tion. At Sept. 30, 1995, Swapco's total capital was
approximately $356 million. Swapco incurs no market risk,
since all counterparty transactions are offset with identical,
matching transactions with SBHC. As a result, counterparty
credit quality is a critical factor in assessing capital levels
and the ability to meet all obligations at an 'AAA' confidence
level in the event of termination.
Swapco minimizes counterparty default risk and capital
requirements by transacting with investment-grade counter-
parties rated 'BBB' or higher. If a counterparty is sub-
sequently downgraded below investment grade, the
exposure is fully capitalized by Swapco. In practice, most
counterparties are highly rated. At Sept. 30, 1995, more
than 90% of counterparties were rated 'A' or higher based
on notional amounts. Affiliate risk is minimized through
daily posting of collateral in an amount that exceeds
affiliate payables to Swapco.
Swapco was established as a "termination vehicle" to
ensure that all trades are settled on a cash basis if certain
trigger events occur. Trigger events include: SBHC bank-
ruptcy; a downgrade of Swapco below 'A'; or Swapco's
inability to meet capital, collateral, or liquidity require-
ments. In such a scenario, all trades would be cash settled
using mid-market prices.
Organization and Management
Swapco is a bankruptcy-remote, stand-alone subsidiary of
SBHC, which, in turn, is wholly owned by Salomon Inc.
Salomon is a full-service, global securities firm with nearly
$4.0 billion of equity as of Sept. 30, 1995. Fitch currently
rates the short-term and senior long-term debt of Salomon
'F-2' and 'BBB+', respectively. The 'AAA' rating assigned
to Swapco reflects its bankruptcy-remote status and strong
ability to meet obligations in accordance with its termina-
Swapco has a separate board of directors, two members
of whom are unaffiliated with Salomon. Additionally, two
Swapco senior officers also must be unaffiliated with Salo-
mon. Swapco maintains a separate staff responsible for
operations and compliance with established procedures.
The company adheres to specific operating guidelines that
are monitored by external auditors to ensure compliance.
Exchange-traded and OTC derivative products play an
integral role in the global capital markets, providing a
number of well established benefits. Derivative products
are used by debt issuers and investors to: 1) lower funding
costs; 2) achieve greater diversification; and 3) shape risk
and return. The OTC derivatives market involves direct
transactions between two counterparties, without the bene-
fit of credit intermediation from an organized exchange.
As a result, the safety and timeliness of cash flows over a
transaction's term ultimately depend on the counterparties'
creditworthiness, particularly for longer dated transactions
and those involving exchange of notional amounts.
Swapco's portfolio has shown moderate growth recently,
following several years of rapid growth. At Sept. 30, 1995,
the portfolio had a total notional value of $100.4 billion,
excluding matched transactions with SBHC. This compares
with $66.8 billion at year-end 1994 and $22.4 billion at
the end of 1993. It will become increasingly difficult for the
portfolio to experience dramatic growth, given its size and
maturity profile. Instead, the portfolio should experience
relatively modest growth in the future, as new transactions
largely replace those that are maturing.
Under the terms of its operating procedures, Swapco
does not enter into commodity-linked transactions. The
company monitors its portfolio profile to limit large credit
exposures. Swapco's conservative product mix is under-
scored by the portfolio's maturity profile. At Sept. 30,
1995, 65.9% of transactions had maturities of five years
or less (see Portfolio Maturity Profile chart above).
Swapco also guarantees affiliate derivative transactions,
primarily equity options, when legal or regulatory restric-
tions prohibit dealing directly with Swapco. Guaranteed
affiliates currently include Salomon Brothers Inc., Salomon
Brothers International Ltd., Salomon Brothers AG, Salomon
Brothers AG (Tokyo Branch), Salomon Brothers U.K. Equity
Ltd., and Salomon Forex Inc.
Counterparty Credit Quality
Over time, the market value of derivative transactions
increases or decreases according to general changes in
Salomon Swapco Inc.
FITCH INVESTORS SERVICE, L.P.