UBS AG
Annual Report 1998

Plain-text annual report

ab Combinations produce synergies and open new perspectives. Financial Report 1998. UBS Group Financial Highlights CHF million (except where indicated) 1998 1997 Income statement key figures Operating income Operating expenses before restructuring Operating profit before restructuring and taxes Net profit / (loss) Per share data (CHF) Basic earnings per share 1 Diluted earnings per share 1 Dividends proposed At year end Total assets Shareholders’ equity Market capitalization Ratios (%) Return on shareholders’ equity 2 Return on risk-weighted assets 3 Cost / income ratio 4 BIS Capital ratios 5 Tier 1 capital (%) Total capital (Tier 1 and Tier 2) (%) Risk-weighted assets 22,328 18,258 4,070 3,030 14.31 14.23 10.00 944,116 32,395 90,720 10.3 1.0 78.4 9.8 14.0 288,296 24,880 18,636 6,244 ( 667 ) 23.05 23.02 n/a 1,086,414 30,927 n/a 14.5 1.3 71.2 8.3 12.6 345,904 Assets under management (CHF billion) Total assets under management 1,572 1,512 Headcount Total headcount of which: Switzerland of which: Rest of world Long-term ratings Moody’s, New York Fitch / IBCA, London Standard & Poor’s, New York BankWatch, New York 55,176 36,638 18,538 48,011 32,706 15,305 Aa1 AAA AA+ AA 1 For EPS calculation, see Note 10 to the Financial Statements. For this disclosure 1997 is adjusted for impact of restructuring including taxes thereon. 2 Net profit / (loss) / average shareholders’ equity excluding dividends from parent bank. 1997 loss and shareholders’ equity adjusted for impact of restructuring including taxes thereon. 3 Net profit / (loss) / average BIS risk-weighted assets. 1997 loss adjusted for impact of restructuring including taxes thereon. 4 Operating expenses before restructuring / operating income before credit loss expenses of CHF 951 m in 1998 and CHF 1,278 m in 1997. 5 For BIS ratio calculations, see Note 34e to the Financial Statements. Contents Letter to Shareholders Review of Businesses UBS Segment Reporting Private Banking Warburg Dillon Read Private and Corporate Clients UBS Brinson UBS Capital Corporate Center Review of Risk Management and Control The UBS Risk Framework Credit Risk Market Risk Operational Risks Review of Asset and Liability Management Funding and Liquidity Management Interest Rate Management Currency Management Capital Management UBS Group Financial Statements Group Financial Review Financial Statements Notes to the Financial Statements Report of the Group Auditors UBS AG (Parent Bank) UBS Corporate Governance UBS Group Human Resources Glossary UBS Share Information 2 7 8 10 14 20 24 28 30 31 32 35 40 42 45 46 46 47 48 49 52 56 60 106 107 117 123 125 129 1 Letter to Shareholders Dear Shareholders, – The gain of CHF 1 billion arising from the divest- ment of BSI-Banca della Svizzera Italiana. This resulted from a condition laid down by the Swiss Competition Commission in the context of the merger. – The provision of CHF 0.8 billion for the settle- ment reached regarding dormant accounts and World War II-related claims. – Losses on pre-merger positions resulting from third-quarter market volatility totaling approx- imately CHF 1.9 billion by the end of 1998. These related to the loss from UBS’s engage- ment in Long Term Capital Management and significant value adjustments on pre-merger equity derivative positions. Analysis of 1998 results A review of the UBS Group 1998 results leads to an ambivalent conclusion. On the one hand, net profit after tax and minorities of CHF 3.0 billion falls short of expectations and is there- fore disappointing. On the other hand, despite a highly unusual combination of very difficult events which compounded the challenge of the merger, the UBS Group made significant progress. This is clear on closer analysis: – If adjusted for the non-recurring items set out above, 1998 net profit would have been CHF 4.4 billion compared to CHF 4.8 billion for 1997 (excluding the restructuring reserve). This is clearly in line with management’s expecta- tions of a 10% decline in net profit as stated in December 1997. – Furthermore, if revenues are adjusted for total non-recurring third-quarter losses and divest- ments, then the decline in 1998 was again well within the 10% decline which had been forecast at the time of the merger. – Finally, if total 1998 operating expenses are adjusted for the provision against the settle- ment regarding dormant accounts and the divestment of BSI, operating expenses declined by 6%, or about CHF 1.1 billion, year-on-year. This is better than expectations set out at the announcement of the merger, especially con- sidering that the merger only became legally effective in the second half of the year. Private Banking most significant contributor to earnings On a divisional basis, Private Banking, with a pre-tax result of CHF 4.3 billion, was the With the execution of the largest European bank merger, 1998 was a year in which UBS firm- ly shaped its own destiny. 