterparty's
obligation to the Company exceeds the obligation of the Company to the
counterparty. Delivery risk arises from the requirement, in certain
circumstances, to release cash or securities before receiving payment. For both
market and delivery risk, the Department sets credit limits or requires specific
approvals that anticipate the potential exposure of transactions.
Credit Risk Management at Salomon Smith Barney Holdings Inc.
The Chief Credit Officer, who is independent of any revenue-generating
function, manages the Department, whose professionals assess, approve, monitor,
and coordinate the extension of credit on a global basis. In considering such
risk, the Department evaluates the risk/return trade-offs as well as current and
potential credit exposures to a counterparty or to groups of counterparties that
are related because of industry, geographic, or economic characteristics. The
Department also has established various credit policies and control procedures
used singularly or in combination, depending upon the circumstances.
Credit Risk Management of Commodities-Related Transactions
Phibro's credit department determines the credit limits for counterparties
in its commodities-related activities. Exposure reports, which contain detailed
information about cash flows with customers, goods in transit and forward
mark-to-market positions, are reviewed daily.
Credit Exposure from Derivatives Activities
The Company's credit exposure for swap agreements, swap options, caps and
floors and foreign exchange contracts and options at December 31, 1998, as
represented by amounts reported on the
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Company's consolidated balance sheet, are primarily with investment grade
counterparties. These amounts do not present potential credit exposure that may
result from factors that influence market risk or from the passage of time.
Severe changes in market factors may cause credit exposure to increase suddenly
and dramatically. Swap agreements, swap options, caps and floors include
transactions with both short- and long-term periods of commitment. See Note 17
to the consolidated financial statements for further discussion of credit
exposure from derivative activities.
With respect to sovereign risk related to derivatives, credit exposure at
December 31, 1998 was primarily to counterparties in the U.S. ($2.8 billion),
Germany ($1.1 billion), Italy ($.5 billion), Spain ($.4 billion), Japan ($.3
billion) and France ($.3 billion).
OPERATIONAL RISK
As a major intermediary in financial and commodities markets, the Company
is directly exposed to market risk and credit risk, which arise in the normal
course of its business activities. Slightly less direct, but of critical
importance, are risks pertaining to operational and back office support. This is
particularly the case in a rapidly changing and increasingly global environment
with increasing transaction volumes and an expansion in the number and
complexity of products in the marketplace.
Such risks include:
- Operational/Settlement Risk -- the risk of financial and opportunity loss
and legal liability attributable to operational problems, such as
inaccurate pricing of transactions, untimely trade execution, clearance
and/or settlement, or the inability to process large volumes of
transactions. The Company is subject to increased risks with respect to
its trading activities in emerging market securities, where clearance,
settlement, and custodial risks are often greater than in more
established markets.
- Technological Risk -- the risk of loss attributable to technological
limitations or hardware failure that constrain the Company's ability to
gather, process, and communicate information efficiently and securely,
without interruption, with customers, among units within the Company, and
in the markets where the Company participates.
- Legal/Documentation Risk -- the risk of loss attributable to deficiencies
in the documentation of transactions (such as trade confirmations) and
customer relationships (such as master netting agreements) or errors that
result in noncompliance with applicable legal and regulatory
requirements.
- Financial Control Risk -- the risk of loss attributable to limitations in
financial systems and controls. Strong financial systems and controls
ensure that assets are safeguarded, that transactions are executed in
accordance with management's authorization, and that financial
information utilized by management and communicated to external
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parties, including the Company's stockholder, creditors, and regulators,
is free of material errors.
YEAR 2000
Many computer applications have been written using two digits rather than
four to define the applicable year, and therefore may not recognize a date using
"00" as the Year 2000. This could result in the inability of the application to
properly process transactions with the dates in the Year 2000 or thereafter. To
ensure the Company's computer systems will correctly handle the date change, a
firm-wide initiative was established to identify and resolve all problems. The
Year 2000 Readiness Program (the "Project") was approved by the Board of
Directors of the Company's sole stockholder and commenced early in 1996. The
total cost of the Project is expected to be approximately $130 million to $150
million. Through 1998 the Company has expended approximately $100 million on the
Project. The majority of the remaining costs are expected to be directed to
testing activities. These costs have been and will continue to be funded through
operating cash flow and are expensed in the period in which they are incurred.
The Project is comprised of five phases: 1) inventory, 2) assessment, 3)
corrections where necessary, 4) testing and certification, and 5) deployment of
Year 2000 compliant components to all locations worldwide. The Project began
with a comprehensive inventory of hardware, vendor products, software developed
in-house, market data feeds, and physical facilities around the world. The
inventory also included electronic data exchanges with industry participants
such as the New York Stock Exchange, the National Association of Securities
Dealers, the Securities Industry Automation Company, the National Securities
Clearing Corporation, The Depository Trust Company and other counterparties. To
eliminate any processing errors associated with the millennium date change and
other associated dates such as 9/9/99 and the leap year in the Year 2000,
elements of the inventory were assessed to determine necessary changes and
upgrades or replacement of vendor products. The inventory and assessment phases
of the project were completed in the third quarter of 1997.
At this time, the correction phase of the project is nearing completion.
Specifically, corrections have been made to 93% of systems developed in-house,
and 63% of vendor products in use by the firm have been upgraded.
Testing and certification is the most complex part of the Project. The
Company began testing in October 1997. Special mainframe and distributed system
test environments were constructed in which dates can be advanced to create a
variety of conditions that will be encountered as the millennium date change
occurs. Applications are put through a rigorous series of tests at the unit,
integration and enterprise levels, with sign-off by the relevant business areas
at each level, before they are certified as Year 2000 compliant. Approximately
68% of the in-house applications are now certified. In addition to rigorous
testing of each component, an enterprise level front-to-back test is being
planned to test multiple systems working together to support business processes.
The Project remains on schedule. Correction work is expected to be
substantially completed by March 31, 1999; internal and external testing,
application certification and global deployment is expected to be completed by
June 30, 1999.
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The Company fully supports initiatives by the Securities Industry
Association and other industry groups in conducting tests among industry
participants, including the completed industry Beta Test, the government
securities clearing test with the Federal Reserve Bank of New York and The
Depository Trust Company, and the Futures Industry Association test. The Company
has achieved successful results in each of these industry-wide tests in which it
participated. The Company is participating in the Streetwide Test which
commenced in March 1999, and expects to continue its testing program during 1999
with counterparties and selected clients.
There are many risks associated with the Year 2000 issue. Even if the
Company successfully remediates its Year 2000 issues, it can be materially and
adversely affected by failures of third parties to remediate their own Year 2000
issues. The failure of third parties with which the Company has financial or
operational relationships such as vendors, clients, or regulators to resolve
their own Year 2000 compliance issues in a timely manner could result in
material financial risk to the Company. Consequently, comprehensive, written
contingency plans are being prepared so that alternative procedures and a
framework for critical decisions are defined before any crisis occurs.
Contingency plans are nearing completion. These plans define alternate processes
to be used in the event of extended system outage. The plans cover each business
area and location around the world. Contingency plans will be validated in the
first half of 1999.
The Company's expectation about future costs and the timely completion of
its Year 2000 modifications are subject to uncertainties that could cause actual
results to differ materially from what has been discussed above. The Project
will remain one of the Company's top priorities until these issues are resolved.
EUROPEAN ECONOMIC AND MONETARY UNION
European Economic and Monetary Union ("EMU") is an historic event in Europe
involving the unification of currency in eleven major countries. The new unified
currency, called the Euro, is expected to compete on a global scale with the
U.S. Dollar and the Japanese Yen.
Introduction of the Euro began on January 1, 1999, when the European
Central Bank assumed control of the monetary policy for participating nations.
Exchange rates between the participating countries were fixed and the Euro is
available for electronic payments. Also on January 1, 1999, various issuers
re-denominated their securities and harmonized bond payment conventions. A
three-year transition period began on January 1, 1999, after which Euro notes
and coins will be issued by the European Central Bank and national currencies
will be phased out.
The Company completed a successful conversion to the Euro and has commenced
trading and settlement in the new currency with no major exceptions.
As the preceding risks are largely interrelated, so are the Company's
actions to mitigate and manage them. The Company's Chief Administrative Officer
is responsible for, among other things, oversight of global operations and
technology. An essential element in mitigating the risks noted above is the
optimization of information technology and the ability to manage and
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implement change. To be an effective competitor in an information-driven
business of a global nature requires the development of global systems and
databases that ensure increased and more timely access to reliable data.
ENVIRONMENTAL RISK
The Company is subject to environmental risk from two primary sources:
discontinued commodities processing and oil refining operations, and existing
energy-related transportation activities.
The Company is subject to uncertain remedial liability as a result of
commodities-related industrial operations, which were discontinued in or prior
to 1984. Such liability arises under the Comprehensive Environmental Response,
Compensation and Liability Act of 1980, as amended ("CERCLA" or "Superfund"),
which provides that potentially responsible parties ("PRPs"), including waste
generators and past and present site owners and operators, may be held jointly
and severally liable for the entire cost of site clean-up. The Company may also
be subject to liability under state or other U.S. environmental laws.
The process of remediating hazardous waste sites under CERCLA is normally
lengthy and involves a series of events including initial site identification,
environmental site studies and evaluations, issuance of the "Preliminary
Identification of Remedial Alternatives," completion of the "Remedial
Investigation and Feasibility Study," selection of an appropriate site remedy
and its related cost estimate known as the "Record of Decision," performance of
site remediation and post-remediation site monitoring. Factors that influence
the cost and time of completion include the remediation method selected; the
number of financially solvent PRPs responsible for payment; whether PRPs were
owners, operators or generators; determination of cost allocation among PRPs,
and the ongoing development of more efficient and effective remediation
technologies. The process may take ten years or more from site identification to
completion and may be further complicated by protracted legal proceedings
involving numerous PRPs.
The ultimate share of remediation costs that will be borne by the Company
and its subsidiaries cannot be predicted with accuracy. Although certain
exposures may be covered by insurance contracts or indemnification agreements
from other parties, the Company has incurred and will continue to incur costs
related to remediation at certain sites already identified. Further, it is
possible that the Company will be named as a PRP at additional sites. Management
believes, based upon currently known facts and established reserves, that the
ultimate disposition of these matters will not have a material adverse effect on
the Company's financial condition.
Phibro has potential environmental exposure in connection with activities
in which cargoes of products are transported and stored. Phibro mitigates this
exposure through insurance coverage and consideration of ports of delivery and
storage terminals.
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FORWARD LOOKING STATEMENTS
Certain of the statements contained herein that are not historical facts
are forward-looking statements within the meaning of the Private Securities
Litigation Reform Act. The Company's actual results may differ materially from
those included in the forward-looking statements. Forward-looking statements are
typically identified by the words "believe," "expect," "anticipate," "intend,"
"estimate," and similar expressions. These forward-looking statements involve
risks and uncertainties including, but not limited to, the following: changes in
general economic conditions, including the performance of global financial
markets, and risks associated with fluctuating currency values and interest
rates; competitive, regulatory or tax changes that affect the cost of or demand
for the Company's products; the resolution of legal proceedings and
environmental matters; the ability of the Company and third party vendors to
modify computer systems for the year 2000 date conversion in a timely manner;
and the ability of the Company generally to achieve anticipated levels of
operational efficiencies related to recent mergers and acquisitions, as well as
achieving its other cost-savings initiatives. Readers are also directed to other
risks and uncertainties discussed in documents filed by the Company with the
Securities and Exchange Commission.
ITEM 7a. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK.
See Item 7, "Management's Discussion and Analysis of Financial Condition
and Results of Operations" above.
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA.
See Index to Consolidated Financial Statements and Schedules on page F-1
hereof. There is also incorporated by reference herein in response to this Item
the Company's Consolidated Financial Statements and the notes thereto and the
material under the caption "Quarterly Financial Data (Unaudited)" set forth in
the Consolidated Financial Statements, and the Independent Accountants' Report
filed as Exhibit 99.01 herewith.
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE.
None.
35
<PAGE> 39
PART III
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT.
Pursuant to General Instruction I of Form 10-K, the information required by
Item 10 is omitted.
ITEM 11. EXECUTIVE COMPENSATION.
Pursuant to General Instruction I of Form 10-K, the information required by
Item 11 is omitted.
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT.
Pursuant to General Instruction I of Form 10-K, the information required by
Item 12 is omitted.
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS.
Pursuant to General Instruction I of Form 10-K, the information required by
Item 13 is omitted.
PART IV
ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K.
(a) Documents filed as a part of the report:
(1) Financial Statements. See Index to Consolidated Financial
Statements and Schedules on page F-1 hereof.
(2) Financial Statement Schedules. See Index to Consolidated Financial
Statements and Schedules on page F-1 hereof.
(3) Exhibits:
See Exhibit Index.
36
<PAGE> 40
(b) Reports on Form 8-K:
On October 14, 1998, the Company filed a Current Report on Form 8-K,
dated October 8, 1998, reporting under Item 5 thereof the consummation
of the Travelers/Citicorp merger and certain results of the Company's
operations for the quarter ended September 30, 1998 and certain other
selected financial data.
On October 23, 1998, the Company filed a Current Report on Form 8-K,
dated October 21, 1998, reporting under Item 5 thereof the results of
the Company's operations for the quarter ended September 30, 1998, and
certain other selected financial data.
On October 29, 1998, the Company filed a Current Report on Form 8-K,
dated October 27, 1998, filing certain exhibits under Item 7 thereof
relating to the offer and sale of its Principal-Protected Equity Linked
Notes due December 30, 2005.
On November 3, 1998, the Company filed a Current Report on Form 8-K,
dated November 1, 1998, reporting under Item 5 thereof certain
information regarding the integration of its corporate business with
the corporate business of Citicorp and related executive matters.
No other reports on Form 8-K were filed during the fourth quarter of
1998; however, on January 25, 1999, the Company filed a Current Report
on Form 8-K, dated January 25, 1999, reporting under Item 5 thereof the
results of its operations for the three and twelve months ended
December 31, 1998 and 1997.
37
<PAGE> 41
EXHIBIT INDEX
<TABLE>
<CAPTION>
EXHIBIT
NUMBER DESCRIPTION OF EXHIBIT
- ------- ----------------------
<C> <S>
3.01 Amended and Restated Certificate of Incorporation of Salomon
Smith Barney Holdings Inc. (the "Company"), effective
December 1, 1997, incorporated by reference to Exhibit 4(a)
to Amendment No. 2 to the Company's Registration Statement
on Form S-3 (No. 333-38931).
3.02 By-Laws of the Company, incorporated by reference to Exhibit
4(b) to Amendment No. 2 to the Company's Registration
Statement on Form S-3 (No. 333-38931).
10.01+ Amended and Restated Lease dated as of March 27, 1998
between State Street Bank and Trust Company of Connecticut,
National Association, as Trustee (Lessor), and Smith Barney
Inc., Salomon Brothers Inc, Travelers Group Inc., Mutual
Management Corp., Smith Barney Capital Services Inc., Smith
Barney Commercial Corp., Smith Barney Futures Management
Inc. and Smith Barney Global Capital Management, Inc., as
tenants in common (Lessee).
10.02 Lease dated November 23, 1988 between 7 World Trade Company
and Salomon Inc, incorporated by reference to Exhibit 10(a)
to the Company's Annual Report on Form 10-K, as amended, for
the fiscal year ended December 31, 1991 (File No. 1-4346).
12.01+ Computation of ratio of earnings to fixed charges.
21.01 Pursuant to General Instruction I of Form 10-K, the list of
subsidiaries of the Company is omitted.
23.01+ Consent of PricewaterhouseCoopers L.L.P.
23.02+ Consent of Arthur Andersen LLP.
27.01+ Financial Data Schedule.
99.01+ Independent Accountants' Report.
</TABLE>
- ---------------
+ Filed herewith.
38
<PAGE> 42
The total amount of securities authorized pursuant to any instrument
defining rights of holders of long-term debt of the Company does not exceed 10%
of the total assets of the Company and its consolidated subsidiaries. The
Company will furnish copies of any such instrument to the SEC upon request.
Copies of any of the exhibits referred to above will be furnished at a cost
of $.25 per page to security holders who make written request therefor to
Salomon Smith Barney Holdings Inc., 388 Greenwich Street, New York, New York
10013, Attention: Corporate Secretary.
39
<PAGE> 43
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities
Exchange Act of 1934, the registrant has duly caused this report to be signed on
its behalf by the undersigned, thereunto duly authorized, on the 16th day of
March, 1999.
SALOMON SMITH BARNEY HOLDINGS INC.
(Registrant)
By: /s/ MICHAEL A. CARPENTER
------------------------------------
Michael A. Carpenter, Chairman and
Chief Executive Officer
Pursuant to the requirements of the Securities Exchange Act of 1934, this
report has been signed by the following persons on behalf of the registrant and
in the capacities indicated on the 16th day of March, 1999.
<TABLE>
<CAPTION>
SIGNATURE TITLE
--------- -----
<C> <S>
/s/ MICHAEL A. CARPENTER Chairman, Chief Executive Officer (Principal
- -------------------------------------------- Executive Officer) and Director
Michael A. Carpenter
/s/ CHARLES W. SCHARF Chief Financial Officer (Principal Financial
- -------------------------------------------- Officer)
Charles W. Scharf
/s/ MICHAEL J. DAY Controller (Principal Accounting Officer)
- --------------------------------------------
Michael J. Day
/s/ DERYCK C. MAUGHAN Director
- --------------------------------------------
Deryck C. Maughan
</TABLE>
40
<PAGE> 44
SALOMON SMITH BARNEY HOLDINGS INC. AND SUBSIDIARIES
INDEX TO CONSOLIDATED FINANCIAL STATEMENTS AND SCHEDULES
<TABLE>
<CAPTION>
PAGE
----
<S> <C>
REPORT OF INDEPENDENT ACCOUNTANTS........................... F-2
CONSOLIDATED FINANCIAL STATEMENTS
Consolidated Statements of Income for the years ended
December 31, 1998, 1997 and 1996....................... F-3
Consolidated Statements of Financial Condition as of
December 31, 1998 and 1997............................. F-4
Consolidated Statements of Changes in Stockholder's Equity
for the years ended December 31, 1998, 1997 and 1996... F-6
Consolidated Statements of Cash Flows for the years ended
December 31, 1998, 1997 and 1996....................... F-7
Notes to Consolidated Financial Statements................ F-8
QUARTERLY FINANCIAL DATA (UNAUDITED)
</TABLE>
F-1
<PAGE> 45
REPORT OF INDEPENDENT ACCOUNTANTS
To the Board of Directors and Stockholder of
Salomon Smith Barney Holdings Inc. and Subsidiaries:
In our opinion, based upon our audits and the report of other auditors, the
accompanying consolidated statements of financial condition and the related
consolidated statements of income, changes in stockholder's equity and cash
flows present fairly, in all material respects, the financial position of
Salomon Smith Barney Holdings Inc. and its Subsidiaries (the "Company") at
December 31, 1998 and December 31, 1997, and the results of their operations and
their cash flows for each of the three years in the period ended December 31,
1998, in conformity with generally accepted accounting principles. These
consolidated financial statements are the responsibility of the Company's
management; our responsibility is to express an opinion on these consolidated
financial statements based on our audits. The consolidated financial statements
as of December 31, 1997 and 1996 give retroactive effect to the merger of
Salomon Inc and Smith Barney Holdings Inc. on November 28, 1997, which has been
accounted for in a manner similar to a pooling of interests as described in Note
1 to the consolidated financial statements. We did not audit the consolidated
financial statements of Salomon Inc and subsidiaries as of December 31, 1996,
and for the year then ended, which statements reflect total revenues, net of
interest expense of $4,367 million for the year ended December 31, 1996, and net
income of $617 million for the year ended December 31, 1996. Those statements
were audited by other auditors whose report thereon has been furnished to us,
and our opinion expressed herein, insofar as it relates to the amounts included
for Salomon Inc and subsidiaries, is based solely on the report of the other
auditor. We conducted our audits of these statements in accordance with
generally accepted auditing standards which require that we plan and perform the
audit to obtain reasonable assurance about whether the consolidated financial
statements are free of material misstatement. An audit includes examining, on a
test basis, evidence supporting the amounts and disclosures in the consolidated
financial statements, assessing the accounting principles used and significant
estimates made by management, and evaluating the overall financial statement
presentation. We believe that our audits and the report of other auditors
provide a reasonable basis for the opinion expressed above.
/s/ PRICEWATERHOUSECOOPERS LLP
New York, New York
January 25, 1999, except for
Note 3 for which the date is February 26, 1999
F-2
<PAGE> 46
SALOMON SMITH BARNEY HOLDINGS INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF INCOME
<TABLE>
<CAPTION>
DOLLARS IN MILLIONS
YEAR ENDED DECEMBER 31, 1998 1997 1996
- ----------------------- ------- ------- -------
<S> <C> <C> <C>
Revenues:
Commissions............................................... $ 3,214 $ 2,967 $ 2,612
Investment banking........................................ 2,320 2,118 2,001
Principal transactions.................................... (113) 2,504 3,027
Asset management and administration fees.................. 2,165 1,715 1,390
Other..................................................... 185 130 150
------- ------- -------
Total noninterest revenues.................................. 7,771 9,434 9,180
------- ------- -------
Interest and dividends.................................... 12,902 12,043 9,663
Interest expense.......................................... 11,466 10,530 8,175
------- ------- -------
Net interest and dividends.................................. 1,436 1,513 1,488
------- ------- -------
Revenues, net of interest expense........................... 9,207 10,947 10,668
------- ------- -------
Noninterest expenses:
Compensation and benefits................................. 5,848 6,037 5,558
Communications............................................ 477 495 486
Occupancy and equipment................................... 429 432 435
Floor brokerage and other production...................... 446 389 302
Advertising and market development........................ 312 276 218
Professional services..................................... 245 210 190
Other operating and administrative expenses............... 408 450 456
Restructuring charge, net................................. (274) 838 7
------- ------- -------
Total noninterest expenses.................................. 7,891 9,127 7,652
------- ------- -------
Gain on sale of subsidiaries and affiliates................. -- -- 48
------- ------- -------
Income from continuing operations before income taxes....... 1,316 1,820 3,064
Provision for income taxes.................................. 498 675 1,199
------- ------- -------
Income from continuing operations........................... 818 1,145 1,865
------- ------- -------
Discontinued operations:
Loss, net of benefit for income taxes of $48.............. -- -- (75)
Loss on sale of Basis Petroleum, net of tax benefit of
$215................................................... -- -- (290)
------- ------- -------
Net income.................................................. $ 818 $ 1,145 $ 1,500
======= ======= =======
</TABLE>
The accompanying notes are an integral part of these consolidated financial
statements.
F-3
<PAGE> 47
SALOMON SMITH BARNEY HOLDINGS INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF FINANCIAL CONDITION
<TABLE>
<CAPTION>
DOLLARS IN MILLIONS
DECEMBER 31, 1998 1997
- ------------------- -------- --------
<S> <C> <C> <C> <C>
Assets:
Cash and cash equivalents............................ $ 2,261 $ 1,808
Cash segregated and on deposit for Federal and other
regulations or deposited with clearing
organizations...................................... 2,358 2,034
Collateralized short-term financing agreements:
Securities purchased under agreements to resell.... $38,691 $75,802
Deposits paid for securities borrowed.............. 49,392 33,857
------- -------
88,083 109,659
Financial instruments and commodities owned and
contractual commitments:
U.S. government and government agency securities... 24,643 52,109
Non-U.S. government and government agency
securities...................................... 18,632 46,502
Contractual commitments............................ 14,319 10,120
Corporate debt securities.......................... 11,347 13,614
Mortgage loans and collateralized mortgage
securities...................................... 6,066 3,103
Money market instruments........................... 5,153 2,625
Equity securities.................................. 4,860 6,420
Commodities........................................ 245 1,274
Other financial instruments........................ 3,372 3,965
------- -------
88,637 139,732
Receivables:
Customers.......................................... 14,130 12,415
Brokers, dealers and clearing organizations........ 4,234 3,212
Receivable for securities provided as collateral... 3,101 --
Other.............................................. 2,709 2,462
------- -------
24,174 18,089
Property, equipment and leasehold improvements, net
of accumulated depreciation and amortization of
$1,032 and $884, respectively...................... 1,114 986
Other assets......................................... 5,274 4,312
-------- --------
Total assets......................................... $211,901 $276,620
======== ========
</TABLE>
The accompanying notes are an integral part of these consolidated financial
statements.
F-4
<PAGE> 48
SALOMON SMITH BARNEY HOLDINGS INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF FINANCIAL CONDITION
<TABLE>
<CAPTION>
DOLLARS IN MILLIONS
DECEMBER 31, 1998 1997
- ------------------- -------- --------
<S> <C> <C> <C> <C>
Liabilities and Stockholder's Equity:
Commercial paper and other short-term
borrowings.................................. $ 15,495 $ 11,464
Collateralized short-term financing agreements:
Securities sold under agreements to
repurchase.................................. $61,024 $113,593
Deposits received for securities loaned........ 7,712 5,978
------- --------
68,736 119,571
Financial instruments and commodities sold, not
yet purchased, and contractual commitments:
U.S. government and government agency
securities.................................. 32,538 33,970
Contractual commitments........................ 15,698 11,688
Non-U.S. government and government agency
securities.................................. 10,719 45,166
Equity securities.............................. 4,224 3,462
Corporate debt securities and other............ 3,103 1,880
------- --------
66,282 96,166
Payables and accrued liabilities:
Customers...................................... 13,119 9,791
Obligation to return securities received as
collateral.................................. 5,348 --
Brokers, dealers and clearing organizations.... 3,406 2,972
Other.......................................... 9,851 8,719
------- --------
31,724 21,482
Term debt........................................ 20,151 19,074
Guaranteed beneficial interests in Company
subordinated debt securities................... 345 345
Company-obligated mandatorily redeemable
securities of subsidiary trust holding solely
junior subordinated debt securities of the
Company........................................ 400 --
Stockholder's equity:
Common stock (par value $.01 per share 1,000
shares authorized; 1,000 shares issued and
outstanding)................................ -- --
Additional paid-in capital..................... 1,589 1,574
Retained earnings.............................. 7,159 6,943
Cumulative translation adjustments............. 20 1
------- --------
Total stockholder's equity....................... 8,768 8,518
-------- --------
Total liabilities and stockholder's equity....... $211,901 $276,620
======== ========
</TABLE>
The accompanying notes are an integral part of these consolidated financial
statements.
F-5
<PAGE> 49
SALOMON SMITH BARNEY HOLDINGS INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDER'S EQUITY
<TABLE>
<CAPTION>
OTHER
NON-OWNER
ADDITIONAL CHANGES IN TOTAL
PREFERRED COMMON PAID-IN RETAINED STOCKHOLDER'S TREASURY STOCKHOLDER'S
DOLLARS IN MILLIONS STOCK STOCK CAPITAL EARNINGS EQUITY STOCK EQUITY
- ------------------- --------- ------ ---------- -------- --------------- -------- -------------
<S> <C> <C> <C> <C> <C> <C> <C>
Balance at December 31, 1995... $ 312 $-- $ 2,255 $5,667 $18 $(1,635) $6,617
Net income..................... 1,500 1,500
Common dividends............... (666) (666)
Preferred dividends*........... (68) (68)
Issuance of preferred stock.... 250 250
Retirement of preferred
stock........................ (112) (112)
Other capital transactions..... 144 (42) 102
Net change in cumulative
translation adjustments...... (8) (8)
----- -- ------- ------ --- ------- ------
Balance at December 31, 1996... 450 -- 2,399 6,433 10 (1,677) 7,615
Net income..................... 1,145 1,145
Common dividends............... (581) (581)
Preferred dividends*........... (54) (54)
Merger-related capital
transactions................. (450) (1,035) 1,764 279
Other capital transactions..... 210 (87) 123
Net change in cumulative
translation adjustments...... (9) (9)
----- -- ------- ------ --- ------- ------
Balance at December 31, 1997... -- -- 1,574 6,943 1 -- 8,518
Net income..................... 818 818
Common dividends............... (602) (602)
Other capital transactions..... 15 15
Net change in cumulative
translation adjustments...... 19 19
----- -- ------- ------ --- ------- ------
Balance at December 31, 1998... $ -- $-- $ 1,589 $7,159 $20 $ -- $8,768
===== == ======= ====== === ======= ======
</TABLE>
- ---------------
* Net of after-tax impact of related interest rate swaps that effectively
convert fixed rate dividend obligations to variable rate obligations.
The accompanying notes are an integral part of these consolidated financial
statements.
