Salomon IR 96 1 Q Page 3
Salomon Swapco Inc
To Our Clients
The most important difference between financial
statement capital ("Stockholder's equity") and
capital as used for capital adequacy evaluation
(which we will refer to as "rating agency capital")
is the Deferred revenue balance which we carry as
a liability on our Statement of Financial
Condition. That balance represents
intermediation fees that Swapco has received - in
cash - but which it has not yet recognized as
income.
There are no circumstances under which Swapco
would refund intermediation fees which SBHC
has paid to it. The Deferred revenue balance is,
therefore, a valid element of "capital" in any
assessment of the entity's ability to meet potential
claims. It is classified as a liability on our
financial statements in order to achieve an
appropriate timing match between income and the
related expenses. Swapco will "earn" its
intermediation fees over the life of each trade -
over the same period that it incurs expenses
related to maintaining that trade.
The accompanying graph displays the quarter-end
balances of rating agency capital (the line) and of
its components. As you can see, deferred revenue
accounts for a significant - and growing - share of
Rating agency capital. This is the normal result
of the continuing growth of Swapco's derivatives
portfolio. Intermediation fees - paid in cash when
trades are put on - are coming on faster than we
are amortizing them away.
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Salomon Swapco Inc
To Our Clients
The other differences between Stockholder's
equity and rating agency capital are relatively
minor. Investment haircuts represent the
difference between the market value of Swapco's
investment securities (the value at which they are
carried on the Statement of Financial Condition
and, therefore, the value implicit in the
Stockholder's equity number) and the
conservative post-haircut value used to assess
rating capital adequacy. The omission of Prepaid
expenses is the mirror image of the treatment of
Deferred revenue. These expenditures, already
made on a cash basis, would not be recovered in a
termination and are therefore not an element of
Rating agency capital.
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