Back to GetFilings.com
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, DC 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, 2002
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)
NEW YORK 11-2418067
(STATE OR OTHER JURISDICTION OF (I.R.S. EMPLOYER IDENTIFICATION NO.)
INCORPORATION OR ORGANIZATION)
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.
INDICATE BY CHECK MARK WHETHER THE REGISTRANT IS AN ACCELERATED FILER (AS
DEFINED IN EXCHANGE ACT RULE 12B-2). YES | | NO |X|
DOCUMENTS INCORPORATED BY REFERENCE: NONE
AVAILABLE ON THE WEB @ www.citigroup.com
[COVER PAGE 1 OF 3 PAGES.]
SECURITIES REGISTERED PURSUANT TO SECTION 12(b) OF THE ACT:
TITLE OF EACH CLASS NAME OF EACH EXCHANGE ON WHICH REGISTERED
------------------- -----------------------------------------
SENIOR FLOATING INTEREST NOTES (FINS) DUE 2003 (MEDIUM-TERM NEW YORK STOCK EXCHANGE
NOTES, SERIES D)
SMITH BARNEY S&P 500 EQUITY LINKED NOTES DUE OCTOBER 3, 2003 CHICAGO BOARD OPTIONS EXCHANGE
EQUITY LINKED NOTES BASED UPON THE DOW JONES INDUSTRIAL CHICAGO BOARD OPTIONS EXCHANGE
AVERAGE (SM) DUE SEPTEMBER 6, 2005
PRINCIPAL-PROTECTED EQUITY LINKED NOTES BASED UPON THE S&P AMERICAN STOCK EXCHANGE
500(R) INDEX DUE 2005
PRINCIPAL-PROTECTED EQUITY LINKED NOTES BASED UPON THE S&P CHICAGO BOARD OPTIONS EXCHANGE
500(R) INDEX DUE 2005
CALLABLE PRINCIPAL-PROTECTED EQUITY LINKED NOTES BASED UPON CHICAGO BOARD OPTIONS EXCHANGE
THE S&P 500(R) INDEX DUE 2006
CALLABLE EQUITY LINKED NOTES BASED UPON THE thestreet.com AMERICAN STOCK EXCHANGE
INTERNET SECTOR INDEX DUE 2006
0.25% CASH EXCHANGEABLE NOTES LINKED TO A BASKET OF AMERICAN STOCK EXCHANGE
TELECOMMUNICATIONS STOCKS DUE 2005
TARGETED GROWTH ENHANCED TERMS SECURITIES (TARGETS (SM)) OF CHICAGO BOARD OPTIONS EXCHANGE
SUBSIDIARY TRUST WITH RESPECT TO THE COMMON STOCK OF SUN
MICROSYSTEMS, INC.
0.25% NOTES EXCHANGEABLE FOR A BASKET OF SELECTED TECHNOLOGY AMERICAN STOCK EXCHANGE
STOCKS, DUE 2005
TARGETED GROWTH ENHANCED TERMS SECURITIES (TARGETS (SM)) OF AMERICAN STOCK EXCHANGE
SUBSIDIARY TRUST WITH RESPECT TO THE COMMON STOCK OF ORACLE
CORPORATION
TARGETED GROWTH ENHANCED TERMS SECURITIES (TARGETS (SM)) OF AMERICAN STOCK EXCHANGE
SUBSIDIARY TRUST WITH RESPECT TO THE COMMON STOCK OF CISCO
SYSTEMS, INC.
0.25% NOTES EXCHANGEABLE FOR A BASKET OF SELECTED TECHNOLOGY AMERICAN STOCK EXCHANGE
STOCKS, DUE 2007
TARGETED GROWTH ENHANCED TERMS SECURITIES (TARGETS (SM)) OF AMERICAN STOCK EXCHANGE
SUBSIDIARY TRUST WITH RESPECT TO THE COMMON STOCK OF EMC
CORPORATION
TARGETED GROWTH ENHANCED TERMS SECURITIES (TARGETS (SM)) OF AMERICAN STOCK EXCHANGE
SUBSIDIARY TRUST WITH RESPECT TO THE COMMON STOCK OF THE
HOME DEPOT, INC.
TARGETED GROWTH ENHANCED TERMS SECURITIES (TARGETS (SM)) OF AMERICAN STOCK EXCHANGE
SUBSIDIARY TRUST WITH RESPECT TO THE COMMON STOCK OF GENERAL
ELECTRIC COMPANY
TARGETED GROWTH ENHANCED TERMS SECURITIES (TARGETS (SM)) OF AMERICAN STOCK EXCHANGE
SUBSIDIARY TRUST WITH RESPECT TO THE COMMON STOCK OF
AMERICAN EXPRESS COMPANY
NOTES EXCHANGEABLE FOR THE COMMON STOCK OF PFIZER INC., DUE AMERICAN STOCK EXCHANGE
2008
TARGETED GROWTH ENHANCED TERMS SECURITIES (TARGETS (SM)) OF AMERICAN STOCK EXCHANGE
SUBSIDIARY TRUST WITH RESPECT TO THE COMMON STOCK OF PFIZER
INC.
PRINCIPAL-PROTECTED KNOCK-OUT NOTES LINKED TO THE NASDAQ-100 AMERICAN STOCK EXCHANGE
INDEX(R) DUE 2004
TARGETED GROWTH ENHANCED TERMS SECURITIES (TARGETS (SM)) OF AMERICAN STOCK EXCHANGE
SUBSIDIARY TRUST WITH RESPECT TO THE COMMON STOCK OF
WAL-MART STORES, INC.
TARGETED GROWTH ENHANCED TERMS SECURITIES (TARGETS (SM)) OF AMERICAN STOCK EXCHANGE
SUBSIDIARY TRUST WITH RESPECT TO THE COMMON STOCK OF THE
WALT DISNEY COMPANY
EQUITY LINKED SECURITIES (ELKS (SM)) BASED UPON THE COMMON AMERICAN STOCK EXCHANGE
STOCK OF MOTOROLA, INC. DUE 2003
[COVER PAGE 2 OF 3 PAGES.]
EQUITY LINKED SECURITIES (ELKS (SM)) BASED UPON THE COMMON
STOCK OF INTEL CORPORATION DUE 2003 AMERICAN STOCK EXCHANGE
95% PRINCIPAL-PROTECTED NOTES LINKED TO THE S&P 500(R) INDEX AMERICAN STOCK EXCHANGE
DUE 2004
EQUITY LINKED SECURITIES (ELKS (SM)) BASED UPON THE COMMON AMERICAN STOCK EXCHANGE
STOCK OF TEXAS INSTRUMENTS INCORPORATED DUE 2003
TARGETED GROWTH ENHANCED TERMS SECURITIES (TARGETS (SM)) OF AMERICAN STOCK EXCHANGE
SUBSIDIARY TRUST WITH RESPECT TO THE COMMON STOCK OF BANK
ONE CORPORATION
EQUITY LINKED SECURITIES (ELKS (SM)) BASED UPON THE COMMON AMERICAN STOCK EXCHANGE
STOCK OF THE WALT DISNEY COMPANY DUE 2003
PRINCIPAL-PROTECTED NOTES LINKED TO THE S&P 500(R) INDEX DUE AMERICAN STOCK EXCHANGE
2007
TARGETED GROWTH ENHANCED TERMS SECURITIES (TARGETS (SM)) OF AMERICAN STOCK EXCHANGE
SUBSIDIARY TRUST WITH RESPECT TO THE COMMON STOCK OF AMGEN
INC.
PRINCIPAL-PROTECTED NOTES LINKED TO THE NASDAQ-100 INDEX(R) AMERICAN STOCK EXCHANGE
DUE 2007
PRINCIPAL-PROTECTED NOTES LINKED TO THE DOW JONES EURO STOXX AMERICAN STOCK EXCHANGE
50 INDEX (SM) DUE 2007
EQUITY LINKED SECURITIES (ELKS (SM)) BASED UPON THE COMMON AMERICAN STOCK EXCHANGE
STOCK OF AMERICAN EXPRESS COMPANY DUE 2003
TARGETED GROWTH ENHANCED TERMS SECURITIES (TARGETS (SM)) OF AMERICAN STOCK EXCHANGE
SUBSIDIARY TRUST WITH RESPECT TO THE COMMON STOCK OF DELL
COMPUTER CORPORATION
TARGETED GROWTH ENHANCED TERMS SECURITIES (TARGETS (SM)) OF AMERICAN STOCK EXCHANGE
SUBSIDIARY TRUST WITH RESPECT TO THE COMMON STOCK OF
INTERNATIONAL BUSINESS MACHINES CORPORATION
EQUITY LINKED SECURITIES (ELKS (SM)) BASED UPON THE COMMON AMERICAN STOCK EXCHANGE
STOCKS OF APPLIED MATERIALS, INC., GENERAL ELECTRIC COMPANY,
THE HOME DEPOT, INC., J.P. MORGAN CHASE & CO. AND PFIZER
INC. DUE 2003
SECURITIES REGISTERED PURSUANT TO SECTION 12(g) OF THE ACT:
NONE
[COVER PAGE 3 OF 3 PAGES.]
SALOMON SMITH BARNEY HOLDINGS INC.
ANNUAL REPORT ON FORM 10-K
FOR FISCAL YEAR ENDED DECEMBER 31, 2002
------------------------------
TABLE OF CONTENTS
FORM 10-K
ITEM NUMBER PAGE
- ----------- ----
PART I
1. Business ...................................................................................... 1
2. Properties .................................................................................... 10
3. Legal Proceedings ............................................................................. 10
4. Omitted Pursuant to General Instruction I
PART II
5. Market For Registrant's Common Equity and Related Stockholder Matters ......................... 15
6. Omitted Pursuant to General Instruction I
7. Management's Discussion and Analysis of Financial Condition and Results
of Operations .............................................................................. 16
7A. Quantitative and Qualitative Disclosures About Market Risk .................................... 45
8. Financial Statements And Supplementary Data ................................................... 45
9. Changes in and Disagreements with Accountants on Accounting and
Financial Disclosure .......................................................................... 45
PART III
10-13. Omitted Pursuant to General Instruction I
14. Controls and Procedures ....................................................................... 45
PART IV
15. Exhibits, Financial Statement Schedules, and Reports on Form 8-K .............................. 46
Exhibit Index ................................................................................. 47
Signatures .................................................................................... 48
Certifications ................................................................................ 49
Index to Consolidated Financial Statements and Schedules ...................................... F-1
PART I
ITEM 1. BUSINESS.
Salomon Smith Barney Holdings Inc. ("SSBH"), operating through its subsidiaries,
is a global, full-service investment banking and securities brokerage firm.
Salomon Smith Barney provides a full range of financial advisory, research and
capital raising services to corporations, governments and individuals. Salomon
Smith Barney operates in three business segments: (i) Investment Services, (ii)
Private Client Services and (iii) Asset Management. Salomon Smith Barney
provides investment banking, securities and commodities trading, capital
raising, asset management, advisory, research, brokerage and other financial
services to its customers, and executes proprietary trading strategies on its
own behalf. As used in this Form 10-K, "Salomon Smith Barney" and the "Company"
refer generally to SSBH and its consolidated subsidiaries, and where the context
requires refer to specific subsidiaries.
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 the Global Consumer, Global Corporate and Investment Bank, Private
Client Services, Global Investment Management, and Proprietary Investment
Activities business segments. The periodic reports of Citigroup provide
additional business and financial information concerning that company and its
consolidated subsidiaries.
The principal offices of SSBH are located at 388 Greenwich Street, New York, New
York 10013, telephone number (212) 816-6000. SSBH was incorporated in New York
in 1977 and is the successor to Salomon Smith Barney Holdings Inc., a Delaware
corporation, following a statutory merger effective on July 1, 1999, for the
purpose of changing its state of incorporation.(1)
INVESTMENT SERVICES
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.
- ----------
(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, the outcome of pending
litigation and regulatory matters as well as other risks and uncertainties
detailed in "Outlook" in the MD&A.
1
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 approximately 850 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 and affiliates, 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, currency, and commodity 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."
2
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.
PHIBRO
Phibro conducts a global proprietary commodities dealer business through its
offices in Westport (Connecticut), London and Singapore. Commodities traded
include crude oil, refined oil products, natural gas, metals and various soft
commodities. Phibro makes extensive use of futures markets and is a participant
in the OTC physical and derivatives markets. Its principal competitors are major
integrated oil companies, other commodity trading companies, certain investment
banks, utility companies 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 trading with counterparties 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.
PRIVATE CLIENT SERVICES
Private Client Services provides investment advice, financial planning and
brokerage services to affluent individuals, small and mid-size companies,
non-profits and large corporations primarily through a network of more than
12,600 Smith Barney Financial Consultants in more than 500 offices worldwide. In
addition, Private Client Services provides independent client-focused research
to individuals and institutions around the world.
A significant portion of Private Client Services revenue is generated from fees
earned by managing client assets as well as commissions earned as a broker for
its clients in the purchase and sale of securities. Additionally, Private Client
Services generates net interest revenue by financing customers' securities
transactions and other borrowing needs through security-based lending. Private
Client Services also receives commissions and other sales and service revenues
through the sale of proprietary and third-party mutual funds. As part of Private
Client Services, Global Equity Research produces equity research
3
to serve both institutional and individual investor clients. Expenses for Global
Equity Research are allocated primarily to the Global Equities business and
Global Private Client business.
ASSET MANAGEMENT
The portion of Citigroup's Asset Management segment housed within SSBH is
comprised primarily of two asset management business platforms: Salomon Brothers
Asset Management and Smith Barney Asset Management (the "Asset Management
Group"). These platforms offer a broad range of asset management products and
services from global investment centers, including mutual funds, closed-end
funds and managed accounts. In addition, the Asset Management Group offers a
broad range of unit investment trusts.
Clients include private and public retirement plans, endowments, foundations,
banks, insurance companies, other corporations, government agencies, high net
worth and other individuals. Client relationships may be introduced through
Smith Barney's network of Financial Consultants and other cross-marketing and
distribution opportunities within the Citigroup structure, through the Asset
Management Group'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, 2002, client
assets managed by the Asset Management Group were approximately $258.0 billion,
as compared to approximately $273.1 billion at December 31, 2001 and
approximately $243.8 billion at December 31, 2000. These amounts include
separately managed accounts with assets of approximately $87.0 billion at
December 31, 2002, approximately $93.2 billion at December 31, 2001 and
approximately $83.4 billion at December 31, 2000.
The following table shows the aggregate assets in, and number of, investment
companies managed by the Asset Management Group at December 31st for each of the
last three years.
INVESTMENT COMPANY ASSETS UNDER MANAGEMENT
DECEMBER 31,
-------------------------------------------------------------------------
2002 2001 2000
------------------- ------------------- --------------------
(Dollars in billions)
NO. OF NO. OF NO. OF
FUNDS ASSETS FUNDS ASSETS FUNDS ASSETS
----- ------ ----- ------ ----- ------
Money market 29 $ 97.0 32 $ 97.7 16 $ 83.0
Mutual funds 171 56.5 156 62.4 124 56.2
Annuity funds 36 6.0 37 6.7 40 6.0
Closed-end funds 20 6.2 21 6.2 21 5.8
--- ------ --- ------ --- ------
Total 256 $165.7 246 $173.0 201 $151.0
=== ====== === ====== === ======
At December 31, 2002, the Asset Management Group managed 200 mutual funds
(open-end investment companies), including taxable and tax-exempt money market
funds, equity funds, and taxable and tax-exempt fixed income funds sold
primarily through Smith Barney Financial Consultants, the sales force of
Primerica Financial Services, an affiliate of the
4
Company, and other affiliates of the Company. In addition, certain of the funds
are sold through a variety of other national and regional brokerage firms
pursuant to dealer agreements. Of the mutual funds managed by the Asset
Management Group, 37 are domiciled outside the United States and are offered to
non-resident aliens through Salomon Smith Barney and other financial
intermediaries. In addition, at December 31, 2002, the Asset Management Group
managed 36 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
Smith Barney Financial Consultants. The Asset Management Group also serves as
the primary investment manager to 20 closed-end investment companies, the shares
of which are listed for trading on one or more securities exchanges. At December
31, 2002, the Asset Management Group managed approximately $6.2 billion of
closed-end investment company assets.
The Asset Management Group 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, insurance companies, other corporations and
government agencies. Client relationships may be introduced through
cross-marketing and distribution opportunities within the Citigroup structure,
including Smith Barney's network of Financial Consultants, through the Asset
Management Group's own sales force, or through independent sources such as
consultant evaluations as well as through individual and institutional client
relationships.
The Asset Management Group 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 the Asset Management Group;
other trusts are jointly sponsored through a syndicate of major broker-dealers
of which Salomon Smith Barney is a member. At December 31, 2002, outstanding
unit trust assets held by Salomon Smith Barney's clients were approximately $5.3
billion, as compared to approximately $6.9 billion at December 31, 2001 and
approximately $9.4 billion at December 31, 2000.
5
OTHER INFORMATION
OPERATIONS BY GEOGRAPHIC AREA
For a summary of the Company's operations by geographic area, see Note 6 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
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 currency contracts, 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 1, 5, 8, 14, 16, 17 and 19 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 through acquisitions. Certain of
those competitors may have greater capital and other resources than the Company.
Competitors of the mutual funds and asset management groups include a large
number of mutual fund management and sales companies, asset management firms,
banks and insurance companies. Competition in mutual fund sales and investment
management is based on a variety of factors, including investment performance,
service to clients and product design.
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
6
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 U.S. broker-dealer subsidiary, Salomon Smith Barney
Inc. ("SSB"), is registered as a broker-dealer in all 50 states, the District of
Columbia, Puerto Rico, Taiwan and Guam. SSB is also a primary dealer in U.S.
Treasury securities and a member of the principal United States futures
exchanges. SSB is subject to extensive regulation, 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 SSB is a
member and the securities administrators of the 50 states, the District of
Columbia, Puerto Rico and 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.
Salomon Smith Barney's operations abroad are conducted through various
subsidiaries and affiliates, principally Salomon Brothers International Limited
in London, Nikko Salomon Smith Barney Limited (a joint venture formed in
February 1999, between the Company (49%) and The Nikko Securities Co., Ltd
(51%)) 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 and Markets Act
2000, 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
principally by the Financial Services 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 several foreign
countries. SSBH is the direct or indirect parent of investment advisers
registered and regulated under the Investment Advisers Act of 1940. Such
investment advisers are subject to the Investment Company Act of 1940 in
advising mutual funds registered under such Act. Under these Acts, the advisory
contracts between SSBH's registered investment adviser subsidiaries and the
registered mutual funds they serve ("Registered 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 Registered Funds involved would be
needed for the advisory relationships to continue. In addition, SSBH's
affiliates, including its registered investment adviser subsidiaries, and the
Registered Funds are subject to certain restrictions in their dealings with each
other.
7
For example, SSB may act as broker to a Registered 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 a
Registered Fund. Further, a Registered Fund may acquire securities during the
existence of an underwriting where SSB is a principal underwriter only in
certain limited situations.
SSB is a member of the Securities Investor Protection Corporation (the "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. To supplement the SIPC coverage, SSBH has purchased additional
protection for securities up to the full net equity of all accounts and per
account cash coverage of $900,000 in excess of the basic $100,000 protection.
CAPITAL REQUIREMENTS
As a registered broker-dealer, SSB is subject to the SEC's net capital rule,
Rule 15c3-1 (the "Net Capital Rule"), promulgated under the Exchange Act. SSB
computes 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 aggregate 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 that broker-dealer's designated examining authority (in
the case of SSB, the New York Stock Exchange) 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
8
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.
At December 31, 2002, SSB had net capital, computed in accordance with the Net
Capital Rule, of $3.8 billion, which exceeded the minimum net capital
requirement by $3.4 billion. For further discussion of capital requirements
related to the Company's principal regulated subsidiaries, see Note 11 of Notes
to Consolidated Financial Statements.
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, 2002, the Company had approximately 39,000 full-time and 1,000
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 7 and 8 of Notes to Consolidated
Financial Statements.
TAXATION
For a discussion of tax matters affecting the Company and its operations, see
Note 13 of Notes to Consolidated Financial Statements.
CODE OF ETHICS
The Company has adopted a code of ethics for financial professionals which
applies to the Company's principal executive officer, principal financial
officer and principal accounting officer. The code of ethics for financial
professionals has been included as an exhibit to this Form 10-K.
9
ITEM 2. PROPERTIES.
The Company's principal executive offices are located at 388 Greenwich Street,
New York, New York. The Company leases two buildings located at 388 and 390
Greenwich Street, New York, totaling approximately 2,300,000 square feet. These
leases, which expire in 2008, include a purchase option with respect to the
related properties.
Most of the Company's other offices are located in other leased premises, the
leases for which expire at various times. 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 9 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 SSBH or its subsidiaries
is a party or to which any of their property is subject.