F-6
<PAGE> 50
SALOMON SMITH BARNEY HOLDINGS INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
<TABLE>
<CAPTION>
DOLLARS IN MILLIONS
YEAR ENDED DECEMBER 31, 1998 1997 1996
- ----------------------- -------- -------- --------
<S> <C> <C> <C>
Cash flows from operating activities:
Net income adjusted for noncash items and non-operating
activities --
Net income................................................ $ 818 $ 1,145 $ 1,500
Loss on disposal of Basis Petroleum....................... -- -- 290
Deferred income tax benefit............................... (254) (675) (207)
Depreciation and amortization............................. 331 290 353
Gain on Genesis transaction and limited service motels.... -- -- (59)
Gain on the sale of subsidiaries and affiliates........... -- -- (31)
-------- -------- --------
Cash items included in net income......................... 895 760 1,846
-------- -------- --------
(Increase) decrease in operating assets --
Cash segregated and on deposit for Federal and other
regulations or deposited with clearing organizations.... (324) (588) (99)
Collateralized short-term financing agreements............ 21,576 (11,749) (12,959)
Financial instruments and commodities owned and
contractual commitments................................. 51,095 (13,159) (5,443)
Receivables............................................... (6,085) (4,818) (1,539)
Other assets.............................................. (442) 223 (128)
-------- -------- --------
(Increase) decrease in operating assets..................... 65,820 (30,091) (20,168)
-------- -------- --------
Increase (decrease) in operating liabilities --
Collateralized short-term financing agreements............ (50,835) 16,777 (10,123)
Financial instruments and commodities sold, not yet
purchased, and contractual commitments.................. (29,884) 4,025 29,847
Payables and accrued liabilities.......................... 10,473 4,330 (1,166)
-------- -------- --------
Increase (decrease) in operating liabilities................ (70,246) 25,132 18,558
-------- -------- --------
Cash provided by (used in) operating activities............. (3,531) (4,199) 236
-------- -------- --------
Cash flows from financing activities:
Net increase (decrease) in commercial paper and other
short-term borrowings................................... 4,031 1,444 (1,178)
Proceeds from issuance of term debt....................... 5,831 8,059 5,398
Term debt maturities and repurchases...................... (5,093) (4,397) (4,318)
Collateralized mortgage obligations....................... (101) (185) (403)
Dividends paid............................................ (732) (604) (820)
Issuance of mandatorily redeemable securities of
subsidiary trusts....................................... 400 -- 345
Issuance of preferred stock............................... -- -- 250
Redemption of preferred stock............................. -- -- (112)
Other capital transactions................................ -- (95) (45)
-------- -------- --------
Cash provided by (used in) financing activities............. 4,336 4,222 (883)
-------- -------- --------
Cash flows from investing activities:
Genesis transaction and limited service motels............ -- -- 123
Sales (purchases) of subsidiaries and affiliates.......... (129) 365 82
Assets securing collateralized mortgage obligations....... 117 175 480
Property, equipment and leasehold improvements............ (365) (220) (225)
Other..................................................... 25 (142) (159)
-------- -------- --------
Cash provided by (used in) investing activities............. (352) 178 301
-------- -------- --------
Increase (decrease) in cash and cash equivalents............ 453 201 (346)
Cash and cash equivalents at beginning of year.............. 1,808 1,607 1,962
Cash of discontinued operations............................. -- -- (9)
-------- -------- --------
Cash and cash equivalents at end of year.................... $ 2,261 $ 1,808 $ 1,607
======== ======== ========
</TABLE>
Interest paid did not differ materially from the amount of interest expense
recorded for financial statement purposes in 1998, 1997 and 1996.
The accompanying notes are an integral part of these consolidated financial
statements.
F-7
<PAGE> 51
SALOMON SMITH BARNEY HOLDINGS INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE 1. THE MERGER
On November 28, 1997, a newly formed, wholly owned subsidiary of Travelers
Group Inc. ("Travelers") was merged into Salomon Inc ("Salomon"). Pursuant to
the merger agreement, Salomon common stockholders received 1.695 shares of
Travelers Group Inc. common stock for each share of Salomon common stock; each
share of preferred stock of Salomon was exchanged for a share of Travelers
preferred stock having substantially identical terms, except that the Travelers
preferred stock has certain voting rights; and Salomon became a wholly owned
subsidiary of Travelers. Following this merger, Salomon and Smith Barney
Holdings Inc. ("Smith Barney") were merged (the "Merger") to form Salomon Smith
Barney Holdings Inc. (the "Parent Company" and, collectively, with its
subsidiaries the "Company"). The transaction was a tax free exchange.
The 1997 and 1996 consolidated financial statements give retroactive effect
to the Merger as a combination of entities under common control in a transaction
accounted for in a manner similar to a pooling of interests. The pooling of
interests method of accounting requires the restatement of all periods presented
as if Salomon and Smith Barney had always been combined. Certain
reclassifications have been made to conform the accounting policies of Salomon
and Smith Barney.
As a result of the Merger, the Company recorded a pre-tax restructuring
charge of $838 million ($496 million after tax) in the fourth quarter of 1997.
The material components of the restructuring reserve were as follows:
<TABLE>
<CAPTION>
RESTRUCTURING RESERVE
RESTRUCTURING RESERVE AS CHARGES AND CREDITS THROUGH BALANCE AT
DOLLARS IN MILLIONS ORIGINALLY RECORDED DECEMBER 31, 1998 DECEMBER 31, 1998
- ------------------- ------------------------ --------------------------- ---------------------
<S> <C> <C> <C>
Seven World Trade Center
lease......................... $610 $(324)* $286
Other facilities................ 53 (34)** 19
---- ----- ----
Total facilities...... 663 (358) 305
Severance....................... 161 (153)** 8
Other........................... 14 (14)** --
---- ----- ----
$838 $(525) $313***
---- ----- ----
</TABLE>
- ---------------
* In the second quarter of 1998,the Company recorded an adjustment of $324
million ($191 million after tax) to the restructuring reserve relating to
the Seven World Trade Center lease. This reduction in the reserve resulted
from negotiations on a sublease which indicated that excess space would be
disposed of on terms more favorable than had been originally estimated. A
current reassessment of space needs, including the Citicorp merger
(discussed in Note 2 to the consolidated financial statements), could
indicate a need for increased occupancy by the Company of space previously
considered excess, and could result in a further adjustment to reduce the
restructuring reserve.
** In the fourth quarter of 1998, the Company recorded an adjustment of $30
million ($18 million after tax) to the restructuring reserve. The components
of the reduction are as follows: severance $10 million; other facilities $11
million; other $9 million. The reduction in severance reserves was due to a
higher level of attrition than originally anticipated. The reduction in
reserves related to other facilities was mainly due to the abandonment of
space on terms more favorable than originally anticipated. The other reserve
reversal was mainly due to anticipated duplicate contract payments which
were avoided due to favorable negotiations.
*** Consists of $101 million cash component and $212 million non-cash component.
All of the amounts were determined in accordance with the guidelines
included in Emerging Issues Task Force ("EITF") 94-3 and represent costs that
are not associated with future revenues and are either incremental or
contractual with no economic benefit.
F-8
<PAGE> 52
SALOMON SMITH BARNEY HOLDINGS INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
At December 31, 1998, the portion of the cash and non-cash balances of the
restructuring reserve that related to facilities were $93 million and $212
million, respectively. Such costs include lease costs, which represent the
difference between contractual obligations and the estimated fair market rental
obtainable through sublease from the date that such facilities are expected to
be vacated, and other costs incidental to sublease. These contractual lease
payments are estimated to be made over the remaining term and the remaining cash
costs are expected to be paid in 1999.
Non-cash costs of other facilities reflect the write-off of leasehold
improvements, furniture and equipment upon abandonment and represent the
remaining depreciated book value at the estimated dates of abandonment.
Depreciation and amortization of these assets will continue during the period
they are in use. The facilities are located primarily in the United States and
generally support multiple lines of business. The assets have not been
reclassified to a held for sale category since substantially all are subject to
abandonment and will not be realized through sale.
The balance of severance costs are expected to be paid by the first quarter
of 1999. As of December 31, 1998, 1,602 employees were severed, of which 1,474
employees were in the United States. None of the amounts included in the
restructuring charge represent operating losses or income. The cash component of
these restructuring costs will be funded from working capital and will not
require any incremental funding source.
NOTE 2. TRAVELERS MERGER WITH CITICORP
On October 8, 1998, Travelers and Citicorp completed their merger of
equals, pursuant to which Citicorp merged with and into a wholly owned
subsidiary of Travelers. The subsidiary changed its name to Citicorp and
Travelers changed its name to Citigroup Inc. ("Citigroup").
Upon consummation of the merger, Citigroup became a bank holding company
subject to regulation under the U.S. Bank Holding Company Act of 1956 (the
"BHCA"), the requirements of the Glass-Steagall Act and certain other laws and
regulations.
Section 20 of the Glass-Steagall Act prohibits a member bank of the
Federal Reserve System from being affiliated with a company that is principally
engaged in underwriting and dealing in securities. The Federal Reserve Board
has determined by regulation that underwriting and dealing in certain
"eligible" securities is an activity closely related to banking and is
therefore permissible for bank holding companies and their subsidiaries. The
Federal Reserve Board has also determined that a securities firm that does not
generate more than 25% of its gross revenues from underwriting and dealing in
certain, ineligible, securities is not deemed for purposes of the
Glass-Steagall Act to be "principally engaged" in securities underwriting and
dealing. The Company believes that the ineligible revenues of its securities
businesses are below this threshold.
The activities of U.S. bank holding companies are generally limited to the
business of banking, managing or controlling banks and other activities that
the Federal Reserve Board determines to be so closely related to banking or
managing or controlling banks as to be a proper incident thereto. Under the
BHCA in its current form, after two years from the date as of which Citigroup
became a bank holding company, Citigroup will be required to conform any
activities that are not considered to be closely related to banking under the
BHCA. This two-year period may be
F-9
<PAGE> 53
SALOMON SMITH BARNEY HOLDINGS INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
extended by the Federal Reserve Board for three additional one-year periods,
upon application by Citigroup and finding by the Federal Reserve Board that
such an extension would not be detrimental to the public interest.
Nonbank acquisitions in the U.S. are generally limited to 5% of voting
shares unless the Federal Reserve Board determines that the acquisition is so
closely related to banking as to be a proper incident to banking or managing or
controlling banks. Subject to prior specific or general Federal Reserve Board
consent, a bank holding company may generally acquire less than 20% of
the voting securities of a company that does not do business in the United
States, and 20% or more of the voting securities of any such company if
the Federal Reserve Board finds by regulation or order that its activities are
usual in connection with banking or finance outside the United States. In
general, bank holding companies may engage in a broader set of activities
outside of the United States. Outside the United States, for example, bank
holding company subsidiaries may sponsor, distribute, and advise open-end
mutual funds without regard to the 20% revenue limit discussed above. Bank
holding companies may also underwrite and deal in debt, and to a limited
extent, equity securities, subject to local country laws. In addition, a bank
holding company and its bank subsidiaries may, subject to certain requirements
for prior Federal Reserve Board consent or notice, acquire banks and establish
branches subject to local country laws and to United States laws prohibiting
companies from doing business in certain countries.
Various legislation, including proposals to overhaul the bank regulatory
system and expand the powers of bank holding companies and their affiliates, is
from time to time introduced in Congress. Such legislation may change banking
statutes and the operating environment of Citigroup and the Company in
substantial and unpredictable ways. The Company cannot determine whether such
potential legislation will ultimately be enacted, and if enacted, the ultimate
effect that any such potential legislation or implementing regulations would
have upon the financial condition or results of operations of the Company or
its subsidiaries.
The Company does not believe that its compliance with applicable law as a
result of the Citigroup merger will have a material adverse effect on its
ability to continue to operate the businesses in which it is presently engaged.
There is pending federal legislation that would, if enacted, amend the BHCA
and the Glass-Steagall Act to authorize a bank holding company and its
affiliates to conduct certain activities which are currently prohibited. There
is no assurance that such legislation will be enacted. At the expiration of the
BHCA Compliance Period, the Company and Citigroup each will evaluate its
alternatives to comply with whatever laws are then applicable.
As a result of the Citigroup merger, the Company recorded a pre-tax
restructuring charge of $80 million ($47 million after tax) in the fourth
quarter of 1998. The material components of the restructuring reserve were as
follows:
<TABLE>
<CAPTION>
RESTRUCTURING RESERVE
RESTRUCTURING RESERVE AS CHARGES THROUGH BALANCE AT
DOLLARS IN MILLIONS ORIGINALLY RECORDED DECEMBER 31, 1998 DECEMBER 31, 1998
- ------------------- ------------------------ ----------------- ---------------------
<S> <C> <C> <C>
Severance.................... $69 $(10) $59
Facilities................... 9 (2) 7
Other........................ 2 -- 2
--- ---- ---
$80 $(12) $68*
=== ==== ===
</TABLE>
- ---------------
* All cash components
All the amounts were determined in accordance with the guidelines included
in EITF 94-3 and represent costs that are not associated with future revenues
and are either incremental or contractual with no economic benefits.
Facilities costs include lease payments, which represent the difference
between contractual obligations and the estimated fair market rental obtainable
through sublease from the date that such facilities are expected to be vacated,
and other costs incidental to sublease. These contractual lease payments are
estimated to be expended over the remaining term and are expected to be paid in
1999 and 2000. The facilities are located in various foreign locations and
generally support multiple lines of business. The assets have not been
reclassified to a held for sale category since substantially all are subject to
abandonment and will not be realized through sale.
The balance of severance costs, which apply to 1,195 employees (1,062
employees in the United States and 133 employees overseas), are expected to be
paid by the end of 1999. None of the amounts included in the restructuring
charge represent operating losses or income. All components of these
restructuring costs will be funded from working capital and will not require any
incremental funding source.
F-10
<PAGE> 54
SALOMON SMITH BARNEY HOLDINGS INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
NOTE 3. THE NIKKO SECURITIES CO., LTD.
On February 26, 1999, the Company and The Nikko Securities Co., Ltd
("Nikko") formed a joint venture. The joint venture, Nikko Salomon Smith Barney
Limited ("Nikko Salomon Smith Barney"), provides investment banking, sales and
trading and research services for corporate and institutional clients in Japan
and other foreign jurisdictions. Nikko Salomon Smith Barney combined the
Japanese institutional and corporate business of the Company with Nikko's
domestic and international institutional and corporate business. Nikko's retail
business and other activities, including asset management, will remain under
Nikko's management. Nikko Salomon Smith Barney is headquartered in Tokyo and
maintains offices and staff worldwide.
Nikko Salomon Smith Barney is owned 51% by Nikko and 49% by the Company.
NOTE 4. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
Basis of Presentation
The consolidated financial statements are prepared in accordance with
generally accepted accounting principles in the United States, which require the
use of management's best judgment and estimates. Estimates, including the fair
value of financial instruments, commodities and contractual commitments, may
vary from actual results.
The Company provides investment banking, asset management, brokerage,
securities trading, advisory and other financial services to customers, and
engages in proprietary trading activities for its own account.
Material intercompany transactions have been eliminated in consolidation.
Long-term investments in operating joint ventures and affiliated (20% to 50%
owned) companies are carried on the equity method of accounting and are included
in "Other assets." The Company's equity in the earnings of joint ventures and
affiliates is reported in "Other" revenues.
Assets and liabilities denominated in non-U.S. dollar currencies are
translated into U.S. dollar equivalents using year-end spot foreign exchange
rates. Revenues and expenses are translated monthly at amounts that approximate
weighted average exchange rates, with resulting gains and losses included in
income. The effects of translating the statements of financial condition of
non-U.S. subsidiaries with functional currencies other than the U.S. dollar are
recorded, net of related hedge gains and losses and income taxes, as "Cumulative
translation adjustments," a separate component of "Stockholder's equity." Hedges
of such exposure include forward currency contracts and, to a lesser extent,
designated issues of non-U.S. dollar term debt.
As discussed in Note 6 to the consolidated financial statements, Basis
Petroleum, Inc. ("Basis Petroleum") is classified as a discontinued operation in
the Company's consolidated financial statements.
F-11
<PAGE> 55
SALOMON SMITH BARNEY HOLDINGS INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
Certain prior period amounts have been restated to conform to the current
year's presentation.
Cash and Cash Equivalents
The Company defines "Cash and cash equivalents" as highly liquid
investments with original maturities of three months or less at the time of
purchase, other than investments held for sale in the ordinary course of
business.
Collateralized Short-Term Financing Agreements
Securities purchased under agreements to resell ("reverse repurchase
agreements") and securities sold under agreements to repurchase ("repurchase
agreements") are collateralized principally by government and government agency
securities and generally have terms ranging from overnight to up to five years
and are carried at their contractual amounts, including accrued interest as
specified in the respective agreements. In the determination of income, certain
financing transactions are marked to fair value, which has no material effect on
the Company's results of operations.
It is the Company's policy to take possession of the underlying collateral,
monitor its market value relative to the amounts due under the agreements, and,
when necessary, require prompt transfer of additional collateral or reduction in
the loan balance in order to maintain contractual margin protection. In the
event of counterparty default, the financing agreement provides the Company with
the right to liquidate the collateral held. Reverse repurchase and repurchase
agreements are reported net by counterparty, when applicable, pursuant to the
provisions of Financial Accounting Standards Board ("FASB") Interpretation 41,
Offsetting of Amounts Related to Certain Repurchase and Reverse Repurchase
Agreements ("FIN 41"). Excluding the impact of FIN 41, reverse repurchase
agreements totaled $89.2 billion and $114.3 billion at December 31, 1998 and
1997, respectively. At December 31, 1998, and 1997, the market value of
securities collateralizing reverse repurchase agreements was $91.2 billion and
$116.6, respectively.
Deposits paid for securities borrowed ("securities borrowed") and deposits
received for securities loaned ("securities loaned") are recorded at the amount
of cash advanced or received and are collateralized principally by government
and government agency securities, corporate debt and equity securities. The
Company monitors the market value of securities borrowed and securities loaned
daily, and additional collateral is obtained as necessary. Excluding the impact
of FIN 41, securities borrowed totaled $50.2 and $40.5 billion, respectively at
December 31, 1998 and 1997. At December 31, 1998 and 1997, the market value of
securities collateralizing securities borrowed was $49.3 billion and $40.1
billion, respectively.
Financial Instruments, Commodities and Contractual Commitments
Financial instruments, commodities and contractual commitments (also
referred to as "derivative instruments"), including derivatives used for trading
purposes, are recorded at either market value or, when market prices are not
readily available, fair value, which is determined under an alternative
approach, such as matrix or model pricing. Fair value includes related accrued
interest or dividends. The determination of market or fair value considers
various factors, including: closing exchange or over-the-counter market price
quotations; time value and volatility factors underlying options, warrants and
contractual commitments; price activity for equivalent or synthetic instruments
in markets located in different time zones; counterparty credit quality; and the
potential impact on
F-12
<PAGE> 56
SALOMON SMITH BARNEY HOLDINGS INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
market prices or fair value of liquidating the Company's positions in an orderly
manner over a reasonable period of time under current market conditions.
The majority of the Company's financial instruments, commodities and
contractual commitments are recorded on a trade date basis. Recording the
remaining instruments on a trade date basis would not materially affect the
consolidated financial statements. Commissions, underwriting, and principal
transaction revenues and related expenses are recognized in income on a trade
date basis. Customer security transactions are recorded on a settlement date
basis.
Derivative Instruments
Derivatives Used for Trading Purposes
Derivatives used for trading purposes include interest rate, currency and
commodity swap agreements, swap options, caps and floors, options, warrants and
financial and commodity futures and forward contracts. The market values
(unrealized gains and losses) associated with contractual commitments are
reported net by counterparty, provided a legally enforceable master netting
agreement exists, and are netted across products and against cash collateral
when such provisions are stated in the master netting agreement. Contractual
commitments in a net receivable position, as well as options owned and warrants
held, are reported as assets in "Contractual commitments." Similarly,
contractual commitments in a net payable position, as well as options written
and warrants issued, are reported as liabilities in "Contractual commitments."
This category also includes the Company's long-term obligations that have
principal repayments directly linked to equity securities of unaffiliated
issuers for which the Company holds in inventory a note exchangeable for the
same equity securities. Cash collateral received in connection with interest
rate swaps totaled $4,178 million and $340 million at December 31, 1998 and
1997, respectively, and cash collateral paid totaled $4,385 million and $2,507
million, respectively, at these dates. Revenues generated from derivative
instruments used for trading purposes are reported as "Principal transactions"
and include realized gains and losses as well as unrealized gains and losses
resulting from changes in the market or fair value of such instruments.
Margin on futures contracts is included in "Receivables -- Brokers, dealers
and clearing organizations" and "Payables and accrued liabilities -- Brokers,
dealers and clearing organizations."
Derivatives Used for Non-Trading Purposes
Non-trading derivative instruments that are designated as hedges must be
effective at reducing the risk associated with the exposure being hedged and
must be designated as a hedge at the inception of the derivative contract.
Accordingly, changes in the market or fair value of the derivative instrument
must be highly correlated with changes in the market or fair value of the
underlying hedged item. The Company monitors the effectiveness of its hedges by
periodically comparing the change in value of the derivative instrument with the
change in value of the underlying hedged item. Derivatives used as hedges
include interest rate swaps, cross currency swaps and forward currency
contracts.
Interest rate and cross currency swaps are utilized to effectively convert
a portion of the Company's short-term borrowings and the majority of its fixed
rate term debt to variable rate instruments. These swaps are recorded
"off-balance sheet," with
F-13
<PAGE> 57
SALOMON SMITH BARNEY HOLDINGS INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
accrued inflows and outflows reflected as adjustments to interest expense. Upon
early termination of an underlying hedged instrument, the derivative is
accounted for at market or fair value and the impact is recognized currently in
income. Changes in market or fair value of such instruments, or realized gains
or losses resulting from the termination of such instruments, are also
recognized currently in income.
The Company utilizes forward currency contracts to hedge a portion of the
currency exchange rate exposure relating to non-U.S. dollar term debt issued by
the Company. The impact of translating the forward currency contracts and the
related debt to prevailing exchange rates is recognized currently in income. The
Company also utilizes forward currency contracts to hedge certain investments in
subsidiaries with functional currencies other than the U.S. dollar. The impact
of marking open contracts to prevailing exchange rates and the impact of
realized gains or losses on maturing contracts, both net of the related tax
effects, are included in "Cumulative translation adjustments" in "Stockholder's
equity" as is the impact of translating the investments being hedged. Upon the
disposition of an investment in a subsidiary with a functional currency other
than the U.S. dollar, accumulated gains or losses previously included in
"Cumulative translation adjustments" are recognized currently in income.
Derivative instruments that do not meet the criteria to be designated as a
hedge are considered trading derivatives and are recorded at market or fair
value.
See Note 9 to the consolidated financial statements for a further
discussion of the use of interest rate swaps and forward currency contracts for
non-trading purposes.
Property, Equipment and Leasehold Improvements
Property, equipment and leasehold improvements are carried at cost less
accumulated depreciation and amortization. Depreciation and amortization are
recorded substantially on a straight-line basis over the lesser of the estimated
useful lives of the related assets or noncancelable lease terms, as appropriate.
Maintenance and repairs are charged to occupancy expense as incurred.
Intangible Assets
The excess of purchase price over fair value of net assets acquired, which
amounted to $447 million at December 31, 1998, is being amortized over remaining
periods ranging from 20 to 30 years. The Company amortizes other intangible
assets, which are included in "Other assets," on a straight-line basis over
remaining periods ranging from 5 to 15 years.
New Accounting Pronouncements
Effective January 1, 1998, the Company adopted Statement of Financial
Accounting Standards ("SFAS") No. 127, Deferral of the Effective Date of Certain
Provisions of SFAS 125 ("SFAS 127"), which was effective for transfers and
pledges of certain financial assets and collateral made after December 31, 1997.
The adoption of SFAS 127 created additional assets and liabilities on the
Company's consolidated statement of financial condition related to the
recognition of securities provided and received as collateral. At December 31,
1998, the impact of SFAS 127 on the Company's consolidated statement of
financial position was an increase to total assets and liabilities of
approximately $200 million. In addition, as a result of SFAS 127, certain
inventory positions, primarily "Non-U.S. government and government
F-14
<PAGE> 58
SALOMON SMITH BARNEY HOLDINGS INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
agency securities," have been reclassified to receivables or payables.
Effective January 1, 1998, the Company adopted SFAS No. 130, Reporting
Comprehensive Income ("SFAS 130"). SFAS 130 establishes standards for the
reporting and display of comprehensive income and its components in a full set
of general-purpose financial statements. This statement stipulates that
comprehensive income reflect the change in equity of an enterprise during a
period from transactions and other events and circumstances from nonowner
sources. Comprehensive income will thus represent the sum of net income and
other changes in stockholder's equity from nonowner sources. The accumulated
balance of changes in equity from nonowner sources is required to be displayed
separately from retained earnings and additional paid-in-capital in the
statement of financial position. Other than net income, cumulative translation
adjustments is the only change in the Company's equity from nonowner sources.
The Company's comprehensive income, net of tax, is as follows:
<TABLE>
<CAPTION>
DOLLARS IN MILLIONS
YEAR ENDED DECEMBER 31, 1998 1997 1996
- ----------------------- ---- ------ ------
<S> <C> <C> <C>
Net income................................................. $818 $1,145 $1,500
Other changes in equity from non-owner sources............. 19 (9) (8)
---- ------ ------
Total comprehensive income................................. $837 $1,136 $1,492
==== ====== ======
</TABLE>
During the third quarter of 1998, the Company adopted the Accounting
Standards Executive Committee of the American Institute of Certified Public
Accountants' Statement of Position 98-1, Accounting for the Costs of Computer
Software Developed or Obtained for Internal Use ("SOP 98-1"). SOP 98-1 provides
guidance on accounting for costs of computer software developed or obtained for
internal use and for determining when specific costs should be capitalized and
when they should be expensed. The impact of adopting SOP 98-1 on the Company's
consolidated financial statements was not material.
In the fourth quarter of 1998 the Company adopted SFAS 131, Disclosures
about Segments of an Enterprise and Related Information ("SFAS 131"). SFAS 131
defines the management approach as the basis for determining the entity's
reportable segments. The management approach designates the internal
organization that is used by management for making operating decisions and
assessing performance as the source of the entity's reportable segments. The
adoption of SFAS 131 did not affect the Company's financial postion, liquidity
or results of operations. See Note 7 to the consolidated financial statements
for a discussion of the Company's segments.
In June 1998, the Financial Accounting Standards Board issued SFAS No. 133,
Accounting for Derivative Instruments and Hedging Activities ("SFAS 133"). SFAS
133 requires that an entity recognize all derivatives in the statement of
financial condition and measure those instruments at fair value. If certain
conditions are met, a derivative may be specifically designated as a hedge of
the exposure to changes in the fair value of a recognized asset or liability or
an unrecognized firm commitment, or a hedge of the exposure to variable cash
flows of a forecasted transaction, or a hedge of the foreign currency exposure
of a net investment in a foreign operation, an unrecognized firm commitment, an
available-for-sale
F-15
<PAGE> 59
SALOMON SMITH BARNEY HOLDINGS INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
security or a foreign-currency-denominated forecasted transaction. SFAS 133 is
effective for fiscal years beginning after June 15, 1999. The Company is in the
process of evaluating the potential impact of the new accounting standard.
NOTE 5. PRINCIPAL TRANSACTION REVENUES
The following table presents principal transaction revenues by business
activity from continuing operations for the years ended December 31, 1998, 1997
and 1996.
<TABLE>
<CAPTION>
DOLLARS IN MILLIONS
YEAR ENDED DECEMBER 31, 1998 1997 1996
- ----------------------- ------ ------ ------
<S> <C> <C> <C>
Fixed income.............................................. $(869) $1,882 $2,049
Equities.................................................. 536 397 576
Commodities............................................... 205 218 393
Other..................................................... 15 7 9
----- ------ ------
Total principal transaction revenues...................... $(113) $2,504 $3,027
===== ====== ======
</TABLE>
Fixed Income
Fixed income revenues include realized and unrealized gains and losses
arising from the trading of government and government agency securities,
investment and non-investment grade corporate debt, municipal securities, and
preferred stock, mortgage securities (primarily U.S. government agencies,
including interest only and principal only strips), and emerging market fixed
income securities and derivatives. Revenues also include realized and unrealized
gains and losses generated from a variety of fixed income securities utilized in
arbitrage strategies for the Company's own account, and realized and unrealized
gains and losses arising from the spot and forward trading of currencies and
exchange-traded and over-the-counter ("OTC") currency options. In 1998, the
Company restructured and significantly decreased the risk profile of the global
fixed income arbitrage groups because of lessening profit opportunities and
growing risk and volatility. Realized and unrealized gains and losses resulting
from changes in the market or fair value of options on fixed income securities,
interest rate swaps, currency swaps, swap options, caps and floors, financial
futures, options and forward contracts on fixed income securities are reflected
as fixed income revenue.
Equities
Revenues from equities consist of realized and unrealized gains and losses
arising from proprietary and customer trading of U.S. and non-U.S. equity
securities, including common and convertible preferred stock, convertible
corporate debt, equity-linked notes and exchange-traded and OTC equity options
and warrants. Revenues also include realized and unrealized gains and losses on
equity securities and related derivatives utilized in arbitrage strategies for
the Company's own account.
Commodities
The Company, primarily through its wholly owned subsidiary Phibro Inc. and
its wholly owned subsidiaries (collectively, "Phibro"), conducts a commodities
trading and dealer business. Commodities traded include crude oil, refined
F-16
<PAGE> 60
SALOMON SMITH BARNEY HOLDINGS INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
oil products, natural gas, electricity, metals and various soft commodities.
