-----BEGIN PRIVACY-ENHANCED MESSAGE----- Proc-Type: 2001,MIC-CLEAR Originator-Name: webmaster@www.sec.gov Originator-Key-Asymmetric: MFgwCgYEVQgBAQICAf8DSgAwRwJAW2sNKK9AVtBzYZmr6aGjlWyK3XmZv3dTINen TWSM7vrzLADbmYQaionwg5sDW3P6oaM5D3tdezXMm7z1T+B+twIDAQAB MIC-Info: RSA-MD5,RSA, A6P2/uB912zCM4y5yUvEvvdqmuJNvnScMPoyKK61BBMDSkwELZLZAKGCWSGAE8Qm 9VoQG3xBRPBfn/NXICJXKQ== 0000950123-99-002171.txt : 19990317 0000950123-99-002171.hdr.sgml : 19990317 ACCESSION NUMBER: 0000950123-99-002171 CONFORMED SUBMISSION TYPE: 10-K405 PUBLIC DOCUMENT COUNT: 7 CONFORMED PERIOD OF REPORT: 19981231 FILED AS OF DATE: 19990316 FILER: COMPANY DATA: COMPANY CONFORMED NAME: SALOMON SMITH BARNEY HOLDINGS INC CENTRAL INDEX KEY: 0000200245 STANDARD INDUSTRIAL CLASSIFICATION: SECURITY BROKERS, DEALERS & FLOTATION COMPANIES [6211] IRS NUMBER: 221660266 STATE OF INCORPORATION: DE FISCAL YEAR END: 1231 FILING VALUES: FORM TYPE: 10-K405 SEC ACT: SEC FILE NUMBER: 001-04346 FILM NUMBER: 99566166 BUSINESS ADDRESS: STREET 1: 388 GREENWICH ST STREET 2: 28TH FLOOR CITY: NEW YORK STATE: NY ZIP: 10013 BUSINESS PHONE: 2128166000 MAIL ADDRESS: STREET 1: SEVEN WORLD TRADE CENTER STREET 2: 29TH FLOOR CITY: NEW YORK STATE: NY ZIP: 10048 FORMER COMPANY: FORMER CONFORMED NAME: SALOMON INC DATE OF NAME CHANGE: 19920703 FORMER COMPANY: FORMER CONFORMED NAME: PHIBRO CORP DATE OF NAME CHANGE: 19820526 FORMER COMPANY: FORMER CONFORMED NAME: ENGELHARD MINERALS & CHEMICALS CORP DATE OF NAME CHANGE: 19811104 10-K405 1 SALOMON SMITH BARNEY HOLDINGS INC. 1 - -------------------------------------------------------------------------------- - -------------------------------------------------------------------------------- UNITED STATES SECURITIES AND EXCHANGE COMMISSION WASHINGTON, D.C. 20549 ------------------------ 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 ------------------------ COMMISSION FILE NUMBER 1-4346 ------------------------ SALOMON SMITH BARNEY HOLDINGS INC. (EXACT NAME OF REGISTRANT AS SPECIFIED IN ITS CHARTER) 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)
(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.] - -------------------------------------------------------------------------------- - -------------------------------------------------------------------------------- 2 SECURITIES REGISTERED PURSUANT TO SECTION 12(b) OF THE ACT:
TITLE OF EACH CLASS NAME OF EACH EXCHANGE ON WHICH REGISTERED ------------------- ----------------------------------------- 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
SECURITIES REGISTERED PURSUANT TO SECTION 12(G) OF THE ACT: NONE [COVER PAGE 2 OF 2 PAGES.] 3 SALOMON SMITH BARNEY HOLDINGS INC. ANNUAL REPORT ON FORM 10-K FOR FISCAL YEAR ENDED DECEMBER 31, 1998 ------------------------ TABLE OF CONTENTS
FORM 10-K ITEM NUMBER PAGE - ----------- ---- 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
4 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) - --------------- (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. 1 5 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 2 6 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 3 7 ("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. 4 8 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 5 9 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.