ENRON CORP. AND RELATED MATTERS
In April 2002, Citigroup Inc. ("Citigroup") and, in one case, Salomon Smith
Barney Inc. ("SSB") were named as defendants along with, among others,
commercial and/or investment banks, certain current and former Enron officers
and directors, lawyers and accountants in two putative consolidated class action
complaints that were filed in the United States District Court for the Southern
District of Texas seeking unspecified damages. One action, brought on behalf of
individuals who purchased Enron securities (NEWBY, ET AL. V. ENRON CORP., ET
AL.), alleges violations of Sections 11 and 15 of the Securities Act of 1933, as
amended, and Sections 10(b) and 20(a) of the Securities Exchange Act of 1934, as
amended, and the other action, brought on behalf of current and former Enron
employees (TITTLE, ET AL. V. ENRON CORP., ET AL.), alleges violations of the
Employment Retirement Income Security Act of 1974, as amended ("ERISA"), and the
Racketeer Influenced and Corrupt Organizations Act ("RICO"), as well as claims
for negligence and civil conspiracy. On May 8, 2002, Citigroup and SSB filed
motions to dismiss the complaints. On December 19, 2002, the motions to dismiss
the NEWBY complaint were denied. The motion to dismiss the complaint in TITTLE
remains pending.
In July 2002, Citigroup, SSB and various of its affiliates and certain of their
officers and other employees were named as defendants, along with, among others,
commercial and/or investment banks, certain current and former Enron officers
and directors, lawyers and accountants in a putative class action filed in the
United States District Court for the Southern District of New York on behalf of
purchasers of the Yosemite Notes and Enron Credit-Linked Notes, among other
securities (HUDSON SOFT CO., LTD. V. CREDIT SUISSE FIRST BOSTON CORPORATION, ET
AL.). The amended complaint alleges violations of RICO and of Sections 10(b) and
20(a) of the Securities Exchange Act of 1934, as amended, and seeks unspecified
damages.
10
Additional actions have been filed against Citigroup and certain of its
affiliates, including SSB, along with other parties, including (i) three actions
brought in different state courts by state pension plans, alleging violations of
state securities law and claims for common law fraud and unjust enrichment; (ii)
an action by banks that participated in two Enron revolving credit facilities,
alleging fraud, gross negligence, and breach of implied duties in connection
with defendants' administration of a credit facility with Enron; (iii) an action
brought by several funds in connection with secondary market purchases of Enron
debt securities, alleging violations of the federal securities law, including
Section 11 of the Securities Act of 1933, as amended, and claims for fraud and
misrepresentation; (iv) a series of putative class actions by purchasers of
NewPower Holdings common stock, alleging violations of the federal securities
law, including Section 11 of the Securities Act of 1933, as amended, and Section
10(b) of the Securities Exchange Act of 1934, as amended; (v) an action brought
by two investment funds in connection with purchases of Enron-related securities
for alleged violations of state securities and unfair competition statutes; (vi)
an action brought by several investment funds and fund owners in connection with
purchases of notes of the Osprey I and Osprey II Trusts for alleged violation of
state and federal securities laws and claims for common law fraud,
misrepresentation and conspiracy; (vii) an action brought by several investment
funds and fund owners in connection with purchases of notes of the Osprey I and
Osprey II Trusts for alleged violation of state and federal securities laws and
state unfair competition laws and claims for common law fraud and
misrepresentation; (viii) an action brought by the Attorney General of
Connecticut in connection with various commercial and investment banking
services provided to Enron; (ix) a putative class action brought by clients of
SSB in connection with research reports concerning Enron, alleging breach of
contract; (x) actions brought by several investment funds in connection with the
purchase of notes and/or certificates of the Osprey Trusts, the Marlin Trust,
and the Marlin Water trust, as well as the purchase of other Enron or
Enron-related securities, alleging violation of state and federal securities
laws, and common law civil conspiracy and fraud; (xi) an action brought by a
retirement and health benefits plan in connection with the purchase of certain
Enron notes, alleging violation of federal securities law, including Section 11
of the Securities Act of 1933, as amended, violations of state securities and
unfair competition law, and common law fraud and breach of fiduciary duty; and
(xii) an action brought by two broker/dealers in connection with the purchase of
certain notes, alleging violation of federal and state securities laws. Several
of these cases have been consolidated with the NEWBY action and stayed pending
the Court's decision on the pending motions of certain defendants to dismiss
NEWBY.
Additionally, Citigroup and certain of its affiliates, including SSB, have
provided substantial information to, and have entered into substantive
discussions with, the Securities and Exchange Commission regarding certain of
their transactions with Enron and a transaction with Dynegy Inc. Citigroup and
certain of its affiliates, including SSB, also have received subpoenas and
requests for information from various other regulatory and governmental
agencies and Congressional committees, as well as from the Special Examiner in
the Enron bankruptcy, regarding certain transactions and business relationships
with Enron and its affiliates. Citigroup and such affiliates, including SSB,
are cooperating fully with all such requests.
11
RESEARCH
Since May 2002, Citigroup, SSB and certain executive officers and current and
former employees have been named as defendants in numerous putative class action
complaints by purchasers of various securities alleging they violated federal
securities law, including Sections 10 and 20 of the Securities Exchange Act of
1934, as amended, for allegedly issuing research reports without a reasonable
basis in fact and for allegedly failing to disclose conflicts of interest with
companies in connection with published investment research, including Global
Crossing, Ltd., WorldCom, Inc., AT&T Corp., Winstar Communications, Inc., Rhythm
NetConnections, Inc., Level 3 Communications, Inc., Metromedia Fiber Network,
Inc., XO Communications, Inc., and Williams Communications Group Inc. Almost all
of these actions are pending before a single judge in the United States District
Court for the Southern District of New York for coordinated proceedings. The
court has consolidated these actions into nine separate categories corresponding
to the companies named above.
Additional actions have been filed against Citigroup and certain of its
affiliates, including SSB, and certain of their current and former directors,
officers and employees, along with other parties, including: (1) three putative
class actions filed in state courts and federal courts on behalf of persons who
maintained accounts with SSB asserting, among other things, common law claims,
claims under state statutes, and claims under the Investment Advisers Act of
1940, for allegedly failing to provide objective and unbiased investment
research and investment management, seeking, among other things, return of fees
and commissions; (2) approximately fifteen actions filed in different state
courts by individuals asserting, among other claims, common law claims and
claims under state securities laws, for allegedly issuing research reports
without a reasonable basis in fact and for allegedly failing to disclose
conflicts of interest with companies in connection with published investment
research, including Global Crossing and WorldCom, Inc.; (3) approximately five
actions filed in different state courts by pension and other funds asserting
common law claims and statutory claims under, among other things, state and
federal securities laws, for allegedly issuing research reports without a
reasonable basis in fact and for allegedly failing to disclose conflicts of
interest with companies in connection with published investment research,
including WorldCom, Inc. and Qwest Communications International Inc.; and (4)
more than two hundred arbitrations asserting common law claims and statutory
claims under, among other things, state and federal securities laws, for
allegedly issuing research reports without a reasonable basis in fact and for
allegedly failing to disclose conflicts of interest with companies in connection
with published investment research.
On or about January 27, 2003, lead plaintiff in a consolidated putative class
action in the United States District Court for the District of New Jersey (IN RE
AT&T CORPORATION SECURITIES LITIGATION) sought leave to amend its complaint on
behalf of purchasers of AT&T common stock asserting claims against, among
others, AT&T Corporation, to add as named defendants Citigroup, SSB and certain
executive officers and current and former employees, asserting claims under
federal securities laws for allegedly issuing research reports without a
reasonable basis in fact and for allegedly failing to disclose conflicts of
interest with AT&T in connection with published investment research.
12
On or about January 28, 2003, lead plaintiff in a consolidated putative class
action in the United States District Court for the Southern District of New York
(IN RE GLOBAL CROSSING, LTD. SECURITIES LITIGATION) filed a consolidated
complaint on behalf of purchasers of the securities of Global Crossing and its
subsidiaries, which names as defendants, among others, Citigroup, SSB and
certain executive officers and current and former employees, asserting claims
under federal securities laws for allegedly issuing research reports without a
reasonable basis in fact and for allegedly failing to disclose conflicts of
interest with Global Crossing in connection with published investment research.
Since April 2002, SSB and several other broker/dealers have received subpoenas
and/or requests for information from various governmental and self-regulatory
agencies and Congressional committees. On December 20, 2002, Citigroup and a
number of other broker/dealers reached a settlement-in-principle with the
Securities and Exchange Commission (the "SEC"), the National Association of
Securities Dealers (the "NASD"), the New York Stock Exchange (the "NYSE") and
the Attorney General of New York of all issues raised in their research, initial
public offerings allocation and spinning-related inquiries. In addition, with
respect to issues raised by the NASD, the NYSE and the SEC about SSB's and other
firms' e-mail retention practices, SSB and several other broker/dealers and the
NASD, the NYSE and the SEC entered into a settlement agreement in December 2002.
SSB agreed to pay a penalty in the amount of $1.65 million and did not admit to
any allegation of wrongdoing.
WORLDCOM, INC.
Citigroup and SSB are involved in a number of lawsuits arising out of the
underwriting of debt securities of WorldCom, Inc. These lawsuits include
putative class actions filed in July 2002 by alleged purchasers of WorldCom debt
securities in the United States District Court for the Southern District of New
York (ABOVE PARADISE INVESTMENTS LTD. V. WORLDCOM, INC., ET AL.; MUNICIPAL
POLICE EMPLOYEES RETIREMENT SYSTEM OF LOUISIANA V. WORLDCOM, INC., ET AL.), and
in the United States District Court for the Southern District of Mississippi
(LONGACRE MASTER FUND V. WORLDCOM, INC., ET AL.). These putative class action
complaints assert violations of federal securities law, including Sections 11
and 12 of the Securities Act of 1933, as amended, and seek unspecified damages
from the underwriters.
On October 11, 2002, the ABOVE PARADISE and MUNICIPAL POLICE EMPLOYEES lawsuits
filed in the United States District Court for the Southern District of New York
were superseded by the filing of a consolidated putative class action complaint
in the United States District Court for the Southern District of New York (IN RE
WORLDCOM, INC. SECURITIES LITIGATION). In the consolidated complaint, in
addition to the claims of violations by the underwriters of the federal
securities law, including Sections 11 and 12 of the Securities Act of 1933, as
amended, the plaintiffs allege violations of Section 10(b) of the Securities
Exchange Act of 1934, as amended, and Rule 10b-5 promulgated thereunder, by SSB
arising out of alleged conflicts of interest of SSB and Jack Grubman. The
plaintiffs continue to seek unspecified compensatory damages. In addition to the
consolidated class action complaint, the Southern District of Mississippi class
13
action has been transferred by the Judicial Panel on MultiDistrict Litigation to
the Southern District of New York for centralized pre-trial proceedings with
other WorldCom-related actions.
In addition to the several putative class actions that have been commenced,
certain individual actions have been filed in various federal and state courts
against Citigroup and SSB, along with other parties, concerning WorldCom debt
securities including individual state court actions brought by approximately 18
pension funds and other institutional investors in connection with the
underwriting of debt securities of WorldCom alleging violations of Section 11 of
the Securities Act of 1933, as amended, and, in one case, violations of various
state securities laws and common law fraud. Most of these actions have been
removed to federal court and have been transferred to the Southern District of
New York for centralized pre-trial proceedings with other WorldCom-related
actions.
A putative class action on behalf of participants in WorldCom's 401(k) salary
savings plan and those WorldCom benefit plans covered by ERISA alleging
violations of ERISA and common law fraud (EMANUELE V. WORLDCOM, INC., ET AL.),
which was commenced in the United States District Court for the District of
Columbia, also has been transferred by the Judicial Panel on MultiDistrict
Litigation to the Southern District of New York for centralized pre-trial
proceedings with other WorldCom-related actions. In December 2002, the claims
against SSB and the other underwriters were dismissed without prejudice.
OTHER
In March 1999, a complaint seeking in excess of $250 million was filed by a
hedge fund and its investment advisor against SSB in the Supreme Court of the
State of New York, County of New York (MKP MASTER FUND, LDC ET AL. V. SALOMON
SMITH BARNEY INC.). Plaintiffs allege that while acting as their prime broker
SSB breached its contracts with plaintiffs, converted plaintiffs' monies and
engaged in tortious conduct, including breaching its fiduciary duties. In
October 1999, the court dismissed plaintiffs' tort claims, including the breach
of fiduciary duty claims, but allowed the breach of contract and conversion
claims to stand. In December 1999, SSB filed an answer and asserted
counterclaims against the investment advisor. In response to plaintiffs' motion
to strike the counterclaims, in January 2000, SSB amended its counterclaims
against the investment advisor to seek indemnification and contribution.
Plaintiffs moved to strike SSB's amended counterclaims in February 2000. In
September 2000, the court denied plaintiffs' motion to dismiss SSB's
counterclaims based on indemnification and contribution. In August 2002, SSB
filed a motion for summary judgment.
In April 2002, consolidated amended complaints were filed against the Company
and other investment banks named in numerous putative class actions filed in the
United States District Court for the Southern District of New York alleging
violations of certain federal securities laws (including Section 11 of the
Securities Act of 1933, as amended, and Section 10(b) of the Securities Exchange
Act of 1934, as amended) with respect to the allocation of shares for certain
initial public offerings and related aftermarket transactions and damage to
investors caused by allegedly biased research analyst reports.
14
On February 19, 2003, the court issued an opinion denying the defendants' motion
to dismiss. Also pending in the Southern District of New York against the
Company and other investment banks are several putative class actions which have
been consolidated into a single class action alleging violations of certain
federal and state antitrust laws in connection with the allocation of shares in
initial public offerings when acting as underwriters. The defendants in this
action have moved to dismiss the consolidated amended complaint but the Court
has not yet rendered a decision on those motions.
Additional lawsuits containing similar claims to those described above may be
filed in the future.
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 Inc.
ITEM 6. SELECTED FINANCIAL DATA.
Pursuant to General Instruction I of Form 10-K, the information required by Item
6 is omitted.
15
SALOMON SMITH BARNEY HOLDINGS INC.
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS.
SETTLEMENT-IN-PRINCIPLE AND CHARGE FOR REGULATORY AND LEGAL MATTERS
During the fourth quarter of 2002, the Company, through its parent, Citigroup,
reached a settlement-in-principle with the Securities and Exchange Commission,
the National Association of Securities Dealers, the New York Stock Exchange and
the Attorney General of New York of all issues raised in their research, IPO
allocation and spinning-related inquiries.
The Company established a reserve for the cost of this settlement and toward
estimated costs of the private litigation related to the matters that were the
subject of the settlement as well as the regulatory inquiries and private
litigation related to Enron. The reserve for these matters resulted in an
after-tax charge of approximately $863 million. The Company believes that it
has substantial defenses to the pending private litigations which are at a very
early stage. Given the uncertainties of the timing and outcome of this type of
litigation, the large number of cases, the novel issues, the substantial time
before these cases will be resolved, and the multiple defendants in many of
them, this reserve is difficult to determine and of necessity subject to future
revision.
EVENTS OF SEPTEMBER 11, 2001
As a result of the September 11, 2001 terrorist attack, the Company experienced
a disruption in business, as well as significant property loss. The Company and
its parent, Citigroup, are insured against certain of these losses. The Company
initially recorded insurance recoveries up to the net book value of the assets
written off. These items were recorded in the consolidated statement of income
in "Other operating and administrative expenses." The Company recorded a
receivable of $199 million relating to these insurance recoveries in 2001.
During 2002, additional insurance recoveries were recorded when realized.
Through December 31, 2002, the Company and its parent collected substantially
all of this balance.
SIGNIFICANT ACCOUNTING POLICIES AND SIGNIFICANT ESTIMATES
The consolidated financial statements contain a summary of the Company's
significant accounting policies, including a discussion of recently-issued
accounting pronouncements. Certain of these policies are considered to be more
important to the portrayal of the Company's financial condition, since they
require management to make difficult, complex or subjective judgments, some of
which may relate to matters that are inherently uncertain. These policies
include accounting for securitizations, and the valuation of financial
instruments and contractual commitments where no ready market exists. Additional
information about these policies can be found in Note 1 to the consolidated
financial statements.
16
SALOMON SMITH BARNEY HOLDINGS INC.
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS
SECURITIZATIONS
Securitization is a process by which a legal entity issues certain securities to
investors, which pay a return based on the principal and interest cash flows
from a pool of loans or other financial assets. These assets may have belonged
to the Company prior to their being sold to the entity. The Company securitizes
financial assets that it originated and/or purchased. The Company also assists
its clients in securitizing the clients' financial assets. The Company may
provide administrative, underwriting, liquidity facilities and/or other services
to the resulting securitization entities. See the Off-Balance Sheet Arrangements
section of Management's Discussion and Analysis for additional information about
our securitization programs.
There are two key accounting determinations that must be made relating to
securitizations. In the case where the Company originated or previously owned
the financial assets transferred to the securitization entity, a decision must
be made as to whether that transfer would be considered a sale for generally
accepted accounting principles. The second key determination to be made is
whether the securitization entity should be considered a subsidiary of the
Company and be consolidated into the Company's financial statements or whether
the entity is sufficiently independent that it does not need to be consolidated.
If the securitization entity's activities are sufficiently restricted to meet
certain accounting requirements, the securitization entity is not consolidated
by the seller of the transferred assets. Most of the Company's securitization
transactions are structured to meet the criteria for sale accounting and
non-consolidation. In January 2003, the Financial Accounting Standards Board
("FASB") issued a new interpretation on consolidation. See "Consolidation of
Variable Interest Entities" on page 19.
The Company's securitization activities are conducted on behalf of our clients
and to generate revenues for services provided to the special purpose entities
("SPEs"). The Company uses SPEs for securitizing mortgage-backed securities and
clients' trade receivables, to create investment opportunities for clients
through collateralized debt obligations ("CDOs"), and to meet other client needs
through structuring financing transactions. All the mortgage-backed securities
transactions use qualifying special purpose entities ("QSPEs"), as do certain
CDOs and structured finance transactions. At December 31, 2002, the Company was
involved with 773 SPEs with assets of $308.1 billion, including 102 SPEs with
assets of $3.0 billion that were consolidated by the Company and 300 QSPEs with
assets amounting to $247.4 billion.
Additional information on the Company's securitization activities can be found
in Note 19 to the consolidated financial statements.
17
SALOMON SMITH BARNEY HOLDINGS INC.
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS
VALUATIONS OF FINANCIAL INSTRUMENTS AND CONTRACTUAL COMMITMENTS WITH NO READY
MARKETS
Financial instruments and contractual commitments include fixed maturity and
equity securities, commodities, derivatives and structured securities. The
Company's policy is to carry its financial instruments and contractual
commitments at market value, or when market prices are not readily available,
fair value. For the substantial majority of our portfolios, fair values are
determined based upon externally verifiable model inputs and quoted prices.
Changes in the fair value of trading account assets and liabilities are
recognized in earnings. Deteriorating economic conditions - global, regional, or
related to specific issuers - could adversely affect these values.
If available, quoted market prices are generally the best indication of value.
If quoted market prices are not available for fixed maturity securities,
derivatives or commodities, the Company discounts the expected cash flows using
market interest rates commensurate with the credit quality and maturity of the
investment. Alternatively, matrix or model pricing may be used to determine an
appropriate fair value. The determination of market or fair value considers
various factors, including time value and volatility factors, underlying
options, warrants, and derivatives; price activity for equivalent synthetic
instruments; counterparty credit quality; the potential impact on 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; and derivative
transaction maintenance costs during the period. Changes in assumptions could
affect the fair value of financial instruments and contractual commitments.
In certain situations (primarily equity securities), including thinly-traded
securities, large block holdings, restricted shares or other special situations,
the quoted market price is adjusted to produce an estimate of the attainable
fair value for the securities. For investments that are not publicly-traded,
estimates of fair value are made based upon a review of the investee's financial
results, condition and prospects, together with comparisons to similar companies
for which quoted market prices are available.
For the Company's trading portfolios amounting to assets of $108.1 billion and
liabilities of $61.7 billion at December 31, 2002, fair values were verified in
the following ways: externally verified via comparison to third-party broker
quotations or other third-party sources; models were validated by qualified
personnel independent of the area that created the model and inputs were
verified by comparison to third party broker quotations or other third-party
sources; and by using alternative procedures such as comparison to comparable
securities and/or subsequent liquidation prices. At December 31, 2002,
approximately 97% of the trading portfolios gross assets and liabilities were
considered verified and approximately 3% were considered unverified. Of the
unverified, approximately 65% consists of cash products, where independent
quotes were not available and/or alternative procedures were not feasible, and
35% consists of derivative products where either the model was not validated or
the inputs were not verified due to lack of appropriate market quotations. Such
values are actively reviewed by management.
18
SALOMON SMITH BARNEY HOLDINGS INC.
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS
In determining the fair values of our securities portfolios, management also
reviews the length of time trading positions have been held to identify aged
inventory. During 2002, the average monthly aged inventory designated as
available for immediate sale was approximately $4.2 billion. Inventory positions
that are both aged and whose values are unverified amounted to less than $2.1
billion at December 31, 2002. The fair value of the aged inventory is actively
monitored and, where appropriate, is discounted to reflect the implied
illiquidity for positions that have been available for immediate sale longer
than 90 days. At December 31, 2002, such valuation adjustments amounted to $55
million.