During 1998, Phibro continued its downsizing effort to significantly reduce the
scope of some of its activities. In 1997, Phibro discontinued trading
petrochemicals. Commodity revenues consist of realized and unrealized gains and
losses from trading these commodities and related derivative instruments.
NOTE 6. DISCONTINUED OPERATIONS
In March 1997, the Board of Directors of Salomon Inc approved a non-binding
letter of intent to sell all of the outstanding stock of Basis Petroleum to
Valero Energy Corporation ("Valero") and a plan of disposition for Basis
Petroleum. This transaction resulted in a pretax loss in 1996 of approximately
$505 million ($290 million after tax). The sale was completed on May 1, 1997.
Proceeds from the sale included cash of $365 million, Valero common stock with a
market value of $120 million and participation payments based on a fixed
notional throughput and the difference, if any, between an average market
crackspread, as defined, and a base crackspread, as defined, over each of the
next ten years. The total of the participation payments is capped at $200
million, with a maximum of $35 million per year. During 1998, the Company
received $11 million in participation payments from Valero. In addition, as a
result of Valero's merger agreement with PG&E Corporation, Valero's common stock
was exchanged for stock of PG&E Corporation and a new stock of the "spin-off"
company ("New Valero"), representing Valero's refining assets. In the third
quarter of 1997, the Company liquidated its interest in the PG&E and New Valero
common stock. In July 1997, the Company paid Valero $3 million in connection
with the final determination of working capital. The loss included severance
costs and anticipated operating losses to be incurred prior to the completion of
the sale, and reflects other estimates of value at time of closing. The
Company's investment in Genesis Energy, L.P., a publicly traded crude oil
gathering, marketing and transportation partnership, was not transferred to
Valero.
The following table presents Basis Petroleum's results of operations and
the loss on the disposal of Basis Petroleum, which are included in "Discontinued
operations" on the consolidated statements of income.
<TABLE>
<CAPTION>
DOLLARS IN MILLIONS
YEAR ENDED DECEMBER 31, 1996
- ----------------------- -----
<S> <C>
Discontinued operations:
Revenues, net of interest................................. $ (85)
Expenses.................................................. 38
-----
Loss before income taxes.................................... (123)
Benefit for income taxes.................................... (48)
-----
Loss from operations........................................ (75)
Loss on sale, net of tax benefit of $215.................... (290)
-----
Loss from discontinued operations, net of taxes............. $(365)
=====
</TABLE>
NOTE 7. SEGMENT INFORMATION
F-17
<PAGE> 61
SALOMON SMITH BARNEY HOLDINGS INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
The Company's reportable segments include investment services and asset
management. The investment services segment includes investment banking and
trading, and retail brokerage as well as related derivative and commodity
trading. The Company's global investment banking services encompasses a full
range of capital market activities, including the underwriting and distribution
of debt and equity securities for United States and foreign corporations and for
state, local and other governmental and government sponsored authorities.
Investment services executes securities and commodities futures brokerage
transactions on all major exchanges on behalf of its customers and its own
account. Investment services engages in principal transactions in fixed income
securities and is a major participant in the over-the-counter ("OTC") market for
various derivative instruments. The segment earns commissions as a broker for
its clients in the purchase and sale of securities. Investment services also
generates revenue from fees received from the internal management of client
assets by Financial Consultants, as well as client assets managed externally by
the segment's Consulting Group. The asset management segment provides
discretionary and non-discretionary asset management services to a wide array of
mutual funds and institutional and individual investors, with respect to
domestic and foreign equity and debt securities, municipal bonds, money market
instruments, and related options and futures contracts. The segment receives
ongoing fees, generally stated as a percentage of the clients assets, from asset
management clients.
Segment data presented includes the allocation of all corporate overhead to
each segment. Intersegment revenue and expense are eliminated between segments.
Information concerning operations in the Company's segments of business is as
follows:
<TABLE>
<CAPTION>
DOLLARS IN MILLIONS
YEAR ENDED DECEMBER 31, 1998 1997 1996
- ----------------------- -------- -------- --------
<S> <C> <C> <C>
Revenues:
Investment Services.............................. $ 6,847 $ 8,654 $ 8,516
Asset Management................................. 924 780 664
-------- -------- --------
Total.............................................. $ 7,771 $ 9,434 $ 9,180
======== ======== ========
Net interest and dividends:
Investment Services.............................. $ 1,456 $ 1,533 $ 1,515
Asset Management................................. (20) (20) (27)
-------- -------- --------
Total.............................................. $ 1,436 $ 1,513 $ 1,488
======== ======== ========
Income from continuing operations before income
taxes:*
Investment Services.............................. $ 899 $ 1,475 $ 2,755
Asset Management................................. 417 345 261
-------- -------- --------
Total.............................................. $ 1,316 $ 1,820 $ 3,016
======== ======== ========
Total assets:
Investment Services.............................. $210,577 $275,440 $245,080
Asset Management................................. 1,324 1,180 1,034
-------- -------- --------
Total.............................................. $211,901 $276,620 $246,114
======== ======== ========
</TABLE>
- ---------------
* The 1996 sale of The Mortgage Company Limited which resulted in a pre-tax gain
of $48 million has not been allocated to either segment.
The accompanying table summarizes the Company's operations by geographic
area. Amounts are determined principally by the respective legal jurisdictions
of the Company's subsidiaries. Substantially all amounts for the asset
management segment are included in North America. North America consists of the
United States and Canada; Europe primarily consists of the United Kingdom and
Germany; Asia and other primarily consists of Japan and Australia. Because of
the global nature of the markets in which the Company competes and the
integration of the Company's worldwide business activities, the Company believes
that amounts determined in this manner are not particularly useful in
understanding its business.
F-18
<PAGE> 62
SALOMON SMITH BARNEY HOLDINGS INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
<TABLE>
<CAPTION>
REVENUES INCOME (LOSS) FROM
BEFORE INTEREST CONTINUING OPERATIONS
DOLLARS IN MILLIONS EXPENSE BEFORE INCOME TAXES TOTAL ASSETS*
------------------- --------------- --------------------- -------------
<S> <C> <C> <C>
Year Ended December 31, 1998
North America........................ $18,270 $ 2,873 $140,532
Europe............................... 1,845 (1,483) 47,785
Asia and other....................... 558 (74) 23,584
------- ------- --------
Consolidated........................... $20,673 $ 1,316 $211,901
======= ======= ========
Year Ended December 31, 1997
North America........................ $16,601 $ 1,376 $162,684
Europe............................... 4,506 351 82,497
Asia and other....................... 370 93 31,439
------- ------- --------
Consolidated........................... $21,477 $ 1,820 $276,620
======= ======= ========
Year Ended December 31, 1996
North America........................ $15,298 $ 2,943 $152,423
Europe............................... 3,365 77 76,875
Asia and other....................... 180 44 16,816
------- ------- --------
Consolidated........................... $18,843 $ 3,064 $246,114
======= ======= ========
</TABLE>
- ---------------
* The net realizable value of Basis Petroleum, $490 million, is included in
North America in 1996.
F-19
<PAGE> 63
SALOMON SMITH BARNEY HOLDINGS INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
NOTE 8. COMMERCIAL PAPER AND OTHER SHORT-TERM BORROWINGS
Information regarding the Company's short-term borrowings used to finance
operations, including the securities settlement process is presented below.
Average balances were computed based on month-end outstanding balances.
<TABLE>
<CAPTION>
DOLLARS IN MILLIONS
YEAR ENDED DECEMBER 31, 1998 1997
- ----------------------- ------- -------
<S> <C> <C>
Bank borrowings:
Balance at year-end....................................... $ 1,743 $ 2,415
Weighted average interest rate............................ 4.2% 5.9%
Annual averages --
Amount outstanding..................................... $ 2,175 $ 3,766
Weighted average interest rate......................... 5.3% 5.3%
Maximum amount outstanding at any month-end............... $ 3,532 $ 5,436
------- -------
Commercial paper:
Balance at year-end....................................... $10,493 $ 7,110
Weighted average interest rate............................ 5.3% 5.8%
Annual averages --
Amount outstanding..................................... $12,140 $ 5,189
Weighted average interest rate......................... 5.6% 5.6%
Maximum amount outstanding at any month-end............... $14,187 $ 7,110
------- -------
Other short-term borrowings:
Balance at year-end....................................... $ 3,259 $ 1,939
Weighted average interest rate............................ 2.1% 5.3%
Annual averages --
Amount outstanding..................................... $ 3,141 $ 2,258
Weighted average interest rate......................... 3.0% 4.5%
Maximum amount outstanding at any month-end............... $ 4,992 $ 2,580
======= =======
Total commercial paper and other short term
borrowings....................................... $15,495 $11,464
======= =======
</TABLE>
Outstanding bank borrowings include both U.S. dollar and non-U.S. dollar
denominated loans. The non-U.S. dollar loans are denominated in multiple
currencies including Japanese yen, German mark and U.K. sterling. All of the
Company's
F-20
<PAGE> 64
SALOMON SMITH BARNEY HOLDINGS INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
commercial paper outstanding at December 31, 1998 and 1997 was U.S. dollar
denominated. Also included in short-term borrowings are deposit liabilities and
other short-term obligations.
The Company has a $3.5 billion 364-day revolving credit agreement that
extends through May 1999. The Company may borrow under its revolving credit
facility at various interest rate options (LIBOR, CD or base rate) and
compensates the banks for the facility through facility fees. Under this
facility the Company is required to maintain a certain level of consolidated
adjusted net worth (as defined in the agreement). At December 31, 1998, this
requirement was exceeded by $2.8 billion.
At December 31, 1998, there were no outstanding borrowings under this
facility. In addition, the Company also has substantial borrowing arrangements
consisting of facilities that the Company has been advised are available, but
where no contractual lending obligation exists.
NOTE 9. TERM DEBT
Term debt consists of issues with original maturities in excess of one
year. Certain issues are redeemable, in whole or in part, at par or at premiums
prior to maturity.
<TABLE>
<CAPTION>
FIXED RATE
OBLIGATIONS FIXED RATE TOTAL FIXED VARIABLE
SWAPPED TO OBLIGATIONS RATE RATE TOTAL TOTAL
DOLLARS IN MILLIONS VARIABLE NOT SWAPPED OBLIGATIONS OBLIGATIONS DEC. 31, 1998 DEC. 31, 1997
- ------------------- ----------- ----------- ----------- ----------- ------------- -------------
<S> <C> <C> <C> <C> <C> <C>
U.S. dollar denominated:
Salomon Smith Barney Holdings
Inc. (Parent Company)....... $10,689 $2,062 $12,751 $2,773 $15,524 $15,647
Subsidiaries.................. 56 -- 56 1,627 1,683 --
------- ------ ------- ------ ------- -------
U.S. dollar denominated....... 10,745 2,062 12,807 4,400 17,207 15,647
------- ------ ------- ------ ------- -------
Non-U.S. dollar denominated:
Salomon Smith Barney Holdings
Inc. (Parent Company)....... 707 -- 707 1,105 1,812 2,134
Subsidiaries.................. 1,086 16 1,102 30 1,132 1,293
------- ------ ------- ------ ------- -------
Non-U.S. dollar denominated... 1,793 16 1,809 1,135 2,944 3,427
------- ------ ------- ------ ------- -------
Term debt....................... $12,538 $2,078 $14,616 $5,535 $20,151 $19,074
======= ====== ======= ====== ======= =======
</TABLE>
The maturity structure of the Company's term debt, based on contractual
maturities or the earliest date on which the debt is repayable at the option of
the holder, was as follows at December 31, 1998:
<TABLE>
<CAPTION>
SALOMON SMITH BARNEY
HOLDINGS INC.
DOLLARS IN MILLIONS (PARENT COMPANY) SUBSIDIARIES TOTAL
- ------------------- -------------------- ------------ -------
<S> <C> <C> <C>
1999....................................... $ 2,786 $ 23 $ 2,809
2000....................................... 3,360 353 3,713
2001....................................... 2,088 218 2,306
</TABLE>
F-21
<PAGE> 65
SALOMON SMITH BARNEY HOLDINGS INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
<TABLE>
<CAPTION>
SALOMON SMITH BARNEY
HOLDINGS INC.
DOLLARS IN MILLIONS (PARENT COMPANY) SUBSIDIARIES TOTAL
- ------------------- -------------------- ------------ -------
<S> <C> <C> <C>
2002....................................... 2,415 75 2,490
2003....................................... 2,781 209 2,990
Thereafter................................. 3,906 1,937 5,843
------- ------ -------
Total............................ $17,336 $2,815 $20,151
======= ====== =======
</TABLE>
The Company issues U.S. dollar and non-U.S. dollar denominated fixed and
variable rate term debt. Fixed rate debt matures at various dates through 2023.
The contractual interest rates on fixed rate debt ranged from 1.25% (U.S. dollar
denominated) to 23.0% (Korean won denominated) at December 31, 1998 and 1.25%
(U.S. dollar denominated) to 11.82% (U.S. dollar denominated) at December 31,
1997. The weighted average contractual rate on total fixed rate term debt (both
U.S. dollar denominated and non-U.S. dollar denominated) was 6.69% at December
31, 1998 and 6.76% at December 31, 1997. The Company utilizes interest rate swap
agreements to convert most of its fixed rate term debt to variable rate
obligations. The maturity structure of the swaps generally corresponds with the
maturity structure of the debt being hedged.
The Company's non-U.S. dollar fixed rate term debt includes Japanese yen,
German mark, U.K. sterling, Italian lira, French franc, Portuguese escudos,
European currency unit and the Korean won and, consequently, bears a wide range
of interest rates.
At December 31, 1998, the Company had outstanding approximately $2.9
billion of non-U.S. dollar denominated term debt, of which, $1.3 billion was
German mark denominated and $.8 billion was U.K. sterling denominated, $.3
billion was Japanese yen denominated (converted at the December 31, 1998 spot
rates). Of the $2.9 billion, approximately $.3 billion of Parent Company
non-U.S. dollar denominated debt has been designated as a hedge of investments
in subsidiaries with functional currencies other than the U.S. dollar. Another
$1.2 billion of Parent Company debt has been effectively converted to U.S.
dollar denominated obligations using cross-currency swaps. The remaining $1.4
billion is used for general corporate purposes.
The following table summarizes the Company's fixed rate term debt that is
swapped to variable rate obligations using interest rate swaps at December 31,
1998 and 1997. The variable rates presented are indicative of the Company's
actual costs related to such obligations.
<TABLE>
<CAPTION>
CONTRACTUAL CONTRACTUAL
WEIGHTED WEIGHTED WEIGHTED WEIGHTED
AVERAGE FIXED AVERAGE AVERAGE FIXED AVERAGE
RATE ON VARIABLE RATE RATE ON VARIABLE RATE
PRINCIPAL SWAPPED FIXED ON SWAPPED PRINCIPAL SWAPPED FIXED ON SWAPPED
(DOLLARS IN MILLIONS) BALANCE RATE TERM DEBT TERM DEBT BALANCE RATE TERM DEBT TERM DEBT
- --------------------- --------- -------------- ------------- --------- -------------- -------------
<S> <C> <C> <C> <C> <C> <C>
U.S. dollar denominated.............. $10,745 6.7% 5.5% $ 9,557 6.8% 6.5%
German mark denominated.............. 1,045 7.4 3.5 1,069 7.4 3.8
Japanese yen denominated............. 44 4.5 0.6 77 4.6 0.8
Japanese yen swapped to U.S. dollar
denominated........................ 193 4.0 4.7 187 3.9 6.7
French francs swapped to U.S. dollar
denominated........................ 181 5.4 5.5 168 5.4 6.7
Italian lira swapped to U.S. dollar
denominated........................ 100 2.1 5.2 62 3.9 6.5
U.K. sterling denominated............ 129 7.8 7.6 4 7.6 7.5
Portuguese escudos swapped to U.S.
dollar denominated................. 78 5.0 4.9 67 5.3 6.5
</TABLE>
F-22
<PAGE> 66
SALOMON SMITH BARNEY HOLDINGS INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
<TABLE>
<CAPTION>
CONTRACTUAL CONTRACTUAL
WEIGHTED WEIGHTED WEIGHTED WEIGHTED
AVERAGE FIXED AVERAGE AVERAGE FIXED AVERAGE
RATE ON VARIABLE RATE RATE ON VARIABLE RATE
PRINCIPAL SWAPPED FIXED ON SWAPPED PRINCIPAL SWAPPED FIXED ON SWAPPED
(DOLLARS IN MILLIONS) BALANCE RATE TERM DEBT TERM DEBT BALANCE RATE TERM DEBT TERM DEBT
- --------------------- --------- -------------- ------------- --------- -------------- -------------
<S> <C> <C> <C> <C> <C> <C>
European currency units swapped to
U.S. dollar denominated............ 12 3.1 5.2 -- -- --
Korean won swapped to U.S. dollar
denominated........................ 11 23.0 4.7 -- -- --
Total swapped fixed rate term debt... $12,538 6.6% 5.3% $11,191 6.8% 6.2%
</TABLE>
Variable rate term debt matures at various dates through 2018. The interest
rates are determined periodically by reference to money market rates, or in
certain instances, are calculated based on stock or bond market indices as
specified in the agreements governing the respective issues. The interest rates
on variable rate term debt ranged from .96% (Japanese yen denominated) to 8.75%
(U.S. dollar denominated) at December 31, 1998 and 0.82% (Japanese yen
denominated) to 11.63% (U.S. dollar denominated) at December 31, 1997. The
weighted average contractual rate on total variable rate term debt (both U.S.
dollar denominated and non-U.S. denominated) was 5.14% at December 31, 1998 and
5.83% at December 31, 1997.
Term debt includes subordinated debt, which totaled $30 million at December
31, 1998 and $28 million at December 31, 1997. At December 31, 1998 and 1997,
subordinated debt included approximately $6 million of convertible restricted
notes, convertible at the rate of $8.19 per share into 668,888 shares of
Citigroup common stock. At December 31, 1998, the Company had outstanding $87
million of term debt for which the principal repayment is linked to certain
equity securities of unaffiliated issuers.
The Company has a $1.5 billion revolving credit agreement with a bank
syndicate that extends through May 2001, under which it may borrow at various
interest rate options (LIBOR, CD or base rate) and compensates the banks for the
facility through facility fees. At December 31, 1998, there were no outstanding
borrowings under this facility. Under this facility the Company is required to
maintain a certain level of consolidated adjusted net worth (as defined in the
agreement). At December 31, 1998, this requirement was exceeded by $2.8 billion.
NOTE 10. LEASE COMMITMENTS
The Company has noncancelable leases covering office space and equipment
expiring on various dates through 2012. Presented below is a schedule of minimum
future rentals on noncancelable operating leases, net of subleases, as of
December 31, 1998. Various leases contain provisions for lease renewals and
escalation of rent based on increases in certain costs incurred by the lessors.
<TABLE>
<CAPTION>
DOLLARS IN MILLIONS
-------------------
<S> <C>
1999................................................. $ 220
2000................................................. 206
2001................................................. 183
2002................................................. 164
2003................................................. 113
Thereafter........................................... 455
------
Minimum future rentals............................... $1,341
======
</TABLE>
F-23
<PAGE> 67
SALOMON SMITH BARNEY HOLDINGS INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
Minimum future rentals include $130 million related to space the Company
has vacated or intends to vacate. The Company has provided reserves for these
premises. Rent expense under operating leases from continuing operations totaled
$259 million, $258 million and $251 million for the years ended December 31,
1998, 1997 and 1996, respectively.
NOTE 11. MANDATORILY REDEEMABLE SECURITIES OF SUBSIDIARY TRUSTS
The Parent Company has formed two statutory business trusts under the laws
of the state of Delaware that exist for the exclusive purposes of (i) issuing
trust securities representing undivided beneficial interests in the assets of
the Trust; (ii) investing the gross proceeds of the trust securities in
subordinated debt securities of the Parent Company (in the case of SI Financing
Trust I) and junior subordinated deferrable interest debt securities of the
Parent Company (in the case of SSBH Capital I); and (iii) engaging in only those
activities necessary or incidental thereto. These subordinated debt securities
and the related income effects are eliminated in the consolidated financial
statements. Distributions on the mandatorily redeemable securities of subsidiary
trusts below have been classified as interest expense in the consolidated
statement of income. The following table summarizes the financial structure of
the Parent Company's subsidiary trusts at December 31, 1998:
<TABLE>
<CAPTION>
SI FINANCING SSBH
TRUST I CAPITAL I
------------- -----------------
<S> <C> <C>
Trust Securities:
Issuance date........................... July 1996 January 1998
Shares issued........................... 13,800,000 16,000,000
Liquidation preference per share........ $25 $25
Liquidation value (in millions)......... $345 $400
Coupon rate............................. 9.25% 7.20%
Distributions payable................... Quarterly Quarterly
Distributions guaranteed by............. Parent Company Parent Company
Common shares issued to Parent Company.... 426,800 494,880
Subordinated Debt Securities:
Amount owned (in millions).............. $356 $412
Coupon rate............................. 9.25% 7.20%
Interest payable........................ Quarterly Quarterly
Maturity date........................... June 30, 2026 January 28, 2038
Redeemable by issuer on or after........ June 30, 2001 January 28, 2003
</TABLE>
SI Financing Trust I, a wholly owned subsidiary of the Parent Company,
issued TRUPS(R) units to the public. Each TRUPS(R) unit includes a security of
SI Financing Trust I, as shown in the table above, and a purchase contract that
requires the holder to purchase, in 2021 (or earlier if the Parent Company
elects to accelerate the contract), one depositary share representing a
one-twentieth interest in a share of Citigroup 9.50% Cumulative Preferred Stock,
Series L. The Parent Company is obligated under the terms of each purchase
contract to pay contract fees of 0.25% per annum.
F-24
<PAGE> 68
SALOMON SMITH BARNEY HOLDINGS INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
NOTE 12. CAPITAL REQUIREMENTS
Certain U.S. and non-U.S. subsidiaries are subject to various securities
and commodities regulations and capital adequacy requirements promulgated by the
regulatory and exchange authorities of the countries in which they operate.
Capital requirements related to the Company's principal regulated subsidiaries
are as follows:
<TABLE>
<CAPTION>
EXCESS OVER
DOLLARS IN MILLIONS NET CAPITAL MINIMUM
SUBSIDIARY JURISDICTION OR EQUIVALENT REQUIREMENT
- ------------------- ------------ ------------- -----------
<S> <C> <C> <C>
Salomon Smith Barney Inc.* U.S. Securities and Exchange $3,195 $2,841
Commission Uniform Net
Capital Rule (Rule 15c3-1)
Salomon Brothers United Kingdom's Securities $4,972 $1,090
International Limited and Futures Authority
Salomon Smith Barney Japan Japan's Ministry of Finance $ 688 $ 375
Limited**
Salomon Brothers AG Germany's Banking Supervisory $ 236 $ 150
Authority
The Robinson-Humphrey U.S. Securities and Exchange $ 79 $ 78
Company, LLC Commission Uniform Net
Capital Rule (Rule 15c3-1)
</TABLE>
- ---------------
* On September 1, 1998, Salomon Brothers Inc and Smith Barney Inc. merged to
form Salomon Smith Barney Inc.
** Prior to April 1, 1998, this entity was known as Salomon Brothers Asia
Limited.
Advances, dividend payments and other equity withdrawals from regulated
subsidiaries are restricted by the regulations of the U.S. Securities and
Exchange Commission, the New York Stock Exchange and other regulatory agencies
and by certain covenants contained in the Company's revolving credit facilities.
See Notes 8 and 9 to the consolidated financial statements. These restrictions
may limit the amounts that these subsidiaries pay as dividends or advances to
the Company.
In addition, in order to maintain its triple-A rating, Salomon Swapco Inc
("Swapco"), an indirect wholly owned subsidiary of the Company, must maintain
minimum levels of capital in accordance with agreements with its rating
agencies. At December 31, 1998, Swapco was in compliance with all such
agreements. Swapco's capital requirements are dynamic, varying with the size and
concentration of its counterparty receivables.
F-25
<PAGE> 69
SALOMON SMITH BARNEY HOLDINGS INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
NOTE 13. EMPLOYEE BENEFIT PLANS
Retirement Plans
The Company participates in defined benefit pension plans that cover
certain U.S. and Non-U.S. employees. These plans resulted in expenses from
continuing operations of $53 million, $53 million and $46 million in 1998, 1997
and 1996, respectively.
The Company has defined contribution employee savings plans covering
certain eligible employees. The costs relating to these plans were $23 million,
$34 million and $49 million in 1998, 1997 and 1996, respectively.
Health Care and Life Insurance
The Company provides certain health care and life insurance benefits for
its active employees, qualifying retired U.S. employees and certain non-U.S.
employees who reach the retirement criteria specified by the various plans. At
December 31, 1998, there were approximately 31,800 active and 1,600 retired
employees eligible for such benefits.
Expenses recorded for health care and life insurance benefits from
continuing operations were $109 million, $121 million, and $110 million in 1998,
1997 and 1996, respectively.
Employee Incentive Plans
The Company participates in a stock option plan sponsored by Citigroup that
provides for the granting of stock options in Citigroup common stock to officers
and key employees. The Company also participates in the Salomon Incentive Plan
("SIP") which provides for the issuance of up to 5.9 million shares of Citigroup
common stock in the form of options, restricted stock and stock bonuses, as well
as an additional grant of up to 2.5 million shares of Citigroup common stock in
the form of stand-alone stock appreciation rights, phantom stock and cash
bonuses to certain key employees, including officers of the Company who were
former employees of Salomon. In December 1996, 2.7 million options were awarded
under the SIP with an exercise price set at the market value on the date of
grant ($26.48). The awards expire five years after the grant date and vest 100%
three years after the grant date. At December 31, 1998 there were 1,627, 200
options outstanding relating to the SIP plan. SFAS 123, Accounting for
Stock-Based Compensation ("SFAS 123"), allows the fair value of stock-based
compensation to be included in expense over the period earned; alternatively, if
the fair value of stock-based compensation awards is not included in expense,
SFAS 123 requires disclosure of net income, on a pro forma basis, as if expense
treatment had been applied. As permitted by SFAS 123, the Company continues to
account for such compensation under Accounting Principles Board Opinion No. 25,
Accounting for Stock Issued to Employees ("APB 25"), pursuant to which no
compensation cost has been recognized in connection with the issuance of stock
options. Had the Company applied SFAS 123 in accounting for stock options, net
income would have been reduced by $79 million, $40 million and $15 million in
1998, 1997 and 1996, respectively. The following assumptions were used to
calculate the effect of SFAS 123:
F-26
<PAGE> 70
SALOMON SMITH BARNEY HOLDINGS INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
<TABLE>
<CAPTION>
OTHER AWARDS
CITIGROUP AWARDS SIP PLAN
-------------------------- ------------
ASSUMPTIONS 1998 1997 1996 1996
- ----------- ------ ------ ------ ------
<S> <C> <C> <C> <C>
Expected volatility................... 35.1% 31.8% 28.2% 25.0%
Risk-free interest rate............... 5.05% 5.77% 5.70% 5.88%
Expected annual dividends per share... $0.65 $0.47 $0.37 $ 0.38
Expected annual forfeiture rate....... 5% 5% 5% 0%
</TABLE>
Certain provisions of the Citigroup incentive plan have changed. Certain
employees of the Company will receive Deferred Stock Awards ("DSA's"). A DSA
award is an unfunded promise to deliver shares at the end of a three-year
deferral period. It is comprised of a basic award representing a portion of the
participant's prior year incentive award which vests immediately upon grant, and
an additional premium award amounting to 33% of the basic award which vests
one-third per year over a three year period. The entire award is forfeited if
the participant leaves the Company to join a competitor within three years after
the award date. Participants may elect to receive a portion of their award in
the form of stock options. The basic portion of the award is expensed in the
bonus year that it was earned. The expense associated with the additional 33%
premium award is amortized over the appropriate vesting period. After-tax
expense of approximately $150 million was recognized during 1998 for 1998 awards
that were granted in January 1999.
The Company has various incentive plans under which stock of Citigroup is
purchased for subsequent distribution to employees, subject to vesting
requirements. These plans resulted in expenses of $313 million, $253 million and
$171 million for the years ended December 31, 1998, 1997 and 1996, respectively.
The Equity Partnership Plan (EPP)
Under EPP, qualifying employees of the Company received a portion of their
compensation in the form of common stock. EPP deferred payment of the stock for
three years and required the contribution of an additional 25% of the deferred
compensation amount to the participant's account. The EPP award is forfeited
if the participant's employment is terminated for cause within the three-year
vesting period. The award is forfeited if the participant leaves the Company to
join a competitor within three years after the award date. If a participant
leaves other than by virtue of death, disability, retirement or as a result of
downsizing during the three years following the award, the entire additional
contribution of 25% is forfeited.
Total purchases of shares by the EPP totaled $192 million (4.8 million
shares) in 1997, and $153 million (6.1 million shares) in 1996, there were no
purchases of shares in 1998. Stock awarded under the EPP totaled $191 million
(5.4 million shares), and $147 million (6.1 million shares) in 1997 and 1996
respectively. There was no stock awarded under EPP in 1998. These amounts are
included as a component of compensation expense. The net asset related to the
EPP, which represents the cost of the unawarded shares held by the EPP less the
Company's liability related to the EPP, payable in common stock, is included in
"Other assets."