MUTUAL FUND ASSETS UNDER MANAGEMENT DECEMBER 31, -------------------------------------------------------- 1998 1997 1996 ---------------- ---------------- ---------------- (DOLLARS IN BILLIONS) NO. OF NO. OF NO. OF FUNDS ASSETS FUNDS ASSETS FUNDS ASSETS ------ ------ ------ ------ ------ ------ 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 --- ------ --- ----- --- ----- Total........................... 174 $117.7 155 $98.4 149 $82.0 === ====== === ===== === =====
6 10 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 7 11 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. 8 12 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. 9 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. 10 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. 11 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 12 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 13 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 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
DOLLARS IN MILLIONS YEAR ENDED DECEMBER 31, 1998 1997 1996 - ------------------------ ------ ------ ------ 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 ====== ====== ======
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 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. 16 20 Total assets under fee-based management were as follows:
DOLLARS IN BILLIONS AT DECEMBER 31, 1998 1997 1996 - ------------------- ------ ------ ------ 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 ====== ====== ======
- --------------- * 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 21 ASSET MANAGEMENT
DOLLARS IN MILLIONS YEAR ENDED DECEMBER 31, 1998 1997 1996 - ----------------------- ---- ---- ---- 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 ==== ==== ====
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 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. 19 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. 20 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 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. 22 26 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 23 27 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 24 28 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 25 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 26 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 27 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.
RISK EXPOSURES DECEMBER 31, DECEMBER 31, ($ IN MILLIONS) 1998 1998 AVERAGE 1998 HIGH 1998 LOW 1997* - --------------- ------------ ------------ --------- -------- ------------ 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 ---- --- --- --- ----
- --------------- * 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. 28 32 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 29 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 30 34 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 31 35 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. 32 36 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 33 37 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. 34 38 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 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 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 41 EXHIBIT INDEX
EXHIBIT NUMBER DESCRIPTION OF EXHIBIT - ------- ---------------------- 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.
- --------------- + Filed herewith. 38 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 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.
SIGNATURE TITLE --------- ----- /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
40 44 SALOMON SMITH BARNEY HOLDINGS INC. AND SUBSIDIARIES INDEX TO CONSOLIDATED FINANCIAL STATEMENTS AND SCHEDULES
PAGE ---- 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)
F-1 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 46 SALOMON SMITH BARNEY HOLDINGS INC. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF INCOME
DOLLARS IN MILLIONS YEAR ENDED DECEMBER 31, 1998 1997 1996 - ----------------------- ------- ------- ------- 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 ======= ======= =======
The accompanying notes are an integral part of these consolidated financial statements. F-3 47 SALOMON SMITH BARNEY HOLDINGS INC. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF FINANCIAL CONDITION
DOLLARS IN MILLIONS DECEMBER 31, 1998 1997 - ------------------- -------- -------- 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 ======== ========
The accompanying notes are an integral part of these consolidated financial statements. F-4 48 SALOMON SMITH BARNEY HOLDINGS INC. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF FINANCIAL CONDITION
DOLLARS IN MILLIONS DECEMBER 31, 1998 1997 - ------------------- -------- -------- 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 ======== ========
The accompanying notes are an integral part of these consolidated financial statements. F-5 49 SALOMON SMITH BARNEY HOLDINGS INC. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDER'S EQUITY
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 - ------------------- --------- ------ ---------- -------- --------------- -------- ------------- 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 ===== == ======= ====== === ======= ======
- --------------- * 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 50 SALOMON SMITH BARNEY HOLDINGS INC. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF CASH FLOWS
DOLLARS IN MILLIONS YEAR ENDED DECEMBER 31, 1998 1997 1996 - ----------------------- -------- -------- -------- 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 ======== ======== ========
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 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:
RESTRUCTURING RESERVE RESTRUCTURING RESERVE AS CHARGES AND CREDITS THROUGH BALANCE AT DOLLARS IN MILLIONS ORIGINALLY RECORDED DECEMBER 31, 1998 DECEMBER 31, 1998 - ------------------- ------------------------ --------------------------- --------------------- 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*** ---- ----- ----
- --------------- * 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 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 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:
RESTRUCTURING RESERVE RESTRUCTURING RESERVE AS CHARGES THROUGH BALANCE AT DOLLARS IN MILLIONS ORIGINALLY RECORDED DECEMBER 31, 1998 DECEMBER 31, 1998 - ------------------- ------------------------ ----------------- --------------------- Severance.................... $69 $(10) $59 Facilities................... 9 (2) 7 Other........................ 2 -- 2 --- ---- --- $80 $(12) $68* === ==== ===
- --------------- * 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 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 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 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 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 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:
DOLLARS IN MILLIONS YEAR ENDED DECEMBER 31, 1998 1997 1996 - ----------------------- ---- ------ ------ 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 ==== ====== ======
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 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.