FUTURE APPLICATION OF ACCOUNTING STANDARDS
ACCOUNTING FOR COSTS ASSOCIATED WITH EXIT OR DISPOSAL ACTIVITIES
In June 2002, the FASB issued Statement of Financial Accounting Standards
("SFAS") No. 146, "Accounting for Costs Associated with Exit or Disposal
Activities" ("SFAS 146"). SFAS 146 requires that a liability for costs
associated with exit or disposal activities be recognized when the liability is
incurred. Existing generally accepted accounting principles provide for the
recognition of such costs at the date of management's commitment to an exit
plan. In addition, SFAS 146 requires that the liability be measured at fair
value and adjusted for changes in estimated cash flows.
The provisions of the new standard are effective for exit or disposal activities
initiated after December 31, 2002. It is not expected that SFAS 146 will
materially affect the Company's financial statements.
GUARANTEES AND INDEMNIFICATIONS
In November 2002, the FASB issued FASB Interpretation No. 45, "Guarantor's
Accounting and Disclosure Requirements for Guarantees, Including Indirect
Guarantees of Indebtedness of Others" ("FIN 45"), which requires that, for
guarantees within the scope of FIN 45 issued or amended after December 31, 2002,
a liability for the fair value of the obligation undertaken in issuing the
guarantee be recognized. FIN 45 also requires additional disclosures in
financial statements for periods ending after December 15, 2002. Accordingly,
these new disclosures are included in Note 14 to the consolidated financial
statements. It is not expected that the recognition and measurement provisions
of FIN 45 will have a material effect on the consolidated financial statements.
CONSOLIDATION OF VARIABLE INTEREST ENTITIES
In January 2003, the FASB released FASB Interpretation No. 46, "Consolidation of
Variable Interest Entities" ("FIN 46"). FIN 46 changes the method of determining
whether certain entities, including securitization entities, should be included
in the Company's consolidated financial statements. An entity is subject to FIN
46 and is called a variable interest entity ("VIE") if it has equity that is
insufficient to permit the entity to finance its activities without
19
SALOMON SMITH BARNEY HOLDINGS INC.
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS
additional subordinated financial support from other parties, or equity
investors that cannot make significant decisions about the entity's operations,
or that do not absorb the expected losses or receive the expected returns of the
entity. All other entities evaluate consolidation in accordance with SFAS No.
94, "Consolidation of All Majority-Owned Subsidiaries." A VIE is consolidated by
its primary beneficiary, which is the party involved with the VIE that has a
majority of the expected losses or a majority of the expected residual returns
or both.
The provisions of FIN 46 are to be applied immediately to VIEs created after
January 31, 2003, and to VIEs in which an enterprise obtains an interest after
that date. For any VIEs that must be consolidated under FIN 46 that were created
before February 1, 2003, the assets, liabilities and noncontrolling interest of
the VIE would be initially measured at their carrying amounts with any
difference between the net amount added to the balance sheet and any previously
recognized interest being recognized as the cumulative effect of an accounting
change. If determining the carrying amounts is not practicable, fair value at
the date FIN 46 first applies may be used to measure the assets, liabilities and
noncontrolling interest of the VIE. For VIEs in which an enterprise holds a
variable interest that it acquired before February 1, 2003, FIN 46 applies in
the first fiscal period beginning after June 15, 2003. FIN 46 also mandates new
disclosures about VIEs, some of which are required to be presented in financial
statements issued after January 31, 2003. See Note 19 to the consolidated
financial statements.
The Company is evaluating the impact of applying FIN 46 to existing VIEs in
which it has variable interests and has not yet completed this analysis. The
Company is considering restructuring alternatives that would enable certain VIEs
to meet the criteria for non-consolidation. However, at this time, it is
anticipated that the effect on the Company's consolidated statement of financial
condition could be an increase of as much as $1.4 billion to assets and
liabilities, primarily due to several structured finance entities in which the
Company is involved. As the Company continues to evaluate the impact of applying
FIN 46, additional entities may be identified that would need to be
consolidated.
ACCOUNTING FOR STOCK-BASED COMPENSATION
On January 1, 2003, the Company adopted the fair value recognition provisions of
SFAS 123 prospectively to all awards granted, modified, or settled after January
1, 2003. The prospective method is one of the adoption methods provided for
under SFAS No. 148, " Accounting for Stock-Based Compensation-Transition and
Disclosure," issued in December 2002. SFAS 123 requires that compensation cost
for all stock awards be calculated and recognized over the service period
(generally equal to the vesting period). This compensation cost is determined
using option pricing models, intended to estimate the fair value of the awards
at the grant date. Similar to Accounting Principles Board Opinion No. 25,
"Accounting for Stock Issued to Employees" ("APB 25"), the alternative method of
accounting, an offsetting increase to stockholders equity under SFAS 123 is
recorded equal to the amount of compensation expense charged. Assuming a
three-year vesting period for options, the estimated impact to net
20
SALOMON SMITH BARNEY HOLDINGS INC.
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS
income of this change will be approximately $46 million in 2003 and, when fully
phased in, approximately $91 million annually. The Company, through its parent,
Citigroup, has made changes to various stock-based compensation plan provisions
for future awards. Other changes also may be made that may impact the SFAS 123
estimates previously disclosed.
RESULTS OF OPERATIONS
In 2002, the Company recorded net income of $1,787 million compared to $2,627
million and $3,032 million for the years ended December 31, 2001 and 2000,
respectively. The decrease in 2002 reflects the recording of a provision for
legal and regulatory settlements as well as a continued decline across financial
markets. Revenues, net of interest expense, were $14.4 billion in 2002 compared.
to $15.4 billion and $16.2 billion in 2001 and 2000, respectively.
In 2002, the Company recorded a cumulative after-tax loss of $24 million (net of
tax benefit of $16 million) which related to the adoption of SFAS No. 142,
"Goodwill and Other Intangible Assets." Net income for 2001 was reduced by a
cumulative after tax loss of $1 million, which related to the adoption of SFAS
No. 133, "Accounting for Derivative Instruments and Hedging Activities."
Principal transactions revenues contributed largely to the decline in revenue in
2002 due to decreases in global equities and fixed income trading. For fixed
income, the decline was more than offset by increased net interest revenue
related to fixed income trading activities. Investment banking revenues
decreased 13% as a result of declines in high-grade debt underwriting and merger
and acquisition fees, partially offset by an increase in equity underwriting.
Included in investment banking revenues were fees from the Travelers Property
Casualty Corp. initial public offering which occurred in the first quarter of
2002. Commission revenues increased in 2002 compared to 2001 due to higher
over-the-counter ("OTC") commissions, offset to an extent by a decrease in
listed commissions. Total non-interest expenses increased 2%, excluding the
restructuring charge in 2002 compared to 2001. The increase was primarily the
result of a charge to earnings relating to the establishment of reserves for the
cost of the previously announced proposed settlement-in-principle with
regulators and toward estimated costs of the private litigation related to the
matters that were the subject of the settlement as well as the regulatory
inquiries and private litigation related to Enron. The charge was included in
"Other operating and administrative expenses" in the accompanying consolidated
statement of income. The increase was partially offset by a decrease in
compensation and benefits and savings realized from restructuring actions
initiated in the first and second quarters of 2001. The Company continues to
maintain tight expense controls.
21
SALOMON SMITH BARNEY HOLDINGS INC.
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS
Following is a discussion of the results of operations of the Company's three
operating segments, Investment Services, Private Client Services and Asset
Management.
INVESTMENT SERVICES
Dollars in millions
For the year ended December 31, 2002 2001 2000
------------------------------- ---- ---- ----
Revenues, net of interest expense $7,431 $ 8,209 $8,156
Total non-interest expenses 6,132 5,875 5,681
Income before income taxes and cumulative
effect of change in accounting principle 1,299 2,334 2,475
Provision for income taxes 569 810 847
Cumulative effect of change in accounting
principle (net of tax benefit of $1) -- (1) --
------ ------- ------
Net income $ 730 $ 1,523 $1,628
====== ======= ======
The Company's investment services segment recorded net income in 2002 of $730
million compared to $1.52 billion and $1.63 billion for the years ended December
31, 2001 and 2000, respectively. During 2002 and 2001, the segment recorded a
restructuring credit of $9 million ($5 million net of tax) and a restructuring
charge of $107 million ($64 million net of tax), respectively.
Revenues, net of interest expense, decreased 10% to $7.4 billion in 2002 and
increased 1% to $8.2 billion in 2001. Following is a discussion of the
significant changes to the segment's revenues. Principal transactions revenue
decreased significantly in 2002 and 2001 as the result of decreases in global
equities and fixed income trading. For fixed income, the decline was more than
offset by increased net interest revenue related to fixed income trading
activities. For further information related to principal transactions revenues,
see Note 5 to the consolidated financial statements. Investment banking revenues
declined in 2002 compared to 2001 as a result of a decrease in high-grade debt
underwritings and merger and acqusition fees. These decreases were partially
offset by an increase in equity underwriting. Investment banking revenues
increased in 2001 compared to 2000 as a result of increases in high-grade debt,
public finance and high-yield underwritings, as well as an increase in bank loan
arrangement fees. The increases were partially offset by declines in equity and
unit trust underwritings and merger and acquisition fees. Included in investment
banking revenues in 2002 were fees from the Travelers Property Casualty Corp.
initial public offering which occurred in the first quarter of 2002. Commission
revenues increased in 2002, compared to 2001, as a result of increased OTC
commissions. In 2001, commission revenues were up due to increased listed
commissions. Net interest and dividends increased in 2002 and 2001. The
increases were due primarily to widening spreads in fixed income products,
particularly mortgage-backed securities.
22
SALOMON SMITH BARNEY HOLDINGS INC.
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS
Total non-interest expenses, excluding restructuring-related items, increased 6%
in 2002 compared to 2001 primarily due to a charge related to the establishment
of reserves for the proposed settlement-in-principle with regulators and toward
estimated costs of the private litigation related to the matters that were the
subject of the settlement as well as the regulatory inquiries and private
litigation related to Enron. The increase was partially offset by a decrease in
compensation and benefits expense, reduced communications, occupancy and floor
brokerage expense and savings from restructuring actions initiated during the
first and second quarters of 2001, as well as tight expense controls. Also
partially offsetting the increase in 2002 was the absence of goodwill and other
indefinite-lived intangible amortization due to the adoption of SFAS 141 and
SFAS 142. Total non-interest expenses, excluding restructuring related items,
increased 2% in 2001 compared to 2000 as a result of an increase in compensation
and benefits and floor brokerage expense. This was partially offset by the
savings realized from restructuring actions initiated during the first and
second quarters of 2001 and the release of a rent reserve that was no longer
required. For further discussion of the restructuring-related items, net, see
Note 3 to the consolidated financial statements.
PRIVATE CLIENT SERVICES
Dollars in millions
For the year ended December 31, 2002 2001 2000
------------------------------- ---- ---- ----
Revenues, net of interest expense $5,661 $5,883 $6,864
Total non-interest expenses 4,535 4,677 5,166
Income before income taxes and cumulative
effect of change in accounting principle 1,126 1,206 1,698
Provision for income taxes 424 452 638
Cumulative effect of change in accounting
principle -- -- --
------ ------ ------
Net income $ 702 $ 754 $1,060
====== ====== ======
Private Client Services net income was $702 million in 2002 compared to $754
million in 2001 and $1.1 billion in 2000. Private Client Services net income
decreased $52 million or 7% during 2002 primarily due to lower asset-based fee
revenue, a decline in net interest revenue on securities-based lending and lower
transaction volumes, which were partially offset by lower production-related
compensation, higher revenue from the bank deposit program and the impact of
continued expense control initiatives. Net income of $754 million in 2001
decreased $306 million or 29% compared to 2000 primarily reflecting decreases in
customer transaction volumes, net interest revenue on security-based lending and
asset-based fee revenue, partially offset by higher revenue from the bank
deposit program, the impact of continued expense control initiatives and prior
year restructuring-related pre-tax charge of $8 ($5 million after-tax).
23
SALOMON SMITH BARNEY HOLDINGS INC.
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS
Revenues, net of interest expense, decreased $222 million or 4% in 2002 to $5.7
billion, primarily due to declines in fees from managed accounts, lower net
interest revenue on security-based lending and lower customer transaction
volumes, partially offset by higher revenue from the bank deposit program.
Revenues, net of interest expense, decreased $981 million or 14% in 2001 to $5.9
billion, primarily due to declines in equity markets resulting in lower customer
transaction volumes, decreases in revenue on security-based lending and lower
asset-based fee revenue, partially offset by higher revenue from the bank
deposit program.
Total assets under fee-based management were $179.4 billion, $205.1 billion and
$201.8 billion as of December 31, 2002, 2001 and 2000, respectively (see table
below for detail of Private Client Services assets under fee-based management).
The decrease in 2002 was primarily due to a decline in market values, while the
increase in 2001 reflects higher business volumes compared to 2000. Total client
assets, including assets under fee-based management, of $897 billion in 2002
decreased $80 billion or 8% from $977 billion in 2001, which, in turn, was flat
to 2000. The decrease in 2002 primarily reflects market depreciation, partially
offset by net positive flows of $35 billion. Balances in Smith Barney's bank
deposit program totaled $41 billion in 2002 compared to $36 billion in 2001.
Annualized revenue per financial consultant of $443,000 in 2002 declined 4% from
$461,000 in 2001, which in turn decreased 21% from $580,000 in 2000.
Operating expenses decreased $142 million or 3% in 2002 to $4.5 billion from
$4.7 billion in 2001, which, in turn, decreased $489 million or 10% from $5.2
billion in 2000, primarily reflecting lower production-related compensation
resulting from a decline in revenue combined with the impact of expense control
initiatives. The decrease for 2002 also reflects a prior-year pre-tax
restructuring-related charge of $9 million. For further information concerning
the restructuring-related items, see Note 3 to the consolidated financial
statements.
Assets under fee-based management were as follows:
Dollars in billions
At December 31, 2002 2001 2000
--------------- ---- ---- ----
Financial Consultant managed accounts $ 52.2 $ 54.9 $ 56.2
Consulting Group and internally managed assets 127.2 150.2 145.6
------ ------ ------
Total assets under fee-based management (1) $179.4 $205.1 $201.8
------ ------ ------
(1) Includes assets managed jointly with Salomon Smith Barney Asset
Management.
24
SALOMON SMITH BARNEY HOLDINGS INC.
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS
ASSET MANAGEMENT
Dollars in millions
For the year ended December 31, 2002 2001 2000
------------------------------- ---- ---- ----
Revenues, net of interest expense $ 1,314 $1,295 $1,222
Total non-interest expenses 686 715 653
Income before income taxes and cumulative
effect of change in accounting principle 628 580 569
Provision for income taxes 249 230 225
Cumulative effect of change in accounting
principle (net of tax benefit of $16) (24) -- --
------- ------ ------
Net income $ 355 $ 350 $ 344
======= ====== ======
The asset management segment revenues, net of interest expense, increased to
$1.31 billion in 2002 compared to $1.30 billion in 2001 and $1.22 billion in
2000. The primary revenue component for the asset management segment is asset
management and administration fees, which were $1.26 billion in both 2002 and
2001 and $1.17 billion in 2000. The results for the year 2002 reflect the impact
of positive net flows and the transfer of the managed futures business into the
segment which were partially offset by the impact of negative market action and
decreased U.S. retail money market revenues. The 8% overall increase in fees
from 2000 to 2001 reflects broad growth in all asset management products. Assets
under management for the segment decreased 6% in 2002 and increased 12% in 2001
(see the table on following page for detail of Salomon Smith Barney Asset
Management assets under fee-based management).
Total non-interest expenses were $686 million in 2002 compared to $715 million
in 2001 and $653 million in 2000. The 4% decrease in 2002 is primarily due to
the absence of goodwill/intangible amortization as a result of adopting SFAS 141
and SFAS 142 which offset the increase in variable expenses primarily relating
to distribution fees. The 9% increase in 2001 was driven by an increase in
variable expenses primarily relating to distribution fees. Included in total
expenses in 2001 and 2000 were restructuring charges of $1 million and $4
million, respectively. For further information concerning the
restructuring-related items, net see Note 3 to the consolidated financial
statements.
25
SALOMON SMITH BARNEY HOLDINGS INC.
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS
Assets under fee-based management were as follows:
Dollars in billions
At December 31, 2002 2001 2000
--------------- ---- ---- ----
Money market funds $ 97.0 $ 97.7 $ 83.0
Mutual funds 68.7 75.3 68.0
Managed accounts 85.6 93.2 83.4
Unit investment trusts held in client accounts 5.3 6.9 9.4
Managed commodity pools 1.4 -- --
------ ------ ------
Salomon Smith Barney Asset Management $258.0 $273.1 $243.8
------ ------ ------
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.
26
SALOMON SMITH BARNEY HOLDINGS INC.
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS
CAPITAL AND LIQUIDITY MANAGEMENT
Management of capital and liquidity is critical to a financial institution such
as the Company. It is the policy of the Company to maintain sufficient capital
to support all business initiatives and to ensure access to funding under all
market conditions. The confidence of creditors and counterparties in the
Company's ability to perform pursuant to its contractual obligations is
essential to the Company's continued success.
LIQUIDITY AND CAPITAL RESOURCES
The Company's total assets were $292 billion at December 31, 2002, a decrease
from $301 billion at year-end 2001. Due to the nature of the Company's trading
activities, it is not uncommon for the Company's asset levels to fluctuate from
period to period.
The Company's consolidated statement of financial condition 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 $190.5 billion at
December 31, 2002. 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 $22.2 billion at
December 31, 2002. On March 3, 2003, the Company redeemed for cash all of the
mandatorily redeemable securities of SSBH Capital I, a wholly-owned subsidiary
trust, at the redemption price of $25 per preferred security plus any accrued
interest and unpaid distributions thereon.
The Company has a $5.0 billion 364-day committed uncollateralized revolving line
of credit with unaffiliated banks.
27
SALOMON SMITH BARNEY HOLDINGS INC.
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS
Commitments under this facility terminate in May 2003. Any borrowings under this
facility would mature in May 2005. The Company also has $100 million committed
uncollateralized 364-day facility with an unaffiliated bank that extends through
June 2003, with any borrowings under this facility maturing in June 2004, and a
$100 million 364-day collateralized facility that extends through December 2003.
The Company may borrow under these revolving credit facilities at various
interest rate options (LIBOR or base rate), and compensates the banks for these
facilities through facility fees. At December 31, 2002, there were no
outstanding borrowings under these facilities. The Company also has committed
long-term financing facilities with unaffiliated banks. At December 31, 2002,
the Company had drawn down the full $1.7 billion then available under these
facilities. A bank can terminate its facility by giving the Company prior notice
(generally one year). The Company compensates the banks for the facilities
through facility fees. Under all of these facilities, the Company is required to
maintain a certain level of consolidated adjusted net worth (as defined in the
agreement). At December 31, 2002, this requirement was exceeded by approximately
$4.8 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 $32.3 billion at December 31, 2002, compared with
$27.2 billion at December 31, 2001. 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 3.9
years, including pass-through entities whose debt of $1.4 billion matures in
periods ranging from 2007 to 2097 and are required to be consolidated under
generally accepted accounting principles. The average remaining maturity of the
Company's term debt excluding these pass-through entities was 3.1 years at
December 31, 2002. See Note 8 to the consolidated financial statements for
additional information regarding term debt and an analysis of the impact of
interest rate swaps on term debt.
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 securities purchased under agreements to resell
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
28
SALOMON SMITH BARNEY HOLDINGS INC.
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS
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 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, including
ratings downgrades, which could impact its liquidation horizons and required
margins. In addition, the Company monitors its leverage and capital ratios on a
daily basis.
OFF-BALANCE SHEET ARRANGEMENTS
The Company is involved with several types of off-balance sheet arrangements,
including SPEs, lines and letters of credit, and loan commitments. The volume
and types of our loan commitments and lines and letters of credit are described
in the following section.
SECURITIZATIONS AND SPES
The principal uses of SPEs are to obtain sources of liquidity while reducing
credit risk by securitizing the Company's financial assets, to assist our
clients in securitizing their financial assets, or to create customized
investment products for specific investors.
SPEs may be organized as trusts, partnerships, or corporations. In a
securitization, the company transferring assets to an SPE converts those assets
into cash before they would have been realized had the company held on to them,
at the same time reducing its credit exposure to the borrowers/issuers of those
assets. The SPE obtains the cash needed to pay the transferor for the assets
received by issuing securities to investors in the form of debt instruments,
certificates, commercial paper, and other notes. Investors usually have recourse
to the assets in the SPE that is bankruptcy remote, and often benefit from other
enhancements, such as excess assets in the SPE, a liquidity facility, or credit
insurance. Accordingly, the SPE can typically obtain a more favorable credit
rating from rating agencies, such as Standard and Poor's and Moody's Investors
Service, than the company could obtain for its own debt issuances, resulting in
less expensive financing costs. The cash proceeds from the sale are used for
other business purposes. The SPE may also enter into a derivative, typically a
swap, in order to convert the yield or currency of the underlying assets to
match the needs of the SPE's investors or alter the credit risk profile of the
SPE. The Company may be the counterparty to these derivatives transactions. The
securitization process enhances the liquidity of the
29
SALOMON SMITH BARNEY HOLDINGS INC.