F-27
<PAGE> 71
SALOMON SMITH BARNEY HOLDINGS INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
In December 1998, restrictions on transferability were lifted on
approximately 8 million shares (net of withholding tax requirements) awarded by
the EPP in 1993.
NOTE 14. INCOME TAXES
The components of income taxes from continuing operations reflected on the
consolidated statements of income are:
<TABLE>
<CAPTION>
DOLLARS IN MILLIONS
YEAR ENDED DECEMBER 31, 1998 1997 1996
- ----------------------- ---- ------ ------
<S> <C> <C> <C>
Current tax provision/(benefit):
U.S. federal..................................... $649 $ 817 $1,097
State and local.................................. 117 250 322
Non-U.S.......................................... (14) 283 (13)
---- ------ ------
Total current tax provision................... 752 1,350 1,406
---- ------ ------
Deferred tax provision/(benefit):
U.S. federal..................................... (293) (424) (205)
State and local.................................. (21) (142) (68)
Non-U.S.......................................... 60 (109) 66
---- ------ ------
Total deferred tax benefit.................... (254) (675) (207)
---- ------ ------
Provision for income taxes......................... $498 $ 675 $1,199
==== ====== ======
</TABLE>
Under SFAS 109, Accounting for Income Taxes, temporary differences between
recorded amounts and the tax bases of assets and liabilities are accounted for
at current income tax rates.
At December 31, 1998 and December 31, 1997, respectively, the Company's
consolidated statements of financial condition included net deferred tax assets
from continuing operations of $1,100 million and $844 million, comprised of the
following:
<TABLE>
<CAPTION>
DOLLARS IN MILLIONS
DECEMBER 31, 1998 1997
- ----------------------- ------ ------
<S> <C> <C>
Deferred tax assets:
Employee benefits and deferred compensation.............. $1,191 $1,087
Lease obligations and fixed assets....................... -- 148
U.S. taxes provided on the undistributed earnings of
non-U.S. subsidiaries................................. 67 --
Other deferred tax assets................................ 488 292
------ ------
Total deferred tax assets.................................. $1,746 1,527
------ ------
</TABLE>
F-28
<PAGE> 72
SALOMON SMITH BARNEY HOLDINGS INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
<TABLE>
<CAPTION>
DOLLARS IN MILLIONS
DECEMBER 31, 1998 1997
- ----------------------- ------ ------
<S> <C> <C>
Deferred tax liabilities:
Intangible assets........................................ (302) (323)
Investment position activity............................. (10) (65)
Cumulative translation adjustments....................... (89) (91)
Lease obligations and fixed assets....................... (2) --
U.S. taxes provided on the undistributed earnings of
non-U.S. subsidiaries................................. -- (119)
Other deferred tax liabilities........................... (243) (85)
------ ------
Total deferred tax liabilities............................. (646) (683)
------ ------
Net deferred tax asset..................................... $1,100 $ 844
====== ======
</TABLE>
The Company had no deferred tax valuation allowance at December 31, 1998 or
December 31, 1997.
Tax benefits (liabilities) allocated directly to stockholder's equity were
as follows:
<TABLE>
<CAPTION>
DOLLARS IN MILLIONS
YEAR ENDED DECEMBER 31, 1998 1997 1996
- ----------------------- ---- ---- ----
<S> <C> <C> <C>
Foreign currency translation.......................... $(10) $(11) $(20)
Employee stock plans.................................. 8 82 11
Hedge of preferred stock dividends paid............... -- (10) (15)
---- ---- ----
Total tax benefits (liabilities) allocated directly to
stockholder's equity................................ $ (2) $ 61 $(24)
==== ==== ====
</TABLE>
The Company paid taxes, net of refunds, of $693 million, $918 million and
$1,696 million in 1998, 1997 and 1996, respectively.
The Company provides income taxes on the undistributed earnings of foreign
subsidiaries except to the extent that such earnings are indefinitely invested
outside the United States. At December 31, 1998, $1.3 billion of the Company's
accumulated undistributed earnings was indefinitely invested. At the existing
U.S. federal income tax rate, additional taxes of $376 million would have to be
provided if such earnings were remitted to the United States.
The following table reconciles the U.S. federal statutory income tax rate
to the Company's effective tax rate from continuing operations:
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31, 1998 1997 1996
- ----------------------- ---- ---- ----
<S> <C> <C> <C>
Statutory U.S. federal income tax rate for
corporations.......................................... 35% 35% 35%
Impact of:
State and local (net of U.S. federal tax) and foreign
taxes.............................................. 5 4 6
Tax advantaged income................................. (3) (3) (1)
Other, net............................................ 1 1 (1)
-- -- --
Effective tax rate...................................... 38% 37% 39%
== == ==
</TABLE>
F-29
<PAGE> 73
SALOMON SMITH BARNEY HOLDINGS INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
NOTE 15. PLEDGED ASSETS, COMMITMENTS AND CONTINGENCIES
At December 31, 1998, the approximate market values of securities sold
under agreements to repurchase or other assets pledged by the Company, excluding
the impact of FIN 41, were:
<TABLE>
<CAPTION>
DOLLARS IN MILLIONS
- -------------------
<S> <C>
For securities sold under agreements to repurchase........ $115,652
As collateral for securities borrowed of approximately
equivalent value........................................ 82,571
For securities loaned..................................... 7,751
As collateral on bank loans............................... 3,522
To clearing organizations or segregated under securities
laws and regulations.................................... 3,132
Other..................................................... 285
--------
Repurchase agreements and securities pledged.............. $212,913
========
</TABLE>
At December 31, 1998, the Company had $2.2 billion of outstanding letters
of credit from banks to satisfy various collateral and margin requirements.
Other Contingencies
The Company has provided a residual guarantee of $586 million in connection
with the lease of buildings occupied by the Company's executive offices and New
York operations.
On July 31, 1993, Smith Barney, along with certain of its affiliates and
Travelers Group, acquired the domestic retail brokerage and asset management
businesses (the "Shearson Acquisition") of Lehman Brothers Holdings Inc. (then
known as Shearson Lehman Brothers Holdings Inc.) and its subsidiaries. In
conjunction with the Shearson Acquisition, Smith Barney Inc. has agreed to pay
American Express Company additional amounts contingent upon Smith Barney Inc.'s
future performance, including 10% of its after-tax profits in excess of $250
million per year over a five-year period (1998 was the final year for this
portion of the payout.) The amount to be paid under this agreement in 1998 has
yet to be determined,
F-30
<PAGE> 74
SALOMON SMITH BARNEY HOLDINGS INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
while the amount paid under this agreement amounted to $75 million in 1997. The
contingent consideration is accounted for prospectively, as additional purchase
price, and results in amortization over periods of up to 20 years.
NOTE 16. LEGAL PROCEEDINGS
The Company has been named as a defendant in legal actions relating to its
operations, some of which seek damages of material or indeterminate amounts. In
addition, from time to time the Company is a party to examinations and inquiries
by various regulatory and self-regulatory bodies. In connection with its
discontinued commodities processing operations, the Company and certain of its
subsidiaries are subject to claims asserted by the U.S. Environmental Protection
Agency, certain state agencies and private parties in connection with
environmental matters. Management of the Company, after consultation with
outside legal counsel, believes that the ultimate resolution of legal
proceedings and environmental matters (net of applicable reserves) will not have
a material adverse effect on the Company's financial condition; however, such
resolution could have a material adverse impact on operating results in future
periods depending in part on the results for such periods.
NOTE 17. FINANCIAL INSTRUMENTS, COMMODITIES AND CONTRACTUAL COMMITMENTS AND
RELATED RISKS
The Company and its subsidiaries enter into a variety of contractual
commitments, such as swaps, cap and floor agreements, swap options, futures
contracts, forward currency contracts, forward purchase and sale agreements,
option contracts and warrants. These transactions generally require future
settlement, and are either executed on an exchange or traded as OTC instruments.
Contractual commitments have widely varying terms, and durations that range from
a few days to a number of years depending on the instrument.
Interest rate swaps are OTC instruments where two counterparties agree to
exchange periodic interest payment streams calculated on a predetermined
notional principal amount. The most common interest rate swaps generally involve
one party paying a fixed interest rate and the other party paying a variable
rate. Other types of swaps include basis swaps, cross-currency swaps, equity
swaps and commodity swaps. Basis swaps consist of both parties paying variable
interest streams based on different reference rates. Cross-currency swaps
involve the exchange of coupon payments in one currency for coupon payments in
another currency. An equity swap is an agreement to exchange cash flows on a
notional amount based on changes in the values of a referenced index, such as
the Standard & Poor's 500 Index. Commodity swaps involve the exchange of a fixed
price of a commodity for a floating price, which is usually the prevailing spot
price, throughout the swap term. The most common commodity swaps are
petroleum-based; other types are based on metals or soft commodities.
Caps are contractual commitments that require the writer to pay the
purchaser an excess amount, if the reference rate exceeds a contractual rate at
specified times during the contract. Likewise, a floor is a contractual
commitment that requires the writer to pay an excess amount, if any, of a
contractual rate over a reference rate at specified times over the life of the
contract. Swap options are OTC contracts that entitle the holder to either enter
into an interest rate swap at a future date or to cancel an existing swap at a
future date.
F-31
<PAGE> 75
SALOMON SMITH BARNEY HOLDINGS INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
Futures contracts are exchange-traded contractual commitments to either
receive (purchase) or deliver (sell) a standard amount or value of a commodity
or financial instrument at a specified future date and price (or, with respect
to futures contracts on indices, the net cash amount). Maintaining a futures
contract will typically require the Company to deposit with the futures exchange
(or other financial intermediary), as security for its obligations, an amount of
cash or other specified asset ("initial margin") that typically ranges from 1%
to 10% of the face amount of the contract (but may be higher in some
circumstances). Additional cash or assets ("variation margin") may be required
to be deposited daily as the mark-to-market value of the futures contract
fluctuates. Futures contracts may be settled by physical delivery of the
underlying asset or cash settlement (for index futures) on the settlement date,
or by entering into an offsetting futures contract with the futures exchange
prior to the settlement date. Forward contracts are OTC contractual commitments
to purchase or sell a specified amount of foreign currency, financial
instruments, or commodities at a future date at a predetermined price. The
notional amount for forward settling securities transactions represents the
amount of cash that will be paid or received by the counterparties when the
transaction settles. Upon settlement, the security is reflected on the statement
of financial condition as either long or short inventory.
Option contracts are contractual agreements that give the purchaser the
right, but not the obligation, to purchase or sell a currency, financial
instrument or commodity at a predetermined price. In return for this right, the
purchaser pays a premium to the seller (or writer) of the option. Option
contracts also exist for various indices and are similar to options on a
security or other instruments except that, rather than settling by physical
delivery of the underlying instrument, they are settled in cash. Options on
futures contracts give the purchaser the right, in return for the premium paid,
to assume a position in a futures contract. Warrants have characteristics
similar to those of options whereby the buyer has the right, but not the
obligation, to purchase a certain instrument at a specific future date and
price. The seller (or writer) of the option/warrant is subject to the risk of an
unfavorable change in the underlying financial instrument, commodity, or
currency. The purchaser is subject to market risk to the extent of the premium
paid and credit risk. The Company is obligated to post margin for options on
futures. Option contracts may be either exchange-traded or OTC. Exchange-traded
options issued by certain regulated intermediaries, such as the Options Clearing
Corporation, are the obligations of the issuing intermediary. In contrast to
such options, which generally have standardized terms and performance mechanics,
all of the terms of an OTC option, including the method of settlement, term,
exercise price, premium, guarantees and security, are determined by negotiation
of the parties, and there is no intermediary between the parties to assume the
risks of performance. The Company issues warrants that entitle holders to cash
settlements on exercise based upon movements in market prices of specific
financial instruments and commodities, foreign exchange rates and equity
indices.
The Company sells various financial instruments that have not been
purchased ("short sales"). In order to sell them short, the Company borrows
these securities, or receives the securities as collateral in conjunction with
short-term financing agreements and, at a later date, must deliver (i.e.
replace) like or substantially the same financial instruments or commodities to
the parties from which they were originally borrowed. The Company is exposed to
market risk for short sales. If the market value of an instrument sold short
increases, the Company's obligation, reflected as a liability, would increase
and revenues from principal transactions would be reduced.
F-32
<PAGE> 76
SALOMON SMITH BARNEY HOLDINGS INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
The way in which the Company accounts for and presents contractual
commitments in its financial statements depends on both the type and purpose of
the contractual commitment held or issued. As discussed in Note 4 to the
consolidated financial statements, the Company records all derivatives used for
trading purposes, including those used to hedge trading positions, at market or
fair value. Consequently, changes in the amounts recorded in the Company's
consolidated statements of financial condition resulting from movements in
market or fair value are included in "Principal transactions" in the period in
which they occur. The accounting and reporting treatment of derivatives used for
non-trading purposes varies, depending on the nature of exposure being hedged.
Contractual commitments and short sales risk may expose the Company to both
market risk and credit risk in excess of the amount recorded on the consolidated
statements of financial condition. These off-balance sheet risks are discussed
in more detail below.
Market Risk
Market risk is the potential loss the Company may incur as a result of
changes in the market or fair value of a particular financial instrument,
commodity or contractual commitment. All financial instruments, commodities and
contractual commitments, including short sales, are subject to market risk. The
Company's exposure to market risk is determined by a number of factors,
including the size, duration, composition and diversification of positions held,
the absolute and relative levels of interest rates and foreign currency exchange
rates, as well as market volatility and illiquidity. For instruments such as
options and warrants, the time period during which the options or warrants may
be exercised and the relationship between the current market price of the
underlying instrument and the option's or warrant's contractual strike or
exercise price also affect the level of market risk. The most significant factor
influencing the overall level of market risk to which the Company is exposed is
its use of hedging techniques to mitigate such risk. The Company manages market
risk by setting risk limits and monitoring the effectiveness of its hedging
policies and strategies.
SFAS 105, Disclosure of Information about Financial Instruments with
Off-Balance-Sheet Risk and Financial Instruments with Concentrations of Credit
Risk, and SFAS 119, Disclosure about Derivative Financial Instruments and Fair
Value of Financial Instruments, require the disclosure of the notional amounts
of derivative financial instruments, distinguishing between those used for
trading purposes and those used for purposes other than trading. The
determination of notional amounts does not consider any of the market risk
factors discussed above. Notional amounts are indicative only of the volume of
activity and are not a measure of market risk. Market risk is influenced by the
nature of the items that comprise a particular category of financial instrument.
Market risk is also influenced by the relationship among the various off-balance
sheet categories as well as the relationship between off-balance sheet items and
items recorded in the Company's consolidated statements of financial condition.
For all of these reasons, the interpretation of notional amounts as a measure of
market risk could be materially misleading.
F-33
<PAGE> 77
SALOMON SMITH BARNEY HOLDINGS INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
A summary of contractual commitments as of December 31, 1998 and 1997 is as
follows:
<TABLE>
<CAPTION>
DECEMBER 31, 1998 DECEMBER 31, 1997
--------------------------------- ---------------------------------
CURRENT MARKET OR CURRENT MARKET OR
FAIR VALUE FAIR VALUE
NOTIONAL --------------------- NOTIONAL ---------------------
DOLLARS IN BILLIONS AMOUNTS ASSETS LIABILITIES AMOUNTS ASSETS LIABILITIES
- ------------------- -------- ------ ----------- -------- ------ -----------
<S> <C> <C> <C> <C> <C> <C>
Exchange-issued products:
Futures contracts(a)........... $ 858.3 $ -- $ -- $ 940.5 $ -- $ --
Other exchange-issued
products:................... -- --
Equity contracts............ 9.5 .1 .2 10.6 .2 .4
Fixed income contracts...... 118.1 -- .1 138.1 -- --
Physical commodities
contracts................. 1.3 -- -- 3.5 -- --
-------- ----- ----- -------- ----- -----
Total exchange-issued products... 987.2 .1 .3 1,092.7 .2 .4
-------- ----- ----- -------- ----- -----
Over-the-counter ("OTC") swaps,
swap options, caps and floors:
Swaps.......................... 2,395.3 1,345.9
Swap options written........... 81.7 38.6
Swap options purchased......... 85.4 48.8
Caps and floors................ 191.8 161.4
-------- ----- ----- -------- ----- -----
Total OTC swaps, swap options,
caps and floors(b)............. 2,754.2 8.2 8.8 1,594.7 5.8 6.7
-------- ----- ----- -------- ----- -----
OTC foreign exchange contracts
and options:
Forward currency
contracts(b)................ 146.7 1.0 1.3 115.4 1.0 1.0
Options written................ 52.3 -- .8 41.3 -- .6
Options purchased.............. 47.3 1.1 -- 37.7 .6 --
-------- ----- ----- -------- ----- -----
Total OTC foreign exchange
contracts and options.......... 246.3 2.1 2.1 194.4 1.6 1.6
-------- ----- ----- -------- ----- -----
Other contractual commitments:
Options and warrants on
equities and equity
indices..................... 63.3 3.1 3.2 54.8 1.8 2.7
Options and forward contracts
on fixed income
securities.................. 383.8 .6 1.1 343.4 .3 .1
Physical commodities
contracts................... 7.0 .2 .2 14.3 .4 .2
-------- ----- ----- -------- ----- -----
Total contractual commitments.... $4,441.8 $14.3 $15.7 $3,294.3 $10.1 $11.7
======== ===== ===== ======== ===== =====
</TABLE>
- ---------------
(a) Margin on futures contracts is included in receivables/payables to brokers,
dealers and clearing organizations on the consolidated statements of
financial condition.
(b) Includes notional values of swap agreements and forward currency contracts
for non-trading activities (primarily related to the Company's fixed-rate
long-term debt) of $16.2 billion and $6.1 billion at December 31, 1998 and
$17.6 billion and $4.1 billion at December 31, 1997, respectively.
The annual average balances of the Company's contractual commitments, based
on month-end balances, are as follows:
<TABLE>
<CAPTION>
1998 1997
---------------------- ----------------------
AVERAGE AVERAGE AVERAGE AVERAGE
DOLLARS IN BILLIONS ASSETS LIABILITIES ASSETS LIABILITIES
- ------------------- ------- ----------- ------- -----------
<S> <C> <C> <C> <C>
Swaps, swap options, caps and floors................. $ 7.2 $ 7.8 $4.4 $ 6.2
Index and equity contracts and options............... 2.6 3.3 1.9 2.9
Foreign exchange contracts and options............... 2.2 2.1 1.5 1.4
Physical commodities contracts....................... .3 .2 .3 .2
Forward contracts on fixed income securities......... .6 1.0 .4 .3
----- ----- ---- -----
Total contractual commitments........................ $12.9 $14.4 $8.5 $11.0
===== ===== ==== =====
</TABLE>
F-34
<PAGE> 78
SALOMON SMITH BARNEY HOLDINGS INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
Credit Risk
The Company regularly transacts business with retail customers, and
transacts with or owns securities issued by a broad range of corporations,
governments, international organizations, central banks and other financial
institutions. Phibro regularly transacts business with independent and
government-owned oil producers, a wide variety of end users, trading companies
and financial institutions. Credit risk is measured by the loss the Company
would record if its counterparties failed to perform pursuant to the terms of
their contractual obligations and the value of collateral held, if any, was not
adequate to cover such losses. The Company has established controls to monitor
the creditworthiness of counterparties, as well as the quality of pledged
collateral, and uses bilateral security agreements and master netting agreements
whenever possible to mitigate the Company's exposure to counterparty credit
risk. Master netting agreements enable the Company to net certain assets and
liabilities by counterparty. The Company also nets across product lines and
against cash collateral, provided such provisions are established in the master
netting and cash collateral agreements. The Company may require counterparties
to submit additional collateral pursuant to the above agreements when deemed
necessary.
The Company enters into collateralized financing agreements in which it
extends short-term credit, primarily to major financial institutions. The
Company controls access to the collateral pledged by the counterparties, which
consists largely of securities issued by the G-7 governments or their agencies
that may be liquidated in the event of counterparty default.
In addition, margin levels are monitored daily and additional collateral
must be deposited as required. If customers cannot meet collateral requirements,
the Company will liquidate sufficient underlying financial instruments to bring
the account in compliance with the required margin level.
Concentrations of Credit Risk
Concentrations of credit risk from financial instruments, including
contractual commitments, exist when groups of issuers or counterparties have
similar business characteristics or are engaged in like activities that would
cause their ability to meet their contractual commitments to be adversely
affected, in a similar manner, by changes in the economy or other market
conditions. The Company monitors credit risk on both an individual and group
counterparty basis. The Company's largest single concentration of credit risk
is with securities issued by the U.S. government and its agencies, which
totaled $24.6 billion at December 31, 1998 and $52.1 billion at December 31,
1997. With the addition of U.S. government and U.S. government agency
securities pledged as collateral by counterparties in connection with
collateralized financing activity, the Company's total holdings of U.S.
government securities were $114.1 billion or 43% of the Company's total assets,
before FIN 41 netting, at December 31, 1998 and $132.8 billion or 41% of the
Company's total assets, before FIN 41 netting, at December 31, 1997. Similarly,
concentrations with non-U.S. governments totaled $47.6 billion at December 31,
1998 and $103.5 billion at December 31, 1997. These consist predominantly of
securities issued by the governments of major industrial nations. Remaining
concentrations arise principally from contractual commitments with
counterparties in financial or commodities transactions involving future
settlement and fixed income securities owned. Excluding governments, no
concentration with a single counterparty exceeded 1% of total assets at
December 31, 1998 or 1997. North America and Europe represent the largest
geographic concentrations. Among industries, other major derivatives dealers
represent the largest group of counterparties. The Company has one year
remaining on a three-year credit support agreement
F-35
<PAGE> 79
SALOMON SMITH BARNEY HOLDINGS INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
with Genesis Energy, L.P., pursuant to which it is committed to provide Genesis
with working capital support of up to $300 million until December 31, 1999.
F-36
<PAGE> 80
SALOMON SMITH BARNEY HOLDINGS INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
NOTE 18. FAIR VALUE INFORMATION
SFAS 107, Disclosures about Fair Value of Financial Instruments, requires
the disclosure of the fair value of all financial instruments. The following
information is presented to help users gain an understanding of the relationship
between the amounts reported in the Company's financial statements and the
related market or fair values. Specific accounting policies are discussed in
Note 4 to the consolidated financial statements.
At December 31, 1998, $206 billion or 97% of the Company's total assets and
$188 billion or 93% of the Company's total liabilities were carried at market
value or fair value or at amounts that approximate such values. At December 31,
1997, $272 billion or 98% of the Company's total assets and $253 billion or 94%
of the Company's total liabilities were carried at either market or fair values
or at amounts that approximate such values. Financial instruments recorded at
market or fair value include cash and cash equivalents, financial instruments,
commodities and contractual commitments used for trading purposes.
Financial instruments recorded at contractual amounts that approximate
market or fair value include collateralized short-term financing agreements,
receivables, commercial paper and other short-term borrowings, payables and
accrued liabilities, and variable rate term debt. The market values of such
items are not materially sensitive to shifts in market interest rates because of
the limited term to maturity of many of these instruments and/or their variable
interest rates.
The following table reflects financial instruments which are recorded at
contractual or historical amounts that do not necessarily approximate market or
fair value. Such instruments include U.S. dollar denominated collateralized
mortgage obligations ("CMOs") and the assets securing U.S. dollar denominated
CMOs, the Company's fixed rate term debt, as well as the fair value of
derivative instruments that are used for non-trading, or end user, purposes.
<TABLE>
<CAPTION>
1998 1997
----------------------------------- -----------------------------------
ASSETS LIABILITIES ASSETS LIABILITIES
---------------- ---------------- ---------------- ----------------
DOLLARS IN BILLIONS CARRYING FAIR CARRYING FAIR CARRYING FAIR CARRYING FAIR
DECEMBER 31, VALUE VALUE VALUE VALUE VALUE VALUE VALUE VALUE
------------------- -------- ----- -------- ----- -------- ----- -------- -----
<S> <C> <C> <C> <C> <C> <C> <C> <C>
Financial instruments recorded at
contractual amounts or historical
amounts that do not necessarily
approximate market or fair value:
Assets securing U.S. dollar
denominated CMOs (fixed
rate)......................... $.1 $.1 $.2 $.3
U.S. dollar denominated CMOs
(fixed rate).................. $ .1 $ .1 $ .2 $ .2
Fixed rate term debt............. 14.6 15.1 15.0 15.3
--- --- ----- ----- --- --- ----- -----
Derivatives used for non-trading
purposes......................... $-- $.6 $ -- $ .2 $-- $.5 $ -- $ .2
=== === ===== ===== === === ===== =====
</TABLE>
The fair value of fixed rate term debt has been estimated by using a
discounted cash flow analysis. The Company's U.S. dollar denominated fixed rate
CMOs and assets securing U.S. dollar denominated fixed rate CMOs are carried at
their contractual amounts. CMOs and the assets that secure them should not be
viewed independently. Taken together, the fair
F-37
<PAGE> 81
SALOMON SMITH BARNEY HOLDINGS INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
value of the Company's dollar denominated CMOs and the assets securing them is
the present value of the difference between future cash inflows from the CMO
collateral and cash outflows to service the CMOs.
NOTE 19. RELATED PARTY BALANCES
The Company has related party balances with Citigroup and certain of its
subsidiaries. These balances include cash accounts, collateralized financing
transactions, margin accounts and derivative trading. These transactions are
entered into in the ordinary course of business and are not material to the
Company's consolidated statement of financial condition.
NOTE 20. OTHER EVENTS
In 1996, the Company sold its indirect wholly owned subsidiary, The
Mortgage Corporation Limited ("TMC"), resulting in an after-tax gain of $31
million ($48 million pre-tax). TMC originated and serviced residential mortgages
in the United Kingdom.
NOTE 21. PARENT COMPANY ONLY CONDENSED FINANCIAL STATEMENTS
The following are condensed financial statements of Salomon Smith Barney
Holdings Inc. (Parent Company Only):
PARENT COMPANY ONLY CONDENSED STATEMENTS OF INCOME
<TABLE>
<CAPTION>
DOLLARS IN MILLIONS
YEAR ENDED DECEMBER 31, 1998 1997 1996
- ----------------------- ---- ------ ------
<S> <C> <C> <C>
Revenues, net of interest expense.......................... $202 $ 213 $ 126
Loss on sale of Basis Petroleum............................ -- -- (505)
Restructuring charge....................................... -- 180 --
Noninterest expenses....................................... 94 154 117
---- ------ ------
Income (loss) before income taxes.......................... 108 (121) (496)
Provision/(benefit) for income taxes....................... (24) (57) (225)
Equity in earnings of subsidiaries......................... 686 1,209 1,771
---- ------ ------
Net income................................................. $818 $1,145 $1,500
==== ====== ======
</TABLE>
F-38
<PAGE> 82
SALOMON SMITH BARNEY HOLDINGS INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
PARENT COMPANY ONLY CONDENSED STATEMENTS OF FINANCIAL CONDITION
<TABLE>
<CAPTION>
DOLLARS IN MILLIONS
DECEMBER 31, 1998 1997
- ------------------- ------- -------
<S> <C> <C>
Assets:
Cash and cash equivalents................................ $ 3 $ --
Financial instruments and contractual commitments........ 152 258
Receivables.............................................. 349 280
Receivable from subsidiaries(1).......................... 32,570 29,271
Investment in subsidiaries............................... 7,293 7,241
Property, equipment and leasehold improvements, net...... 216 238
Other assets............................................. 1,818 1,054
------- -------
Total assets............................................. $42,401 $38,342
======= =======
Liabilities and stockholder's equity:
Commercial paper and other short-term borrowings......... $11,210 $ 8,723
Financial instruments sold, not yet purchased and
contractual commitments................................ 863 644
Other liabilities........................................ 3,456 2,320
Term debt................................................ 17,336 17,781
Subordinated debt payable to SI Financing Trust I........ 356 356
Subordinated debt payable to SSBH Capital Trust I........ 412 --
------- -------
Total liabilities........................................ 33,633 29,824
Stockholder's equity..................................... 8,768 8,518
------- -------
Total liabilities and stockholder's equity............... $42,401 $38,342
======= =======
</TABLE>
- ---------------
(1) Includes $3.8 billion and $3.1 billion of subordinated note receivables at
December 31, 1998 and December 31, 1997, respectively.