1998 was also a difficult year for the banking industry and one in which UBS, in particular, was buffeted by an unusual combination of exceptional events. The settlement regarding the role of Swiss banks during and after World War II, combined with the consequences of third-quarter 1998 financial market turbulence, had a severe impact on UBS’s otherwise healthy financial performance. This mixture of events had a clear impact on the UBS share price, which post- ed a high of CHF 657 in July 1998 and a low of CHF 270 only two months later. In view of the underlying strength of the bank, the Board of Directors of UBS recommends to shareholders a dividend of CHF 10 per registered share for 1998. The difficult conditions of 1998 are reflected in the Group’s results. For 1998, UBS reports a pre- tax profit of CHF 4.1 billion, compared to the pre-tax profit of CHF 6.2 billion in 1997 (exclud- ing the CHF 7.0 billion restructuring provision, established in the context of the merger). Earn- ings per share (on a post-tax basis) were down by around 38% from CHF 23.05 in 1997 (again excluding the restructuring provision) to CHF 14.31 in 1998. At the same time, taking into con- sideration the difficult conditions in the latter half of the year, UBS still was able to achieve a respectable return on equity of 10.3%. The pre-tax impact of the major non-recurring factors influencing UBS’s 1998 result is set out below: 2 Letter to Shareholders most important contributor to the UBS Group’s result. Its profit was influenced most significant- ly by the CHF 1 billion divestment proceeds from the sale of BSI. Operating financial performance was primarily driven by asset growth due to per- formance. However, we were able to offset client attrition arising from the merger to a sig- nificant extent by successful marketing, which resulted in a net inflow of new assets under man- agement. Outside Switzerland, Private Banking has completed the merger integration; domesti- cally, the full integration of the information tech- nology platforms is still underway and is expect- ed to be concluded in 1999. Importantly, the division successfully launched a major initia- tive to grow domestic private banking outside Switzerland in core markets, such as Germany, Italy, France, Spain, Australia and Japan. We are highly satisfied with initial indications of prof- itability. Total commitment to investment banking Warburg Dillon Read, the investment banking arm of UBS, was naturally most sensitive to the market turbulence of the third quarter 1998 and consequently achieved a disappointing pre-tax loss of CHF 1 billion. Two factors stand out: part of the Global Equity Derivatives Portfolio, which is difficult to hedge and has a potential for signi- ficant variance, and the losses resulting from our involvement with Long-Term Capital Manage- ment. Excluding these positions, the pre-tax result would have been a significant reduction from the 1997 result, but in line with industry trends. Here the demands of the merger should also be borne in mind. Warburg Dillon Read successfully implement- ed the merger with a reduction in headcount of approximately 5,000 and also undertook a strategic review towards the end of the year to refocus the business and reduce the risk profile. This review confirmed the total commitment of UBS to its investment banking division. This commitment is based on the structural attractive- ness of the market and the distinctive positioning of Warburg Dillon Read as the leading European investment bank, as well as the substantial exist- ing and potential synergies with the other divi- sions, most notably Private Banking. The review called for an alignment of core business activities with similar client requirements, risk character- istics and logistics needs. Capital-intensive activ- ities deemed not to be attractive on a risk / return basis – such as global trade finance, internation- al lending to clients in excess of revised limits and certain segments of the fixed-income business – will be reduced. Finally, the review reconfirmed the course set at the time of the merger to reduce risk appetite with regard to both market and counterparty risk. Substantial increase in Private and Corporate Clients profitability in Switzerland Private and Corporate Clients contributed CHF 0.9 billion pre-tax to the Group’s result, up