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS
financial markets, spreads credit risk among several market participants, and
makes more funds available to extend credit to consumers and commercial
entities.
SECURITIZATION OF CLIENT ASSETS
The Company acts as intermediary or agent for its clients, assisting them in
obtaining sources of liquidity by selling the clients financial assets to an
SPE.
The Company securitizes clients' debt obligations in transactions involving SPEs
that issue CDOs. A majority of the transactions are on behalf of clients where
the Company first purchases the assets at the request of the clients and
warehouses them until the securitization transaction is executed. Other CDOs are
structured where the underlying debt obligations are purchased directly in the
open market or from issuers. Some CDOs have static unmanaged portfolios of
assets, while others have a more actively managed portfolio of financial assets.
At December 31, 2002, assets of CDOs amounted to $17 billion. The Company
receives market-rate fees for structuring and distributing the CDO securities to
investors. For the year ended December 31, 2002, the Company's revenues were $81
million and estimated expenses were $16 million.
In addition to securitizations of mortgage loans originated by the Company, the
Company also securitizes purchased mortgage loans, creating collateralized
mortgage obligations ("CMOs") and other mortgage-backed securities ("MBSs") and
distributes them to investors. Since January 1, 2000, the Company has organized
253 mortgage securitizations with assets of $241 billion at December 31, 2002.
For the year ended December 31, 2002, the Company's revenues were $106 million
and estimated expenses were $34 million. Expenses have been estimated based upon
a percentage of product revenues to total business revenues.
CREATION OF OTHER INVESTMENT AND FINANCING PRODUCTS
The Company packages and securitizes assets purchased in the financial markets
in order to create new security offerings, including hedge funds, mutual funds,
unit investment trusts, and other investment funds, for institutional and
Citigroup's Private Banking clients as well as retail customers, that match the
clients' investment needs and preferences. The SPEs may be credit-enhanced by
excess assets in the investment pool or by third-party insurers assuming the
risks of the underlying assets, thus reducing the credit risk assumed by the
investors and diversifying investors' risk to a pool of assets as compared with
investments in individual assets. The Company typically manages the SPEs for
market-rate fees. In addition, the Company may be one of several liquidity
providers to the SPEs and may place the securities with investors.
30
SALOMON SMITH BARNEY HOLDINGS INC.
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS
CONTRACTUAL OBLIGATIONS AND COMMITMENTS
The following table summarizes the maturity profile of the Company's contractual
long-term debt payments at December 31, 2002:
Dollars in millions Total
------------------- -----
2003 $ 8,756
2004 9,643
2005 3,247
2006 2,539
2007 1,266
Thereafter 6,851
-------
Total $32,302
=======
The Company has noncancelable leases covering office space and equipment
expiring on various dates through 2018. Presented below is a schedule of minimum
future rentals on noncancelable operating leases, net of subleases, as of
December 31, 2002. Various leases contain provisions for lease renewals and
escalation of rent based on increases in certain costs incurred by the lessors.
Dollars in millions Total
------------------- -----
2003 $191
2004 168
2005 130
2006 107
2007 89
Thereafter 163
----
Minimum
future rentals $848
====
A summary of the Company's Other Commercial Commitments at December 31, 2002 are
as follows:
Other Commercial Total Less
Commitments Amounts than 1-3 4-5 Over 5
(Dollars in millions) Committed 1 Year Years Years Years
--------------------- --------- ------ ----- ----- -----
Loan Commitments $8,116 $7,933 $183 $ -- $ --
Guarantees 550 87 365 -- 98
Lines of credit 176 176 -- -- --
Other Commitments 322 242 71 -- 9
------ ------ ---- ---- ----
Total Commercial
Commitments $9,164 $8,438 $619 $ -- $107
====== ====== ==== ==== ====
31
SALOMON SMITH BARNEY HOLDINGS INC.
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS
The loan commitments in the above table primarily consist of agreements to
deliver secured financing that is more than 100% collateralized by securities
issued by G-7 governments or other highly rated securities.
32
SALOMON SMITH BARNEY HOLDINGS INC.
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS
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.
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 their firm 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
33
SALOMON SMITH BARNEY HOLDINGS INC.
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS
OTC instruments. Whenever possible, the Company uses industry master netting
agreements to reduce aggregate credit exposure. Swap and foreign exchange
agreements are generally documented utilizing counterparty 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. Based on
notional amounts, at December 31, 2002 and 2001, approximately 94% and 91%,
respectively, of the Company's swap portfolio (the largest component of the
Company's derivative portfolio) was subject to the bilateral exchange of
collateral. See "Risk Management" for discussions of the Company's management of
market, credit, and operational risks.
NATURE AND TERMS OF DERIVATIVE INSTRUMENTS
The Company enters into various 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 Notes 1 and 16 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 include 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
34
SALOMON SMITH BARNEY HOLDINGS INC.
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS
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 related transactions with customers.
The Company conducts its commodities dealer activities in spot and forward
physical markets, organized futures exchanges as well as in OTC
financially-settled markets where 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. These instruments include interest rate swaps, cross-currency
swaps and forward currency contracts, which 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 to variable-rate obligations. Cross-currency swaps are
utilized to effectively convert a portion of its non-U.S. dollar denominated
term debt to U.S. dollar denominated obligations. Forward currency contracts are
utilized 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 1 - Summary of Significant Accounting Policies
- Note 5 - Principal Transactions Revenues
- Note 8 - Term Debt
- Note 14 - Pledged Assets, Commitments, Contingencies, and
Guarantees
- Note 16 - Financial Instruments and Contractual Commitments
and Related Risks
- Note 17 - Fair Value Information
- Note 19 - Securitizations
35
SALOMON SMITH BARNEY HOLDINGS INC.
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS
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 or decrease in economic value 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, a separate discussion of market risk
for individual products, including derivatives, is not meaningful. 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 and business unit managers and the
coordinated efforts of various support units throughout the Company.
The Company's risk management efforts include the establishment of market and
credit risk controls, policies and procedures; 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 desired risk profile of the Company with assistance from
36
SALOMON SMITH BARNEY HOLDINGS INC.
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS
the Risk Management Committee. This Committee, chaired by the Chief Risk
Officer, is comprised of the Chief Executive Officer, senior business managers,
and the Chief Financial Officer and is documented by the Market Risk Officer as
Secretary. The Committee reviews appropriate levels of risk, risk capital
allocations, balance sheet and regulatory capital usage by business units and
overall risk policies and controls. An independent Global Market Risk Management
Group provides technical and quantitative analysis of the market risk associated
with trading positions to the Chief Risk Officer and the Chief Executive Officer
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 is the responsibility of the Global Market 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 markets. Independent oversight of
pricing is the responsibility of the Controller's organization, with review by
the Risk Management Group. The Company also provides for liquidity risk by
imposing markdowns for illiquid concentrated positions. Additionally, 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 Market 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 counterparty pre-settlement and settlement 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,
by policy, set by the Senior Risk Officer. Business units may not exceed these
risk limits without prior approval from the Global Market Risk Management Group.
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.
37
SALOMON SMITH BARNEY HOLDINGS INC.
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS
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, mortgage derivatives and structured products. Stress analysis provides for
the 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 ANALYSIS Value at risk ("VAR") is a statistical tool for measuring
the potential variability of trading revenue. The VAR reported is an estimate of
the potential range of loss in the market value of the trading portfolio, over a
one-day period, at the 99% confidence level, assuming a static portfolio. This
level implies that on 99 trading days out of 100, the mark-to-market of the
portfolio will likely either (1) increase in value, or (2) decrease in value by
less than the VAR estimate; and that on 1 trading day out of 100, the
mark-to-market of the portfolio will likely decrease in value by an amount that
will exceed the VAR estimate.
VAR is calculated by simulating changes in the key underlying market risk
factors (e.g., interest rates, interest rate spreads, equity prices, foreign
exchange rates, commodity prices, and option volatilities) to calculate the
potential distribution of changes in the market value of the Company's
portfolios of 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 have several known limitations. Most significantly, standard
VAR models do not incorporate the potential loss caused by very unusual market
events. Stress testing is necessary as a complement to VAR to measure this
potential risk.
38
SALOMON SMITH BARNEY HOLDINGS INC.
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS
The following table summarizes the Company's VAR at the 99% confidence level,
which includes all of the Company's financial assets and liabilities which are
marked-to-market, as of December 31, 2002 and 2001, along with the 2002 daily
average, high and low (based on daily VARs). The VAR relating to accrual
portfolios has been excluded from this analysis.
RISK EXPOSURES December 31, December 31,
($ IN MILLIONS) 2002 2002 Average 2002 High 2002 Low 2001
- --------------- ------------ ------------ --------- -------- ------------
Interest rate $ 63 $ 46 $ 82 $ 35 $ 37
Equities 12 21 55 7 4
Commodities 5 12 20 4 14
Currency 4 3 14 -- --
Diversification Benefit (18) (25) N/A N/A (12)
---- ---- ---- ---- ----
Total* $ 66 $ 57 $ 88 $ 43 $ 43
==== ==== ==== ==== ====
*Includes diversification benefit.
The quantification of market risk using VAR analysis requires a number of key
assumptions. In calculating VAR at December 31, 2002, the Company simulates
changes in market factors by using historical volatilities and correlations and
assuming lognormal distributions for changes in each market factor. VAR is
calculated at the 99% confidence level, assuming a static portfolio subject to a
one-day change in market factors. The historical volatilities and correlations
used in the simulation are calculated using a look back period of three years.
The Company is in the middle of a large-scale, long-term process of calculating
its VAR by a more robust methodology. Approximately 60% of the total portfolio
is calculated under the new methodology, which simulates tens of thousands of
market factors to measure VAR. The previous methodology simulated fewer market
factors to measure VAR. VAR reflects the risk profile of the Company at December
31, 2002 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 forward contracts designed to
mitigate such exposure.
39
SALOMON SMITH BARNEY HOLDINGS INC.
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS
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 stocks 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 (principally, oil, natural gas and metals) may rise or
fall.
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 local currency of the trading center, exposure exists from a net open
currency position. Until the position is covered by selling or buying an
equivalent amount of the 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 a debtor, 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 pledging of collateral, the exposure of the transactions to
market risk, macroeconomic developments and sovereign risk.
40
SALOMON SMITH BARNEY HOLDINGS INC.
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS
ORIGIN OF CREDIT RISK
In the normal course of its operations, the Company enters into various
transactions that may give rise to various types of credit risk. The different
forms of credit risk to which the Company may be exposed include:
- - LENDING CREDIT RISK: The risk that an obligor may default on principal or
interest payments of a loan.
- - ISSUER CREDIT RISK: The risk that the issuer of a security will default on
principal or interest payments. One component of the market risk of
securities and derivatives on particular securities is that caused by the
credit risk of the issuer. This component of market risk is also called
the specific risk component of market risk.
- - COUNTERPARTY CREDIT RISK: The risk that a counterparty to a trade will
default on its obligations. Counterparty credit risk takes two forms:
- SETTLEMENT RISK: The risk that a counterparty will fail to perform
during an exchange of cash or other assets. This risk arises from
the requirement, in certain circumstances, to release cash or
securities before receiving payment.
- PRE-SETTLEMENT CREDIT RISK: The risk that a counterparty to a
forward, derivative or repurchase transaction will default prior to
the final cash settlement of the transaction. The magnitude of
pre-settlement credit exposure depends on the potential market value
of the contracts and on the presence of any legally enforceable risk
mitigating agreements that have been entered into, such as netting,
margin or an option to early termination.
For both forms of counterparty credit risk, the Company sets credit limits
or requires specific approvals that attempt to anticipate the potential
exposure of transactions.
CREDIT RISK MANAGEMENT
The Senior Risk 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.
41
SALOMON SMITH BARNEY HOLDINGS INC.
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS
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 DERIVATIVE ACTIVITIES
The Company's credit exposure for swap agreements, swap options, caps and floors
and foreign exchange contracts and options at December 31, 2002, as represented
by amounts reported on the Company's consolidated statement of financial
condition, 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 16 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, 2002 was primarily to counterparties in the U.S. ($8.1 billion),
United Kingdom ($1.7 billion), Germany ($.6 billion), and France ($.5 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.
42
SALOMON SMITH BARNEY HOLDINGS INC.
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS
- - 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 parties, including the
Company's stockholder, creditors, and regulators, is free of material
errors.
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. Essential elements in mitigating the risks noted above are the
optimization of information technology and the ability to manage and 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 may be subject to environmental risk from two primary sources:
discontinued commodities processing and oil refining operations, and existing
energy-related transportation activities.
The Company may be subject to 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") may be held jointly
and severally liable for the cost of site clean-up. The Company may also be
subject to liability under state or other U.S. environmental laws. 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.
43
SALOMON SMITH BARNEY HOLDINGS INC.
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS
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: weakening
global 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 the
demand for the Company's products; the impact of the implementation of new
accounting rules; the resolution of legal proceedings and environmental matters;
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.
44
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.
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE.
See the information contained in the Company's Form 8-K filed on
March 29, 2001.
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.
ITEM 14. CONTROLS AND PROCEDURES.
EVALUATION OF DISCLOSURE CONTROLS AND PROCEDURES
The Company's Chief Executive Officer and Chief Financial Officer have evaluated
the effectiveness of the Company's disclosure controls and procedures (as such
term is defined in Rules 13a-14(c) and 15d-14(c) under the Securities Exchange
Act of 1934, as amended (the "Exchange Act")) as of a date within 90 days prior
to the filing date of this annual report (the "Evaluation Date"). Based on such
evaluation, such officers have concluded that, as of the Evaluation Date, the
Company's disclosure controls and procedures are effective in alerting them on a
timely basis to material information relating to the Company (including its
consolidated subsidiaries) required to be included in the Company's reports
filed or submitted under the Exchange Act.
CHANGES IN INTERNAL CONTROLS
Since the Evaluation Date, there have not been any significant changes in the
Company's internal controls or in other factors that could significantly affect
such controls.
45
PART IV
ITEM 15. 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.
(b) Reports on Form 8-K:
On October 17, 2002, the Company filed a Current Report on
Form 8-K, dated October 15, 2002, reporting under Item 5
thereof the results of its operations for the three- and
nine-month periods ended September 30, 2002 and 2001.
On December 23, 2002, the Company filed a Current Report on
Form 8-K, dated December 17, 2002, filing certain exhibits
under Item 7 thereof relating to the offer and sale of its
Equity Linked Securities (ELKS) based on the common stock of
American Express Company due December 22, 2003.
No other reports on Form 8-K were filed during the fourth
quarter of 2002; however, on January 22, 2003, the Company
filed a Current Report on Form 8-K, dated January 21, 2003,
reporting under Item 5 thereof the results of 2002 and 2001.
46
EXHIBIT INDEX
EXHIBIT
NUMBER DESCRIPTION OF EXHIBIT
- ------ ----------------------
3.01 Restated Certificate of Incorporation of Salomon Smith Barney
Holdings Inc. (the "Company"), effective July 1, 1999, incorporated
by reference to Exhibit 3.2 to Post-Effective Amendment No. 1 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 3.3 to
Post-Effective Amendment No. 1 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) , incorporated by reference to Exhibit
10.01 to the Company's Annual Report on Form 10-K, as amended, for
the fiscal year ended December 31, 1998 (File No. 1-4346).
12.01+ Computation of ratio of earnings to fixed charges.
14.01+ Code of Ethics.
21.01 Pursuant to General Instruction I of Form 10-K, the list of
subsidiaries of the Company is omitted.
23.01+ Consent of KPMG LLP.
23.02+ Consent of PricewaterhouseCoopers LLP.
99.01+ Certification pursuant to 18 U.S.C. Section 1350, as adopted
pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.
- ----------
+ Filed herewith.
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.
47
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 18th day of
March, 2003.
SALOMON SMITH BARNEY HOLDINGS INC.
(Registrant)
By: /s/ Charles Prince
-------------------------------------
Charles Prince, 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 18th day of March, 2003.
SIGNATURE TITLE
--------- -----
/s/ Charles Prince Chairman and Chief Executive Officer
- -------------------------------- (Principal Executive Officer)
Charles Prince
/s/ John C. Morris Chief Financial Officer
- -------------------------------- (Principal Financial Officer)
John C. Morris
/s/ Robert Traficanti Principal Accounting Officer
- --------------------------------
Robert Traficanti
/s/ Robert Druskin Director
- --------------------------------
Robert Druskin
/s/ Deryck C. Maughan Director
- --------------------------------
Deryck C. Maughan
48
CERTIFICATIONS
I, Charles Prince, certify that:
1. I have reviewed this annual report on Form 10-K of Salomon Smith
Barney Holdings Inc.;
2. Based on my knowledge, this annual report does not contain any
untrue statement of a material fact or omit to state a material fact
necessary to make the statements made, in light of the circumstances
under which such statements were made, not misleading with respect
to the period covered by this annual report;
3. Based on my knowledge, the financial statements, and other financial
information included in this annual report, fairly present in all
material respects the financial condition, results of operations and
cash flows of the registrant as of, and for, the periods presented
in this annual report;
4. The registrant's other certifying officers and I are responsible for
establishing and maintaining disclosure controls and procedures (as
defined in Exchange Act Rules 13a-14 and 15d-14) for the registrant
and have:
a) designed such disclosure controls and procedures to ensure
that material information relating to the registrant,
including its consolidated subsidiaries, is made known to us
by others within those entities, particularly during the
period in which this annual report is being prepared;
b) evaluated the effectiveness of the registrant's disclosure
controls and procedures as of a date within 90 days prior to
the filing date of this annual report (the "Evaluation Date");
and
c) presented in this annual report our conclusions about the
effectiveness of the disclosure controls and procedures based
on our evaluation as of the Evaluation Date;
5. The registrant's other certifying officers and I have disclosed,
based on our most recent evaluation, to the registrant's auditors
and the audit committee of registrant's board of directors (or
persons performing the equivalent functions):
a) all significant deficiencies in the design or operation of
internal controls which could adversely affect the
registrant's ability to record, process, summarize and report
financial data and have identified for the registrant's
auditors any material weaknesses in internal controls; and
b) any fraud, whether or not material, that involves management
or other employees who have a significant role in the
registrant's internal controls; and
6. The registrant's other certifying officers and I have indicated in
this annual report whether there were significant changes in
internal controls or in other factors that could significantly
affect internal controls subsequent to the date of our most recent
evaluation, including any corrective actions with regard to
significant deficiencies and material weaknesses.
Date: March 18, 2003
By: /s/ Charles Prince, Chief Executive Officer
-----------------------------------------------
49
I, John C. Morris, certify that:
1. I have reviewed this annual report on Form 10-K of Salomon Smith
Barney Holdings Inc.;
2. Based on my knowledge, this annual report does not contain any
untrue statement of a material fact or omit to state a material fact
necessary to make the statements made, in light of the circumstances
under which such statements were made, not misleading with respect
to the period covered by this annual report;
3. Based on my knowledge, the financial statements, and other financial
information included in this annual report, fairly present in all
material respects the financial condition, results of operations and
cash flows of the registrant as of, and for, the periods presented
in this annual report;
4. The registrant's other certifying officers and I are responsible for
establishing and maintaining disclosure controls and procedures (as
defined in Exchange Act Rules 13a-14 and 15d-14) for the registrant
and have:
a) designed such disclosure controls and procedures to ensure
that material information relating to the registrant,
including its consolidated subsidiaries, is made known to us
by others within those entities, particularly during the
period in which this annual report is being prepared;
b) evaluated the effectiveness of the registrant's disclosure
controls and procedures as of a date within 90 days prior to
the filing date of this annual report (the "Evaluation Date");
and
c) presented in this annual report our conclusions about the
effectiveness of the disclosure controls and procedures based
on our evaluation as of the Evaluation Date;
5. The registrant's other certifying officers and I have disclosed,
based on our most recent evaluation, to the registrant's auditors
and the audit committee of registrant's board of directors (or
persons performing the equivalent functions):
a) all significant deficiencies in the design or operation of
internal controls which could adversely affect the
registrant's ability to record, process, summarize and report
financial data and have identified for the registrant's
auditors any material weaknesses in internal controls; and
b) any fraud, whether or not material, that involves management
or other employees who have a significant role in the
registrant's internal controls; and
6. The registrant's other certifying officers and I have indicated in
this annual report whether there were significant changes in
internal controls or in other factors that could significantly
affect internal controls subsequent to the date of our most recent
evaluation, including any corrective actions with regard to
significant deficiencies and material weaknesses.