F-39
<PAGE> 83
SALOMON SMITH BARNEY HOLDINGS INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
PARENT COMPANY ONLY CONDENSED STATEMENTS OF CASH FLOWS
<TABLE>
<CAPTION>
DOLLARS IN MILLIONS
YEAR ENDED DECEMBER 31, 1998 1997 1996
- ----------------------- ------- -------- -------
<S> <C> <C> <C>
Cash flows from financing activities:
Net increase in commercial paper and other short-term
borrowings............................................. $ 2,487 $ 6,603 $ 229
Proceeds from issuance of term debt....................... 4,155 7,984 4,659
Term debt maturities and repurchases...................... (4,837) (3,955) (4,180)
Issuance of preferred stock............................... -- -- 250
Redemption of preferred stock............................. -- -- (112)
Other capital transactions................................ -- (95) (45)
Dividends paid............................................ (732) (604) (820)
------- -------- -------
Cash provided by (used in) financing activities............. 1,073 9,933 (19)
------- -------- -------
Cash flows from investing activities:
Increase in receivables from subsidiaries, net............ (2,150) (11,356) (3,290)
Dividends received from subsidiaries...................... 841 834 2,359
Capital infusions and other capital transactions with
subsidiaries........................................... (166) (69) (174)
Purchases of property, equipment and leasehold
improvements........................................... -- (9) (3)
Proceeds from sale of Basis Petroleum..................... -- 365 --
------- -------- -------
Cash used in investing activities........................... (1,475) (10,235) (1,108)
------- -------- -------
Cash provided by operating activities....................... 405 299 1,116
------- -------- -------
Increase (decrease) in cash and cash equivalents............ 3 (3) (11)
Cash and cash equivalents at beginning of year.............. 0 3 14
------- -------- -------
Cash and cash equivalents at end of year.................... $ 3 $ 0 $ 3
======= ======== =======
</TABLE>
BASIS OF PRESENTATION
The accompanying condensed financial statements, which include the accounts
of Salomon Smith Barney Holdings Inc. ("SSBH"), a wholly owned subsidiary of
Citigroup, should be read in conjunction with the consolidated financial
statements of SSBH and its subsidiaries.
Investments in subsidiaries are accounted for under the equity method. For
information regarding the Company's term debt see Note 9 of the consolidated
financial statements.
RELATED PARTY TRANSACTIONS
SSBH engages in various transactions with its subsidiaries that are
characteristic of a consolidated group under common control. As a public debt
issuer, SSBH has access to long-term sources of funds that are loaned from SSBH
to certain of its subsidiaries. Such intercompany advances are payable on demand
and bear interest at varying rates.
F-40
<PAGE> 84
SALOMON SMITH BARNEY HOLDINGS INC. AND SUBSIDIARIES
QUARTERLY FINANCIAL DATA (UNAUDITED)
Quarterly results for the year ended December 31, 1998 were as follows:
<TABLE>
<CAPTION>
QUARTER ENDED
--------------------------------------------------
DOLLARS IN MILLIONS MARCH 31 JUNE 30 SEPTEMBER 30 DECEMBER 31
- ------------------- -------- ------- ------------ -----------
<S> <C> <C> <C> <C>
Noninterest revenues........................... $2,733 $2,334 $ 588 $2,116
Net interest and dividends..................... 395 401 325 315
------ ------ ------ ------
Revenues, net of interest expense.............. 3,128 2,735 913 2,431
Expenses, excluding interest................... 2,318 1,766 1,437 2,370
------ ------ ------ ------
Income (loss) from continuing operations before
income taxes................................. 810 969 (524) 61
Provision/(benefit) for income taxes........... 308 368 (199) 21
------ ------ ------ ------
Net income (loss).............................. $ 502 $ 601 $ (325) $ 40
====== ====== ====== ======
</TABLE>
Quarterly results for the year ended December 31, 1997 were as follows:
<TABLE>
<CAPTION>
QUARTER ENDED
--------------------------------------------------
DOLLARS IN MILLIONS MARCH 31 JUNE 30 SEPTEMBER 30 DECEMBER 31
- ------------------- -------- ------- ------------ -----------
<S> <C> <C> <C> <C>
Noninterest revenues........................... $2,379 $2,294 $2,659 $2,102
Net interest and dividends..................... 322 430 366 395
------ ------ ------ ------
Revenues, net of interest expense.............. 2,701 2,724 3,025 2,497
Expenses, excluding interest................... 2,023 1,985 2,197 2,922
------ ------ ------ ------
Income (loss) from continuing operations before
income taxes................................. 678 739 828 (425)
Provision/(benefit) for income taxes........... 267 288 321 (201)
------ ------ ------ ------
Net income (loss).............................. $ 411 $ 451 $ 507 $ (224)
====== ====== ====== ======
</TABLE>
F-41
<PAGE> 85
EXHIBIT INDEX
<TABLE>
<CAPTION>
EXHIBIT
NUMBER DESCRIPTION OF EXHIBIT
- ------- ----------------------
<C> <S>
3.01 Amended and Restated Certificate of Incorporation of Salomon
Smith Barney Holdings Inc. (the "Company"), effective
December 1, 1997, incorporated by reference to Exhibit 4(a)
to Amendment No. 2 to the Company's Registration Statement
on Form S-3 (No. 333-38931).
3.02 By-Laws of the Company, incorporated by reference to Exhibit
4(b) to Amendment No. 2 to the Company's Registration
Statement on Form S-3 (No. 333-38931).
10.01+ Amended and Restated Lease dated as of March 27, 1998
between State Street Bank and Trust Company of Connecticut,
National Association, as Trustee (Lessor), and Smith Barney
Inc., Salomon Brothers Inc, Travelers Group Inc., Mutual
Management Corp., Smith Barney Capital Services Inc., Smith
Barney Commercial Corp., Smith Barney Futures Management
Inc. and Smith Barney Global Capital Management, Inc., as
tenants in common (Lessee).
10.02 Lease dated November 23, 1988 between 7 World Trade Company
and Salomon Inc, incorporated by reference to Exhibit 10(a)
to the Company's Annual Report on Form 10-K, as amended, for
the fiscal year ended December 31, 1991 (File No. 1-4346).
12.01+ Computation of ratio of earnings to fixed charges.
21.01 Pursuant to General Instruction I of Form 10-K, the list of
subsidiaries of the Company is omitted.
23.01+ Consent of PricewaterhouseCoopers L.L.P.
23.02+ Consent of Arthur Andersen LLP.
27.01+ Financial Data Schedule.
99.01+ Independent Accountants' Report.
</TABLE>
- ---------------
+ Filed herewith.
38
<PAGE> 1
AMENDED AND RESTATED LEASE
Dated as of March 27, 1998,
Between
STATE STREET BANK AND TRUST COMPANY
OF CONNECTICUT, NATIONAL ASSOCIATION,
not in its individual capacity,
but solely as Trustee,
Lessor
and
SMITH BARNEY INC.,
SALOMON BROTHERS INC,
TRAVELERS GROUP INC.,
MUTUAL MANAGEMENT CORP.,
SMITH BARNEY CAPITAL SERVICES INC.,
SMITH BARNEY COMMERCIAL CORP.,
SMITH BARNEY FUTURES MANAGEMENT INC.
and
SMITH BARNEY GLOBAL CAPITAL MANAGEMENT, INC.,
as tenants in common,
Lessee
THIS LEASE HAS BEEN MANUALLY EXECUTED IN COUNTERPARTS NUMBERED CONSECUTIVELY
FROM 1 TO 35. TO THE EXTENT, IF ANY, THAT THIS LEASE CONSTITUTES CHATTEL PAPER
(AS SUCH TERM IS DEFINED IN THE UNIFORM COMMERCIAL CODE AS IN EFFECT IN ANY
APPLICABLE JURISDICTION), NO SECURITY INTEREST IN THIS LEASE MAY BE CREATED
THROUGH THE TRANSFER OR POSSESSION OF ANY COUNTERPART OF THIS LEASE OTHER THAN
COUNTERPART NO. 1.
This is Counterpart No. ____
<PAGE> 2
TABLE OF CONTENTS
<TABLE>
<CAPTION>
Page
----
<S> <C>
1. Lease of Property; Title and Condition...................................................................1
2. Use; Quiet Enjoyment; Hazardous Materials................................................................2
3. Term.....................................................................................................3
4. Rent.....................................................................................................3
5. Net Lease; Non-Terminability.............................................................................4
6. Taxes and Assessments; Compliance with Law; Certain Agreements...........................................5
7. Matters of Title.........................................................................................5
8. Certain Zoning Matters...................................................................................6
9. Maintenance and Repair...................................................................................6
10. Lessee Alterations; Removal..............................................................................7
11. Lessee's Right to Contest Property Taxes.................................................................7
12. Condemnation and Casualty................................................................................8
13. Effect of Termination Notice............................................................................10
14. Lessee Purchase Option..................................................................................10
15. Procedure Upon Purchase.................................................................................11
16. Insurance...............................................................................................11
17. Subletting and Non-Disturbance; No Mortgage of Estate; Assignment.......................................13
18. Permitted Contests......................................................................................14
19. Default Provisions......................................................................................15
20. Additional Rights.......................................................................................17
21. Notices, Demands, and Other Instruments.................................................................18
22. No Default Certificate..................................................................................18
23. Surrender...............................................................................................18
</TABLE>
<PAGE> 3
<TABLE>
<CAPTION>
<S> <C>
24. Miscellaneous...........................................................................................19
25. Headings and Table of Contents..........................................................................20
26. Lessor's Right to Cure Lessee's Default.................................................................20
27. Expiration of the Lease.................................................................................20
28. Subordination...........................................................................................21
29. Waiver of Trial by Jury.................................................................................22
30. Jurisdiction............................................................................................22
31. No Merger of Title......................................................................................22
32. Further Assurances......................................................................................22
33. Schedules; Exhibits.....................................................................................22
34. Tenants in Common.......................................................................................22
SCHEDULE A Description of the Parcel
SCHEDULE B Rent Schedule
SCHEDULE C Interests of Tenants in Common
Exhibit A Form of Memorandum of Lease
</TABLE>
2
<PAGE> 4
AMENDED AND RESTATED LEASE dated as of March 27, 1998 (this
"Lease"), between STATE STREET BANK AND TRUST COMPANY OF CONNECTICUT, NATIONAL
ASSOCIATION, not in its individual capacity but solely in its capacity as
Trustee of the 1993 Smith Barney Office Building Trust under that certain
unrecorded Amended and Restated Declaration of Trust dated as of December 30,
1994 (as amended on March 27, 1998, the "Declaration") (the "Lessor"), having
its Corporate Trust Office at c/o State Street Bank and Trust Company, P.O. Box
778, Boston, Massachusetts 02210, and SMITH BARNEY INC., a Delaware corporation,
SALOMON BROTHERS INC, a Delaware corporation, MUTUAL MANAGEMENT CORP. (formerly
Smith Barney Mutual Funds Management Inc., which was successor by merger to
Mutual Management Corp.), a New York Corporation, SMITH BARNEY CAPITAL SERVICES
INC., a Delaware corporation, SMITH BARNEY COMMERCIAL CORP., a Delaware
corporation, SMITH BARNEY FUTURES MANAGEMENT INC., a Delaware corporation, SMITH
BARNEY GLOBAL CAPITAL MANAGEMENT, Inc., a Delaware corporation, and TRAVELERS
GROUP INC. (formerly The Travelers Inc.), a Delaware Corporation, as tenants in
common (collectively, the "Lessee").
Preliminary Statement
The Lessee and Lessor entered into that certain Lease dated
July 30, 1993 (the "Original Lease");
The Lessee and Lessor entered into that certain Amended and
Restated Lease dated December 30, 1994 (the "Amended and Restated Lease");
The Company desires, among other things to refinance the
Instruments and acquire funding to complete construction of the Modifications
and the parties to the Participation Agreement have agreed to such refinancing
and additional construction;
In connection with such refinancing the parties hereto desire
to amend and restate the Amended and Restated Lease in its entirety to provide,
among other things, for an extended lease term;
Lessor wishes to lease the Property to Lessee and Lessee
wishes to lease the same from Lessor. Lessor and Lessee intend that this Lease
be treated, for accounting purposes, as an operating lease. Capitalized terms
used herein and not otherwise defined herein shall have the respective meanings
ascribed to such terms in the Amended and Restated Lease dated as of December
30, 1994 by and among the Lessor, the Lessee and the financial institutions
named therein, as the same may be amended, modified or supplemented from time to
time (the "Participation Agreement").
NOW, THEREFORE, the parties do hereby agree as follows:
1. Lease of Property; Title and Condition.
(a) In consideration of the rents and covenants herein stipulated to be
paid and performed by the Lessee and upon the terms and conditions herein
specified, the Lessor hereby leases the Property to the Lessee and the Lessee
hereby leases the Property from the Lessor.
(b) The Property is leased to the Lessee hereunder subject to (a) all
applicable Legal Requirements and all Insurance Requirements now or hereafter in
effect; and (b) all encumbrances now or hereafter affecting the Property. The
Lessee has examined the Property and title thereto (as well as Lessor's interest
therein) and has found the same satisfactory for all purposes of this Lease.
<PAGE> 5
(c) THE LESSOR MAKES NO WARRANTY OR REPRESENTATION, EXPRESS OR IMPLIED,
WITH RESPECT TO THE PROPERTY, THE IMPROVEMENTS OR ANY FIXTURE OR OTHER ITEM
CONSTITUTING A PORTION THEREOF, OR THE LOCATION, USE, DESCRIPTION, DESIGN,
MERCHANTABILITY, FITNESS FOR USE FOR ANY PARTICULAR PURPOSE, CONDITION, OR
DURABILITY THEREOF OR AS TO THE QUALITY OF THE MATERIAL OR WORKMANSHIP THEREIN,
OR AS TO THE LESSOR'S TITLE THERETO OR OWNERSHIP THEREOF OR OTHERWISE, IT BEING
AGREED THAT ALL RISKS INCIDENT THERETO ARE TO BE BORNE BY THE LESSEE. IN THE
EVENT OF ANY DEFECT OR DEFICIENCY OF ANY NATURE IN THE PROPERTY, THE
IMPROVEMENTS OR ANY FIXTURE OR OTHER ITEM CONSTITUTING A PORTION THEREOF,
WHETHER PATENT OR LATENT, THE LESSOR SHALL HAVE NO RESPONSIBILITY OR LIABILITY
WITH RESPECT THERETO. THE PROVISIONS OF THIS PARAGRAPH 1(c) HAVE BEEN NEGOTIATED
AND ARE INTENDED TO BE A COMPLETE EXCLUSION AND NEGATION OF ANY AND ALL
WARRANTIES, EXPRESS OR IMPLIED, BY THE LESSOR WITH RESPECT TO THE PROPERTY, THE
IMPROVEMENTS OR ANY FIXTURE OR OTHER ITEM CONSTITUTING A PORTION THEREOF,
WHETHER ARISING PURSUANT TO THE UCC OR ANY OTHER LAW, NOW OR HEREAFTER IN
EFFECT.
2. Use; Quiet Enjoyment; Hazardous Materials.
(a) The Lessee may use the Property for any lawful purpose, provided
that the use of the Property shall comply with all material Legal Requirements.
(b) Subject to paragraph 28 hereof, the Lessor covenants that, unless a
Default, Event of Termination, or an Event of Default has occurred and is
continuing, it will not, and will not permit any party claiming by or under the
Lessor to, interfere with the peaceful and quiet possession and enjoyment of the
Property by the Lessee; provided, however, that the Lessor, the Independent
Engineer, the Managing Agents, the Environmental Consultant and their
successors, assigns, representatives and agents (the "Lessor Group"), at
Lessor's sole cost and expense, may, upon reasonable notice to the Lessee
(unless a Default, Event of Termination or an Event of Default has occurred, in
which case, such entrance and examination shall be at Lessee's sole cost and
expense and no such notice shall be necessary), enter upon the Property and
examine the Property and the Lessee's books and records relating to the Property
and its operation as it may require at reasonable times and upon reasonable
notice.
(c) Any failure by the Lessor or any member of the Lessor Group to
comply with the foregoing provisions of this paragraph 2 or any other provision
of this Lease shall not give the Lessee any right to cancel or terminate this
Lease, or to abate, reduce or make deduction from or offset against any Basic
Rent, Additional Rent or other sum payable under this Lease, or to fail to
perform or observe any other covenant, agreement or obligation hereunder.
(d) Lessor, at Lessee's sole cost and expense, shall cooperate and
assist with Lessee's efforts to obtain all services, Applicable Permits and
contracts necessary or useful for the construction of the Modifications or the
operation and maintenance of the Property for the intended purposes thereof and
the Lessor shall execute such documents or papers as may be reasonably necessary
for such purposes.
(e) The Lessee shall, and it shall require (and shall indemnify in the
manner and the Persons specified in Section 9.15 of the Participation Agreement
for the breach of such requirement) that any and all sublessees, employees,
contractors, subcontractors, agents, representatives, affiliates,
2
<PAGE> 6
consultants, occupants and any and all other Persons, (i) comply in all material
respects with all applicable Environmental Laws relating to the Property or
activities undertaken on the Property, and (ii) use, employ, process, emit,
generate, store, handle, transport, dispose of and/or arrange for the disposal
of any and all Hazardous Materials in, on or, directly or indirectly, related to
or used in connection with the Property or any part thereof in compliance in all
material respects with all applicable Environmental Laws and in a manner
consistent with prudent industry practice and which does not pose a significant
risk to human health or the environment.
(f) The Company has entered into the Construction Agency Agreement with
the Lessor pursuant to which the Lessee, as Construction Agent, has agreed to
design, procure and construct the Modifications. All Modifications shall, as the
construction or installation of the same is completed, become a part of the
Improvements, and title thereto shall be and remain in the Lessor.
3. Term. The Property is leased for a term (the "Term"), which
commenced as of July 30, 1993 and shall end on March 27, 2003 (the "Expiration
Date") or on such earlier date as this Lease shall be terminated pursuant to any
provision hereof.
4. Rent.
(a) Lessee shall pay to the Lessor Basic Rent on each Payment Date in
the amounts determined in accordance with Schedule B hereto.
(b) All amounts that the Lessee is required to pay to the Lessor
pursuant to this Lease (other than Basic Rent), including, but not limited to,
(i) all sums, costs and expenses paid or incurred by Lessor pursuant to
Paragraphs 23 and 26 hereof and Item I.B(1) of Schedule B hereto, (ii) all costs
and expenses relating to the Property or the Lessee's use or the Lessor's
ownership thereof or the Lessee's failure to perform its obligations hereunder,
(iii) any and all amounts payable upon transfer or purchase of (or otherwise
relating to) the Property, and (iv) Additional Costs as more fully described in
Item II of Schedule B hereto, as well as Impositions and Charges pursuant to
Section 6.03 of the Participation Agreement, together with every fine, penalty,
interest and cost that may be added for non-payment or late payment thereof, as
well as the costs of enforcement and legal fees in respect of clauses (ii) and
(iii) above, shall constitute "Additional Rent" and shall be paid by Lessee on
demand. Lessor shall give Lessee notice of any Additional Rent due hereunder
promptly after it has knowledge of such Additional Rent, and shall use its best
efforts to notify the Lessee in advance of the due date and amount of such
Additional Rent; provided that failure to give such prompt notice shall not
relieve the Lessee of its obligation to pay such Additional Rent.
(c) The Lessee shall pay on demand to the Lessor interest at the
Default Rate on all amounts payable by it to the Lessor hereunder (i) from the
due date thereof until paid in full and (ii) upon the occurrence and during the
continuance of an Event of Default.
(d) All amounts payable by the Lessee hereunder shall be paid in lawful
money of the United States of America and in immediately available funds by
12:30 P.M. (New York City Time) on the date when due, unless any such due date
is not a Business Day in which case (unless otherwise set forth herein) payment
shall be due and payable on the next succeeding Business Day (but any amounts
due shall be calculated through the date actually paid) at the Lessor's address
for payments set forth in the Participation Agreement or at such other address
or to such other person in the United States of America or in such other manner
as the Lessor from time to time may designate to the Lessee by written
instructions.
3
<PAGE> 7
(e) The Lessee shall perform all of its obligations under this Lease at
its sole cost and expense and shall pay, when due and without notice or demand
(except as otherwise provided in this Lease), all amounts due hereunder. The
Lessee agrees to pay on demand (except as otherwise provided for in the
Operative Documents) (i) all Impositions which have become due and payable
(subject to Lessee's rights pursuant to paragraphs 11 and 18) and (ii) all
indemnity obligations and all charges, fees, costs and expenses of the Lessor
(as well as amounts equal to all indemnity obligations the Lessor undertakes
pursuant to the Declaration or the Participation Agreement to the Purchasers,
including, without limitation, the fees and expenses of Trustee's Counsel and
Special Counsel and the charges, fees and expenses of the Appraiser, the
Independent Engineer and the Environmental Consultant) which are required to be
paid by, or in connection with the preparation, execution, delivery,
administration, performance, modification and amendment of, this Lease and the
other Operative Documents and any other documents to be delivered in connection
herewith or therewith as well as in connection with the enforcement (whether
through negotiations, legal proceedings or otherwise) of the Operative Documents
and such other documents.
5. Net Lease; Non-Terminability.
(a) This Lease is a "net lease" and, except as otherwise expressly
provided herein, this Lease, any present or future Law to the contrary
notwithstanding, shall not terminate, nor shall the Lessee be entitled to any
abatement, reduction, set-off, counterclaim, defense or deduction with respect
to any Basic Rent, Additional Rent or other sum payable hereunder. The
obligations of the Lessee hereunder shall not be affected by reason of: (i) any
damage to or destruction of the Property or any part thereof by any cause
whatsoever (including, without limitation, by fire, Casualty or act of God or
enemy or any other force majeure event);(ii) any Condemnation, including,
without limitation, a temporary Condemnation of the Property (or Lessor's
interest therein) or any part thereof; (iii) any prohibition, limitation,
restriction or prevention of the Lessee's use, occupancy or enjoyment of the
Property or any part thereof by any Person; (iv) any matter affecting title to
the Property or any part thereof; (v) any eviction of the Lessee from, or loss
of possession by the Lessee of, the Property or any part thereof, by reason of
title paramount or otherwise; (vi) any default by the Lessor hereunder or under
any other agreement; (vii) the invalidity or unenforceability of any provision
hereof or the impossibility or illegality of performance by the Lessor or the
Lessee or both; (viii) any action of any Governmental Authority; or (ix) any
other cause or occurrence whatsoever, whether similar or dissimilar to the
foregoing. The parties intend that the obligations of the Lessee hereunder shall
continue unaffected unless such obligations shall have been modified or
terminated pursuant to an express provision of this Lease.
(b) The Lessee shall remain obliged under this Lease in accordance with
its terms and shall not take any action to terminate, rescind or avoid this
Lease, notwithstanding any bankruptcy, insolvency, reorganization, liquidation,
dissolution or other proceeding affecting the Lessor or any action with respect
to this Lease which may be taken by any trustee, receiver or liquidator or by
any court. Except as expressly permitted in this Lease, the Lessee waives all
rights to terminate or surrender this Lease, or to any abatement or deferment of
Basic Rent, Additional Rent or other sums payable hereunder. The Lessee shall
remain obliged under this Lease in accordance with its terms and the Lessee
hereby waives any and all rights now or hereafter conferred by Law or otherwise
to modify or to avoid strict compliance with its obligations under this Lease.
All payments made to the Lessor hereunder as required hereby shall be final, and
the Lessee shall not seek to recover any such payment or any part thereof for
any reason whatsoever, absent manifest error.
4
<PAGE> 8
6. Taxes and Assessments; Compliance with Law; Certain Agreements.
(a) The Lessee shall pay or cause to be paid, subject to paragraphs 11
and 18, all Impositions before any fine, penalty, interest or cost may be added
or any default may be claimed or any termination or foreclosure or forfeiture
procedures for nonpayment may be commenced. If any Imposition may legally be
paid in installments, such Imposition may be so paid in installments; provided,
however, that all such installments which may be due from time to time shall be
paid by the Lessee by, on or before the Expiration Date or the earlier
termination of this Lease.
(b) The Lessee shall comply in all material respects with, and cause
the Property to be in compliance in all material respects with, all Legal
Requirements.
(c) Lessee shall promptly, but in any case within five Business Days of
the receipt thereof, forward to Lessor and the Managing Agents copies of any
notices, complaints, summons, or any other notifications received by Lessee from
any Governmental Authority relating to alleged violations of any Environmental
Law or potential adverse actions in any way involving environmental, health, or
safety matters affecting the Property (or any part thereof) in which the cleanup
obligations or corrective action or the liability under any Environmental Law
could exceed $10,000. Lessee shall promptly notify Lessor when it becomes aware
of any spill or any other release of any Hazardous Material, whether or not such
spill or release occurred prior to, on or after the date hereof, at, in, on,
under or from the Property or any part thereof that is required to be reported
to any Governmental Authority or that could reasonably be expected to result in
any ordered remediation or corrective action or obligation. Whether or not the
Lessee is required to give notice of any of the matters set forth in this
paragraph 6(c), the Lessee shall immediately initiate, at its sole cost and
expense, such actions as may be necessary to comply in all material respects
with all applicable Environmental Laws and to alleviate any significant risk to
human health or the environment. Once the Lessee commences such actions, the
Lessee shall thereafter diligently and expeditiously proceed to comply in a
timely manner with all Environmental Laws and to eliminate any significant risk
to human health or the environment and shall, at the request of the Lessor, give
periodic progress reports on its compliance efforts and actions.
7. Matters of Title.
(a) Other than Permitted Encumbrances, the Lessee shall not create or
permit to be created or exist, and shall promptly remove and discharge, any Lien
upon this Lease or any sublease permitted hereby, the Property (or Lessor's
interest therein) or any part thereof or interest therein, or upon any Basic
Rent, Additional Rent or other sum payable hereunder, which Lien arises for any
reason, including, without limitation, any and all Liens which arise out of the
ownership, use, condition, occupancy, construction, possession, repair or
rebuilding of the Property or any part thereof (including, without limitation,
by reason of construction of the Modifications) or by reason of labor or
materials furnished or claimed to have been furnished to the Lessee or for the
Property or any part thereof.
(b) Nothing contained in this Lease shall be considered as constituting
the consent or request of the Lessor, express or implied, to or for the
performance by any contractor, laborer, materialman, or vendor of any labor or
services or for the furnishing of any materials for any construction,
alteration, addition, repair or demolition of or to the Property or any part
thereof. NOTICE IS HEREBY GIVEN THAT THE LESSOR IS NOT AND SHALL NOT BE LIABLE
FOR ANY LABOR, SERVICES OR MATERIALS FURNISHED OR TO BE FURNISHED TO THE LESSEE,
OR TO ANYONE HOLDING OR POSSESSING THE PROPERTY OR ANY PART THEREOF THROUGH OR
UNDER THE LESSEE, AND THAT NO MECHANIC'S OR OTHER SIMILAR
5
<PAGE> 9
STATUTORY LIENS FOR ANY LABOR, SERVICES OR MATERIALS SHALL ATTACH TO OR AFFECT
THE PROPERTY OR ANY PART THEREOF.
(c) The Lessor shall not create, grant or suffer to exist any Lien upon
this Lease, the Property or any part thereof or upon any Basic Rent or
Additional Rent or any other sum payable hereunder except (i) Permitted
Encumbrances and (ii) in respect of any action taken by the Lessor or the
holders from time to time of the Instruments in connection with the perfection
or enforcement of any rights under any Operative Document.
8. Certain Zoning Matters.
(a) Lessor agrees that the Lessee during the Term shall have the
exclusive right (so long as no Event of Termination or Event of Default has
occurred and is continuing) to secure subdivision approvals, site plan
approvals, annexation or de-annexation approvals, zoning variances, and Permits
necessary or desirable for the development, use, operation, maintenance or
condition of the Property (and Lessor's interest therein) or any part thereof;
provided that the fair market value of the Property as a general purpose office
building is not materially lessened thereby; and provided, further that no such
action shall impair the Lien of the Mortgages or the ability of the Agent to
foreclose thereon.
(b) Lessor agrees to execute such documents and take all other actions
as shall be reasonably necessary, and otherwise cooperate with Lessee, in
connection with the matters described above; provided, however, that (i) all
costs and expenses incurred by the Lessor in connection therewith shall be borne
by Lessee and (ii) Lessor shall not be required to execute any documents which
would, in its opinion, materially diminish the value of the Property (or
Lessor's interest therein) as a general purpose office building or otherwise
adversely affect the transactions contemplated by the Operative Documents or the
rights or interests of the Lessor or the holders from time to time of the
Instruments.
9. Maintenance and Repair.
(a) The Lessee, at its own expense, will manage and maintain the
Property (i) in good working order, (ii) in good mechanical condition and
repair, (iii) in accordance with prudent industry practice and (iv) in a manner
consistent with that of other class A office buildings in downtown Manhattan.
Lessee further agrees to take all action, and make all changes and repairs,
structural and nonstructural, foreseen and unforeseen, ordinary and
extraordinary, which (x) may be required to maintain the Property in accordance
with the above standards and (y) which may be required pursuant to any material
Legal Requirement or any Insurance Requirement at any time in effect. All
repairs, replacements and rebuilding by the Lessee hereunder shall immediately
become and shall remain part of the Property, subject to this Lease. The Lessor
shall not be required to, and the Lessee hereby waives any right to require the
Lessor to, manage, maintain, replace, repair or rebuild the Property or any part
thereof, and the Lessee waives any and all rights it may now or hereafter have
to make any repairs at the cost and expense of the Lessor pursuant to any Legal
Requirement, Insurance Requirement, or otherwise, at any time in effect.