DOLLARS IN MILLIONS YEAR ENDED DECEMBER 31, 1998 1997 1996 - ----------------------- ------ ------ ------ 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 ===== ====== ======
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 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.
DOLLARS IN MILLIONS YEAR ENDED DECEMBER 31, 1996 - ----------------------- ----- 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) =====
NOTE 7. SEGMENT INFORMATION F-17 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:
DOLLARS IN MILLIONS YEAR ENDED DECEMBER 31, 1998 1997 1996 - ----------------------- -------- -------- -------- 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 ======== ======== ========
- --------------- * 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 62 SALOMON SMITH BARNEY HOLDINGS INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
REVENUES INCOME (LOSS) FROM BEFORE INTEREST CONTINUING OPERATIONS DOLLARS IN MILLIONS EXPENSE BEFORE INCOME TAXES TOTAL ASSETS* ------------------- --------------- --------------------- ------------- 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 ======= ======= ========
- --------------- * The net realizable value of Basis Petroleum, $490 million, is included in North America in 1996. F-19 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.
DOLLARS IN MILLIONS YEAR ENDED DECEMBER 31, 1998 1997 - ----------------------- ------- ------- 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 ======= =======
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 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.
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 - ------------------- ----------- ----------- ----------- ----------- ------------- ------------- 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 ======= ====== ======= ====== ======= =======
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:
SALOMON SMITH BARNEY HOLDINGS INC. DOLLARS IN MILLIONS (PARENT COMPANY) SUBSIDIARIES TOTAL - ------------------- -------------------- ------------ ------- 1999....................................... $ 2,786 $ 23 $ 2,809 2000....................................... 3,360 353 3,713 2001....................................... 2,088 218 2,306
F-21 65 SALOMON SMITH BARNEY HOLDINGS INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
SALOMON SMITH BARNEY HOLDINGS INC. DOLLARS IN MILLIONS (PARENT COMPANY) SUBSIDIARIES TOTAL - ------------------- -------------------- ------------ ------- 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 ======= ====== =======
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.
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 - --------------------- --------- -------------- ------------- --------- -------------- ------------- 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
F-22 66 SALOMON SMITH BARNEY HOLDINGS INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
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 - --------------------- --------- -------------- ------------- --------- -------------- ------------- 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%
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.
DOLLARS IN MILLIONS ------------------- 1999................................................. $ 220 2000................................................. 206 2001................................................. 183 2002................................................. 164 2003................................................. 113 Thereafter........................................... 455 ------ Minimum future rentals............................... $1,341 ======
F-23 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:
SI FINANCING SSBH TRUST I CAPITAL I ------------- ----------------- 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
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 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:
EXCESS OVER DOLLARS IN MILLIONS NET CAPITAL MINIMUM SUBSIDIARY JURISDICTION OR EQUIVALENT REQUIREMENT - ------------------- ------------ ------------- ----------- 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)
- --------------- * 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 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 70 SALOMON SMITH BARNEY HOLDINGS INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
OTHER AWARDS CITIGROUP AWARDS SIP PLAN -------------------------- ------------ ASSUMPTIONS 1998 1997 1996 1996 - ----------- ------ ------ ------ ------ 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%
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 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:
DOLLARS IN MILLIONS YEAR ENDED DECEMBER 31, 1998 1997 1996 - ----------------------- ---- ------ ------ 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 ==== ====== ======
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:
DOLLARS IN MILLIONS DECEMBER 31, 1998 1997 - ----------------------- ------ ------ 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 ------ ------
F-28 72 SALOMON SMITH BARNEY HOLDINGS INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
DOLLARS IN MILLIONS DECEMBER 31, 1998 1997 - ----------------------- ------ ------ 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 ====== ======
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:
DOLLARS IN MILLIONS YEAR ENDED DECEMBER 31, 1998 1997 1996 - ----------------------- ---- ---- ---- 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) ==== ==== ====
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:
YEAR ENDED DECEMBER 31, 1998 1997 1996 - ----------------------- ---- ---- ---- 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% == == ==
F-29 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:
DOLLARS IN MILLIONS - ------------------- 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 ========
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 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 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 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 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:
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 - ------------------- -------- ------ ----------- -------- ------ ----------- 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 ======== ===== ===== ======== ===== =====
- --------------- (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:
1998 1997 ---------------------- ---------------------- AVERAGE AVERAGE AVERAGE AVERAGE DOLLARS IN BILLIONS ASSETS LIABILITIES ASSETS LIABILITIES - ------------------- ------- ----------- ------- ----------- 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 ===== ===== ==== =====
F-34 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 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 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.