Date: March 18, 2003
By: /s/ John C. Morris, Chief Financial Officer
-------------------------------------------
50
SALOMON SMITH BARNEY HOLDINGS INC. AND SUBSIDIARIES
INDEX TO CONSOLIDATED FINANCIAL STATEMENTS AND SCHEDULES
PAGE
----
REPORTS OF INDEPENDENT AUDITORS F-2 - F-3
CONSOLIDATED FINANCIAL STATEMENTS
Consolidated Statements of Income for the years ended
December 31, 2002, 2001 and 2000 F-4
Consolidated Statements of Financial Condition as of
December 31, 2002 and 2001 F-5
Consolidated Statements of Changes in Stockholder's Equity
for the years ended December 31, 2002, 2001 and 2000 F-7
Consolidated Statements of Cash Flows for the years ended
December 31, 2002, 2001 and 2000 F-8
Notes to Consolidated Financial Statements F-9
QUARTERLY FINANCIAL DATA (UNAUDITED)
F-1
INDEPENDENT AUDITORS' REPORT
The Board of Directors and Stockholder of
Salomon Smith Barney Holdings Inc. and Subsidiaries:
We have audited the accompanying consolidated statements of financial condition
of Salomon Smith Barney Holdings Inc. and subsidiaries as of December 31, 2002
and 2001, and the related consolidated statements of income, changes in
stockholder's equity, and cash flows for the years then ended. 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 accompanying consolidated
statements of income, changes in stockholder's equity, and cash flows of Salomon
Smith Barney Holdings Inc. and subsidiaries for the year ended December 31,
2000, were audited by other auditors whose report dated January 16, 2001,
expressed an unqualified opinion on those statements.
We conducted our audits in accordance with auditing standards generally accepted
in the United States of America. 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 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 Smith Barney
Holdings Inc. and subsidiaries as of December 31, 2002 and 2001, and the results
of their operations and their cash flows for the years then ended, in conformity
with accounting principles generally accepted in the United States of America.
As discussed in Note 1 to the consolidated financial statements, in 2002 the
Company changed its methods of accounting for goodwill and intangible assets.
Also, as discussed in Note 1 to the consolidated financial statements, in 2001
the Company changed its method of accounting for derivative instruments and
hedging activities.
(signed) KPMG LLP
New York, New York
January 21, 2003
F-2
REPORT OF INDEPENDENT ACCOUNTANTS
To the Board of Directors and Stockholder of
Salomon Smith Barney Holdings Inc. and Subsidiaries:
In our opinion, the accompanying consolidated statements of income, changes in
stockholder's equity and cash flows for the year ended December 31, 2000 present
fairly, in all material respects, the results of operations and cash flows of
Salomon Smith Barney Holdings Inc. and Subsidiaries for the year ended December
31, 2000, in conformity with accounting principles generally accepted in the
United States of America. These financial statements are the responsibility of
the Company's management; our responsibility is to express an opinion on these
financial statements based on our audit. We conducted our audit of these
statements in accordance with auditing standards generally accepted in the
United States of America, which 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 financial statements, assessing
the accounting principles used and significant estimates made by management, and
evaluating the overall financial statement presentation. We believe that our
audit provides a reasonable basis for our opinion. We have not audited the
consolidated financial statements of Salomon Smith Barney Holdings Inc. and
Subsidiaries as of any date or for any period subsequent to December 31, 2000.
(signed) PricewaterhouseCoopers LLP
New York, New York
January 16, 2001
F-3
SALOMON SMITH BARNEY HOLDINGS INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF INCOME
Dollars in millions
Year Ended December 31, 2002 2001 2000
- ----------------------- -------- -------- -------
Revenues:
Commissions $ 3,845 $ 3,619 $ 4,375
Investment banking 3,420 3,914 3,592
Asset management and administration fees 3,147 3,278 3,322
Principal transactions 576 1,783 2,706
Other 662 543 517
-------- -------- -------
Total noninterest revenues 11,650 13,137 14,512
-------- -------- -------
Interest and dividends 9,600 14,237 16,260
Interest expense 6,844 11,987 14,530
-------- -------- -------
Net interest and dividends 2,756 2,250 1,730
-------- -------- -------
Revenues, net of interest expense 14,406 15,387 16,242
-------- -------- -------
Noninterest expenses:
Compensation and benefits 7,425 8,140 8,193
Floor brokerage and other production 710 697 645
Communications 664 668 648
Occupancy and equipment 554 604 568
Professional services 312 302 332
Advertising and market development 289 360 477
Other operating and administrative expenses 1,408 379 633
Restructuring charge (credit), net (9) 117 4
-------- -------- -------
Total noninterest expenses 11,353 11,267 11,500
-------- -------- -------
Income before income taxes and cumulative
effect of changes in accounting principles 3,053 4,120 4,742
Provision for income taxes 1,242 1,492 1,710
-------- -------- -------
Income before cumulative effect of changes
in accounting principles 1,811 2,628 3,032
Cumulative effect of changes in accounting principles
(net of tax benefit of $16 and $1, respectively) (24) (1) --
-------- -------- -------
Net income $ 1,787 $ 2,627 $ 3,032
======== ======== =======
The accompanying notes are an integral part of these consolidated financial
statements.
F-4
SALOMON SMITH BARNEY HOLDINGS INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF FINANCIAL CONDITION
Dollars in millions
December 31, 2002 2001
- ------------------- -------- --------
Assets:
Cash and cash equivalents $ 3,722 $ 3,018
Cash segregated and on deposit for Federal and other regulations
or deposited with clearing organizations 2,461 5,327
Collateralized short-term financing agreements:
Securities purchased under agreements to resell $ 94,775 $ 94,204
Deposits paid for securities borrowed 45,439 45,337
-------- --------
140,214 139,541
Financial instruments owned and contractual commitments:
(Approximately $34 billion was pledged to
various parties at both December 31, 2002 and 2001)
U.S. government and government agency securities 34,610 45,813
Corporate debt securities 17,597 13,463
Contractual commitments 15,788 9,333
Non-U.S. government and government agency securities 9,989 8,084
Equity securities 9,531 10,987
Mortgage loans and collateralized mortgage securities 7,512 6,868
Money market instruments 6,565 4,663
Other financial instruments 6,548 5,157
-------- --------
108,140 104,368
Receivables:
Customers 16,439 19,353
Brokers, dealers and clearing organizations 8,776 15,441
Other 2,858 2,793
-------- --------
28,073 37,587
Property, equipment and leasehold improvements, net of
accumulated depreciation and amortization of $1,048 and
$959, respectively 1,025 1,204
Goodwill 1,530 1,400
Intangibles 808 941
Other assets 6,018 7,466
-------- --------
Total assets $291,991 $300,852
======== ========
The accompanying notes are an integral part of these consolidated financial
statements.
F-5
SALOMON SMITH BARNEY HOLDINGS INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF FINANCIAL CONDITION
Dollars in millions, except share data December 31, 2002 2001
- --------------------------------------------------- --------- ---------
Liabilities and Stockholder's Equity:
Commercial paper and other short-term borrowings $ 22,619 $ 18,890
Collateralized short-term financing agreements:
Securities sold under agreements to repurchase $ 118,878 $ 126,118
Deposits received for securities loaned 10,439 13,050
--------- ---------
129,317 139,168
Financial instruments sold, not yet purchased, and
contractual commitments:
Non-U.S. government and government agency securities 21,783 14,970
Contractual commitments 14,821 9,542
U.S. government and government agency securities 13,133 20,024
Corporate debt securities and other 7,697 6,034
Equity securities 4,243 5,670
--------- ---------
61,677 56,240
Payables and accrued liabilities:
Customers 16,724 20,463
Brokers, dealers and clearing organizations 5,074 13,382
Other 11,320 13,392
--------- ---------
33,118 47,237
Term debt 32,302 27,219
Company-obligated mandatorily redeemable securities
of subsidiary trusts holding solely junior subordinated
debt securities of the Company 400 400
Stockholder's equity:
Common stock (par value $.01 per share 1,000 shares
authorized; 1,000 shares issued and outstanding) -- --
Additional paid-in capital 3,016 2,479
Retained earnings 9,543 9,224
Accumulated changes in equity from nonowner sources (1) (5)
--------- ---------
Total stockholder's equity 12,558 11,698
--------- ---------
Total liabilities and stockholder's equity $ 291,991 $ 300,852
========= =========
The accompanying notes are an integral part of these consolidated financial
statements.
F-6
SALOMON SMITH BARNEY HOLDINGS INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDER'S EQUITY
Accumulated
Changes In
Additional Equity From Total
Common Paid-In Retained Nonowner Stockholder's
Dollars in millions Stock Capital Earnings Sources Equity
- ------------------- ----- ---------- -------- ------------ -------------
Balance at December 31, 1999 $ -- $ 1,626 $ 7,686 $ 14 $ 9,326
Net income 3,032 3,032
Common dividends (1,535) (1,535)
Other capital transactions 228 228
Net change in cumulative translation adjustments (12) (12)
------- ------- ------- -------- --------
Balance at December 31, 2000 -- 1,854 9,183 2 11,039
Net income 2,627 2,627
Common dividends (2,586) (2,586)
Other capital transactions 625 625
Net change in cumulative translation adjustments (7) (7)
------- ------- ------- -------- --------
Balance at December 31, 2001 -- 2,479 9,224 (5) 11,698
Net income 1,787 1,787
Common dividends (1,468) (1,468)
Capital contribution from Parent 500 500
Other capital transactions 37 37
Net change in cumulative translation adjustments 4 4
------- ------- ------- -------- --------
Balance at December 31, 2002 $ -- $ 3,016 $ 9,543 $ (1) $ 12,558
======= ======= ======= ======== ========
The accompanying notes are an integral part of these consolidated financial
statements.
F-7
SALOMON SMITH BARNEY HOLDINGS INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
Dollars in millions
Year Ended December 31, 2002 2001 2000
- ----------------------- -------- -------- --------
Cash flows from operating activities:
Net income $ 1,787 $ 2,627 $ 3,032
Adjustments to reconcile net income to net cash provided by (used in) operating
activities:
Deferred income tax provision (benefit) (25) (31) 415
Depreciation and amortization 323 522 472
Cumulative effect of changes in accounting principles 24 1 --
Net change in:
Cash segregated and on deposit for Federal and other regulations or
deposited with clearing organizations 2,866 (2,629) (277)
Securities borrowed or purchased under agreements to resell (673) (36,305) 9,040
Financial instruments owned and contractual commitments (3,772) (12,609) (14,847)
Receivables 9,514 (9,493) 5,136
Other assets 1,983 (2,065) (1,586)
Securities loaned or sold under agreements to repurchase (9,851) 36,257 14,751
Financial instruments sold, not yet purchased, and contractual commitments 5,437 932 (8,547)
Payables and accrued liabilities (13,860) 20,536 (4,267)
-------- -------- --------
Net cash provided by (used in) operating activities (6,247) (2,257) 3,322
-------- -------- --------
Cash flows from financing activities:
Net increase (decrease) in commercial paper and other short-term borrowings 3,729 (1,532) (442)
Proceeds from issuance of term debt 12,776 13,139 7,358
Term debt maturities and repurchases (8,207) (5,697) (5,257)
Dividends paid (1,727) (2,660) (1,202)
Repayment of mandatorily redeemable securities of subsidiary trusts -- (345) --
Capital contribution from Parent 500 -- --
Other capital transactions 12 203 89
-------- -------- --------
Net cash provided by financing activities 7,083 3,108 546
-------- -------- --------
Cash flows from investing activities:
Purchases of subsidiaries and affiliates -- (198) (2,250)
Property, equipment and leasehold improvements, net (132) (258) (619)
-------- -------- --------
Net cash used in investing activities (132) (456) (2,869)
-------- -------- --------
Net increase in cash and cash equivalents 704 395 999
Cash and cash equivalents at beginning of year 3,018 2,623 1,624
-------- -------- --------
Cash and cash equivalents at end of year $ 3,722 $ 3,018 $ 2,623
======== ======== ========
Interest paid did not differ materially from the amount of interest expense
recorded for financial statement purposes in 2002, 2001 and 2000.
The accompanying notes are an integral part of these consolidated financial
statements.
F-8
SALOMON SMITH BARNEY HOLDINGS INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE 1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
BASIS OF PRESENTATION
The consolidated financial statements reflect the accounts of Salomon Smith
Barney Holdings Inc. ("SSBH" and, collectively with its subsidiaries, the
"Company"), a New York corporation (the successor to Salomon Smith Barney
Holdings Inc., a Delaware corporation). The Company is a direct wholly owned
subsidiary of Citigroup Inc. ("Citigroup").
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.
The consolidated financial statements are prepared in accordance with accounting
principles generally accepted in the United States of America, which require the
use of management's best judgment and estimates. Estimates, including the fair
value of financial instruments and contractual commitments, the outcome of
litigation, realization of deferred tax assets and other matters that affect the
reported amounts and disclosures of contingencies in the consolidated financial
statements, may vary from actual results. Certain prior period amounts have been
reclassified or restated to conform to current period presentation.
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 denominated in non-U.S. dollar currencies 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.
On May 1, 2000, the Company completed the approximately $2.2 billion acquisition
of the global investment banking business and related net assets of Schroders
PLC, including all corporate finance, financial markets and securities
activities. The combined European operations of the Company are now known as
Schroder Salomon Smith Barney.
ACCOUNTING POLICIES
CASH AND CASH EQUIVALENTS - The Company defines "Cash and cash equivalents" as
highly liquid investments with original maturities of three months or less,
other than investments held for sale in the ordinary course of business.
F-9
SALOMON SMITH BARNEY HOLDINGS INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
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 one year and are carried at their
contractual amounts, including accrued interest as specified in the respective
agreements.
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 a 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 No.
41, Offsetting of Amounts Related to Certain Repurchase and Reverse Repurchase
Agreements ("FIN 41"). Excluding the impact of FIN 41, reverse repurchase
agreements totaled $155.5 billion and $145.6 billion at December 31, 2002 and
2001, 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.
FINANCIAL INSTRUMENTS AND CONTRACTUAL COMMITMENTS - Financial instruments and
contractual commitments (also referred to as "derivatives" or "derivative
instruments"), 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. The determination of market or fair
value considers various factors, including: closing exchange or over-the-counter
("OTC") 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 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 fair value of aged inventory
is actively monitored and, where appropriate, is discounted to reflect the
implied illiquidity for positions that have been available-for-immediate-sale
for longer than 90 days. Financial instruments and contractual commitments
include related accrued interest or dividends.
The majority of the Company's financial instruments 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. Customer securities transactions are recorded on a settlement date
basis with the related revenue and expense recorded on trade date. Commissions,
underwriting, and principal transaction revenues and related expenses are
recognized in income on a trade date basis. Fees for mergers and acquisition
advisory services are accrued when services for the transactions are
substantially completed.
F-10
SALOMON SMITH BARNEY HOLDINGS INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DERIVATIVE INSTRUMENTS
Derivatives Used for Trading Purposes
Derivatives used for trading purposes include interest rate, equity, currency
and commodity swap agreements, swap options, caps and floors, options, warrants
and financial and commodity futures and forward contracts. The fair 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."
Cash collateral received in connection with derivative transactions totaled
$7,543 million and $4,086 million at December 31, 2002 and 2001, respectively,
and cash collateral paid totaled $9,162 million and $5,313 million,
respectively. 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. During the fourth quarter of 2002, the
Company adopted EITF Issue No. 02-3, "Issues Involved in Accounting for
Derivative Contracts Held for Trading Purposes and Contracts Involved in Energy
Trading and Risk Management Activities" ("EITF 02-3"). Under EITF 02-3,
recognition of a trading profit at inception of a derivative transaction is
prohibited unless the fair value of that derivative is obtained from a quoted
market price, supported by comparison to other observable market transactions,
or based upon a valuation technique incorporating observable market data.
Margin on futures contracts is included in "Receivables - Brokers, dealers and
clearing organizations" and "Payables and accrued liabilities - Brokers, dealers
and clearing organizations" in the consolidated statement of financial
condition.
Derivatives Used for Non-Trading Purposes
The Company uses interest rate swaps to effectively convert the majority of its
fixed rate term debt to variable rate term debt. Certain interest rate swap
transactions have been designated as fair value hedges under Statement of
Financial Accounting Standards ("SFAS") No. 133, "Accounting for Derivative
Instruments and Hedging Activities" ("SFAS 133"). Where such designations have
been made, the changes of the fair value of the swaps and the gain or loss on
the hedged term debt are recorded currently in the consolidated statement of
income in "Other revenue." To the extent that these two amounts do not offset,
hedge ineffectiveness is therefore deemed to result and is recognized in income.
The Company monitors the effectiveness of interest swaps designated as hedges on
a daily basis.
Upon early termination of a designated hedging relationship, hedge accounting
will cease. Derivatives previously designated are then marked to market in
earnings with no offset of fair value changes from the hedged debt.
F-11
SALOMON SMITH BARNEY HOLDINGS INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
See Notes 8 and 16 to the consolidated financial statements for a further
discussion of the use of interest rate swaps for non-trading purposes.
The Company also designates forward currency contracts and non-U.S. dollar term
debt issued by the Company as hedges of net investments in certain subsidiaries
with functional currencies other than the U.S. dollar. To the extent that the
hedge is effective, the impact of marking the forward contracts to prevailing
forward rates and the impact of revaluing non-U.S. dollar term debt to
prevailing exchange rates, both net of the related tax effects, are included in
cumulative translation adjustments to offset the impact of translating the
investments being hedged. The Company monitors the effectiveness of forward
currency contracts designated as hedges at least quarterly.
See Note 8 to the consolidated financial statements for a further discussion of
the use of forward currency contracts for non-trading purposes.
Derivative instruments that do not meet the criteria to be designated as hedges
are considered trading derivatives and are recorded at market or fair value.
RECEIVABLES AND PAYABLES AND ACCRUED LIABILITIES - CUSTOMERS - Receivables from
and payables to customers include amounts due on cash and margin transactions.
Securities owned by customers, including those that collateralize margin or
similar transactions are not reflected on the consolidated statement of
financial condition.
RECEIVABLES AND PAYABLES AND ACCRUED LIABILITIES - BROKERS, DEALERS AND CLEARING
ORGANIZATIONS - Receivables from brokers, dealers and clearing organizations
include amounts receivable for securities not delivered by the Company to a
purchaser by the settlement date ("fails to deliver"), margin deposits,
commissions and net receivables arising from unsettled trades. Payables to
brokers and dealers include amounts payable for securities not received by the
Company from a seller by the settlement date ("fails to receive"), and net
payables arising from unsettled trades.
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 and equipment" expense as incurred. Certain internal use
software costs are capitalized and amortized on a straight-line basis over the
lesser of the estimate useful lives of the related asset or three years.
SECURITIZATIONS - The Company securitizes various types of assets including
commercial and residential mortgages, high yield bonds, government, agency and
corporate securities, and municipal bonds. In connection with these activities,
the Company utilizes special purpose entities principally for (but not limited
to) the securitizations of these financial assets. The Company derecognizes
financial assets transferred in securitizations provided the Company has
relinquished control over such assets. The Company may retain an interest in the
financial assets it securitizes ("retained interests") which may include assets
in the
F-12
SALOMON SMITH BARNEY HOLDINGS INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
form of residual interest in the special purpose entities established to
facilitate the securitization. Any retained interests are included in "Financial
instruments owned and contractual commitments" in the consolidated statement of
financial condition. Retained interests are recorded at fair value (See
Financial Intstruments and Contractual Commitments section on page F-11 for a
discussion of market and fair value) with any changes in fair value reported in
income (See note 19 to the consolidated financial statements for further
discussion on securitizations).
STOCK-BASED COMPENSATION Prior to January 1, 2003, the Company applied
Accounting Principles Board Opinion No. 25, "Accounting for Stock Issued to
Employees" ("APB 25") and related interpretations in accounting for stock-based
compensation. Under APB 25, there is generally no charge to earnings for
employee stock option awards because the options granted under these plans have
an exercise price equal to the market value of the underlying stock at the grant
date. Alternatively, SFAS No. 123, "Accounting for Stock-based Compensation"
("SFAS 123"), allows companies to recognize compensation expense over the
related service period based on the grant-date fair value of the stock award.
Had the Company applied SFAS 123 in accounting for stock options, net income
would have been reduced by $163 million, $189 million, and $194 million in 2002,
2001, and 2000, respectively. On January 1, 2003, the Company adopted SFAS 123
(see "Future Application of Accounting Standards").
INCOME TAXES - Deferred taxes are recorded for the future tax consequences of
events that have been recognized in the consolidated financial statements or tax
returns, based upon enacted tax laws and rates. Deferred tax assets are
recognized subject to management's judgment that realization is more likely than
not. The Company and its wholly-owned domestic subsidiaries file a consolidated
Federal income tax return with its parent.
ACCOUNTING CHANGES
EITF 02-3
During the fourth quarter of 2002, the Company adopted EITF 02-3. Under EITF
02-3, recognition of a trading profit at inception of a derivative transaction
is prohibited unless the fair value of that derivative is obtained from a quoted
market price, supported by comparison to other observable market transactions,
or based upon a valuation technique incorporating observable market data. The
initial adoption of EITF 02-3 was not material to the Company's consolidated
financial statements for the year ended December 31, 2002. FASB continues to
discuss the ongoing impact of EITF 02-3 on derivative transactions subsequent to
inception.