(b) In the event that all or any part of the Improvements shall
encroach upon any property or right-of-way adjoining or adjacent to the Parcel
or any part thereof, or shall violate any agreements or conditions affecting the
Property or any part thereof, or shall obstruct any easement or right-of-way to
which the Property or any part thereof may be subject, then the Lessee shall, at
its sole cost and expense, (i) contest such matter pursuant to paragraph 18
hereof, or (ii) obtain valid and effective Permits for or consents to such
encroachments and/or violations (without any liability to Lessor
6
<PAGE> 10
or the holders of the Instruments) or waivers or settlements of all claims,
liabilities and damages resulting therefrom, or (iii) make such changes,
including alteration, to the Improvements and take such other action as shall be
necessary to rectify such encroachments, violations, hindrances, obstructions or
impairments without impairing the value of the Property.
10. Lessee Alterations; Removal. Termination has occurred or no Default
or Event of Default shall have occurred and is continuing, the Lessee may, at
its own cost and expense, make alterations to the Property or any part thereof
(in addition to the Modifications); provided, however, that (i) the fair market
value of the Property (and Lessor's rights and interests therein) shall not
materially be lessened thereby and (ii) such work shall be completed in a good
and workmanlike manner free and clear of any Liens for labor, services or
materials (subject to paragraph 18 hereof) and in compliance with all material
applicable Legal Requirements and all Insurance Requirements.
(a) The Lessee shall be permitted at any time during, or upon the
expiration or termination of, the Term, and at its sole cost and expense, to
remove or demolish any alterations to the Property in accordance with prudent
industry practices; provided, however, that, such removal shall not (i) impair
the intended use or materially reduce the fair market value of the Property (or
any part thereof) (or Lessor's interest therein) below its fair market value
immediately prior to such removal or demolition (assuming compliance by the
Lessee with the terms of this Lease) and (ii) cause a violation of any material
Legal Requirement or any Insurance Requirement or significantly increase any
risk of liability under any Environmental Law or any risk to human health or the
environment. Any damage to the Property or any part thereof caused by such
removal shall promptly be repaired by the Lessee and the Property or any part
thereof shall be restored to its condition (or the equivalent thereof) as it
existed immediately prior to the construction of such removed alterations
(assuming compliance by the Lessee with the terms of this Lease) at the Lessee's
sole cost and expense. The Lessee may place upon the Property (or any part
thereof) any inventory, fixtures, machinery, equipment or other property
belonging to the Lessee or third parties and remove the same at any time during
the Term; provided, however, that, at the request of the Lessor (unless the
Lessee (or its designee) shall have purchased Lessor's right, title and interest
in and to the Property pursuant to the terms hereof), the Lessee shall remove
the same at the expiration or termination hereof and any damage to the Property
or any part thereof caused by any such removal shall promptly be repaired by the
Lessee, and the Property or such part thereof restored to its condition (or the
equivalent thereof) as it existed immediately prior to the placement of any such
property upon the Property (assuming the Property was then in the condition
required pursuant to the terms of this Lease), all at the Lessee's sole cost and
expense.
(b) The Lessee shall notify the Lessor of any alterations (other than
the Modifications) to the Property the cost of which is anticipated to exceed in
the aggregate $3,000,000 in any calendar year, which notice shall include a
reasonably detailed description of the work that will be done. All such
alterations shall become and remain part of the Property and shall be subject to
this Lease, unless and until removed by the Lessee in accordance with paragraph
10(b).
11. Lessee's Right to Contest Property Taxes.
(a) The Lessee, at its own cost and expense and in compliance with
paragraph 18, shall have the sole right, at any time, to seek a reduction in the
assessed valuation of the Property or any part thereof and to contest any
Property Taxes for the Property or any part thereof. The Lessor shall not be
required to join in any proceeding or contest brought by the Lessee unless the
provisions of any Legal Requirement require that the proceeding or contest be
brought by or in the name of the owner of the Property. In that case Lessor
shall join in the proceeding or contest or permit it to be brought in the
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Lessor's name as long as Lessee indemnifies and reimburses the Lessor for any
and all costs and expenses incurred by the Lessor in connection therewith. The
Lessee, on a final non-appealable determination of the proceeding or contest,
shall immediately pay, discharge and satisfy any decision or judgment rendered,
together with all costs, interest, additions to tax, fines and penalties
incidental to any such decision or judgment.
12. Condemnation and Casualty.
(a) General. The Lessee hereby irrevocably assigns to the Lessor any
award or compensation or insurance payment to which the Lessee or any Person
claiming through or under the Lessee may become entitled by reason of its
interest in the Property or any part thereof if (i) the Property or any part
thereof (or Lessor's interest therein) is damaged or destroyed by fire or other
casualty (a "Casualty") or (ii) the use, occupancy or title of the Property or
any part thereof (or Lessor's interest therein) is taken or requisitioned or
sold in, or on account of any actual or threatened condemnation, taking or
eminent domain proceedings, or other action by any Person or Governmental
Authority having the power of eminent domain (a "Condemnation").
The Lessee shall promptly notify the Lessor in writing of any such
Casualty or Condemnation and shall appear in any proceeding or action to defend,
negotiate, prosecute or adjust any claim for any award or compensation or
insurance payment on account of any Casualty or Condemnation and shall take all
appropriate action in connection with any Casualty or Condemnation, including
the employment of counsel satisfactory to the Lessor. The Lessor shall have the
right to appear and participate and to employ counsel in any such proceeding or
action, and the reasonable fees and expenses of such counsel shall be paid by
the Lessee. If the Lessee shall elect not to appear or shall fail to prosecute
diligently, the Lessor may assume the prosecution thereof and the Lessee shall
pay all of the costs and expenses of the Lessor (including, but not limited to,
reasonable fees and expenses of the Lessor's counsel) and the reasonable fees
and expenses of Special Counsel. Other than as provided in paragraph 16(b)
(iii), no settlement of any such proceeding or action shall be made by the
Lessee or the Lessor without the written consent of the other party hereto,
which consent shall not unreasonably be withheld.
Except as provided below, any and all amounts representing proceeds
paid in connection with any such Condemnation or Casualty, as the case may be
(collectively, the "Proceeds"), shall be paid over to the Proceeds Trustee (as
defined below) to be held in trust by such Proceeds Trustee and distributed
either pursuant to this paragraph 12 or pursuant to the Declaration and
paragraph 15 hereof, as appropriate, (all such Proceeds, less the costs and
expenses incurred by the Lessor in collecting such amounts, but including any
reimbursement by the Lessee for costs and expenses in connection therewith to
which the Lessor and the holders from time to time of the Instruments are
entitled pursuant to this Lease or the other Operative Documents, are the "Net
Proceeds"). Any and all Proceeds received by the Lessee in connection with any
such proceeding or action shall be received and held in trust for the benefit of
the Lessor, shall be segregated from other funds of the Lessee and shall be
forthwith paid over to the Proceeds Trustee. The Lessee agrees that this Lease
shall control the rights of the Lessor and the Lessee in any such Proceeds, and
any present or future Law to the contrary is hereby waived. Any and all
reasonable charges, fees and expenses of the Proceeds Trustee shall be paid from
the Net Proceeds. "Proceeds Trustee" shall mean SSBTC or such title company or
other independent bank or trust company as may be designated by the Lessor, at
the direction of the Majority Purchasers. Notwithstanding the foregoing, if the
total amount of Net Proceeds are $25,000,000 or less, and a Termination Notice
shall not have been (or have been deemed to be) delivered and no Event of
Default shall have occurred and is
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continuing, such proceeds shall not be required to be paid over to the Proceeds
Trustee, but shall be paid to the Lessee, for application pursuant to paragraph
12(c) below.
(b) Condemnation or Casualty with Termination.
(i) If a Casualty or a Condemnation shall in the good faith
opinion of the Lessee affect the Property in such manner as to render
it unsuitable for restoration or for continued use and occupancy by the
Lessee for the intended purposes thereof, then the Lessee may deliver
to the Lessor, not later than 30 days after such occurrence a written
notice (herein called a "Termination Notice") describing the event
giving rise to such termination and describing the status of any
proceeding or action and the amount of any Condemnation award or
insurance payment received or expected to be received in connection
therewith, together with the date, or anticipated date, of such
receipt.
(ii) If a Condemnation shall result in the taking of more than
20% of the then fair market value of the Property prior to such
Condemnation, or if a Casualty shall result in the damage or
destruction of more than 20% of the then fair market value of the
Lessor's interest in the Property prior to such Casualty, in each
instance as determined pursuant to the Appraisal Procedure, or if
restoration of the Property to its value and utility prior to such
Casualty or Condemnation shall be impractical or uneconomical or cannot
be completed prior to the Expiration Date, then the Lessee shall be
deemed to have delivered to the Lessor a Termination Notice with
respect to the Property as of such occurrence. Either the Lessor or the
Lessee may initiate the Appraisal Procedure by submitting a written
request that an appraiser be appointed.
(c) Condemnation or Casualty Without Termination. If, after a Casualty
or Condemnation, the Lessee has not given or been deemed to have given a
Termination Notice in accordance with subparagraph 12(b), then this Lease shall
continue in full force and effect, and the Lessee shall, at its cost and
expense, within a reasonable period (not to exceed 30 days) commence and
diligently pursue to completion, regardless of whether or not any Net Proceeds
in respect of such Casualty or Condemnation have been paid to the Proceeds
Trustee or the Lessee, as the case may be, the rebuilding, replacement or repair
of any damage to the Property caused by such event in conformity with the
requirements of this Lease, including without limitation paragraphs 9 and 10 in
order to restore the Property (in the case of a Condemnation, as nearly as
practicable) to the value and operating condition (assuming Lessee's compliance
with the terms of this Lease prior to the occurrence of the Condemnation or
Casualty) thereof immediately prior to such event. In connection with such
restoration the Lessee shall, before beginning such restoration, submit plans
and specifications for such restoration, together with an estimate of the cost
thereof, and all necessary construction contracts therefor for the Lessor's and
the Independent Engineer's approval (provided, that if Lessee proposes to
restore the Property to the same plans and specifications existing immediately
prior to the Casualty or Condemnation, using all new materials of at least like
quality used prior to the occurrence of such Condemnation or Casualty and
otherwise consistent with the construction of first class office buildings in
New York City, no approval of such plans and specifications by Lessor or the
Independent Engineer shall be required), which consent will not unreasonably be
withheld; provided that (i) the capacity and useful life of the Improvements
shall not, after such restoration, be substantially less than the capacity and
useful life prior to such Casualty or Condemnation;(ii) neither the fair market
value of the Property nor Lessor's interest therein shall, after such
restoration, be substantially less than its fair market value prior to such
Casualty or Condemnation and (iii) if the estimated cost to complete such
restoration exceeds the amount of Net Proceeds, the Lessor is, in its sole
judgment, satisfied that the Lessee shall have sufficient funds (the "Excess
Funds") available to pay such excess. If either Mortgage has been recorded, the
Lessee shall
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hold such Excess Funds and any Net Proceeds then held by the Lessee pursuant to
paragraph 12(a) in a segregated account, subject to application in accordance
with the terms of the next succeeding paragraph hereof. Such work shall be
completed in a good and workmanlike manner free and clear of all Liens for
labor, services or materials and in compliance with all applicable material
Legal Requirements and all Insurance Requirements. All reasonable fees and
expenses of the Lessor and the Independent Engineer in connection with any
rebuilding and restoration shall be at the Lessee's sole cost and expense.
The Lessee shall be entitled to pay the Excess Funds or to receive
payment from the Net Proceeds or to pay the Net Proceeds if then held by Lessee
pursuant to paragraph 12(a), as the case may be, from time to time as such work
of rebuilding, replacement or repair progresses, but only after presentation of
an Officer's Certificate of the Lessee certifying that no Default or Event of
Default under any of the Operative Documents has occurred and is continuing and
that the Net Proceeds held by the Proceeds Trustee or the Lessee, as the case
may be, plus all necessary undisbursed Excess Funds are adequate to complete
such rebuilding, replacement or repair. The Proceeds Trustee shall deliver, or
cause to be delivered, payment within five days after its receipt of the
certificates required above. In connection with such payments Lessee shall first
disburse all Excess Funds for the cost of such restoration prior to the
disbursement of any Net Proceeds by the Proceeds Trustee or the Lessee. Upon
receipt by the Proceeds Trustee (with a copy to the Lessor) of an Officer's
Certificate from the Lessee, to the effect that final payment has been made for
any such work and stating that the rebuilding, replacement or repair has been
completed in compliance with the terms and conditions of this Lease, the
remaining amount of such Net Proceeds shall (i) be paid to the Lessee or (ii) if
such remaining Net Proceeds shall then be held by the Lessee pursuant to the
terms hereof, may be used by the Lessee for purposes other than those set forth
in this paragraph 12.
(d) Temporary Condemnation or Lease Termination. Notwithstanding any
provision to the contrary contained in this paragraph 12, in the event of any
temporary Condemnation this Lease shall remain in full force and effect, and
provided no Default or Event of Default has occurred and is continuing, the
Lessee shall be entitled to receive the Net Proceeds allocable to such temporary
Condemnation, except that if this Lease shall expire or terminate during such
temporary Condemnation (other than by reason of the Lessee's exercise of its
Option to Purchase and its payment of the Purchase Price), then the Lessor shall
be entitled to the Net Proceeds allocable to the period after the termination or
expiration of this Lease.
13. Effect of Termination Notice. The Termination Notice given pursuant
to paragraph 12(b) shall specify a date, not less than 30 nor more than 60 days
after the giving of such Notice upon which this Lease shall terminate. If the
Termination Notice is deemed given, the date of termination shall be the 30th
day after the receipt of the appraisal required by paragraph 12(b)(ii). On such
date this Lease will terminate, except with respect to obligations and
liabilities, actual or contingent, which have arisen on or prior to such date.
Upon such termination, the provisions of the Instrument Guaranty and the Company
Guaranty shall apply.
14. Lessee Purchase Option.
(a) At any time during the Term, Lessee may deliver to Lessor a notice
of exercise of its option to purchase (the "Option to Purchase") Lessor's
interest in the Property.
(b) Any exercise of Lessee's Option to Purchase shall be irrevocable
and unconditional and shall set forth the applicable Purchase Price. The
procedure for the purchase of the Property and the purchase price therefor shall
be governed by paragraph 15 hereof.
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(c) In addition to the foregoing rights, in the event this Lease has
been terminated as a result of an Event of Default Lessee may for a period of 30
days after such termination deliver to the Lessor a notice of exercise of its
Option to Purchase the Property, and in such event, the provisions of paragraph
14(b) and paragraph 15 shall apply.
15. Procedure Upon Purchase.
(a) The date of the closing of the Lessee's purchase of Lessor's
interest in the Property (the "Closing Date") shall be (i) in the case of a
purchase by the Lessee pursuant to paragraph 14(c), on the fifth Business Day
following the Lessee's delivery of notice of exercise of the Option to Purchase,
or (ii) otherwise, on the first Payment Date occurring at least 15 days
following the date of Lessor's receipt of the notice of exercise in compliance
with the notice provisions of the Participation Agreement, but in no event later
than the Expiration Date. On the Closing Date, upon receipt of the Purchase
Price, the Lessor shall, subject to compliance with all Legal Requirements,
convey, or cause to be conveyed, any and all of its right, title and interest in
and to the Property, (or, in the case of an occurrence of a Casualty or
Condemnation, the remaining portion thereof) to the Lessee or its designee by
appropriate instruments of conveyance, containing no representation or warranty
(expressed or implied) except that the Lessor's interest in the Property is free
and clear of any conveyance, mortgage, lease, or Lien or other adverse interest
of any kind created or caused by the Lessor or any person claiming by, through
or under the Lessor (except in connection with the arrangements contemplated by
the Operative Documents or as otherwise consented to or created or caused by the
Lessee and except as to any interest created by the Lessor upon the exercise of
any right hereunder upon any Event of Default or Event of Termination).
(b) On the Closing Date, the Lessee shall pay, or cause to be paid, to
the Lessor a price equal to the Capitalized Cost of the Property (as defined in
Schedule B hereof) together with all Basic Rent, Additional Rent and all other
sums then due and payable hereunder or under any of the Operative Documents
relating to the Property up to and including such Closing Date plus all Closing
Costs (such amounts are herein referred to as the "Purchase Price"), and the
Lessor shall simultaneously (i) deliver to the Lessee or its designee the
instrument(s) referred to in subparagraph 15(a) above and any other instruments
reasonably necessary to convey to the Lessee or its designee Lessor's interest
in the Property (and assign all Real Estate Agreements to which Lessor is a
party) (other than any indemnities thereunder) and any other related property
then required to be assigned pursuant hereto, and (ii) convey, or cause to be
conveyed, to the Lessee or its designee any Net Proceeds related to the Property
and/or the right to receive the same. In the event that the payments due under
this paragraph are not paid in full when due, any moneys actually paid shall be
deemed to be a payment after an Event of Default and shall not be deemed to be
Purchase Price.
(c) Upon the completion of any purchase of the Property pursuant to
this paragraph 15, but not prior thereto, this Lease shall terminate, or, at the
request and expense of the Lessee, the Lessor shall transfer its interest in
this Lease, in either case except with respect to obligations and liabilities of
the Lessee actual or contingent which have arisen on or prior to such date of
purchase, and except as elsewhere expressly provided herein and as provided in
Section 9.15(b) of the Participation Agreement.
16. Insurance.
(a) The Lessee will purchase and maintain, or cause to be purchased and
maintained, insurance with respect to the Property of the following types and in
the following amounts (or in such
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greater amounts as may become necessary from time to time to prevent the Lessor,
the Lessee and the holders from time to time of the Instruments from becoming
co-insurers of any loss) but in no event in amounts less than those customarily
maintained for other similar buildings in downtown Manhattan; provided, however,
that the Lessee may self-insure (other than in respect of business interruption
insurance which may include a three-day deductible) for the first $1,000,000 in
coverage for any of the following:
(i) Property Insurance: Insurance against physical damage to
the Property caused by "all risks" perils, including flood insurance
and business interruption coverage as well as broad form boiler and
machinery coverage;
(ii) "All Risk", Builder's Risk Insurance: Insurance against
all risk of physical loss or damage to the Property while in the course
of construction;
(iii) General Public Liability Insurance: Insurance against
claims for bodily injury (including death) and property damage
occurring on, in or about the Property or resulting from activities on
the Property, in the minimum combined single limit amount of $75
million in the annual aggregate and $75 million for bodily injury (or
death) and/or property damage;
(iv) Workers' Compensation Insurance: Insurance, including,
without limitation, workers' compensation insurance at statutory levels
and employers' liability insurance, with a limit of $100,000 in the
aggregate; and
(v) Other Insurance: Such other insurance, in such amounts and
against such risks, as is either (x) customarily carried by companies
owning, operating or leasing property or conducting businesses similar
and/or similarly situated to the Property and/or the Lessee, or (y)
reasonably requested from time to time by Lessor or the Managing
Agents.
Such insurance shall be written by companies that are nationally
recognized (including Lloyd's of London or other recognized international
insurers); primary insurance shall be written by companies rated at least A- XI
or better in Best's Key Guide (provided that the insurance required pursuant to
clauses (iii) and (iv) of this paragraph 16(a) may be written by Gulf Insurance
Company so long as such company maintains a rating of at least A+ VIII in Best's
Key Guide) and legally qualified to issue such insurance, selected by the Lessee
and shall name SSBTC (in its individual capacity and as Trustee) and the Agent
for the benefit of the holders from time to time of the Instruments and their
assigns, as additional insureds, as their interests may appear.
(b) (i) The insurance referred to in paragraph 16(a)(i) and (ii) for
the Property may be a blanket policy and shall (i) at all times be in an amount
at least equal to 100% of the replacement cost value (without depreciation), and
(ii) shall name SSBTC (in its individual capacity and as Trustee) and the Agent
for the benefit of the holders from time to time of the Instruments, and their
assignees, as additional insureds, as their interests may appear.
(ii) Every policy required under paragraph 16(a) shall: (1) expressly
(A) provide that it will not be canceled or terminated or changed except upon 30
days' prior written notice to the Lessor and the Lessee and the Agent, except in
the case of cancellation or termination due to a lapse for non-payment, in which
case only 10 days' prior written notice shall be required; (B) provide that the
interests of the Lessor and the Agent for the benefit of the holders from time
to time of the Instruments shall be insured regardless of any breach or
violation by the Lessee of any warranties, declarations or conditions
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contained in such insurance; (C) provide that any act, omission or negligence of
one party insured thereunder shall not invalidate or affect said insurance
coverage for any other party insured thereunder and that such insurance shall
not be invalidated by any foreclosure or other proceedings or notices thereof
relating to the Property or any part thereof, nor by legal title to, or
ownership of the Property or any part thereof becoming vested in or by Lessor or
its agents, nor by occupancy or use of the Property or any part thereof for
purposes more hazardous than permitted by such policy; (D) include a waiver of
all rights of subrogation against the Lessor and the holders from time to time
of the Instruments and any recourse against the Lessor or the holders from time
to time of the Instruments for payment of any premiums or assessments under any
policy; and (E) not contain a provision relieving the insurer thereunder of
liability for any loss by reason of the existence of other policies of insurance
covering the Property or any part thereof against the peril involved, whether
collectible or not, if such other policies do not name the Lessor and the Agent
for the benefit of the holders from time to time of the Instruments as
additional insureds. The Lessee shall advise the Lessor and the Agent promptly
of any policy cancellation or any change adversely affecting the coverage
provided thereby.
(iii) As long as no Event of Default shall have occurred and be
continuing, the Lessee may agree to the adjustment of any insurance claim
pertaining to the Property or any part thereof; provided, however, that if such
claim originally involved an amount of $25,000,000 or more, the amount equal to
the difference between such original amount and the adjusted amount shall be
treated as Net Proceeds and Lessee shall either pay over such amount to the
Proceeds Trustee or provide the Proceeds Trustee with a letter of credit,
reasonably acceptable to the Lessor, for such amount.
(c) The Lessee shall deliver to the Lessor the certificates of
insurance evidencing the existence of all insurance which is required to be
maintained by the Lessee hereunder including descriptions of the previously
mentioned Insurance Requirements not customarily found in a standard insurance
policy as well as descriptions of the exceptions to coverage under such
policies, such delivery to be made (i) as provided in Section 2.01(j) of the
Participation Agreement, (ii) within 30 days of the issuance of any additional
policies or amendments or supplements to any of such insurance, and (iii) on or
prior to the expiration date of any such insurance. The Lessee shall notify
Lessor of any nonrenewal of any policy required hereunder and shall cause each
insurer under each policy required hereunder to give the Lessor notice within
the time frames specified in paragraph 16(b)(ii)(1)(A) of any lapse under any
such policy. The Lessee shall not obtain or carry separate insurance concurrent
in form, or contributing in the event of loss, with that required by this
paragraph 16 unless the Lessor and the Agent for the benefit of the holders from
time to time of the Instruments are named as additional insureds therein, with
loss payable as provided in this Lease. The Lessee shall immediately notify the
Lessor and the holders from time to time of the Instruments whenever any such
separate insurance is obtained and shall deliver to the Lessor the certificates
of insurance evidencing the same as is required hereunder.
17. Subletting and Non-Disturbance; No Mortgage of Estate; Assignment.
(a) The Lessee may sublet or license a portion or portions of the
Property to any third party from time to time, provided that (i) such sublease
shall by its terms be expressly made subject and subordinate to the terms of
this Lease and the Mortgages and (ii) there shall exist no Default or Event of
Default or Event of Termination as of the date such sublease is executed by the
Lessee.
(b) No sublease or license pursuant to this paragraph 17 shall modify
or limit any right or power of the Lessor hereunder or affect or reduce any
obligation of the Lessee hereunder, and all such obligations shall continue in
full force and effect as obligations of a principal and not of a guarantor or
surety, as though no subletting had been made or occupancy permitted.
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(c) The Lessee shall provide a conformed copy of any sublease or
license to Lessor and the Managing Agents no later than 15 days prior to the
effective date of such sublease.
(d) The Lessee or any sublessee or licensee permitted hereby shall not
directly or indirectly assign (except as provided in clause (f) below),
mortgage, pledge or otherwise encumber its interest in and to this Lease or in
and to any sublease or the rentals payable thereunder without the prior written
consent of the Lessor and all such subleases and license agreements shall
contain such a restriction.
(e) Any sublease or license of Lessee's interest or any further
sublease thereof made otherwise than as expressly permitted by this paragraph 17
and any mortgage, pledge or assignment of the Lessee's interest hereunder or
under any such sublease shall be null and void.
(f) Each entity comprising the Lessee shall have the right to assign
all (other than as provided below) or portions of its interest as tenant in
common hereunder to one or more wholly owned subsidiaries or Affiliates of the
Guarantor by delivering written notice to the Lessor, the Managing Agents and
the Agent, which notice shall be accompanied by a copy of the assignment
instrument and the original validly executed and delivered agreement of the
assignee to assume all the obligations of the Lessee hereunder. Upon delivery of
any such notice, the assignee named therein shall, without further action or the
need for any additional documentation, be deemed a tenant in common hereunder
and shall thereafter be included in the term "Lessee"; provided, that the
Company and Salomon Brothers Inc shall at all times retain a combined undivided
51% interest in this Lease as tenants in common with the other entities
comprising the Lessee.
18. Permitted Contests.
(a) So long as no Default or Event of Default has occurred and is
continuing, the Lessee shall not be required, nor shall the Lessor have the
right, to pay, discharge or remove any Imposition (other than Excluded Taxes) or
to comply or cause the Property or any part thereof to comply with any
applicable Legal Requirement or to pay any materialman's, laborer's or
undischarged or unremoved Lien, as long as the Lessee shall at its sole cost and
expense contest, or cause to be contested, in good faith, the existence, amount
or validity thereof by appropriate proceedings which shall (i) in the case of an
unpaid Imposition or undischarged or unremoved Lien, prevent the collection
thereof from the Lessor or against the Property or any part thereof or Lessor's
interest in any of the foregoing, (ii) prevent the sale, forfeiture or loss of
the Property or any part thereof, and prevent the impairment or subordination of
the Agent's Lien, if any, pursuant to the Mortgage(s), and (iii) in the case of
a Legal Requirement, not subject the Lessor or the holders from time to time of
the Instruments to the risk of any criminal liability or civil liability for
failure to comply therewith. The Lessee shall give such reasonable security as
may be demanded by the Lessor to insure ultimate payment of such Imposition or
the discharge or removal of any materialman's, laborer's or mechanic's Lien or
to insure compliance with such Legal Requirement and to prevent any sale or
forfeiture of the Property or any part thereof or Lessor's interest in any of
the foregoing, or any interference with or deductions from any Basic Rent,
Additional Rent or any other sum required to be paid by the Lessee hereunder by
reason of such non-payment, non-discharge, non-removal or non-compliance;
provided, that, unless a Default or Event of Default has occurred and is
continuing, the Lessee shall not be obliged to post any such security if at any
time the aggregate amount needed for all such purposes shall not exceed
$7,000,000.
(b) The Lessor shall cooperate with the Lessee in any contest and shall
allow the Lessee to conduct such contest (in the name of the Lessor, if
necessary) at the Lessee's sole cost and
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expense. The Lessee shall notify the Lessor of each such proceeding within ten
Business Days prior to the commencement thereof, which notice shall describe
such proceeding in reasonable detail.
(c) The Lessee shall, promptly after the final determination (including
appeals) of any contest brought by it pursuant to this paragraph 18, pay and
discharge all amounts which shall be determined to be payable therein and shall
be entitled to receive and retain for its own account all amounts refunded
and/or rebated as a result of any such contest and if the Lessor receives any
amount as a result of such contest to which it is not otherwise entitled
pursuant to this Lease, it shall promptly return such amount to the Lessee.
19. Default Provisions.
(a) Any of the following occurrences or acts shall constitute an event
of default (each, an "Event of Default") under this Lease:
(i) if the Lessee shall fail to pay (a) any Basic Rent,
Additional Rent or any other amounts required to be paid hereunder
within five business days after the date on which payment is due or (b)
Purchase Price on the date on which payment is due;
(ii) subject to paragraph 18, if the Lessee shall fail to pay
any Imposition when such payment shall become due or within any grace
period provided for payment of such Imposition;
(iii) if the Lessee shall fail to comply with any Insurance
Requirement or, if such failure is due to a downgrading in the rating
of any insurer in Best's Key Guide to a level below that required
pursuant to paragraph 16(a) hereof, the Lessee's failure to replace
such insurer with another insurer having the required rating within
thirty-five (35) days of such downgrading;
(iv) if the Lessee shall grant, suffer to exist (for ten
Business Days without removal or full bonding) or create any Lien
(other than Permitted Encumbrances) upon this Lease or the Property or
any part thereof or interest therein or upon any Basic Rent, Additional
Rent or other sum payable hereunder;
(v) if the Lessee shall fail to comply with the requirements
of paragraph 27(b)(i) within the time periods provided therein;
(vi) if the Lessee has elected to abandon the Property
pursuant to paragraph 27(a), and does not comply with the provisions of
paragraph 27(a);
(vii) if the Lessee shall fail to observe or perform any other
provision hereof and such failure shall continue until the earlier of
(a) 30 days after the date on which the Lessee becomes aware of such
failure or (b) 10 days after notice by the Lessor to the Lessee of such
failure;
(viii) if an Event of Default under the Participation
Agreement or any other Operative Document shall have occurred;
(ix) if the Lessee shall have abandoned the Property for a
period of 30 consecutive days; or
(x) if any entity comprising the Lessee shall commence an
action for the partition of Lessee's interest in this Lease.