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 ------------------- -------- ----- -------- ----- -------- ----- -------- ----- 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 === === ===== ===== === === ===== =====
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 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
DOLLARS IN MILLIONS YEAR ENDED DECEMBER 31, 1998 1997 1996 - ----------------------- ---- ------ ------ 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 ==== ====== ======
F-38 82 SALOMON SMITH BARNEY HOLDINGS INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED) PARENT COMPANY ONLY CONDENSED STATEMENTS OF FINANCIAL CONDITION
DOLLARS IN MILLIONS DECEMBER 31, 1998 1997 - ------------------- ------- ------- 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 ======= =======
- --------------- (1) Includes $3.8 billion and $3.1 billion of subordinated note receivables at December 31, 1998 and December 31, 1997, respectively. F-39 83 SALOMON SMITH BARNEY HOLDINGS INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED) PARENT COMPANY ONLY CONDENSED STATEMENTS OF CASH FLOWS
DOLLARS IN MILLIONS YEAR ENDED DECEMBER 31, 1998 1997 1996 - ----------------------- ------- -------- ------- 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 ======= ======== =======
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 84 SALOMON SMITH BARNEY HOLDINGS INC. AND SUBSIDIARIES QUARTERLY FINANCIAL DATA (UNAUDITED) Quarterly results for the year ended December 31, 1998 were as follows:
QUARTER ENDED -------------------------------------------------- DOLLARS IN MILLIONS MARCH 31 JUNE 30 SEPTEMBER 30 DECEMBER 31 - ------------------- -------- ------- ------------ ----------- 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 ====== ====== ====== ======
Quarterly results for the year ended December 31, 1997 were as follows:
QUARTER ENDED -------------------------------------------------- DOLLARS IN MILLIONS MARCH 31 JUNE 30 SEPTEMBER 30 DECEMBER 31 - ------------------- -------- ------- ------------ ----------- 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) ====== ====== ====== ======
F-41 85 EXHIBIT INDEX
EXHIBIT NUMBER DESCRIPTION OF EXHIBIT - ------- ---------------------- 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.
- --------------- + Filed herewith. 38 EX-10.01 2 AMENDED AND RESTATED LEASE 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. ____ 2 TABLE OF CONTENTS
Page ---- 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
3
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
2 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. 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 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 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 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 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 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 7 11 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 8 12 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 9 13 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. 10 14 (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 11 15 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 12 16 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. 13 17 (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 14 18 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. 15 19 (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 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 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 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 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 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 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 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 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: 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 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] 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] 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] 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] 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] 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] 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] 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] 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] 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; 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; 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. 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. 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. 43 SCHEDULE C
INTERESTS OF TENANTS IN COMMON 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%
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"). 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 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 47 SALOMON BROTHERS INC By: ------------------------------------------ Name: Title: TRAVELERS GROUP INC. By: ------------------------------------------ Name: Title: MUTUAL MANAGEMENT CORP. By: ------------------------------------------ Name: Title: A-4 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 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. 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 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 EX-12.01 3 COMPUTATION OF RATIO OF EARNINGS TO FIXED CHARGES 1 EXHIBIT 12.01 SALOMON SMITH BARNEY HOLDINGS INC. AND SUBSIDIARIES Calculation of Ratio of Earnings to Fixed Charges (Unaudited)
Years Ended December 31, ------------------------------------------------------- Dollars in millions 1998 1997 1996 1995 1994 - ------------------------------------------------------------------------------------------------------------------------------ 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* ======== ======== ======== ======== =======
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. EX-23.01 4 CONSENT OF PRICEWATERHOUSECOOPERS L.L.P. 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 EX-23.02 5 CONSENT OF ARTHUR ANDERSEN LLP 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 EX-27.01 6 FINANCIAL DATA SCHEDULE
BD 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. 1,000,000 YEAR DEC-31-1998 DEC-31-1998 4,619 24,174 38,691 49,392 88,637 1,114 211,901 15,495 31,724 61,024 7,712 66,282 20,151 745 0 0 8,768 211,901 (113) 12,902 3,214 2,320 2,165 11,466 5,848 1,316 818 0 0 818 0 0
EX-99.01 7 INDEPENDENT ACCOUNTANTS' REPORT 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 -----END PRIVACY-ENHANCED MESSAGE-----