BUSINESS COMBINATIONS AND GOODWILL AND OTHER INTANGIBLE ASSETS
Effective July 1, 2001, the Company adopted the provisions of SFAS 141,
"Business Combinations" and certain provisions of SFAS No. 142, "Goodwill and
Other Intangible Assets" ("SFAS 142") as required for goodwill and intangible
assets resulting from business combinations consummated after June 30, 2001. The
new rules require that all business combinations initiated after June 30, 2001
be accounted for under the purchase method. The nonamortization provisions of
the new rules
F-13
SALOMON SMITH BARNEY HOLDINGS INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
affecting goodwill and intangible assets deemed to have indefinite lives are
effective for all purchase business combinations completed after June 30, 2001.
On January 1, 2002, the Company adopted the remaining provisions of SFAS 142,
when the rules became effective for calendar year companies. Under the new
rules, effective January 1, 2002, goodwill and intangible assets deemed to have
indefinite lives are no longer amortized, but are subject to annual impairment
tests. Other intangible assets will continue to be amortized over their useful
lives.
The Company has performed the required impairment tests of goodwill and
indefinite lived intangible assets as of January 1, 2002. There was no
impairment of goodwill upon adoption of SFAS 142. The initial adoption resulted
in a cumulative adjustment of $24 million (net of tax benefit of $16 million)
recorded as a charge to earnings related to the impairment of certain intangible
assets in the Asset Management segment.
Net income adjusted to exclude amortization expense (net of taxes) related to
goodwill and indefinite lived intangible assets are as follows:
(In millions)
Year ended 2002 2001 2000
---------- ---- ---- ----
Net income:
Reported net income $1,787 $2,627 $3,032
Goodwill amortization 63 45
Indefinite lived intangible assets 39 45
------ ------ ------
Adjusted net income $1,787 $2,729 $3,122
====== ====== ======
For the years ended December 31, 2001, and 2000, the after-tax amortization
expense related to goodwill and indefinite lived intangible assets which are no
longer amortized included $53 million and $49 million, respectively, related to
the Investment Services segment, $40 million and $40 million, respectively,
related to the Asset Management segment and $9 million and $1 million,
respectively, related to the Private Client Services Segment.
At January 1, 2002, the goodwill balance was $1,115 million for the Investment
Services segment, $251 million for the Private Client Services segment, and $34
million for the Asset Management segment. During 2002, no goodwill was impaired
or written off. In connection with the adoption of SFAS 142, the Company
reviewed the classification of intangible assets and determined that $117
million of workforce in-place, relating to the Private Client Services segment,
should be reclassified to goodwill at January 1, 2002. During 2002, the Company
recorded additional goodwill of $13 million primarily related to adjustments to
the purchase prices of AST StockPlan, Inc. and Geneva Companies Inc. Each of
these changes related to the Private Client Services segment. The Company's
goodwill balances at December 31, 2002 were $1,114 million for the Investment
Services segment, $381 million for the Private Client Group segment, and $35
million for the Asset Management segment.
F-14
SALOMON SMITH BARNEY HOLDINGS INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
At December 31, 2002, $772 million of the Company's acquired intangible assets,
primarily asset management and administration contracts, were considered to be
of indefinite life and not subject to amortization.
All other acquired intangible assets are subject to amortization. During 2002,
the Company acquired $26 million in software licenses, which will be amortized
over approximately 3 years. No significant residual value is estimated for these
intangible assets. Intangible assets amortization expense for the twelve months
ended December 31, 2002 and 2001 was $16 million, and $9 million, respectively.
The components of intangible assets that are subject to amortization were as
follows:
December 31, 2002 December 31, 2001
----------------------------- ------------------------------
Gross Gross
Carrying Accumulated Carrying Accumulated
(In millions) Amount Amortization Amount Amortization
------------- -------- ------------ -------- ------------
Software licenses $68 $32 $42 $15
=== === === ===
Intangible assets amortization expense is estimated to be $15 million in 2003,
$10 million in 2004, $6 million in 2005, $4 million in 2006, and $1 million in
2007.
DERIVATIVES AND HEDGE ACCOUNTING The Company adopted SFAS 133 on January 1, 2001
and recorded a cumulative after-tax transition charge of $1 million.
Under SFAS 133, an entity is required to recognize all freestanding and embedded
derivative instruments at fair value in earnings unless the derivative
instruments can be designated as hedges of certain exposures for which specific
hedge accounting is prescribed. If certain conditions are met, a derivative
instrument may be designated as a hedge of the fair value changes of a
recognized asset, liability or an unrecognized firm commitment; or a hedge of
the exposure to variable cash flows of a recognized asset, liability or a
forecasted transaction; or a hedge of the foreign currency exposure of a
recognized asset, liability, a net investment in a foreign operation, an
unrecognized firm commitment or a forecasted transaction. If certain conditions
are met, a non-derivative instrument may be designated as a fair value hedge of
a foreign currency denominated unrecognized firm commitment or a hedge of the
foreign currency exposure of a net investment in a foreign operation.
For the twelve months ended December 31, 2002, hedge ineffectiveness resulting
from designating interest rate swaps as fair value hedges of fixed rate term
debt was reported in the consolidated statement of income in "Other revenue" and
was not material.
For the twelve months ended December 31, 2002 and 2001, hedges of net
investments in foreign operations were considered effective and the loss of $105
million and the gain of $73 million, respectively, that pertained to the
designated hedging instruments was included in cumulative translation
adjustments, a component of "Accumulated changes in equity from nonowner
sources" in the consolidated statement of financial condition.
FUTURE APPLICATION OF ACCOUNTING STANDARDS
F-15
SALOMON SMITH BARNEY HOLDINGS INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
COSTS ASSOCIATED WITH EXIT OR DISPOSAL ACTIVITIES
In June 2002, the FASB issued SFAS No. 146, "Accounting for Costs Associated
with Exit or Disposal Activities" ("SFAS 146"). SFAS 146 requires that a
liability for costs associated with exit or disposal activities be recognized
when the liability is incurred. Existing generally accepted accounting
principles provide for the recognition of such costs at the date of management's
commitment to an exit plan. In addition, SFAS 146 requires that the liability be
measured at fair value and adjusted for changes in estimated cash flows.
The provisions of the new standard are effective for exit or disposal activities
initiated after December 31, 2002. It is not expected that SFAS 146 will
materially affect the Company's financial statements.
CONSOLIDATION OF VARIABLE INTEREST ENTITIES In January 2003, the FASB released
FASB Interpretation No. 46, "Consolidation of Variable Interest Entities" ("FIN
46"). This Interpretation changes the method of determining whether certain
entities, including securitization entities, should be included in the Company's
consolidated financial statements. An entity is subject to FIN 46 and is called
a variable interest entity ("VIE") if it has equity that is insufficient to
permit the entity to finance its activities without additional subordinated
financial support from other parties, or equity investors that cannot make
significant decisions about the entity's operations, or that do not absorb the
expected losses or receive the expected returns of the entity. All other
entities evaluate consolidation in accordance with SFAS No. 94, "Consolidation
of All Majority-Owned Subsidiaries." A VIE is consolidated by its primary
beneficiary, which is the party involved with the VIE that has a majority of the
expected losses or a majority of the expected residual returns or both.
The provisions of FIN 46 are to be applied immediately to VIEs created after
January 31, 2003, and to VIEs in which an enterprise obtains an interest after
that date. For any VIEs that must be consolidated under FIN 46 that were created
before February 1, 2003, the assets, liabilities and noncontrolling interest of
the VIE would be initially measured at their carrying amounts with any
difference between the net amount added to the balance sheet and any previously
recognized interest being recognized as the cumulative effect of an accounting
change. If determining the carrying amounts is not practicable, fair value at
the date FIN 46 first applies may be used to measure the assets, liabilities and
noncontrolling interest of the VIE. For VIEs in which an enterprise holds a
variable interest that it acquired before February 1, 2003, FIN 46 applies in
the first fiscal period beginning after June 15, 2003. FIN 46 also mandates new
disclosures about VIEs, some of which are required to be presented in financial
statements issued after January 31, 2003.
The Company is evaluating the impact of applying FIN 46 to existing VIEs in
which it has variable interests and has not yet completed this analysis. The
Company is considering restructuring alternatives that would enable certain VIEs
to meet the criteria for non-consolidation. However, at this time, it is
anticipated that the effect on the Company's consolidated statement of financial
condition could be an increase of as much as $1.4 billion to assets and
liabilities, primarily due to several structured finance entities in which the
Company is involved. As the Company continues to evaluate the impact of applying
F-16
SALOMON SMITH BARNEY HOLDINGS INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
FIN 46, additional entities may be identified that would need to be
consolidated. See Note 19 to the consolidated financial statements for further
discussion of FIN 46.
GUARANTEES AND INDEMNIFICATIONS
In November 2002, the FASB issued FASB Interpretation No. 45, "Guarantor's
Accounting and Disclosure Requirements for Guarantees, Including Indirect
Guarantees of Indebtedness of Others" ("FIN 45"), which requires that, for
guarantees within the scope of FIN 45 issued or amended after December 31, 2002,
a liability for the fair value of the obligation undertaken in issuing the
guarantee be recognized. FIN 45 also requires additional disclosures in
financial statements for periods ending after December 15, 2002. Accordingly,
these new disclosures are included in Note 14 to the consolidated financial
statements. It is not expected that the recognition and measurement provisions
of FIN 45 will have a material effect on the consolidated financial statements.
ACCOUNTING FOR STOCK-BASED COMPENSATION
On January 1, 2003, the Company adopted the fair value recognition provisions of
SFAS 123, prospectively to all awards granted, modified, or settled after
January 1, 2003. The prospective method is one of the adoption methods provided
for under SFAS No. 148, " Accounting for Stock-Based Compensation-Transition and
Disclosure," issued in December 2002. SFAS 123 requires that compensation cost
for all stock awards be calculated and recognized over the service period
(generally equal to the vesting period). This compensation cost is determined
using option pricing models, intended to estimate the fair value of the awards
at the grant date. Similar to APB 25, the alternative method of accounting, an
offsetting increase to stockholders equity under SFAS 123 is recorded equal to
the amount of compensation expense charged. Assuming a three-year vesting period
for options, the estimated impact to net income of this change will be
approximately $46 million in 2003 and, when fully phased in approximately $91
million annually. The Company, through its parent, Citigroup, has made changes
to various stock-based compensation plan provisions for future awards. Other
changes also may be made that may impact the SFAS 123 estimates disclosed above.
NOTE 2. EVENTS OF SEPTEMBER 11, 2001
As a result of the September 11, 2001 terrorist attack, the Company experienced
a disruption in business, as well as significant property loss. The Company and
its Parent, Citigroup, are insured against certain of these losses. The Company
initially recorded insurance recoveries up to the net book value of the assets
written off. These items were recorded in the consolidated statement of income
in "Other operating and administrative expenses." The Company recorded a
receivable of $199 million relating to these insurance recoveries in 2001.
During 2002, additional insurance recoveries were recorded when realized.
Through December 31, 2002, the Company and its parent collected substantially
all of this balance.
F-17
SALOMON SMITH BARNEY HOLDINGS INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE 3. RESTRUCTURING CHARGE (CREDIT), NET
In the third quarter of 2002, the Company recorded an adjustment of $9 million
($5 million after tax) to the restructuring reserve, which was recorded in 2001.
The adjustment relates to severance related costs, which were lower than
originally anticipated.
During 2001, the Company recorded restructuring charges totaling $117 million
($70 million after tax) for severance and related costs associated with the
reduction of staffing in certain businesses. These amounts apply to the
involuntary termination of approximately 2,000 employees (90% located in the
United States and 10% overseas) . The charges are net of a reversal of $18
million ($11 million after tax) which relates to the accrual in the first
quarter of severance and other related costs associated with the reduction of
staffing in certain businesses which were subsequently sold. These related costs
will not be borne by the Company due to the sale which closed in the third
quarter of 2001. At December 31, 2002, this reserve had been fully charged off.
In the fourth quarter of 2000, the Company booked a restructuring charge of $4
million ($2 million after tax). This primarily related to severance issues
resulting from the consolidation and discontinuance of certain asset management
businesses. At December 31, 2002, this reserve had been fully utilized.
NOTE 4. COMPREHENSIVE INCOME
Comprehensive income represents the sum of net income and other changes in
stockholder's equity from nonowner sources which, for the Company, are comprised
of cumulative translation adjustments, net of tax:
Dollars in Millions
Year Ended December 31, 2002 2001 2000
----------------------- ------- ------- -------
Net income $ 1,787 $ 2,627 $ 3,032
Other changes in equity from non-owner sources 4 (7) (12)
------- ------- -------
Total comprehensive income $ 1,791 $ 2,620 $ 3,020
======= ======= =======
F-18
SALOMON SMITH BARNEY HOLDINGS INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE 5. PRINCIPAL TRANSACTIONS REVENUES
The following table presents principal transactions revenues by business
activity for the years ended December 31, 2002, 2001 and 2000:
Dollars in millions
Year Ended December 31, 2002 2001 2000
----------------------- ---- ------ ------
Fixed income $499 $1,008 $1,208
Equities 45 700 1,243
Commodities 62 39 224
Other (30) 36 31
---- ------ ------
Total principal transactions revenues $576 $1,783 $2,706
==== ====== ======
FIXED INCOME Fixed income revenues include realized and unrealized gains and
losses arising from the proprietary and customer trading of government and
government agency securities, investment and non-investment grade corporate
debt, municipal securities, 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 OTC currency options.
Revenues also included realized and unrealized gains and losses 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, equity swaps 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 oil products, natural gas, metals and other commodities. Commodity
revenues consist of realized and unrealized gains and losses from trading these
commodities and related derivative instruments.
F-19
SALOMON SMITH BARNEY HOLDINGS INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE 6. SEGMENT INFORMATION
The Company's reportable segments include Investment Services, Private Client
Services and Asset Management. The Investment Services segment includes
investment banking and trading, as well as related derivative and commodity
trading. The Company'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.
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 OTC market for various derivative
instruments. The segment earns commissions as a broker for its clients in the
purchase and sale of securities.
Private Client Services provides investment advice and financial planning and
brokerage services, primarily through the network of the Company's Financial
Consultants. A significant portion of Private Client Services' revenue is
generated from the commissions earned as a broker for its clients in the
purchase and sale of securities as well as fees earned by managing client
assets. Private Client Services generates additional revenue by financing
customers' securities transactions through secured margin lending. Private
Client Services also receives commissions and other sales and service revenues
through the sale of proprietary mutual funds and third-party mutual funds. As
part of Private Client Services, Global Equity Research creates equity research
to serve both institutional and individual investor clients and as such the
group's expenses are allocated primarily to the Global Equities and Global
Private Client businesses.
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 determined as a
percentage of the client's assets, from asset management clients.
F-20
SALOMON SMITH BARNEY HOLDINGS INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Segment data presented includes the allocation of all corporate overhead.
Inter-segment revenues and expenses have been eliminated. Information concerning
operations in the Company's business segments is as follows:
Year ended December 31,
Dollars in millions 2002 2001 2000
----------------------- -------- -------- --------
Revenues, net of interest expense:
Investment Services $ 7,431 $ 8,209 $ 8,156
Private Client Services 5,661 5,883 6,864
Asset Management 1,314 1,295 1,222
-------- -------- --------
Total $ 14,406 $ 15,387 $ 16,242
======== ======== ========
Total expenses:
Investment Services $ 6,132 $ 5,875 $ 5,681
Private Client Services 4,535 4,677 5,166
Asset Management 686 715 653
-------- -------- --------
Total $ 11,353 $ 11,267 $ 11,500
======== ======== ========
Net income:
Investment Services $ 730 $ 1,523 $ 1,628
Private Client Services 702 754 1,060
Asset Management 355 350 344
-------- -------- --------
Total $ 1,787 $ 2,627 $ 3,032
======== ======== ========
Year-end total assets:
Investment Services $278,462 $285,395 $217,558
Private Client Services 11,884 13,818 18,451
Asset Management 1,645 1,639 1,522
-------- -------- --------
Total $291,991 $300,852 $237,531
======== ======== ========
F-21
SALOMON SMITH BARNEY HOLDINGS INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
The following table summarizes the Company's operations by geographic areas
which are determined principally by the respective legal jurisdictions of SSBH's
subsidiaries. Substantially all amounts for the asset management segment are
included in North America. For purposes of this disclosure, North America
consists of the United States and Canada; Europe primarily consists of the
United Kingdom and Germany; and Asia and other primarily consists of Japan, Hong
Kong 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.
Income Before Income
Revenues Taxes and Cumulative
Before Interest Effect of Changes in
Dollars in millions Expense Accounting Principles Total Assets
------------------- --------------- --------------------- ------------
Year Ended December 31, 2002
North America $16,583 $2,920 $217,169
Europe 3,932 21 70,895
Asia and other 735 112 3,927
------- ------ --------
Consolidated $21,250 $3,053 $291,991
======= ====== ========
Year Ended December 31, 2001
North America $22,701 $3,834 $243,839
Europe 4,221 196 54,061
Asia and other 452 90 2,952
------- ------ --------
Consolidated $27,374 $4,120 $300,852
======= ====== ========
Year Ended December 31, 2000
North America $26,050 $4,266 $185,181
Europe 4,245 413 49,463
Asia and other 477 63 2,887
------- ------ --------
Consolidated $30,772 $4,742 $237,531
======= ====== ========
F-22
SALOMON SMITH BARNEY HOLDINGS INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE 7. 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, 2002 2001
----------------------- ------- -------
Bank borrowings:
Balance at year-end $ 1,326 $ 1,524
Weighted average interest rate 3.5% 3.4%
Annual averages --
Amount outstanding $ 1,732 $ 1,491
Weighted average interest rate 3.4% 4.2%
Maximum amount outstanding at any month-end $ 2,382 $ 2,252
------- -------
Commercial paper:
Balance at year-end $18,293 $13,858
Weighted average interest rate 1.4% 1.9%
Annual averages --
Amount outstanding $15,363 $13,019
Weighted average interest rate 1.7% 3.9%
Maximum amount outstanding at any month-end $18,293 $17,266
------- -------
Other short-term borrowings:
Balance at year-end $ 3,000 $ 3,508
Weighted average interest rate 5.5% 5.6%
Annual averages --
Amount outstanding $ 2,186 $ 1,509
Weighted average interest rate 5.9% 4.1%
Maximum amount outstanding at any month-end $ 3,503 $ 3,509
======= =======
Total commercial paper and other short term borrowings $22,619 $18,890
======= =======
Outstanding bank borrowings include both U.S. dollar and non-U.S. dollar
denominated loans. The non-U.S. dollar loans are denominated in various
currencies including Japanese yen, EURO, and U.K. sterling. All of the Company's
commercial paper outstanding at December 31, 2002 and 2001 was U.S. dollar
denominated. Included in other short-term borrowings are deposit liabilities and
other short-term obligations.
The Company has a $5.0 billion 364-day committed uncollateralized revolving line
of credit with unaffiliated banks that terminates in May 2003. Any borrowings
under this facility would mature in May 2005. The Company also has a $100
million 364-day committed uncollateralized revolving line of credit with an
unaffiliated bank that extends through June 2003, with any borrowings under this
facility maturing in June 2004, and a $100 million collateralized 364-day
facility that extends through December 2003. The Company may borrow under these
revolving credit facilities at various interest rate options (LIBOR or base
rate) and compensates the banks for the facilities through facility fees. At
December 31, 2002, there were no outstanding borrowings under these facilities.
The Company also has committed long-term financing facilities with
F-23
SALOMON SMITH BARNEY HOLDINGS INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
unaffiliated banks. At December 31, 2002, the Company had drawn down the full
$1.7 billion then available under these facilities. A bank can terminate its
facility by giving the Company one year's notice. The Company compensates the
banks for the facilities through facility fees. Under all of these facilities,
the Company is required to maintain a certain level of consolidated adjusted net
worth (as defined in the respective agreements). At December 31, 2002, these
requirements were exceeded by $4.8 billion. 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 8. 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.