by 20% against restated 1997 results. For this division, the year was marked by intense and successful merger integration efforts. Significant progress was achieved by aligning both predeces- sor banks’ client services, activities, products and organizations. Plans to migrate the technical plat- forms are on track and will be completed in 1999, thereby facilitating significant operational synergies and cost savings. At the same time, risk- adjusted pricing in the credit area has been imple- mented and technology-based banking business- es have expanded significantly, with approxi- mately 160,000 Telebanking (Internet / Videotex) clients and with 230,000 brokerage transactions and 14.5 million payment transactions executed via Telebanking in 1998. UBS Brinson posts steady growth UBS Brinson’s pre-tax earnings were up 11% from CHF 403 million to CHF 448 million despite the impact of market volatility in 1998. Positive results from the UBS Brinson business area were to some extent offset by a decline in revenue due to short-term performance issues and a very competitive UK marketplace for the Phillips & Drew business area. Strong results for UBS Capital UBS Capital posted pre-tax earnings of CHF 428 million versus CHF 381 million in 1997, thus continuing its excellent track record. This business enjoys significant synergies with both Private Banking and Warburg Dillon Read and is well-placed to benefit from increasing levels of corporate restructuring in Europe. Logistical challenges 1998 was a year of logistical challenges, the biggest of which for UBS was, of course, the 3 Letter to Shareholders 4 merger. Here we are pleased to confirm that UBS is absolutely on course: implementation has been completed outside Switzerland and further sub- stantial progress will be made domestically in 1999. In addition to the merger, the whole bank- ing industry has been preoccupied with the Euro and the Year 2000. In the case of the former, UBS conducted an intensive preparation in the form of a number of dress rehearsals in November and December 1998 resulting in an extremely smooth introduction of the Euro in all divisions. With regard to preparations for Year 2000, we also made substantial progress in remediating and testing our hardware and software in 1998. We expect the work on the remaining systems to be substantially completed by mid-1999. Total expenditure on the introduction of the Euro and the Year 2000 amounted to CHF 662 million in 1998. In addition to managing merger integration, UBS spent considerable effort in fine-tuning its strategy, as outlined at the merger announce- ment. Strategic overview Our strategy is based on the following assumptions: significant financial markets growth world-wide, especially in Europe where we see heightened potential for asset gathering and for European investment banking business. Ongoing industry consolidation and restructuring will favor industry leaders, and quality earnings are increasingly at a premium given heightened market cyclicality. Finally, technology is becoming a major driver of business. UBS is well-positioned to succeed in such an environment and has clear leadership aspirations. We aim to achieve sustainable profitable growth within defined parameters for risk, leading to ongoing value creation. We see UBS as managing its own destiny rather than being shaped by exter- nal forces and, thus, as being recognized as a role model for success and quality. We aim to foster a co-operative, meritocratic and professional cor- porate culture, which goes far beyond financial conglomerate management. On this basis, UBS corporate strategy has developed as follows: – Firstly, UBS seeks to position itself as a global financial institution with the goal of becoming a leading European asset gathering house. This will be achieved with all business divisions con- tributing as part of an integrated business model leveraging cross-divisional synergies. The main emphasis is on organic growth, facilitated by sustained technology investments and comple- mented by selected acquisitions. At present, we have two major initiatives underway: we are building up domestic private banking in key European markets and are encouraged by the good degree of success achieved already. Secondly, we have mandated the Private and Corporate Clients Division to build a techno- logy-driven asset gathering business, using platforms already developed in this business to expand into major European markets. – UBS is committed to best practice in its com- munication with shareholders. In this context we have gone further than many of our com- petitors in providing indicative medium-term