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(b) The Lessor may take all steps to protect and enforce the rights of
the Lessor or obligations of the Lessee hereunder, whether by action, suit or
proceeding at law or in equity (for the specific performance of any covenant,
condition or agreement contained in this Lease, or in aid of the execution of
any power herein granted or for any foreclosure, or for the enforcement of any
other appropriate legal or equitable remedy) or otherwise as the Lessor shall
deem necessary or advisable.
(c) (i) subject to paragraph 14(c), if an Event of Default shall have
occurred and be continuing, then upon five days' written notice by the Lessor to
the Lessee, in addition to all other rights or remedies available, the Lessor
may terminate this Lease and the Lessee's right to possession of the Property or
any part thereof. This Lease and the estate hereby granted shall expire and
terminate at midnight on the fifth day (or such later date as may be specified
therein) after the date of such notice, as fully and completely and with the
same effect as if such date were the date herein fixed for the expiration of the
Term and all rights of the Lessee shall terminate but the Lessee shall remain
liable as hereinafter provided.
(ii) Should the Lessor elect not to terminate this Lease, this Lease
shall continue in effect and Lessor may enforce all Lessor's rights and remedies
under this Lease including the right to recover Basic Rent and Additional Rent
as it becomes due under this Lease. For the purposes hereof, the following shall
not be deemed to constitute a termination of this Lease:
(A) Acts of maintenance or preservation of the Property or any
part thereof or efforts to relet the Property or any part thereof,
including, without limitation, termination of any sublease of the
Property and removal of such subtenant from the Property; and/or
(B) The appointment of a receiver upon the initiative of the
Lessor to protect the Lessor's interest under this Lease.
(d) If an Event of Default shall have occurred and be continuing, upon
five (5) days' notice the Lessor shall have (i) the right, whether or not this
Lease shall have been terminated pursuant to paragraph 19(c) hereof, to re-enter
and repossess the Property or any part thereof, as the Lessor may elect, by
summary proceedings, ejectment, any other legal action or in any other lawful
manner the Lessor determines to be necessary or desirable and (ii) the right to
remove all Persons and property therefrom. The Lessor shall be under no
liability by reason of any such re-entry, repossession or removal. No re-entry
or repossession of the Property or any part thereof shall be construed as an
election by the Lessor to terminate this Lease unless a notice of such
termination is given to the Lessee pursuant to paragraph 19(c) hereof, or unless
such termination is decreed by a court or other Governmental Authority of
competent jurisdiction. Should the Lessor elect to re-enter the Property as
herein provided or should the Lessor take possession pursuant to legal
proceedings or pursuant to any notice provided for by Law or upon termination of
this Lease pursuant to paragraph 19(c) hereof or otherwise as permitted by Law,
the Lessee shall peaceably quit and surrender the Property or any part thereof
to the Lessor. In any such event, neither the Lessee nor any Person claiming
through or under the Lessee, by virtue of any Law, shall be entitled to
possession or to remain in possession of the Property or any such part thereof,
but shall forthwith quit and surrender the Property to the Lessor.
(e) At any time or from time to time after the re-entry or repossession
of the Property or any part thereof pursuant to paragraph 19(d) hereof, whether
or not this Lease shall have been terminated pursuant to paragraph 19(c) hereof,
the Lessor may (but shall be under no obligation to) relet the Property or any
part thereof, for the account of the Lessee, without notice to the Lessee, for
such term or terms and on such conditions and for such uses as the Lessor, in
its sole discretion, may determine.
16
<PAGE> 20
The Lessor may collect and receive any rents payable by reason of such
reletting. The Lessor shall not be liable for any failure to relet the Property
or any part thereof or for any failure to collect any rent due upon any such
reletting.
(f) No termination of this Lease pursuant to paragraph 19(c) hereof, or
by operation of Law, and no re-entry or repossession of the Property or any part
thereof, pursuant to paragraph 19(d) hereof, and no reletting of the Property or
any part thereof pursuant to paragraph 19(e) hereof, shall relieve the Lessee of
its liabilities and obligations hereunder, all of which shall survive such
termination, re-entry, repossession or reletting.
(g) In the event of any termination of this Lease or of the Lessee's
right to possession of the Property or any part thereof by reason of the
occurrence of any Event of Default, the Lessee shall promptly pay to the Lessor
all Basic Rent and Additional Rent and other sums required to be paid to and
including the date of such termination of this Lease or of the Lessee's right to
possession; and thereafter, until the end of the Term, whether or not the
Property or any part thereof shall have been relet, the Lessee to the extent
permitted by applicable Law shall be liable to the Lessor for, and shall pay to
the Lessor, on the days on which such amounts would be payable under this Lease
in the absence of such termination, re-entry or repossession, as agreed current
damages and not as a penalty: all Basic Rent, all Additional Rent and other sums
which would be payable under this Lease by the Lessee, in the absence of such
termination, re-entry or repossession, and all costs (including attorneys' fees
and expenses) incurred by the Lessor hereunder (payable on demand). The Lessor
shall apply against Lessee's obligations, when received, the net proceeds, if
any, of any reletting effected for the account of the Lessee pursuant to
paragraph 19(e), after deducting from such proceeds all the Lessor's expenses in
connection with such reletting (including, but not limited to, all repossession
costs, brokerage commissions, attorneys' fees and expenses, employees' expenses,
alteration and financing costs and expenses of preparation for such reletting).
20. Additional Rights.
(a) No right or remedy hereunder shall be exclusive of any other right
or remedy, but shall be cumulative and in addition to any other right or remedy
hereunder or now or hereafter existing by Law or in equity and the exercise by
the Lessor of any one or more of such rights, powers or remedies shall not
preclude the simultaneous exercise of any or all of such other rights, powers or
remedies. Failure to insist upon the strict performance of any provision hereof
or to exercise any option, right, power or remedy contained herein shall not
constitute a waiver or relinquishment thereof for the future. Receipt by the
Lessor of any Basic Rent, Additional Rent or other sum payable hereunder with
knowledge of the breach by Lessee of any provision hereof shall not constitute
waiver of such breach, and no waiver by the Lessor of any provision hereof shall
be deemed to have been made unless made in writing. The Lessor shall be entitled
to injunctive relief in case of the violation or attempted or threatened
violation of any of the provisions hereof, a decree compelling performance of
any of the provisions hereof or any other remedy allowed to the Lessor by Law or
in equity.
(b) The Lessee hereby waives and surrenders for itself and all those
claiming under it, including creditors of all kinds, (i) any right and privilege
which they may have to redeem the Property or any part thereof or to have a
continuance of this Lease after termination of the Lessee's right of occupancy
by Law or by any legal process or writ, or under the terms of this Lease, or
after the termination of the Term as herein provided and (ii) the benefits of
any Law which exempts property from liability for debt or for distress for rent.
17
<PAGE> 21
(c) If an Event of Default has occurred hereunder, the Lessee shall pay
to the Lessor on demand, all reasonable fees and expenses, including attorneys'
fees and expenses, incurred by the Lessor, up to the time the Lessor has
knowledge that such Event of Default has been cured by the Lessee, in enforcing
its rights under this Lease.
(d) TIME IS OF THE ESSENCE IN LESSEE'S PERFORMANCE UNDER THIS LEASE AND
THE TERMS HEREIN SHALL BE SO CONSTRUED.
21. Notices, Demands, and Other Instruments. All notices, offers,
consents and other instruments given pursuant to this Lease shall be sent to the
parties hereto at the addresses set forth on Schedule I to the Participation
Agreement and shall be given in the manner and shall be effective at the times
and under the terms set forth in Section 9.02 of the Participation Agreement;
provided that, each of the Lessor and the Lessee may from time to time specify,
by giving not less than fifteen (15) days' prior notice thereof to the other
party (i) any other address in the United States as its address for purposes of
this Lease and (ii) any other Person that is to receive copies of notices,
offers, consents and other instruments hereunder; provided that neither party
shall be entitled to designate more than 2 other Persons to receive copies of
notices hereunder.
22. No Default Certificate. Each party hereto shall, at the reasonable
request of the other party hereto, deliver to such other party a certificate
stating whether such first party has knowledge of, or has received notice from
any Person of, any Casualty, Condemnation, Default or Event of Default.
23. Surrender.
(a) Upon the expiration or termination of this Lease or the termination
of Lessee's possession of the Property, the Lessee shall surrender the Property
to the Lessor in the condition in which the Property was upon the commencement
of the Term hereof except as altered by the Modifications and as otherwise
repaired, rebuilt, altered, added to or built as permitted or required hereby
and except for ordinary wear and tear. To the extent that the Property is not in
compliance with the above upon such expiration or termination, the Lessee shall
pay to the Lessor as Additional Rent such additional amounts as are required to
place it in compliance therewith.
(b) The Lessee shall also surrender the Property to the Lessor free and
clear of all Liens, easements, consents and restrictive covenants and agreements
affecting the Property which the Lessee is obliged hereunder to remove.
(c) The Lessee shall also surrender the Property in a condition such
that the Property is in compliance with all applicable Environmental Laws at
surrender (whether or not the deadline for such compliance would otherwise
expire before the end of the Term). Nothing contained in this paragraph 23 shall
relieve or discharge or in any way affect the obligation of the Lessee to cure
promptly pursuant to this Lease any violations of Legal Requirements referred to
in this Lease, or to pay and discharge any Liens and Impositions against the
Property. Lessee shall cooperate, to the fullest extent, with the Lessor, its
subsequent lessees, operators or purchasers to effect the transfer of all of
Lessee's Applicable Permits for the Property to such Persons.
(d) The Lessee, at its sole cost and expense, shall remove from the
Property on or prior to the thirtieth (30th) day following such expiration or
termination all property situated thereon which is not owned by the Lessor and
shall repair any damage caused by such removal and shall restore the Property to
the condition and working order (or reasonable equivalent thereof) in which it
existed
18
<PAGE> 22
immediately prior to the installation of such property, except for ordinary wear
and tear. Lessee shall indemnify and hold harmless the Lessor, the holders of
Instruments and their respective successors and assigns from and against any
loss, liability or claim arising out of the Lessee's removal of such property
from the Property. Any such property of the Lessee not so removed shall become
the property of the Lessor, and the Lessor may cause such property to be removed
from the Property and disposed of, and the cost of any such removal and
disposition of the Lessee's property and of repairing any damage caused by such
removal and of the restoration of the Property to the condition and working
order (or reasonable equivalent thereof) in which it existed immediately prior
to the installation of such property, ordinary wear and tear excepted, shall be
borne by the Lessee.
(e) The obligations of the Lessee under this paragraph 23 shall survive
the expiration or any termination of this Lease (whether by operation of Law or
otherwise) for all matters described herein which occur or arise prior to such
expiration or termination or arise out of or result from facts, events, claims,
liabilities, actions or conditions occurring, arising or existing on or before
such expiration or termination.
24. Miscellaneous.
(a) This Lease supersedes all prior agreements between the parties
hereto with respect to the matters addressed herein. Each provision hereof shall
be separate and independent and the breach of any such provision by the Lessor
shall not discharge or relieve the Lessee from its obligations to perform each
and every covenant to be performed by the Lessee hereunder. If any provision
hereof or the application thereof to any Person or circumstance shall be invalid
or unenforceable, the remaining provisions hereof, or the application of such
provision to persons or circumstances other than those as to which it is invalid
or unenforceable, shall not be affected thereby, and each provision hereof shall
be valid and shall be enforceable to the extent permitted by Law. All provisions
contained in this Lease shall be binding upon, inure to the benefit of, and be
enforceable by, the respective permitted successors and assigns of the Lessor
and the Lessee to the same extent as if each successor and assignee were named
as a party hereto. Except for subleases and licenses permitted or created in
accordance with paragraph 17 hereof, the Lessee may not assign its rights or
obligations hereunder or any interest herein. The Lessor may assign all or any
part of its interest in the Property and/or its rights and obligations under
this Lease to the extent permitted by the Operative Documents. This Lease may
not be changed, modified or discharged except by a writing signed by the Lessor
and the Lessee, in compliance with the requirements set forth in the
Participation Agreement. Any change, modification or discharge made otherwise
than as expressly permitted by this paragraph 24 shall be null and void. THIS
LEASE SHALL BE GOVERNED BY AND INTERPRETED IN ACCORDANCE WITH THE LAWS OF THE
STATE OF NEW YORK. This Lease, when delivered, shall constitute an original,
fully enforceable counterpart for all purposes except that only the counterpart
stamped or marked "COUNTERPART NUMBER ONE" or "COUNTERPART NUMBER 1" shall
constitute, to the extent applicable, "chattel paper" or other "collateral"
within the meaning of the Uniform Commercial Code in effect in any jurisdiction.
(b) No recourse shall be had against the Lessor, the Trustee, the
Agent, Managing Agents or any holder of any Instrument or their respective
employees, agents, beneficiaries or shareholders, for any claim based on any
failure by the Lessor in the performance or observance of any of the agreements,
covenants or provisions contained in this Lease and in the event of any such
failure, recourse shall be had solely against the Lessor's interest in the
Property; provided, however, that nothing contained in this Lease shall be taken
to prevent enforcement of any claim against the Lessor or any other Person
arising out of or in connection with this Lease based on fraud, gross negligence
or willful misconduct of any officer, director, shareholder or employee of the
Lessor and nothing shall prevent
19
<PAGE> 23
enforcement against any other Person to which any part thereof shall have been
transferred, or obligations undertaken or assumed in writing by such Person.
25. Headings and Table of Contents. The table of contents and the
headings of the various paragraphs and Schedules of this Lease are for
convenience only and shall not affect the meaning of the terms and conditions of
this Lease.
26. Lessor's Right to Cure Lessee's Default. If the Lessee shall fail
to make any payment or perform any act required to be made or performed under
this Lease, and such failure results in an Event of Default hereunder, the
Lessor, without waiving any Default or Event of Default or releasing Lessee from
any obligation, may (but shall be under no obligation to) make such payment or
perform such act for the account and at the sole cost and expense of the Lessee,
and may enter upon the Property for such purpose and take all such action
thereon as, at the Lessor's sole discretion, may be necessary or appropriate
therefor. No such entry shall be deemed an eviction of the Lessee. The Lessor
shall endeavor to give notice to the Lessee of any such action taken pursuant to
this paragraph 26, but its failure to do so shall not affect its rights
hereunder. All sums so paid by the Lessor and all costs and expenses (including,
without limitation, attorneys' fees and expenses so incurred, together with
interest thereon at the Default Rate to the extent permitted by Law) shall be
paid by the Lessee to the Lessor on demand as Additional Rent.
27. Expiration of the Lease.
(a) The Lessee shall give notice to the Lessor, not less than twelve
(12) months prior to the Expiration Date, if it intends to abandon the Property
as of the Expiration Date and pay to the Lessor on the Expiration Date any Basic
Rent, Additional Rent and any other amounts then due and payable to the Lessor
hereunder (and the failure to give such notice shall constitute a notice that
the Lessee will exercise its Option to Purchase the Property on the Expiration
Date (unless earlier purchased in accordance with paragraphs 14 and 15)). Upon
the giving of such notice that it intends to abandon the Property, the Lessee
shall be obliged to comply with the requirements of paragraph 27(b)(i) hereof.
The Lessee shall not be entitled to give such notice, or to abandon the
Property, if the Property is included on the CERCLIS list maintained by the U.S.
Environmental Protection Agency, unless such agency has issued a no further
action letter in connection therewith.
(b) (i) Upon the election of the Lessee to abandon the Property
pursuant to paragraph 27(a) hereof, Lessee shall provide, or cause to be
provided or accomplished, at the sole cost and expense of the Lessee, to or for
the benefit of the Lessor and the holders of the Instruments, within the time
frame specified:
(A) A Phase I environmental audit of the Property (and any
additional investigations suggested by the results of the Phase I
environmental audit), commissioned by the Lessor which shall be
completed not less than 30 days and not more than 60 days prior to the
Expiration Date, and shall be satisfactory in all respects to the
Managing Agents, the Lessor and the holders of B-Notes and
Certificates, in each case, in their sole discretion;
(B) A report of an Independent Engineer commissioned by the
Lessor shall have been completed not less than 30 days and not more
than 60 days prior to the Expiration Date, and shall be satisfactory in
all respects to the Managing Agents, the Lessor and the Majority
Holders of the B-Notes and the Certificates, in their sole
20
<PAGE> 24
discretion, to the effect that the Property has been maintained in
accordance with the terms and conditions of the Lease and will, at the
Expiration Date, be in the condition required by the Lease;
(C) At least 30 but not more than 60 days prior to the
Expiration Date, evidence satisfactory to the Lessor and the Majority
Holders of the B-Notes and Certificates that all necessary easements,
permits, material contracts and other matters to be delivered pursuant
to the Services Agreement will be provided;
(D) Evidence satisfactory to the Lessor and the Majority
Holders of the B-Notes and Certificates that a Permanent Certificate of
Occupancy for the Improvements shall have been issued no less than nine
months prior to the Expiration Date and shall be in full force and
effect on the Expiration Date;
(E) At the Expiration Date, no Casualty or Condemnation shall
have occurred for which rebuilding and restoration pursuant to
paragraph 12(c) is not complete, and there shall be no temporary
Condemnation which extends beyond the Expiration Date; and
(F) If the Lessee has removed or made material alterations to
the Modifications after the Completion Date, not less than 30 and not
more than 60 days prior to the Expiration Date the Lessee shall deliver
an appraisal from an appraiser reasonably satisfactory to the Lessor
and the Majority Holders of the B-Notes and Certificates which shall
indicate that the fair market value of the Property at the Expiration
Date will be at least $300,000,000. If such appraisal indicates a fair
market value which is below $300,000,000 (the "Appraised Value"), such
appraisal shall also indicate what the fair market value of the
Property would have been had the Modifications remained in the
condition required on the Completion Date (ordinary wear and tear
excepted) (the "Required Value").
(ii) Upon the Lessee's election to abandon the Property pursuant to
paragraph 27(a) hereof, the Lessor shall have the sole and exclusive right to
sell or dispose of its interest in the Property and, as of the Expiration Date,
the Lessee shall have no further claim thereto except pursuant to Section 5.03
of the Declaration. The proceeds of any sale or disposition of the Lessor's
interest in the Property pursuant to this paragraph 27(b) (herein called a
"Qualified Sale") shall be applied by the Lessor as follows: first, to pay all
Closing Costs in connection with the Qualified Sale; and second, as provided in
the Declaration. If (A) the Required Value (as defined in clause (i)(F) above)
is higher than the Appraised Value (as defined in clause (i)(F) above) and (B)
the Sales Proceeds are less than the principal and stated amount of, plus
interest and yield and all other amounts due and owing with respect to, the
B-Notes and Certificates, the Lessee shall pay to Lessor funds equal to the
difference between the Sales Proceeds and such amounts due and owing with
respect to the B-Notes and Certificates, but in no case shall Lessee be required
to pay an amount exceeding the lesser of (x) the difference between the Required
Value and the Appraised Value and (y) the difference between $300,000,000 and
the Appraised Value (such payment, the "Required Value Payment").
28. Subordination. Notwithstanding anything to the contrary contained
in this Lease, this Lease and all rights of Lessee hereunder shall be, and the
same are hereby made and shall be subject and subordinate in all respects to the
lien created by, as well as to all of the terms, covenants and
21
<PAGE> 25
conditions contained in, any and all mortgages, in whatever amount(s), on
whatever terms and conditions and without regard to the order of recordation
thereof (each such mortgage hereinafter referred to as the "Prior Mortgage"),
now or at any time hereafter affecting or encumbering the Property, including,
without limitation, any such mortgage now or hereafter granted by the Lessor on
its interest in the Property, as well as to any and all advances under, and
increases to, the Prior Mortgage, and any and all extensions, consolidations,
modifications and supplements thereto. The foregoing subordination provision
shall be self-operative and no further instrument of subordination shall be
required to effect the same. In confirmation of such subordination, the Lessee
shall promptly execute and deliver any instrument that the Lessor, the holder of
any Prior Mortgage, or any of their respective successors in interest may
reasonably request to evidence such subordination. Notwithstanding the
foregoing, the Agent may at any time elect to subordinate any one or more of the
Prior Mortgages held by the Agent to this Lease upon such terms and conditions,
and reserving such rights as the holder of such Prior Mortgages, as the Agent
desires. Any such subordination shall be effectuated by an instrument in
writing, executed by the Agent and shall be effectuated by the Agent only upon
the direction of all of the holders of the series of Instruments for whose
benefit such Prior Mortgage was granted.
29. Waiver of Trial by Jury. IN ANY ACTION OR PROCEEDING UNDER OR
RELATED TO THIS LEASE OR THE OPERATIVE DOCUMENTS OR ANY AMENDMENT, INSTRUMENT,
DOCUMENT OR AGREEMENT DELIVERED OR WHICH MAY IN THE FUTURE BE DELIVERED IN
CONNECTION WITH THE FOREGOING, THE LESSOR AND THE LESSEE HEREBY AGREE THAT ANY
SUCH ACTION OR PROCEEDING SHALL BE TRIED BEFORE A COURT AND NOT BEFORE A JURY,
REGARDLESS OF WHICH PARTY COMMENCES SUCH ACTION OR PROCEEDING.
30. Jurisdiction. Jurisdiction hereunder shall be governed by the
provisions governing jurisdiction set forth in Section 7.20 of the Participation
Agreement, which procedures are hereby incorporated herein mutatis mutandis, by
reference, as if fully set forth herein.
31. No Merger of Title. There shall be no merger of this Lease nor of
the leasehold estate created by this Lease with the fee ownership of the
Property by reason of the fact that the same Person may acquire, own or hold,
directly or indirectly, this Lease or the leasehold estate created by this Lease
or any interest in this Lease or interest in the fee ownership of the Parcel,
and no such merger shall occur unless and until all Persons having any interest
in (x) the leasehold estate created by this Lease (y) the fee ownership of the
Property or any part thereof shall join in a written instrument effecting such
merger and shall duly record the same.
32. Further Assurances. Each party hereto agrees that it will promptly
and duly execute and deliver to the other party such documents and assurances
and take such further actions as the other party may from time to time
reasonably request to carry out more effectively the intent and purpose of this
Lease, or to establish and protect the rights and remedies created or intended
to be created hereunder in favor of any party.
33. Schedules; Exhibits. Schedules A, B and C referred to in this Lease
are hereby incorporated by reference herein.
34. Tenants in Common. At all times each tenant-in-common comprising
the Lessee under this Lease shall be jointly and severally liable for the
performance of all obligations of the Lessee hereunder, including without
limitation, the obligation to pay Basic Rent, Additional Rent and all other
amounts becoming due and payable from time to time hereunder.
22
<PAGE> 26
IN WITNESS WHEREOF, the parties hereto have caused this Lease
to be duly executed by their respective Officers thereunto duly authorized as of
the date hereof.
STATE STREET BANK AND TRUST
COMPANY OF
CONNECTICUT, NATIONAL
ASSOCIATION, not in
its individual
capacity but solely as
Trustee of the 1993
Smith Barney Office
Building Trust, as
lessor
By: /s/ Arthur J. MacDonald
----------------------------------------
Name: Arthur J. MacDonald
Title: Assistant Vice President
SMITH BARNEY INC.
By: /s/ Mark I. Kleinman
----------------------------------------
Name: Mark I. Kleinman
Title: Deputy Treasurer
By: /s/ Joseph J. Martinelli
----------------------------------------
Name: Joseph J. Martinelli
Title: Assistant Treasurer
SALOMON BROTHERS INC
By: /s/ Mark I. Kleinman
----------------------------------------
Name: Mark I. Kleinman
Title: Deputy Treasurer
By: /s/ Thomas W. Jasper
----------------------------------------
Name: Thomas W. Jasper
Title: Treasurer
TRAVELERS GROUP INC.
By: /s/ Robert Matza
----------------------------------------
Name: Robert Matza
Title: Treasurer
<PAGE> 27
By: /s/ Firoz B. Tarapore
----------------------------------------
Name: Firoz B. Tarapore
Title: Deputy Treasurer
MUTUAL MANAGEMENT CORP.
By: /s/ Michael J. Day
----------------------------------------
Name: Michael J. Day
Title: Treasurer
By: /s/ James S. Conahan
----------------------------------------
Name: James S. Conahan
Title: Controller
SMITH BARNEY CAPITAL SERVICES INC.
By: /s/ Mark I. Kleinman
----------------------------------------
Name: Mark I. Kleinman
Title: Treasurer
By: /s/ Lee Grohman
----------------------------------------
Name: Lee Grohman
Title: Assistant Treasurer
SMITH BARNEY COMMERCIAL CORP.
By: /s/ Mark I. Kleinman
----------------------------------------
Name: Mark I. Kleinman
Title: Treasurer
By: /s/ Lee Grohman
----------------------------------------
Name: Lee Grohman
Title: Assistant Treasurer
SMITH BARNEY FUTURES MANAGEMENT INC.
By: /s/ Daniel G. Dontuono
----------------------------------------
Name:
Title:
<PAGE> 28
By: /s/ Lee Grohman
----------------------------------------
Name: Lee Grohman
Title: Assistant Treasurer
SMITH BARNEY GLOBAL CAPITAL MANAGEMENT, INC.
By: /s/ Mark I. Kleinman
----------------------------------------
Name: Mark I. Kleinman
Title: Treasurer
By: /s/ Lee Grohman
----------------------------------------
Name: Lee Grohman
Title: Assistant Treasurer
<PAGE> 29
STATE OF MASSACHUSETTS )
) ss.:
COUNTY OF SUFFOLK )
On the 25th day of March, 1998, before me personally came
Arthur J. MacDonald, to me known, who, being by me duly sworn, did depose and
say that he resides at Middleboro MA; that he is the Assistant Vice President of
State Street Bank and Trust Company of Connecticut, National Association, a
national banking association, not in its individual capacity but solely as
Trustee under a Declaration of Trust dated as of December 30, 1994, as amended;
and that he signed his name thereto by authority of the board of directors of
said national banking association.
/s/ Rose Marie Mogauro
----------------------------------------
Notary Public
[ROSE MARIE MOGAURO
Notary Public
My Commission Expires January 14, 2005]
<PAGE> 30
STATE OF NEW YORK )
) ss.:
COUNTY OF NEW YORK )
On the 27th day of March, 1998, before me personally came Mark
I. Kleinman, to me known, who, being by me duly sworn, did depose and say that
he is the Deputy Treasurer of Smith Barney Inc., the corporation described in
and which executed the foregoing instrument; and that he signed his name thereto
by authority of the board of directors of said corporation.
/s/ Maria T. Santiago
----------------------------------------
Notary Public
[MARIA T. SANTIAGO
Notary Public, State of New York
No. 015A5050058
Qualified in New York County
Commission Expires Oct. 2, 1999]
<PAGE> 31
STATE OF NEW YORK )
) ss.:
COUNTY OF NEW YORK )
On the 27th day of March, 1998, before me personally came Mark
I. Kleinman, to me known, who, being by me duly sworn, did depose and say that
he is the Deputy Treasurer of Salomon Brothers Inc, the corporation described in
and which executed the foregoing instrument; and that he signed his name thereto
by authority of the board of directors of said corporation.
/s/ Maria T. Santiago
----------------------------------------
Notary Public
[MARIA T. SANTIAGO
Notary Public, State of New York
No. 015A5050058
Qualified in New York County
Commission Expires Oct. 2, 1999]
<PAGE> 32
STATE OF NEW YORK )
) ss.:
COUNTY OF NEW YORK )
On the 27th day of March, 1998, before me personally came
Robert Matza, to me known, who, being by me duly sworn, did depose and say that
he is the Treasurer of Travelers Group Inc., the corporation described in and
which executed the foregoing instrument; and that he signed his name thereto by
authority of the board of directors of said corporation.
/s/ Maria T. Santiago
----------------------------------------
Notary Public
[MARIA T. SANTIAGO
Notary Public, State of New York
No. 015A5050058
Qualified in New York County
Commission Expires Oct. 2, 1999]
<PAGE> 33
STATE OF NEW YORK )
) ss.:
COUNTY OF NEW YORK )
On the 27th day of March, 1998, before me personally came
Michael J. Day, to me known, who, being by me duly sworn, did depose and say
that he is the Treasurer of Mutual Management Corp., the corporation described
in and which executed the foregoing instrument; and that he signed his name
thereto by authority of the board of directors of said corporation.
/s/ Maria T. Santiago
----------------------------------------
Notary Public
[MARIA T. SANTIAGO
Notary Public, State of New York
No. 015A5050058
Qualified in New York County
Commission Expires Oct. 2, 1999]
<PAGE> 34
STATE OF NEW YORK )
) ss.:
COUNTY OF NEW YORK )
On the 27th day of March, 1998, before me personally came
Daniel Dantuono, to me known, who, being by me duly sworn, did depose and say
that he is the Treasurer of Smith Barney Futures Management Inc., the
corporation described in and which executed the foregoing instrument; and that
he signed his name thereto by authority of the board of directors of said
corporation.