Equity-
Fixed Rate Fixed Rate Linked &
Obligations Obligations Total Variable Indexed Total Total
Swapped to Not Fixed Rate Rate Obligations December December
Dollars in millions Variable Converted Obligations Obligations (1) 31, 2002 31, 2001
- ------------------- ----------- ----------- ----------- ----------- ----------- -------- --------
U.S. dollar denominated:
Salomon Smith Barney Holdings
Inc. (SSBH) $ 7,684 $213 $ 7,897 $12,882 $1,718 $22,497 $19,947
Subsidiaries -- -- -- 468 3,012 3,480 2,750
------- ---- ------- ------- ------ ------- -------
U.S. dollar denominated 7,684 213 7,897 13,350 4,730 25,977 22,697
------- ---- ------- ------- ------ ------- -------
Non-U.S. dollar denominated:
Salomon Smith Barney Holdings
Inc. (SSBH) 1,908 -- 1,908 2,139 722 4,769 4,020
Subsidiaries 450 11 461 356 739 1,556 502
------- ---- ------- ------- ------ ------- -------
Non-U.S. dollar denominated 2,358 11 2,369 2,495 1,461 6,325 4,522
------- ---- ------- ------- ------ ------- -------
Term debt $10,042 $224 $10,266 $15,845 $6,191 $32,302 $27,219
======= ==== ======= ======= ====== ======= =======
(1) Includes Targeted Growth Enhanced Term Securities ("TARGETS") with
carrying values of $368 million issued by TARGETS Trusts V through XVII at
December 31, 2002 and $460 million issued by TARGETS Trusts III through
XIII at December 31, 2001 (collectively the "Trusts"). The Company owns
all of the voting securities of the Trusts which are consolidated in the
Company's condensed consolidated statements of financial condition. The
Trusts have no assets, operations, revenues or cash flows other than those
related to the issuance, administration, and repayment of the TARGETS and
the Trusts' common securities. The Trusts' obligations under the TARGETS
are fully and unconditionally guaranteed by the Company.
F-24
SALOMON SMITH BARNEY HOLDINGS INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
The maturity structure of the Company's term debt was as follows at December 31,
2002:
Salomon Smith Barney
Holdings Inc.
Dollars in millions (SSBH) Subsidiaries Total
------------------- -------------------- ------------ -----
2003 $ 8,360 $ 396 $ 8,756
2004 7,175 2,468 9,643
2005 2,998 249 3,247
2006 2,341 198 2,539
2007 782 484 1,266
Thereafter 5,609 1,242 6,851
------- ------ -------
Total $27,265 $5,037 $32,302
======= ====== =======
The Company issues U.S. dollar and non-U.S. dollar denominated fixed and
variable rate term debt. The contractual interest rates on fixed rate debt
ranged from .45 % (Japanese yen denominated) to 9.13% (U.S. dollar denominated)
at December 31, 2002 and December 31, 2001. The weighted average contractual
rate on total fixed rate term debt (both U.S. dollar denominated and non-U.S.
dollar denominated) was 5.66% at December 31, 2002 and 5.88% at December 31,
2001. 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 and variable rate term debt includes Euro,
Japanese yen, U.K. sterling, Hong Kong dollar, Australian dollar, Canadian
dollar, Swiss franc, and, consequently, bears a wide range of interest rates.
At December 31, 2002, the Company had outstanding approximately $6.3 billion of
non-U.S. dollar denominated term debt, which included $3.0 billion of EURO
denominated, $2.8 billion of Japanese yen denominated, and $.4 billion of U.K.
sterling denominated debt. Of the $6.3 billion, approximately $.6 billion of
SSBH Japanese yen denominated debt has been designated as a hedge of net
investments in certain subsidiaries with functional currencies other than the
U.S. dollar. Another $1.6 billion of SSBH debt has been effectively converted to
U.S. dollar denominated obligations using cross-currency swaps. The remaining
$4.1 billion is used to finance other non-U.S. denominated assets.
F-25
SALOMON SMITH BARNEY HOLDINGS INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
The following table summarizes the significant components of the Company's fixed
rate term debt that is converted to variable rate obligations at December 31,
2002 and 2001.
2002 2001
------------------------------------------------------------------------------------------------------
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 Term Principal Swapped Fixed on Swapped Term
(Dollars in millions) Balance Rate Term Debt Debt Balance Rate Term Debt Debt
- --------------------- ------- -------------- --------------- --------- -------------- ---------------
U.S. dollar $ 7,684 6.5% 2.4% $ 8,907 6.4% 3.7%
Japanese yen 1,026 1.1 .9 611 1.0 .3
Japanese yen swapped to
U.S. dollar 662 2.9 1.7 615 3.0 1.9
Euro 499 7.3 3.1 413 7.0 3.5
U.K. sterling 125 7.8 4.5 113 7.8 5.0
French francs swapped to
U.S. dollar -- -- -- 136 5.4 3.0
The interest rates on variable rate term debt ranged from .08% (Japanese yen
denominated) to 5.03% (Australian dollar denominated) at December 31, 2002 and
..14% (Japanese denominated ) to 4.72% (U.K. sterling real denominated) at
December 31, 2001. The weighted average contractual rates on total variable rate
term debt (both U.S. dollar denominated and non-U.S. denominated) was 1.73 % and
2.08% at December 31, 2002 and 2001, respectively.
The following table summarizes the significant components of the Company's
variable rate term debt that is swapped at December 31, 2002 and 2001:
2002 2001
----------------------------------------------------------------------------------------------------
Contractual Contractual
Weighted Weighted Weighted Weighted
Average Rate Average Average Rate Average
on Swapped Variable Rate on Swapped Variable Rate
Principal Variable Rate on Swapped Principal Variable Rate on Swapped
(Dollars in millions) Balance Term Debt Term Debt Balance Term Debt Term Debt
- --------------------- -------- -------------- ------------- --------- ------------- -------------
Japanese yen swapped to
U.S. dollar 177 .2% 1.6% 167 .3% 2.0%
U.S. dollar 150 2.4 2.2 190 4.1 2.2
Euro swapped to
U.S. dollar 104 3.6 2.1 88 4.0 4.0
U.K sterling swapped to
U.S. dollar -- -- -- 182 4.7 2.4
Term debt includes subordinated debt, which totaled $103 million at December 31,
2002 and $124 million at December 31, 2001. At December 31, 2002, subordinated
debt included approximately $5 million of convertible restricted notes,
convertible at the rate of $3.85 per share into 1,190,086 shares of Citigroup
common stock. At December 31, 2002, these convertible restricted notes were
convertible at the rate of $4.10 per share into 1,116,769 shares of Citigroup
common stock.
The Company has a $5.0 billion 364-day committed uncollateralized revolving line
of credit with unaffiliated banks that terminates in May 2003. Any borrowings
under this facility would mature in May 2005. The Company also has a $100
million 364-day committed uncollateralized revolving line of credit with an
unaffiliated bank that extends through June 2003, with any borrowings under this
facility maturing in June 2004, and a $100 million collateralized 364-day
facility that extends through December 2003. The Company may borrow under these
revolving credit facilities at various interest rate options (LIBOR or base
rate) and compensates the banks for the facilities through facility fees. At
December 31, 2002, there were no outstanding borrowings under these facilities.
The Company also has committed long-term financing facilities with
F-26
SALOMON SMITH BARNEY HOLDINGS INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
unaffiliated banks. At December 31, 2002, the Company had drawn down the full
$1.7 billion then available under these facilities. A bank can terminate its
facility by giving the Company one year's notice. The Company compensates the
banks for the facilities through facility fees. Under all of these facilities,
the Company is required to maintain a certain level of consolidated adjusted net
worth (as defined in the respective agreements). At December 31, 2002, these
requirements were exceeded by $4.8 billion. 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.
F-27
SALOMON SMITH BARNEY HOLDINGS INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE 9. LEASE COMMITMENTS
The Company has noncancelable leases covering office space and equipment
expiring on various dates through 2018. Presented below is a schedule of minimum
future rentals on noncancelable operating leases, net of subleases, as of
December 31, 2002. Various leases contain provisions for lease renewals and
escalation of rent based on increases in certain costs incurred by the lessors.
Dollars in millions
-------------------
2003 $191
2004 168
2005 130
2006 107
2007 89
Thereafter 163
----
Minimum future rentals $848
====
Rent expense under operating leases totaled $475 million, $425 million, and $367
million for the years ended December 31, 2002, 2001, and 2000, respectively.
NOTE 10. MANDATORILY REDEEMABLE SECURITIES OF SUBSIDIARY TRUST
SSBH formed a statutory business trust under the laws of the state of Delaware
that exist for the exclusive purpose 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 junior subordinated
deferrable interest debt securities of SSBH; and (iii) engaging in only those
activities necessary or incidental thereto. The common securities, subordinated
debt securities and the related income effects are eliminated in the
consolidated financial statements. Distributions on the mandatorily redeemable
securities of the subsidiary trust have been classified as interest expense in
the consolidated statement of income.
The following table summarizes the financial structure of SSBH's subsidiary
trust:
SSBH
Capital I
---------
Trust Securities:
Issuance date January 1998
Securities issued 16,000,000
Liquidation preference per security $ 25
Liquidation value (in millions) $400
Coupon rate 7.20%
Distributions payable Quarterly
Distributions guaranteed by SSBH
Common securities issued to SSBH 494,880
Subordinated Debt Securities:
Amount owned (in millions) $412
Coupon rate 7.20%
Interest payable Quarterly
Maturity date January 28, 2038
Redeemable by issuer on or after January 28, 2003
F-28
SALOMON SMITH BARNEY HOLDINGS INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE 11. 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 Commission Uniform Net $3,832 $3,444
Capital Rule (Rule 15c3-1)
Salomon Brothers International Limited United Kingdom's Financial Services Authority $3,154 $ 587
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 7 and 8 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, 2002, 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-29
SALOMON SMITH BARNEY HOLDINGS INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE 12. EMPLOYEE BENEFIT PLANS
RETIREMENT PLANS
The Company participates in defined benefit pension plans through Citigroup that
cover certain U.S. and non-U.S. employees. These plans resulted in expenses of
$60 million, $42 million, and $40 million in 2002, 2001, and 2000, respectively.
The Company has defined contribution employee savings plans through Citigroup
covering certain eligible employees. The costs relating to these plans were $17
million, $7 million, and $4 million in 2002, 2001, and 2000, respectively.
HEALTH CARE AND LIFE INSURANCE
The Company participates in various benefit plans through Citigroup which
provide 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,
2002, there were approximately 32,900 active and 1,700 retired employees
eligible for such benefits.
Expenses recorded for health care and life insurance benefits from continuing
operations were $180 million, $129 million, and $100 million in 2002, 2001, and
2000, respectively.
PRO FORMA EFFECT OF SFAS 123
The Company participates in a stock option plan sponsored by Citigroup in which
it currently applies APB 25 in accounting for stock options. Under APB 25, there
is generally no charge to earnings for employee stock option awards, because the
options granted under these plans have an exercise price equal to the market
value of the underlying common stock on the grant date. Alternatively, SFAS 123
allows companies to recognize compensation expense over the related service
period based on the grant-date fair value of the stock award. Refer Note 1 to
the consolidated financial statements for a further description of these
accounting standards and a presentation of net income had the Company applied
SFAS 123 in accounting for stock option plans. The pro forma adjustments relate
to stock options granted from 1995 through 2002, for which the fair value on the
date of the grant was determined using a Black-Scholes option pricing model. No
effect has been given to options granted prior to 1995. Shares received from
options granted are subject to restrictions on sale. Discounts have been
applied to the fair value of options granted to reflect these sale
restrictions. The fair values of stock-based compensation awards are based on
assumptions that were determined at the grant date. The following assumptions
were used to calculate the effect of SFAS 123:
Assumptions 2002 2001 2000
----------- ---- ---- ----
Expected volatility 37.2% 38.6% 40.8%
Risk-free interest rate 3.90% 4.66% 6.19%
Expected annual dividends per share $0.92 $0.92 $0.76
Expected annual forfeiture rate 7% 5% 5%
RESTRICTED STOCK PLANS
The Company has various restricted stock plans through Citigroup, including the
Capital Accumulation Plan, under which stock of Citigroup is issued in the form
of restricted stock to participating officers and employees. The restricted
stock
F-30
SALOMON SMITH BARNEY HOLDINGS INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
generally vests after a two- or three-year period. Except under limited
circumstances, during the vesting period the stock cannot be sold or transferred
by the participant, and is subject to total or partial cancellation if the
participant's employment is terminated. Certain participants may elect to
receive part of their awards in restricted stock and part in stock options.
Unearned compensation associated with the restricted stock grants is included in
"Other assets" in the consolidated statement of financial condition and
represents the market value of Citigroup common stock at the date of grant and
is recognized as a charge to income ratably over the vesting period. These plans
resulted in expenses of $1,111 million, $873 million, and $619 million for the
years ended December 31, 2002, 2001, and 2000, respectively.
NOTE 13. INCOME TAXES
Under income tax allocation agreements with Citigroup, the Company's U.S.
federal, state and local income taxes are provided on a separate return basis
and are subject to the utilization of tax attributes in Citigroup's consolidated
income tax provision. Under the tax sharing agreement with Citigroup, the
Company remits its current tax liabilities to Citigroup throughout the year
except for certain liabilities expected to be payable as a separate taxpayer.
The components of income taxes reflected on the consolidated statements of
income are:
Dollars in millions
Year Ended December 31, 2002 2001 2000
----------------------- ------- ------- ------
Current tax provision:
U.S. federal $ 972 $ 1,108 $1,064
State and local 261 265 129
Non-U.S 34 150 102
------- ------- ------
Total current tax provision 1,267 1,523 1,295
------- ------- ------
Deferred tax provision/(benefit):
U.S. federal (91) (13) 331
State and local 24 (18) 57
Non-U.S 42 -- 27
------- ------- ------
Total deferred tax provision/(benefit) (25) (31) 415
------- ------- ------
Provision for income taxes $ 1,242 $ 1,492 $1,710
======= ======= ======
Under SFAS 109, Accounting for Income Taxes, temporary differences between
recorded amounts and the tax bases of assets and liabilities are measured using
the enacted tax rates and laws that will be in effect when such differences are
expected to reverse.
F-31
SALOMON SMITH BARNEY HOLDINGS INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
At December 31, 2002 and December 31, 2001, respectively, the Company's
consolidated statements of financial condition included net deferred tax assets
of $1,002 million and $922 million, comprised of the following:
Dollars in millions
Year Ended December 31, 2002 2001
----------------------- ------- -------
Deferred tax assets:
Employee benefits and deferred compensation $ 1,123 $ 1,363
Restructuring and settlement reserves 374 19
U.S. taxes provided on the undistributed earnings of non-U.S subsidiaries 22 40
Cumulative translation adjustments 17 15
Other deferred tax assets 322 292
------- -------
Total deferred tax assets 1,858 1,729
------- -------
Deferred tax liabilities:
Intangible assets (331) (314)
Investment position activity (61) (53)
Lease obligations and fixed assets (391) (383)
Other deferred tax liabilities (73) (57)
------- -------
Total deferred tax liabilities (856) (807)
------- -------
Net deferred tax asset $ 1,002 $ 922
======= =======
The Company believes that the recognized net deferred tax asset is more likely
than not to be realized.
The Company had no deferred tax valuation allowance at December 31, 2002 or
December 31, 2001.
Tax benefits (liabilities) allocated directly to stockholder's equity were as
follows:
Dollars in millions
Year Ended December 31, 2002 2001 2000
----------------------- ------- -------- -------
Foreign currency translation $ 5 $ (5) $ --
Employee stock plans 18 17 14
------- -------- -------
Total tax benefits allocated directly to stockholder's equity $ 23 $ 12 $ 14
======= ======== =======
The Company paid $2,077 million in 2002 and received net tax refunds of $114
million in year 2001. The Company paid taxes, net of refunds, of $1,394 million
in 2000. As a result of the September 11, 2001 terrorist attack, the United
States Internal Revenue Service allowed affected taxpayers, including the
Company to postpone year 2001's third and fourth quarter estimated tax payments
until January 15, 2002.
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, 2002, $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 $399 million would have to be
provided if such earnings were remitted to the United States.
F-32
SALOMON SMITH BARNEY HOLDINGS INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
The following table reconciles the U.S. federal statutory income tax rate to the
Company's effective tax rate:
Year Ended December 31, 2002 2001 2000
----------------------- ---- ---- ----
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 3
Tax advantaged income (1) (1) (1)
Other, net 2 (2) (1)
---- ---- ----
Effective tax rate 41% 36% 36%
==== ==== ====
NOTE 14. PLEDGED ASSETS, COMMITMENTS, CONTINGENCIES, AND GUARANTEES
At December 31, 2002 and 2001, the approximate market values of collateral
received that can be sold or repledged by the Company, excluding the impact of
FIN 41, were:
(Dollars in millions)
Sources of collateral 2002 2001
--------------------- -------- --------
Securities purchased under agreements to resell $164,569 $147,378
Securities received in securities borrowed vs. pledged transactions 56,559 45,486
Securities received in securities borrowed vs. cash transactions 44,612 44,136
Collateral received in margined broker loans 19,827 24,221
Collateral received in securities loaned vs. pledged transactions 4,450 2,777
Collateral received in derivative transactions and other 1,914 1,104
-------- --------
Total $291,931 $265,102
======== ========
During 2002 and 2001, almost all collateral received was sold or repledged. At
December 31, 2002 and 2001, the approximate market values of this portion of
collateral and financial instruments owned that were sold or repledged by the
Company, excluding the impact of FIN 41, were:
(Dollars in millions)
Uses of collateral and trading securities 2002 2001
----------------------------------------- -------- --------
Securities sold under agreements to repurchase $212,523 $180,320
Collateral pledged out in securities borrowed vs. pledged transactions 51,206 44,202
Financial instruments sold, not yet purchased 46,856 46,698
Securities loaned out in securities loaned vs. pledged transactions 12,288 4,237
Securities loaned out in securities loaned vs. cash transactions 9,780 12,541
Collateral pledged to clearing organization or segregated under
securities laws or regulations 7,936 7,337
Collateral pledged in derivative transactions and other 1,871 338
-------- --------
Total $342,460 $295,673
======== ========
F-33
SALOMON SMITH BARNEY HOLDINGS INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
OTHER CONTINGENCIES
At December 31, 2002, the Company had $962 million of outstanding letters of
credit from banks to satisfy various collateral and margin requirements.
OBLIGATIONS UNDER GUARANTEES
The Company provides a variety of guarantees and indemnifications to customers
to enhance their credit standing and enable them to complete a wide variety of
business transactions. The Company believes the guarantees which are provided
relate to an asset, liability, or equity security of the guaranteed parties.
In the normal course of business, the Company provides standard representations
and warranties to counterparties in contracts in connection with numerous
transactions and also provides indemnifications that protect counterparties to
contracts in the event that additional taxes are owed due either to a change in
the tax law or an adverse interpretation of the tax law. Counterparties to these
transactions provide the Company with comparable indemnifications. In addition,
the Company is a member of numerous value transfer networks ("VTNs") (payment,
clearing and settlement systems as well as securities exchanges) around the
world. As a condition of membership, many of these VTNs require that members
stand ready to backstop the net effect on the VTNs of a member's default on its
obligations. The indemnification clauses are often standard contractual terms
and were entered into in the normal course of business based on an assessment
that the risk of loss would be remote. In many cases, there are no stated or
notional amounts included in the indemnification clauses and the contingencies
triggering the obligation to indemnify have not occurred and are not expected to
occur. There are no amounts reflected on the statement of financial condition as
of December 31, 2002, related to these indemnifications.
Derivative instruments which include guarantees are credit default swaps, total
return swaps, written foreign exchange options, written put options, written
equity warrants, and written caps and floors. At December 31, 2002, the carrying
amount of the liabilities related to these derivatives were $2.6 billion.
The maximum potential loss represents the amounts that could be lost under the
guarantees if there were a total default by the guaranteed parties, without
consideration of possible recoveries under recourse provisions or from
collateral held or pledged. Such amounts bear no relationship to the anticipated
losses on these guarantees and greatly exceed anticipated losses. At December
31, 2002, the maximum potential loss at notional value related to credit default
swaps and total rate of return swaps amounted to $38.8 billion, of which $3.1
billion expire within one year and $ 35.7 billion expire after one year. At
December 31, 2002 the maximum potential loss at fair value related to all other
derivative guarantees amounted to $2.3 billion.
Guarantees to joint ventures primarily include guarantees of their debt
obligations. At December 31, 2002 the carrying amount of the liabilities and the
maximum potential loss related to these joint venture guarantees were $453
million.
F-34
SALOMON SMITH BARNEY HOLDINGS INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
The Company has provided a residual value guarantee of $78 million in connection
with the lease of buildings occupied by the Company's executive offices and New
York operations. The residual value guarantee provides that the guarantor will
pay the difference between the fair value of the guaranteed property and the
value specified in the contract to the guarantor at the termination or renewal
date of the operating lease.
NOTE 15. LEGAL PROCEEDINGS
During the fourth quarter of 2002, the Company, through its parent, Citigroup,
reached a settlement-in-principle with the Securities and Exchange Commission,
the National Association of Securities Dealers, the New York Stock Exchange and
the Attorney General of New York of all issues raised in their research, IPO
allocation and spinning-related inquiries. The Company established a reserve for
the cost of this settlement and toward estimated costs of the private litigation
related to the matters that were the subject of the settlement as well as the
regulatory inquiries and private litigation related to Enron. The reserve for
these matters resulted in an after-tax charge of approximately $863 million. The
Company believes that it has substantial defenses to the pending private
litigations which are at a very early stage. Given the uncertainties of the
timing and outcome of this type of litigation, the large number of cases, the
novel issues, the substantial time before these cases will be resolved, and the
multiple defendants in many of them, this reserve is difficult to determine and
of necessity subject to future revision.