earnings forecasts. During the year, we have revised our preliminary forecast for the year 2002 set out at the time of the merger from earnings per share of approximately CHF 50 to earnings per share of approximately CHF 45, representing a net income range of CHF 9 – 10 billion. The main adjustments reflect the lower risk appetite in and capital allocation to War- burg Dillon Read. Here a marked reduction in risk appetite and international counterparty risk has already taken place and further reduc- tions will follow. Importantly, we maintain our return on equity target of 15%– 20% and our cost/income target of approximately 60 %. – UBS is already one of the best capitalized finan- cial institutions world-wide with a Tier 1 ratio of 9.8 % at end-1998. This exceeds our target range of 8.5% – 9%. UBS has already made progress in divesting non-core, capital-intensive businesses. Given our high level of capitaliza- tion and focused allocation of resources, we expect UBS to continue to generate excess cap- ital. UBS is committed to efficient equity man- agement, and we see investment in own stock as an acceptable alternative in the absence of value-enhancing acquisitions. In terms of material events to date in 1999, jointly UBS and Swiss Life / Rentenanstalt announced the intended termination of their co- operation agreement on 19 February 1999. This was a result of growing competition between the strategies of the two companies in the area of European asset gathering. In this context, UBS’s 25% stake in Swiss Life / Rentenanstalt will be Letter to Shareholders acquired by a number of Swiss and international investors. Swiss Life / Rentenanstalt will also acquire UBS’s 50 % stake in the UBS Swiss Life joint venture. UBS expects a post-tax gain of CHF 1.2 –1.4 billion from these divestments. The cross directorships between the two companies will be relinquished during the course of 1999. UBS does, however, continue to consider the life assur- ance business as an important component of its European asset gathering strategy. In conclusion, UBS is embarking upon 1999 tested and strengthened by the events of the pre- vious year. We are confident that we are on course with our strategy, and we expect a signifi- cant profit increase which will bring us close to our return on equity target. In drawing to a close, we would like to take this opportunity to thank our clients, staff and you, our shareholders, for your support during a difficult year. UBS AG Alex Krauer Chairman of the Board of Directors Marcel Ospel President and Group CEO 5 UBS Presence world-wide 6 Review of Businesses Review of Businesses UBS Segment Reporting UBS Segment Reporting To enable a more mean- Segment Reporting by Business 1 ingful analysis of UBS’s results, Group results are CHF million Operating income Less: Credit loss expenses 2 presented on a man- Total agement reporting basis. Consequently, internal charges and transfer pricing adjustments have been reflected in the Personnel, general and administrative expenses Depreciation and amortization Total Segment performance before tax Tax expense / (benefit) Segment performance after tax Less: Minority interests Net profit / (loss) Regulatory equity used (avg) Assets under management (bn) 3, 4 performance of each busi- Cost / income (%) 3 Private Banking 12.97 12.98 Warburg Dillon Read 12.97 12.98 7,223 26 7,197 2,605 256 2,861 4,336 737 3,599 0 3,599 1,500 607 46 6,215 59 6,156 2,773 218 2,991 3,165 561 2,604 0 2,604 2,100 610 48 6,987 500 6,487 6,984 524 7,508 ( 1,021) ( 306) ( 715) ( 9) ( 706) 10,888 300 10,588 8,714 595 9,309 1,279 213 1,066 0 1,066 13,300 13,600 0 107 0 85 ness. The basis of the reporting reflects the management of the business within the UBS Group. 8 Purpose Based on UBS’s Management Accounting, seg- ment reporting provides accurate performance measurements of the UBS divisions to increase substantially transparency and accountability. Segment reports follow the organizational struc- ture of UBS. Therefore, the results reported are performance indicators for the UBS divisions. Accounting Standards Although segment reports are based on Management Accounting, they comply with International Accounting Standards (IAS), and they are also examined by the UBS’s auditors, ATAG Ernst & Young AG. Where a different approach has been applied in order to increase transparency, the figures are fully reconciled to Financial Accounting. Segment reports disclose additional informa- tion not required by IAS in order to measure the performance of the business divisions in a more accurate way. Examples in this context are: assets under management, headcount, and