/s/ Maria T. Santiago
----------------------------------------
Notary Public
[MARIA T. SANTIAGO
Notary Public, State of New York
No. 015A5050058
Qualified in New York County
Commission Expires Oct. 2, 1999]
<PAGE> 35
STATE OF NEW YORK )
) ss.:
COUNTY OF NEW YORK )
On the 27th day of March, 1998, before me personally came Mark
I. Kleinman, to me known, who, being by me duly sworn, did depose and say that
he is the Treasurer of Smith Barney Capital Services Inc., the corporation
described in and which executed the foregoing instrument; and that he signed his
name thereto by authority of the board of directors of said corporation.
/s/ Maria T. Santiago
----------------------------------------
Notary Public
[MARIA T. SANTIAGO
Notary Public, State of New York
No. 015A5050058
Qualified in New York County
Commission Expires Oct. 2, 1999]
<PAGE> 36
STATE OF NEW YORK )
) ss.:
COUNTY OF NEW YORK )
On the 27th day of March, 1998, before me personally came Mark
I. Kleinman, to me known, who, being by me duly sworn, did depose and say that
he is the Treasurer of Smith Barney Commercial Corp., the corporation described
in and which executed the foregoing instrument; and that he signed his name
thereto by authority of the board of directors of said corporation.
/s/ Maria T. Santiago
----------------------------------------
Notary Public
[MARIA T. SANTIAGO
Notary Public, State of New York
No. 015A5050058
Qualified in New York County
Commission Expires Oct. 2, 1999]
<PAGE> 37
STATE OF NEW YORK )
) ss.:
COUNTY OF NEW YORK )
On the 27th day of March, 1998, before me personally came, to
me known, who, being by me duly sworn, did depose and say that he is the
Treasurer of Smith Barney Global Capital Management, Inc., the corporation
described in and which executed the foregoing instrument; and that he signed his
name thereto by authority of the board of directors of said corporation.
/s/ Maria T. Santiago
----------------------------------------
Notary Public
[MARIA T. SANTIAGO
Notary Public, State of New York
No. 015A5050058
Qualified in New York County
Commission Expires Oct. 2, 1999]
<PAGE> 38
SCHEDULE A
Description of the Parcel
PARCEL 1
The fee of Parcel 1 and the Lease (in part) cover premises more particularly
described as follows:
ALL that certain plot, piece or parcel of land, situate, lying and being in the
Borough of Manhattan, County, City and State of New York, bounded and described
as follows:
BEGINNING at the corner formed by the intersection of the southerly line of
Hubert Street with the westerly line of Greenwich Street;
RUNNING THENCE South 21 degrees 23 minutes 00 minutes east along the westerly
line of Greenwich Street, 210.01 feet;
THENCE South 68 degrees 07 minutes 20 seconds West 140.00 feet;
THENCE South 21 degrees 52 minutes 40 seconds East 9.00 feet;
THENCE South 68 degrees 07 minutes 20 seconds West 281.89 feet to a point in the
easterly line of West Street;
THENCE North 20 degrees 04 minutes 45 seconds West along the easterly line of
West Street, 219.11 feet to the corner formed by the intersection of the
easterly line of West Street with southerly line of Hubert Street;
THENCE North 68 degrees 07 minutes 20 seconds East along the southerly line of
Hubert Street, 416.52 feet to the point or place of BEGINNING.
The street lines described above as shown on map entitled "Map Showing a Change
in the Street System etc. in Connection with the Washington Market Urban Renewal
Area", dated March 4, 1970, modified July 1, 1970, Acc. No. 29985, adopted by
the Board of Estimate, October 8, 1970, Cal. No. 15.
Elevations refer to Datum use by the Topographical Bureau, Borough of Manhattan,
which is 2.75 feet above United States Coast and Geodetic Survey Datum, mean sea
level, Sandy Hook, New Jersey.
The bearings area in the system used on the Borough Survey, Borough President's
Office, Manhattan.
PARCEL 2
The Lease in part covers premises more particularly described as follows:
ALL that certain plot, piece or parcel of land, situate, lying and being in the
Borough of Manhattan, County, City and State of New York, bounded ad described
as follows:
BEGINNING at the corner formed by the intersection of the easterly line of West
Street with the northerly line of N. Moore Street;
<PAGE> 39
RUNNING THENCE North 20 degrees 04 minutes 45 seconds West, along the easterly
line of West Street, 190.09 feet;
THENCE North 21 degrees 52 minutes 40 seconds West 9.00 feet;
THENCE North 68 degrees 07 minutes 20 seconds East 140.00 feet to a point in the
westerly line of Greenwich Street;
THENCE South 21 degrees 28 minutes 00 seconds East, along the westerly line of
Greenwich Street, 199.00 feet to the corner formed by the intersection of the
northerly line of N. Moore Street with the westerly line of Greenwich Street;
THENCE South 68 degrees 07 minutes 20 seconds West, along the northerly line of
N. Moore Street, 426.43 feet to the point or place of BEGINNING.
The street lines described above are as shown on map entitled "Map Showing a
Change in the Street System etc. in Connection wit the Washington Market Urban
Renewal Area", dated March 4, 1970, modified July 1, 1970, Acc. No. 29985,
adopted by the Board of Estimate, October 8, 1970, Cal. No. 15.
Elevations refer to Datum use by the Topographical Bureau, Borough of Manhattan,
which is 2.75 feet above United States Coast and Geodetic Survey Datum, mean sea
level, Sandy Hook, New Jersey.
The bearings area in the system used on the Borough Survey, Borough President's
Office, Manhattan.
BLANKET DESCRIPTION (PARCELS 1 AND 2)
The Lease covers premises more particularly described as follows:
ALL that certain plot, piece or parcel of land, situate, lying and being in the
Borough of Manhattan, County, City and State of New York, bounded ad described
as follows:
BEGINNING at the corner formed by the intersection of the southerly line of
Hubert Street with the westerly line of Greenwich Street;
RUNNING THENCE South 21 degrees 28 minutes 00 seconds East along the westerly
line of Greenwich Street, 409.01 feet to the corner formed by the intersection
of the westerly line of Greenwich Street with the northerly line of N. Moore
Street;
THENCE South 68 degrees 07 minutes 20 seconds West along the northerly line of
N. Moore Street, 426.43 feet to the corner formed by the intersection of the
northerly line of N. Moore Street with the easterly line of West Street;
THENCE North 20 degrees 04 minutes 45 seconds West along the easterly line of
West Street, 409.20 feet to the corner formed by the intersection of the
easterly line of West Street with the southerly line of Hubert Street;
THENCE North 68 degrees 07 minutes 20 seconds East along the southerly line of
Hubert Street, 416.52 feet to the point or place of BEGINNING;
<PAGE> 40
The street lines described above are as shown on map entitled "Map Showing a
Change in the Street System etc. in Connection wit the Washington Market Urban
Renewal Area", dated March 4, 1970, modified July 1, 1970, Acc. No. 29985,
adopted by the Board of Estimate, October 8, 1970, Cal. No. 15.
Elevations refer to Datum use by the Topographical Bureau, Borough of Manhattan,
which is 2.75 feet above United States Coast and Geodetic Survey Datum, mean sea
level, Sandy Hook, New Jersey.
The bearings area in the system used on the Borough Survey, Borough President's
Office, Manhattan.
<PAGE> 41
SCHEDULE B
Rent Schedule
Capitalized terms used herein and not defined herein shall
have the meanings ascribed to them in the Lease (and the other Schedules
thereto) to which this Schedule B is attached including terms defined by
reference in the Lease to the other Operative Documents.
I. Basic Rent
(A) Capitalized Cost.
The "Capitalized Cost" of the Property is equal to the sum of
the outstanding aggregate principal amounts of the A-Notes,
B-Notes and Construction Notes plus the aggregate stated
amount of the Certificates.
The "Series A Portion" shall mean that portion of the
Capitalized Cost which is equal to the sum of the aggregate
principal amount outstanding of the Construction A-Notes and
the A-Notes.
The "Series B Portion" shall mean that portion of the
Capitalized Cost which is equal to the sum of the aggregate
principal amount outstanding of the Construction B-Notes and
the B-Notes.
The "Series C Portion" shall mean that portion of the
Capitalized Cost which is equal to the aggregate stated amount
outstanding of the Certificates.
B. Basic Rent.
"Basic Rent" shall be due and payable in arrears on each
Payment Date in amounts calculated as set forth below:
(1) If the Construction Notes are exchanged on a day
which is not a regular Payment Date, Basic Rent shall
be proportionately adjusted to such date of exchange,
and any additional costs (including, without
limitation, any Break Costs) incurred by the Lessor
in connection with such exchange shall also be
payable on such date as Additional Rent under this
Lease. A certificate as to the amount of such costs
submitted to the Lessee by the Lessor shall be
conclusive and binding for all purposes, absent
manifest error.
(2) Basic Rent shall equal the sum of (A) an amount equal
to the product of the Series A Portion times the
Applicable Rate, and (B) an amount equal to the
product of the Series B Portion times the Applicable
Rate, and (C) an amount equal to the product of the
Series C Portion times the Applicable Rate; all
calculated in compliance with the Rate Calculations.
No payments in respect of Basic Rent will be due and payable to the
Lessor to the extent that payments of interest and other payments due
under or with respect to the Construction Notes are made by
Construction Advances pursuant to Section 1.05(c) of the Participation
Agreement.
<PAGE> 42
II. Additional Rent
In addition to such Additional Rent as may otherwise be payable under the
Lease, Lessee shall pay subject to the provisions of this Lease and the
Participation Agreement, within 30 days of a demand therefor but subject in
all cases to Lessee's rights under the Operative Documents, as Additional
Rent, without duplication, all Break Costs, Funding Costs, Reserve Costs,
Increased Costs (for the period beginning 30 days before the Lessee's
receipt of the relevant holder's notice thereof) and Illegality Costs
(collectively, "Additional Costs"); provided, however, that no Additional
Rent shall be payable hereunder in respect of Increased Costs incurred by
any Certificate Purchaser which is not a bank or an affiliate of a bank.
Promptly after Lessor receives notice from any holder of Instruments of any
Additional Costs to be payable as Additional Rent Lessor shall supply (i) a
copy of the same to the Lessee; provided, however, that, other than as
provided in the first parenthetical of the preceding paragraph with respect
to Increased Costs, the failure to provide such notice as to Additional
Costs shall not affect the Lessor's right to recover Additional Rent for
the same but shall merely affect the timing of such recovery; and (ii) a
certificate in reasonable detail setting forth the basis for and the amount
of such Additional Costs submitted by the Lessor (on behalf of a holder) to
the Lessee which notice shall be conclusive and binding for all purposes,
absent manifest error.
<PAGE> 43
SCHEDULE C
<TABLE>
<CAPTION>
INTERESTS OF TENANTS IN COMMON
<S> <C>
Smith Barney Inc. 84.86%
Travelers Group Inc. 7.38%
Salomon Brothers Inc 5.00%
Mutual Management Corp. 2.50%
Smith Barney Capital Services Inc. 0.07%
Smith Barney Commercial Corp. 0.07%
Smith Barney Futures Management Inc. 0.06%
Smith Barney Global Capital Management, Inc. 0.06%
</TABLE>
<PAGE> 44
Exhibit A
Form of Memorandum of Amended and Restated Lease
STATE OF: NEW YORK
COUNTY OF: NEW YORK
Prepared by, Recording Requested by
and When Recorded Return to:
STATE STREET BANK AND TRUST COMPANY
OF CONNECTICUT, NATIONAL ASSOCIATION,
not in its individual capacity but
solely as Trustee of the 1993
Smith Barney Office Building Trust
c/o Thomas C. Mazza, Esq.
Dewey Ballantine LLP
1301 Avenue of the Americas
New York, New York 10019-6092
MEMORANDUM OF AMENDED AND RESTATED LEASE
THIS MEMORANDUM OF AMENDED AND RESTATED LEASE (this
"Memorandum") is entered into and executed as of March 27, 1998, by and between
STATE STREET BANK AND TRUST COMPANY OF CONNECTICUT, NATIONAL ASSOCIATION, not in
its individual capacity but solely in its capacity as Trustee of the 1993 Smith
Barney Office Building Trust under that certain unrecorded Amended and Restated
Declaration of Trust dated as of December 30, 1994 (as amended on March 27,
1998, the "Declaration"), (the "Lessor") having its Corporate Trust Office at
c/o State Street Bank and Trust Company, P.O. Box 778, Boston, Massachusetts
02210, and SMITH BARNEY INC., a Delaware corporation, SALOMON BROTHERS INC, a
Delaware corporation, MUTUAL MANAGEMENT CORP. (formerly Smith Barney Mutual
Funds Management Inc., which was a successor by merger to Mutual Management
Corp.), a New York Corporation, SMITH BARNEY CAPITAL SERVICES INC., a Delaware
corporation, SMITH BARNEY COMMERCIAL CORP., a Delaware corporation, SMITH BARNEY
FUTURES MANAGEMENT INC., a Delaware corporation, SMITH BARNEY GLOBAL CAPITAL
MANAGEMENT, INC., a Delaware corporation, and TRAVELERS GROUP INC. (formerly The
Travelers Inc.), a Delaware corporation, as tenants in common (collectively, the
"Lessee").
<PAGE> 45
PRELIMINARY STATEMENT
Lessor is the owner of the parcels of land more particularly
described on Schedule A hereto and all easements, rights, and appurtenances
relating thereto (collectively, the "Parcel") and all structures, buildings, or
other improvements now or hereafter located on the Parcel (collectively, the
"Improvements"). Lessor leased the Parcel and the Improvements (collectively,
the "Property") to Lessee pursuant to that certain Lease, dated as of July 30,
1993 (the "Original Lease"). The Lessee and the Lessor amended and restated, in
its entirety, the Original Lease to, among other things, extend the lease term
(the "Amended and Restated Lease"). The Lessee and the Lessor wish to amend the
Amended and Restated Lease to, among other things, extend the lease term.
Lessor wishes to evidence of record in the State of New York a
memorandum of that certain unrecorded amendment to the Amended and Restated
Lease between Lessor and Lessee dated March 27, 1998 (the "Lease"). All
capitalized terms used herein and not otherwise defined herein shall have the
meanings ascribed to them in the Lease.
PART I
MEMORANDUM OF LEASE
NOW, THEREFORE, the parties do hereby agree that the Lease
provides as follows:
(i) The term of the Lease is for a term commencing as of July
30, 1993 and ending on March 27, 2003, or such earlier date as provided
in the Lease;
(ii) Nothing contained in the Lease shall be considered as
constituting the consent or request of the Lessor, express or implied,
to or for the performance by any contractor, laborer, materialman, or
vendor of any labor or services or for the furnishing of any materials
for any construction, alteration, addition, repair or demolition of or
to the Property or any part thereof. NOTICE IS HEREBY GIVEN THAT THE
LESSOR IS NOT AND SHALL NOT BE LIABLE FOR ANY LABOR, SERVICES OR
MATERIALS FURNISHED OR TO BE FURNISHED TO THE LESSEE, OR TO ANYONE
HOLDING OR POSSESSING THE PROPERTY OR ANY PART THEREOF THROUGH OR UNDER
THE LESSEE, AND THAT NO MECHANIC'S OR OTHER SIMILAR STATUTORY LIENS FOR
ANY LABOR, SERVICES OR MATERIALS SHALL ATTACH TO OR AFFECT THE PROPERTY
OR ANY PART THEREOF.
A-2
<PAGE> 46
PART II
MISCELLANEOUS
1. No Modification; Conflict. Nothing contained in this
Memorandum shall modify or be deemed to modify the Lease. Should any conflict
exist between the provisions of this Memorandum and the Lease, the terms and
provisions of the Lease shall govern.
2. Multiple Counterparts. The parties may sign this Memorandum
in any number of counterparts and on separate counterparts, each of which shall
be an original but all of which together shall constitute one and the same
instrument.
IN WITNESS WHEREOF, the parties hereto have caused this
Memorandum of Lease to be duly executed by their respective officers solely for
the purposes of acknowledging and placing of record their agreements referred to
above.
STATE STREET BANK AND TRUST
COMPANY OF CONNECTICUT,
NATIONAL ASSOCIATION,
not in its individual capacity but solely as
Trustee of the 1993 Smith Barney Office
Building Trust, as lessor
By:
------------------------------------------
Name:
Title:
SMITH BARNEY INC.
By:
------------------------------------------
Name:
Title:
A-3
<PAGE> 47
SALOMON BROTHERS INC
By:
------------------------------------------
Name:
Title:
TRAVELERS GROUP INC.
By:
------------------------------------------
Name:
Title:
MUTUAL MANAGEMENT CORP.
By:
------------------------------------------
Name:
Title:
A-4
<PAGE> 48
SMITH BARNEY FUTURES
MANAGEMENT INC.
By:
------------------------------------------
Name:
Title:
SMITH BARNEY CAPITAL SERVICES INC.
By:
-----------------------------------------
Name:
Title:
SMITH BARNEY COMMERCIAL CORP.
By:
------------------------------------------
Name:
Title:
SMITH BARNEY GLOBAL
CAPITAL MANAGEMENT, INC.
By:
------------------------------------------
Name:
Title:
A-5
<PAGE> 49
SCHEDULE A
to Memorandum of Lease
Description of the Parcel
PARCEL 1
The fee of Parcel 1 and the Lease (in part) cover premises more particularly
described as follows:
ALL that certain plot, piece or parcel of land, situate, lying and being in the
Borough of Manhattan, County, City and State of New York, bounded and described
as follows:
BEGINNING at the corner formed by the intersection of the southerly line of
Hubert Street with the westerly line of Greenwich Street;
RUNNING THENCE South 21 degrees 23 minutes 00 minutes east along the westerly
line of Greenwich Street, 210.01 feet;
THENCE South 68 degrees 07 minutes 20 seconds West 140.00 feet;
THENCE South 21 degrees 52 minutes 40 seconds East 9.00 feet;
THENCE South 68 degrees 07 minutes 20 seconds West 281.89 feet to a point in the
easterly line of West Street;
THENCE North 20 degrees 04 minutes 45 seconds West along the easterly line of
West Street, 219.11 feet to the corner formed by the intersection of the
easterly line of West Street with southerly line of Hubert Street;
THENCE North 68 degrees 07 minutes 20 seconds East along the southerly line of
Hubert Street, 416.52 feet to the point or place of BEGINNING.
The street lines described above as shown on map entitled "Map Showing a Change
in the Street System etc. in Connection with the Washington Market Urban Renewal
Area", dated March 4, 1970, modified July 1, 1970, Acc. No. 29985, adopted by
the Board of Estimate, October 8, 1970, Cal. No. 15.
Elevations refer to Datum use by the Topographical Bureau, Borough of Manhattan,
which is 2.75 feet above United States Coast and Geodetic Survey Datum, mean sea
level, Sandy Hook, New Jersey.
The bearings area in the system used on the Borough Survey, Borough President's
Office, Manhattan.
<PAGE> 50
PARCEL 2
The Lease in part covers premises more particularly described as follows:
ALL that certain plot, piece or parcel of land, situate, lying and being in the
Borough of Manhattan, County, City and State of New York, bounded ad described
as follows:
BEGINNING at the corner formed by the intersection of the easterly line of West
Street with the northerly line of N. Moore Street;
RUNNING THENCE North 20 degrees 04 minutes 45 seconds West, along the easterly
line of West Street, 190.09 feet;
THENCE North 21 degrees 52 minutes 40 seconds West 9.00 feet;
THENCE North 68 degrees 07 minutes 20 seconds East 140.00 feet to a point in the
westerly line of Greenwich Street;
THENCE South 21 degrees 28 minutes 00 seconds East, along the westerly line of
Greenwich Street, 199.00 feet to the corner formed by the intersection of the
northerly line of N. Moore Street with the westerly line of Greenwich Street;
THENCE South 68 degrees 07 minutes 20 seconds West, along the northerly line of
N. Moore Street, 426.43 feet to the point or place of BEGINNING.
The street lines described above are as shown on map entitled "Map Showing a
Change in the Street System etc. in Connection wit the Washington Market Urban
Renewal Area", dated March 4, 1970, modified July 1, 1970, Acc. No. 29985,
adopted by the Board of Estimate, October 8, 1970, Cal. No. 15.
Elevations refer to Datum use by the Topographical Bureau, Borough of Manhattan,
which is 2.75 feet above United States Coast and Geodetic Survey Datum, mean sea
level, Sandy Hook, New Jersey.
The bearings area in the system used on the Borough Survey, Borough President's
Office, Manhattan.
BLANKET DESCRIPTION (PARCELS 1 AND 2)
The Lease covers premises more particularly described as follows:
ALL that certain plot, piece or parcel of land, situate, lying and being in the
Borough of Manhattan, County, City and State of New York, bounded ad described
as follows:
BEGINNING at the corner formed by the intersection of the southerly line of
Hubert Street with the westerly line of Greenwich Street;
RUNNING THENCE South 21 degrees 28 minutes 00 seconds East along the westerly
line of Greenwich Street, 409.01 feet to the corner formed by the intersection
of the westerly line of Greenwich Street with the northerly line of N. Moore
Street;
ii
<PAGE> 51
THENCE South 68 degrees 07 minutes 20 seconds West along the northerly line of
N. Moore Street, 426.43 feet to the corner formed by the intersection of the
northerly line of N. Moore Street with the easterly line of West Street;
THENCE North 20 degrees 04 minutes 45 seconds West along the easterly line of
West Street, 409.20 feet to the corner formed by the intersection of the
easterly line of West Street with the southerly line of Hubert Street;
THENCE North 68 degrees 07 minutes 20 seconds East along the southerly line of
Hubert Street, 416.52 feet to the point or place of BEGINNING;
The street lines described above are as shown on map entitled "Map Showing a
Change in the Street System etc. in Connection wit the Washington Market Urban
Renewal Area", dated March 4, 1970, modified July 1, 1970, Acc. No. 29985,
adopted by the Board of Estimate, October 8, 1970, Cal. No. 15.
Elevations refer to Datum use by the Topographical Bureau, Borough of Manhattan,
which is 2.75 feet above United States Coast and Geodetic Survey Datum, mean sea
level, Sandy Hook, New Jersey.
The bearings area in the system used on the Borough Survey, Borough President's
Office, Manhattan.
iii
<PAGE> 1
EXHIBIT 12.01
SALOMON SMITH BARNEY HOLDINGS INC. AND SUBSIDIARIES
Calculation of Ratio of Earnings to Fixed Charges
(Unaudited)
<TABLE>
<CAPTION>
Years Ended December 31,
-------------------------------------------------------
Dollars in millions 1998 1997 1996 1995 1994
- ------------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C>
Earnings from continuing operations:
Income (loss) from continuing operations before income taxes
and cumulative effect of change in accounting principles $ 1,316 $ 1,820 $ 3,064 $ 1,820 $ (173)
Add fixed charges (see below) 11,523 10,626 8,265 8,890 7,204
Other adjustments 0 0 1 0 0
-------- -------- -------- -------- -------
Earnings as defined $ 12,839 $ 12,446 $ 11,330 $ 10,710 $ 7,031
======== ======== ======== ======== =======
Fixed charges from continuing operations:
Interest expense $ 11,466 $ 10,530 $ 8,175 $ 8,797 $ 7,112
Other adjustments 57 96 90 93 92
-------- -------- -------- -------- -------
Fixed charges from continuing operations as defined $ 11,523 $ 10,626 $ 8,265 $ 8,890 $ 7,204
======== ======== ======== ======== =======
Ratio of earnings to fixed charges 1.11 1.17 1.37 1.20 0.98*
======== ======== ======== ======== =======
</TABLE>
NOTES:
The ratio of earnings to fixed charges from continuing operations was
calculated by dividing the sum of fixed charges into the sum of income (loss)
from continuing operations before income taxes and cumulative effect of change
in accounting principles and fixed charges. Fixed charges consist of interest
expense, including capitalized interest and a portion of rental expense
representative of the interest factor.
* For the year ended December 31, 1994, earnings as defined were inadequate to
cover fixed charges. The amount by which fixed charges exceeded earnings as
defined for the year was $173 million.
<PAGE> 1
Exhibit 23.1
[LETTERHEAD OF PRICEWATERHOUSECOOPERS L.L.P.]
CONSENT OF INDEPENDENT ACCOUNTANTS
To the Board of Directors and Stockholder
of Salomon Smith Barney Holdings Inc.
We consent to the incorporation by reference in the following Registration
Statements on Form S-3 of Salomon Smith Barney Holdings Inc.:
Nos. 33-40600, 33-41932, 33-48199, 33-49136, 33-57922, 33-51269, 33-54929,
33-56481, 333-01807, 333-02897, 333-11881, 333-38931, 333-45529 and
333-71667
of our report dated January 25, 1999 relating to our audit of the consolidated
statements of financial condition of Salomon Smith Barney Holdings Inc. and
Subsidiaries as of December 31, 1998 and 1997 and the related consolidated
statements of income, cash flows, and changes in stockholder's equity for each
of the three years in the period ended December 31, 1998, which report is
included in the Form 10-K of Salomon Smith Barney Holdings Inc. for the year
ended December 31, 1998.
/s/ PricewaterhouseCoopers L.L.P.
---------------------------------
New York, New York
March 12, 1999
<PAGE> 1
Exhibit 23.2
[ARTHUR ANDERSEN LLP LETTERHEAD]
CONSENT OF INDEPENDENT CERTIFIED PUBLIC ACCOUNTANTS
As independent public accountants, we hereby consent to the incorporation by
reference in the following Registration Statements on Form S-3 of Salomon Smith
Barney Holdings Inc.:
Nos. 33-40600, 33-41932, 33-48199, 33-49136, 33-57922, 33-51269, 33-54929,
33-56481, 333-01807, 333-02897, 333-11881, 333-38931, 333-45529 and
333-71667
of our report dated March 13, 1997, relating to the consolidated statement of
financial condition of Salomon Inc and subsidiaries as of December 31, 1996 and
1995, and the related consolidated statements of income, changes in
stockholders' equity and cash flows for each of the three years in the period
ended December 31, 1996, which is incorporated by reference or included in the
annual report on Form 10-K of Salomon Smith Barney Holdings Inc. for the year
ended December 31, 1998.
/s/ ARTHUR ANDERSEN LLP
New York, New York
March 12, 1999
<TABLE> <S> <C>
<ARTICLE> BD
<LEGEND>
THE SCHEDULE CONTAINS SUMMARY FINANCIAL INFORMATION EXTRACTED FROM THE COMPANY'S
CONSOLIDATED FINANCIAL STATEMENTS AND IS QUALIFIED IN ITS ENTIRETY BY REFERENCE
TO SUCH FINANCIAL STATEMENTS.
</LEGEND>
<MULTIPLIER> 1,000,000
<S> <C>
<PERIOD-TYPE> YEAR
<FISCAL-YEAR-END> DEC-31-1998
<PERIOD-END> DEC-31-1998
<CASH> 4,619
<RECEIVABLES> 24,174
<SECURITIES-RESALE> 38,691
<SECURITIES-BORROWED> 49,392
<INSTRUMENTS-OWNED> 88,637
<PP&E> 1,114
<TOTAL-ASSETS> 211,901
<SHORT-TERM> 15,495
<PAYABLES> 31,724
<REPOS-SOLD> 61,024
<SECURITIES-LOANED> 7,712
<INSTRUMENTS-SOLD> 66,282
<LONG-TERM> 20,151
745
0
<COMMON> 0
<OTHER-SE> 8,768
<TOTAL-LIABILITY-AND-EQUITY> 211,901
<TRADING-REVENUE> (113)
<INTEREST-DIVIDENDS> 12,902
<COMMISSIONS> 3,214
<INVESTMENT-BANKING-REVENUES> 2,320
<FEE-REVENUE> 2,165
<INTEREST-EXPENSE> 11,466
<COMPENSATION> 5,848
<INCOME-PRETAX> 1,316
<INCOME-PRE-EXTRAORDINARY> 818
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> 818
<EPS-PRIMARY> 0
<EPS-DILUTED> 0
</TABLE>
<PAGE> 1
Exhibit 99.01
[ARTHUR ANDERSEN LLP LETTERHEAD]
REPORT OF INDEPENDENT PUBLIC ACCOUNTANTS
TO THE SHAREHOLDERS AND BOARD OF DIRECTORS OF SALOMON INC:
We have audited the accompanying consolidated statement of financial condition
of Salomon Inc (a Delaware corporation) and subsidiaries as of December 31,
1996 and 1995, and the related consolidated statements of income, changes in
stockholders' equity and cash flows for each of the three years in the period
ended December 31, 1996. These consolidated financial statements are the
responsibility of the Company's management. Our responsibility is to express an
opinion on these consolidated financial statements based on our audits.
We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements are free of
material misstatement. An audit includes examining, on a test basis, evidence
supporting the amounts and disclosures in the consolidated financial
statements. An audit also includes assessing the accounting principles used and
significant estimates made by management, as well as evaluating the overall
financial statement presentation. We believe that our audits provide a
reasonable basis for our opinion.
In our opinion, the consolidated financial statements referred to above present
fairly, in all material respects, the financial position of Salomon Inc and
subsidiaries as of December 31, 1996 and 1995, and the results of their
operations and their cash flows for each of the three years in the period ended
December 31, 1996, in conformity with generally accepted accounting principles.
/s/ Arthur Andersen LLP
NEW YORK, NEW YORK
MARCH 13, 1997