For a discussion of these and certain other legal proceedings, see Part I, Item
3, "Legal Proceedings". In addition, in the ordinary course of business, the
Company and its subsidiaries are defendants or co-defendants or parties in
various litigation and regulatory matters incidental to and typical of the
businesses in which they are engaged. 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. In the opinion of the Company's management, the ultimate resolution of
these legal and regulatory proceedings would not be likely to have a material
adverse effect on the consolidated financial condition of the Company but, if
involving monetary liability, may be material to the Company's operating results
for any particular period.
NOTE 16. FINANCIAL INSTRUMENTS AND CONTRACTUAL COMMITMENTS AND RELATED RISKS
The Company and its subsidiaries enter into a variety of contractual
commitments, such as interest rate, equity, currency and commodity swap
agreements, cap and floor agreements, swap options, forward purchase and sale
agreements, option contracts, warrants and commodity and financial futures and
forward contracts. 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, currency
F-35
SALOMON SMITH BARNEY HOLDINGS INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
swaps, equity swaps, commodity swaps and swap options. 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 or the
exchange of one floating price for a different floating price, throughout the
swap term. The most common commodity swaps entered into by the Company include
crude oil, refined oil products and natural gas.
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.
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
consolidated statement of financial condition as either financial instruments
owned and contractual commitments or financial instruments sold, not yet
purchased, and contractual commitments.
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.
F-36
SALOMON SMITH BARNEY HOLDINGS INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
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.
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 1 to the
consolidated financial statements, the Company records all derivatives,
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 or decrease in economic value 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.
F-37
SALOMON SMITH BARNEY HOLDINGS INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
The table on the following page includes the disclosure of the notional amounts
of the Company's derivative financial instruments. 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-38
SALOMON SMITH BARNEY HOLDINGS INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
A summary of contractual commitments as of December 31, 2002 and 2001 is as
follows:
DECEMBER 31, 2002 DECEMBER 31, 2001
--------------------------------------- -------------------------------------
Notional Current Market or Notional Current Market or
or Fair Value or Fair Value
Contractual ------------------------ Contractual ----------------------
Dollars in billions Amounts Assets Liabilities Amounts Assets Liabilities
- ------------------- ----------- ------- ----------- ----------- ------- -----------
Exchange-traded products:
Futures contracts (a) $ 192.2 $ -- $ -- $ 172.5 $ -- $ --
Other exchange-traded products:
Equity contracts 50.8 1.4 2.0 86.2 .4 .5
Fixed income contracts 7.2 -- -- 26.1 -- --
Commodity contracts 2.3 -- -- 1.0 -- --
-------- -------- -------- -------- -------- --------
Total exchange-traded products 252.5 1.4 2.0 285.8 .4 .5
-------- -------- -------- -------- -------- --------
Over-the-counter ("OTC") swaps, swap options,
caps, floors and forward rate agreements:
Swaps 2,567.7 2,603.1
Swap options written 60.1 86.2
Swap options purchased 52.7 50.4
Caps, floors and forward rate
agreements 181.9 181.4
-------- -------- -------- -------- -------- --------
Total OTC swaps, swap options, caps, floors
and forward rate agreements (b) 2,862.4 11.9 9.4 2,921.1 6.7 5.9
-------- -------- -------- -------- -------- --------
Other options and contractual commitments:
Options and warrants on equities and
equity indices 73.5 1.1 2.4 66.8 1.1 2.2
Options and forward contracts on fixed
income securities 628.7 .8 .4 1,134.8 .5 .3
Foreign exchange contracts and options (b) 58.7 .5 .5 49.1 .5 .5
Commodity contracts 9.2 .1 .1 9.9 .1 .1
-------- -------- -------- -------- -------- --------
Total contractual commitments $3,885.0 $ 15.8 $ 14.8 $4,467.5 $ 9.3 $ 9.5
======== ======== ======== ======== ======== ========
(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 $14.3 billion and $4.1 billion at December 31, 2002 and
$14.1 billion and $2.7 billion at December 31, 2001, respectively.
The annual average balances of the Company's contractual commitments, based on
month-end balances, are as follows:
2002 2001
----------------------- ----------------------
Average Average Average Average
Dollars in billions Assets Liabilities Assets Liabilities
------------------- ------- ----------- ------- -----------
Swaps, swap options, caps and floors $ 8.1 $ 7.4 $ 7.4 $ 6.3
Index and equity contracts and options 2.2 3.5 3.0 4.0
Foreign exchange contracts and options .3 .3 .2 .2
Commodity contracts .1 .1 .1 .1
Forward contracts on fixed income securities .6 .4 .7 .4
----- ----- ----- -----
Total contractual commitments $11.3 $11.7 $11.4 $11.0
===== ===== ===== =====
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.
F-39
SALOMON SMITH BARNEY HOLDINGS INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
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 in securities issued by the U.S. government and its agencies,
which totaled $34.6 billion at December 31, 2002 and $45.8 billion at December
31, 2001. 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 $153.0 billion or 43% of the Company's total assets
before FIN 41 netting at December 31, 2002 and $176.0 billion or 50% of the
Company's total assets before FIN 41 netting at December 31, 2001. Similarly,
concentrations with non-U.S. governments totaled $53.8 billion at December 31,
2002 and $63.7 billion at December 31, 2001. 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, 2002 or 2001. North America and Europe represent the largest geographic
concentrations. Among industries, other major derivatives dealers represent the
largest group of counterparties.
NOTE 17. 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 the reader gain an understanding of the
relationship between the amounts reported in the Company's consolidated
financial statements and the related market or fair values. Specific accounting
policies are discussed in Note 1 to the consolidated financial statements.
At December 31, 2002, $282.6 billion or 97% of the Company's total assets and
$268.7 billion or 96% of the Company's total liabilities were carried at market
value or fair value or at amounts that approximate such values. At December 31,
2001, $289.8 billion or 96% of the Company's total assets and $274.2 billion or
95% 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, and contractual commitments.
F-40
SALOMON SMITH BARNEY HOLDINGS INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
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.
Dollars in billions
- -------------------
December 31, 2002 2001
Liabilities Liabilities
------------------ -------------------
Carrying Fair Carrying Fair
Value Value Value Value
-------- ----- -------- -----
Financial instruments primarily recorded at
contractual amounts or historical amounts that do
not necessarily approximate market or fair value:
Fixed rate term debt $10.3 $10.3 $11.2 $11.2
----- ----- ----- -----
The fair value of fixed rate term debt has been estimated by using a discounted
cash flow analysis.
NOTE 18. RELATED PARTY BALANCES
The Company has related party balances with Citigroup and certain of its
subsidiaries and affiliates. These balances, which are short-term in nature,
include cash accounts, collateralized financing transactions, margin accounts,
receivables and payables, securities and underwriting transactions, derivative
trading, charges for operational support and the borrowing and lending of funds.
These balances result from related party transactions that are generally
conducted at prices equivalent to prices for transactions conducted at arm's
length with unrelated third parties. Amounts charged for operational support
represent an allocation of costs.
NOTE 19. SECURITIZATIONS
During 2002 and 2001, the Company securitized various types of assets including
commercial and residential mortgages, high yield bonds, government, agency and
corporate securities, and municipal bonds. Proceeds from these securitizations
were approximately $24 billion in 2002 and $19 billion in 2001, which
contributed to pre-tax gains and related fees of $105 million and $97 million in
2002 and 2001, respectively.
To a limited extent, the Company also retains interests in these securitizations
for which the Company was the securitizer. Such retained positions are carried
at fair value with the changes in fair value reported in earnings. As of
December 31, 2002, the largest portion of these retained positions was in
securitizations of commercial and residential mortgages, agency mortgage
securities and collateralized debt obligations which totaled $1.0 billion. As of
December 31, 2001, the largest portion of retained positions was in commercial
and residential mortgages and agency mortgage securities which totaled $861
million.
F-41
SALOMON SMITH BARNEY HOLDINGS INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
The key assumptions used in estimating the fair value of these retained
interests at December 31, 2002, were:
COMMERCIAL MORTGAGES
Discount Rate 2%-28%
RESIDENTIAL MORTGAGES
Discount Rate 23%-40%
Expected Prepayment Rate 5%-40%
Anticipated Credit Loss 30%-50%
AGENCY SECURITIES
Discount Rate 2%-49%
Expected Prepayment Rate 15%-51%
COLLATERALIZED DEBT OBLIGATIONS
Discount Rate 1%-18%
Recovery Rate 40%-70%
The impact of altering each of the assumptions to assumptions that are 10% and
20% less favorable at December 31, 2002, is as follows. The impact of altering
the above assumptions are pre-tax and do not include the impact of hedges that
the Company has in place.
COMMERCIAL MORTGAGES
(Dollars in millions) 10% 20%
--------------------- ---- ----
Discount Rate $1.5 $2.9
F-42
SALOMON SMITH BARNEY HOLDINGS INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
RESIDENTIAL MORTGAGES
(Dollars in millions) 10% 20%
--------------------- ---- -----
Discount Rate $1.8 $3.5
Expected Prepayment rate $0.5 $1.0
Anticipated Credit Loss $1.9 $3.9
AGENCY SECURITIES
(Dollars in millions) 10% 20%
--------------------- ---- -----
Discount Rate $11.3 $22.0
Expected Prepayment rate $ 4.0 $ 7.8
COLLATERALIZED DEBT OBLIGATIONS
(Dollars in millions) 10% 20%
--------------------- ---- -----
Discount Rate $2.5 $5.1
Recovery Rate $ -- $0.1
VARIABLE INTEREST ENTITIES
FIN 46 introduces a new concept of a VIE, which is defined as an entity (1) that
has a total equity investment at risk that is not sufficient to finance its
activities without additional subordinated financial support from other parties,
or (2) where the group of equity owners does not have the ability to make
significant decisions about the entity's activities through voting or similar
rights, or the obligation to absorb the entity's expected losses, or the right
to receive the entity's expected residual returns. FIN 46 exempts certain
entities from its scope. These exemptions include: transferors to qualifying
special-purpose entities ("QSPEs") meeting the requirements of SFAS No. 140
"Accounting for Transfers of Financial Assets and Extinguishments of
Liabilities, a replacement of SFAS No. 125," ("SFAS 140") and all other parties
to a QSPE, unless that party can unilaterally liquidate the QSPE or change the
entity so that it no longer qualifies as a QSPE; investment companies registered
under the Investment Company Act of 1940 ("RICs") will not consolidate any
entity that is not also a RIC; employee benefit plans accounted for under the
SFAS No. 87, "Employers' Accounting for Pensions," SFAS No. 106, "Employers'
Accounting for Postretirement Benefits Other Than Pensions," and SFAS No. 112,
"Employers' Accounting for Postemployment Benefits"; and separate accounts of
life insurance entities. The Company's securitizations of certain financial
assets use trust arrangements that meet the specified conditions of SFAS 140 to
be considered QSPEs. Accordingly, those trusts are not subject to the provisions
of FIN 46.
F-43
SALOMON SMITH BARNEY HOLDINGS INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
The Company is a party to numerous entities that may be considered to be VIEs.
These include collateralized debt obligations ("CDOs"), structured finance
transactions, and various investment funds. The Company acts as intermediary or
agent for its corporate clients, assisting them in obtaining sources of
liquidity, by selling the clients' financial assets to a VIE.
The Company securitizes clients' debt obligations in transactions involving SPEs
that issue CDOs. A majority of the transactions are on behalf of clients where
the Company first purchases the assets at the request of the clients and
warehouses them until the securitization transaction is executed. Other CDOs are
structured where the underlying debt obligations are purchased directly in the
open market or from issuers. Some CDOs have static unmanaged portfolios of
assets, while others have a more actively managed portfolio of financial assets.
At December 31, 2002, assets of CDOs amounted to $17 billion. The Company
receives fees for structuring and distributing the CDO securities to investors.
Certain CDOs with assets of $1 billion meet the conditions of QSPEs which are
specifically exempted from FIN 46.
In addition to securitizations of mortgage loans originated by the Company, the
Company also securitizes purchased mortgage loans, creating collateralized
mortgage obligations ("CMOs") and other mortgage-backed securities (MBSs) and
distributes them to investors. Since January 1, 2000, the Company has organized
253 mortgage securitizations with assets of $241 billion at December 31, 2002.
The trusts used in these CMO and MBS securitizations meet the conditions of
QSPEs and are, therefore, not considered to be VIEs.
The Company also organizes structured finance entities to repackage certain
securities obtained in the secondary market, to issue equity-linked or
credit-linked notes to investors, or to obtain financing. In general, these
structured finance entities are established to meet the needs of the Company's
clients. The Company has organized structured finance transactions with $23.0
billion in assets. Certain structured finance entities with assets of $5.1
billion meet the conditions of QSPEs and are, therefore, not considered to be
VIEs.
CREATION OF OTHER INVESTMENT PRODUCTS
The Company packages and securitizes assets purchased in the financial markets
in order to create new security offerings for institutional and private bank
clients as well as retail customers, including hedge funds, mutual funds, unit
investment trusts, and other investment funds, that match the clients'
investment needs and preferences. The entities may be credit-enhanced by excess
assets in the investment pool or by third-party insurers assuming the risks of
the underlying assets, thus reducing the credit risk assumed by the investors
and diversifying investors' risk to a pool of assets as compared with
investments in individual assets. In a limited number of cases, the Company may
guarantee the return of principal to investors. The Company typically manages
the funds for market-rate fees. In addition, the Company may be one of several
liquidity providers to the funds and may place the securities with investors.
Many of these funds are RICs and, therefore, will not have to consolidate any of
the entities in which they invest, except for other RICs if the funds are
considered to be the primary beneficiaries of those RIC investees. Many other
investment funds are organized as corporations or partnerships with sufficient
capital to fund their operations without additional credit support. Accordingly,
we expect that many of these funds will ultimately be determined not to be VIEs.
F-44
SALOMON SMITH BARNEY HOLDINGS INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
The Company has also established a number of investment funds as opportunities
for selected employees to invest in venture capital investments. The Company
acts as investment manager to these funds and may provide employees with
financing on both a recourse and non-recourse basis for a portion of the
employees' investment commitments.
The following table summarizes the Company's significant involvement in VIEs by
product type at December 31, 2002:
Total No. Assets
Of VIEs (in billions)
------- -------------
CDOs 44 $ 16.3
Leasing 1 0.6
Structured Finance 173 17.9
Other 290 31.8
--- --------
Total (1) 508 $ 66.6
--- --------
(1) This total includes 130 VIEs with assets of $5.0 billion that are
consolidated at December 31, 2002.
Some of the Company's private equity investments may also be subject to this
interpretation and are not included in the table above. The Company may provide
liquidity facilities to VIEs, may be a party to derivative contracts with VIEs,
may provide second loss enhancement in the form of letters of credit and other
guarantees to the VIEs, and may also have an ownership interest in certain VIEs.
At December 31, 2002, the Company's maximum exposure to loss as a result of its
involvement with VIEs is approximately $3.2 billion. For this purpose, maximum
exposure is considered to be the notional amounts of credit lines, guarantees,
other credit support, and liquidity facilities and the amount invested where
SSBHI has an ownership interest in the VIEs. In addition, the Company may be a
party to other derivative contracts with VIEs. However, actual losses are not
expected to be significant. Exposures that are considered to be guarantees
subject to FIN 45 are also included in obligations under guarantees in Note 14
to the consolidated financial statements.
F-45
SALOMON SMITH BARNEY HOLDINGS INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE 20. SSBH ONLY CONDENSED FINANCIAL STATEMENTS
The following are condensed financial statements of Salomon Smith Barney
Holdings Inc. (SSBH Only):
SSBH ONLY CONDENSED STATEMENTS OF INCOME
Dollars in millions
Year Ended December 31, 2002 2001 2000
----------------------- ------ ------- -------
Revenues, net of interest expense $ 100 $ (27) $ 104
Noninterest expenses 24 54 14
------ ------- -------
Income (loss) before income taxes 76 (81) 90
Provision (benefit) for income taxes 28 26 (59)
Equity in earnings of subsidiaries 1,739 2,734 2,883
------ ------- -------
Net income $1,787 $ 2,627 $ 3,032
====== ======= =======
SSBH ONLY CONDENSED STATEMENTS OF FINANCIAL CONDITION
Dollars in millions
December 31, 2002 2001
- ------------------- ------- -------
Assets:
Cash and cash equivalents $ -- $ --
Financial instruments owned and contractual commitments 143 68
Receivables 609 268
Receivable from subsidiaries (1) 51,753 44,302
Investment in subsidiaries 10,077 10,213
Other assets 1,665 2,321
------- -------
Total assets $64,247 $57,172
======= =======
Liabilities and stockholder's equity:
Commercial paper and other short-term borrowings $20,180 $16,041
Payable to subsidiaries 1,189 1,475
Financial instruments sold, not yet purchased, and
contractual commitments 647 406
Other liabilities 1,429 2,940
Term debt 27,832 24,200
Subordinated debt payable to SSBH Capital Trust I 412 412
------- -------
Total liabilities 51,689 45,474
Stockholder's equity 12,558 11,698
------- -------
Total liabilities and stockholder's equity $64,247 $57,172
======= =======
(1) Includes $4.4 billion and $3.7 billion of subordinated note receivables at
December 31, 2002 and December 31, 2001, respectively.
F-46
SALOMON SMITH BARNEY HOLDINGS INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
SSBH ONLY CONDENSED STATEMENTS OF CASH FLOWS
Dollars in millions
Year ended December 31, 2002 2001 2000
- ----------------------- ------- -------- -------
Cash flows from financing activities:
Net increase (decrease) in commercial paper
and other short-term borrowings $ 4,139 $ (2,519) $ 4,463
Proceeds from issuance of term debt 8,898 10,530 6,269
Term debt maturities and repurchases (6,034) (5,378) (4,126)
Capital contribution from Parent 500 -- --
Other capital transactions 12 203 89
Dividends paid (1,727) (2,660) (1,202)
------- -------- -------
Cash provided by financing activities 5,788 176 5,493
------- -------- -------
Cash flows from investing activities:
Increase in receivables from subsidiaries, net (7,533) (5,418) (6,320)
Dividends received from subsidiaries 2,236 2,723 2,404
Capital (infusions to) distributions from subsidiaries, net (261) 14 (933)
------- -------- -------
Cash used in investing activities (5,558) (2,681) (4,849)
------- -------- -------
Cash provided by (used in) operating activities (230) 2,505 (644)
------- -------- -------
Increase in cash and cash equivalents 0 0 0
Cash and cash equivalents at beginning of year 0 0 0
------- -------- -------
Cash and cash equivalents at end of year $ 0 $ 0 $ 0
======= ======== =======
BASIS OF PRESENTATION
The accompanying condensed financial statements, which include the accounts of
SSBH, a direct wholly owned subsidiary of Citigroup, should be read in
conjunction with the consolidated financial statements of the Company.
Investments in subsidiaries are accounted for under the equity method. For
information regarding the Company's term debt and commercial paper and other
short term borrowings, see Notes 7 and 8 to 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-47
SALOMON SMITH BARNEY HOLDINGS INC. AND SUBSIDIARIES
QUARTERLY FINANCIAL DATA (UNAUDITED)
Quarterly results for the year ended December 31, 2002 were as follows:
Quarter Ended
Dollars in millions March 31 June 30 September 30 December 31
- ------------------- -------- ------- ------------ -----------
Noninterest revenues $ 3,396 $3,051 $2,655 $ 2,548
Net interest and dividends 678 781 646 651
------- ------ ------ -------
Revenues, net of interest expense 4,074 3,832 3,301 3,199
Expenses, excluding interest 2,872 2,843 2,453 3,185
------- ------ ------ -------
Income before income taxes and cumulative
effect of change in accounting principle 1,202 989 848 14
Provision for income taxes 449 370 319 104
------- ------ ------ -------
Income (loss) before cumulative effect of
change in accounting principle 753 619 529 (90)
------- ------ ------ -------
Cumulative effect of change in accounting principle
(net of tax benefit of $1) (24) -- -- --
------- ------ ------ -------
Net income $ 729 $ 619 $ 529 $ (90)
======= ====== ====== =======
Quarterly results for the year ended December 31, 2001 were as follows:
Quarter Ended
Dollars in millions March 31 June 30 September 30 December 31
- ------------------- -------- ------- ------------ -----------
Noninterest revenues $ 4,331 $3,414 $2,634 $ 2,758
Net interest and dividends 401 530 596 723
------- ------ ------ -------
Revenues, net of interest expense 4,732 3,944 3,230 3,481
Expenses, excluding interest 3,543 2,808 2,261 2,655
------- ------ ------ -------
Income before income taxes and cumulative
effect of change in accounting principle 1,189 1,136 969 826
Provision for income taxes 422 402 363 305
------- ------ ------ -------
Income before cumulative effect of
change in accounting principle 767 734 606 521
------- ------ ------ -------
Cumulative effect of change in accounting principle
(net of tax benefit of $1) (1) -- -- --
------- ------ ------ -------
Net income $ 766 $ 734 $ 606 $ 521
======= ====== ====== =======
F-48