regulatory equity used. Basic assumptions The divisions are treated for this purpose as if they were autonomous business units. Hence, the amount of equity capital that would be required for the divisions operating as separate entities is attributed to them, and this resource is not free of funding. (Please see the Review of Asset and Lia- bility Management Section.) Inter-segmental revenues and costs are allo- cated to the divisions based on market prices or on service level agreements. Basically, all Corporate Center costs are allocated to the divisions based upon the concepts of benefit and controllability, which are explained below. At the end of the process, the Corporate Center comprises all revenues and costs that actually belong to the Corporate Center (e.g. income from treasury activities or from risk management and control), or that cannot reasonably be attributed to the divisions (e.g. provisions for settlement reached in the US). Taxes are also debited (or, in the case of a loss, credited) to the divisions. Management Accounting Principles – Interest revenues are apportioned across the divisions based on the opportunity costs of fun- ding. Accordingly, all assets and liabilities are re- financed with the fixed-income business within Warburg Dillon Read based on market rates. Revenues relating to balance-sheet products are calculated on a fully-funded basis. Therefore, there is no free capital. As a result, in the seg- ment reports, the divisions are credited with the risk-free return on the equity used. Commis- sions are credited to the business division with the corresponding customer relationship. – In addition to the direct costs of the divi- sions, inter-divisional costs are allocated based on service level agreements and treated as a cost reduction in the division providing the service. Private & Corporate Clients 12.97 12.98 7,025 1,170 5,855 3,999 948 4,947 908 154 754 0 754 7,005 1,092 5,913 4,305 852 5,157 756 135 621 0 621 8,250 8,600 434 70 398 74 12.98 1,163 0 1,163 608 107 715 448 128 320 0 320 100 531 61 UBS Brinson 12.97 UBS Capital 12.97 12.98 Corporate Center 12.97 12.98 1,040 0 1,040 593 44 637 403 127 276 0 276 50 504 61 585 0 585 152 5 157 428 15 413 0 413 250 0 27 492 0 492 108 3 111 381 2 379 0 379 200 0 23 296 ( 745) 1,041 2,085 ( 15) 2,070 ( 1,029) 317 ( 1,346) 4 ( 1,350) 6,350 0 n/a Group Total 12.97 26,158 1,278 12.98 23,279 951 22,328 24,880 16,433 1,825 16,874 1,762 18,258 18,636 4,070 1,045 3,025 ( 5) 3,030 6,244 1,395 4,849 16 4,833 518 ( 173 ) 691 381 50 431 260 357 ( 97 ) 16 ( 113 ) 4,150 29,750 28,700 0 n.a. 1,572 1,512 78 71 assets under management are included in both business segments. Custody-only assets are excluded. – Headcounts of the divisions include trainees and staff of special management development programmes. Contractors are not part of the figures. – The allocation of Corporate Center costs to the business segments is based upon concepts of benefit and controllability. Basically the divi- sion which controls the process or is responsi- ble for the logistic bears the costs. – In order to report the relevant divisional per- formance over time, adjusted expected loss figures are reported for all business divisions rather than the net credit loss expenses as in the financial income statement. The statistically- derived adjusted expected losses reflect the inherent counterparty and country risks in the respective portfolios. The difference between these figures and the financially-booked credit loss expense at Group level is in Corporate Center. (Please see page 36 of the Review of Risk Management and Control.) – Taxes reflect an average effective tax rate for each division, based on the different geograph- ical regions in which they operate. – Equity is allocated to the divisions based on the average regulatory capital requirement during the period. Utilized equity only is taken into account, and a mark-up of 10 % as a security margin is added. The remaining equity, mainly for real estate investments, as well as excess capital remains in Corporate Center. (Please see page 48 in the Review of Asset and Liability Management.) – Assets under management include client-related on- and off-balance sheet assets. Where two divisions share responsibility for management of the funds (such as investment funds), the Review of Businesses UBS Segment Reporting 1 The 1997 results do not take into account the merger provision and the merger impact on taxes. The net loss of the whole Group including these items would be CHF 667 million. Private Banking and Private and Corporate Clients 1997 figures were restated in order to properly reflect the new client segmentation (transfer of investment clients from Private Banking to Private and Corporate Clients). 