Citibank and Continental Bank have withdrawn their bids to set up separately capitalized units to compete in the booming market for swaps.

The subsidiaries of Citicorp and Continental Bank Corp. had filed applications this year with Office of the Comptroller of Currency to establish the independent entities. The proposed units were designed to win AAA credit ratings that would attract new business from swap counterparties.

OCC Rejection Indicated

But last month, the banks withdrew their applications after receiving indications from the OCC that the proposals would be rejected.

"If there is a cocktail party and you don't get an invitation, it's best not to go," said a senior executive at one of the banks.

A spokeswoman for the OCC confirmed that the applications had been withdrawn. She would not comment further.

But sources familiar with the applications said the OCC was concerned about implications of the units' proposed capital structures.

The agency was said to fear approving a unit whose creditors would gain priority over those of the affiliated bank in case of default.

"The OCC had trouble with the concept of capital being taken out of an insured depository institution and being put into a subsidiary," a banking lawyer said.

"People who deal with the subsidiary would be getting a priority over people that do business with the bank."

Another source said the OCC did not want to appear to be circumventing market forces by permitting lower-rated banks to create AAA-rated spinoffs.

Relatively Low Credit Ratings

Continental Bank, which had planned to inject $200 million into its swaps spinoff, has a long-term deposit rating of Baa2 from Moody's Investors Service. Citibank's deposit rating is A2.

One banker speculated that, if the applications had come from banks with top-level credit ratings, the OCC would have approved them.

Meanwhile, several securities firms, including Merrill Lynch & Co. and Goldman, Sachs & Co., have established independent units to compete in the $3.8 trillion market for currency and interest rate derivative products.

|Not a Great Problem'

Richard Huber, a vice chairman at Continental, said the derivatives business would continue to be run as usual out of the bank. He pointed out that Continental's credit rating had improved since it applied in February.

"It's not a great problem," he said of the application's withdrawal, which was reported in Monday's editions of Swaps Monitor and Investment Dealers' Digest.

"But we wouldn't have requested it if we didn't think it was important."

Mr. Huber added that, before Continental applied to the OCC, the regulator had indicated it favored the idea of swaps subsidiaries at banks.

Continental may reapply for an AAA-rated unit, Mr. Huber said, noting that the decision could turn on who President-elect Clinton chooses as Comptroller of the Currency.

"It would be nice to be able to compete with the Wall Street firms," he said.

Volume Has Been High

Continental had $56.4 billion of outstanding swaps at the end of 1991.

Citibank, which had $257 billion of swap agreements outstanding at the end of 1991, did not respond to a request for comment.

People in the swaps market said banks could use other structures to circumvent credit rating problems. For example, they said, banks may be able to use a third party's capital for that purpose.

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