2 In order to show the rele- vant divisional performance over time, adjusted expected loss figures rather than the net credit loss expense are reported for all business divisions. The statistically derived adjusted expected losses reflect the inherent counterparty and country risks in the respective port- folios. The difference between the statistically derived adjusted expected loss figures to the financially booked net credit loss expenses at Group level is reported in the Corporate Center. For 1997, basically the same methodology as for full-year 1998 Segment Re- porting is applied. Due to the unavailability of some pre- merger data, management estimates were used. The divisional breakdown of the net credit loss expense of CHF 951 million as of December 1998 is as follows: Private Banking CHF 48 million,Warburg Dillon Read CHF 506 million, Private and Corporate Clients CHF 397 million. 3 Banca della Svizzera Italiana not included as at 31 December 1998 (assets under management CHF 37 billion). 4 UBS Brinson 1998: institu- tional assets CHF 360 billion, funds CHF 171 billion. 9 Review of Businesses Private Banking Private Banking The Private Banking Business Profile / Mission Statement Division focuses on comprehensive wealth management solutions for high-net-worth individuals and holds the leading position in this highly-fragmented global market. Size enables specialization and thus truly individualized, high-quality services. By leveraging the strengths and the expertise of the whole UBS Group, the Private Banking Division can offer an extraordinary range of services and financial products, the breadth and depth of which hardly can be found anywhere With CHF 607 billion in assets under man- agement (AuM), UBS holds the leading position in the global private banking industry. The Pri- vate Banking Division focuses on comprehensive wealth management solutions for high-net-worth individuals. Its mission is to deliver outstanding advice and execution in financial matters world- wide to wealthy private individuals and to the intermediaries serving them. Size enables the Private Banking Division to offer truly individual services: through size, the division can cater to the specific needs of client segments and markets. The client advisor is cen- tral to the delivery of services to our clients. He or she manages the relationship and is the main advisor for clients. The focus on the long-term client relationship is in line with the division’s emphasis on the lifetime value of our client rela- tions rather than short-term revenue. The four core services, or “product lines”, of the Private Banking Division – Portfolio Manage- ment, Active Advisory Team, Investment Funds and Financial Planning and Wealth Management – provide the building blocks of the Private Bank- ing services. Further strengths are derived from our position as an integral part of the UBS Group: The division leverages the financial strength and capital of the UBS Group, the wide and sophisti- cated product range of Warburg Dillon Read, the asset management expertise of UBS Brinson and the technological and physical infrastructure of Private and Corporate Clients in Switzerland. Employing 7,634 people, the Private Banking Division is represented through 78 branches and subsidiaries in Switzerland and around the world (excluding Representative Offices). else in the world. Review of Divisional Results During a challenging year which included merger integration and extraordinarily volatile market conditions in the third quarter, the Private Banking Division demonstrated consistent and stable earnings power. Private Banking was able to minimize the potentially significant risks of client defections identified at the time of the merger, and was much less negatively affected by events in the third quarter than the market in gen- eral. Market turmoil had no lasting impact on performance of the division and the managed portfolios. Pre-tax profit for 1998 was CHF 4.3 billion, up 37% from 1997. (1998 and 1997 results were restated to take into consideration the effect of interdivisional client business transfers.) 1998 pre-tax profit was impacted by divestments. Eliminating the impact of divestments, net profit before tax went up by 4%, year-on-year. Assets under management (also adjusted for divestments) grew 6% to CHF 607 billion over end-1997. Operating income Net operating income (after credit loss expens- es) increased by 17% to CHF 7.2 billion from CHF 6.2 billion in 1997. This included CHF 1.4 billion (sales proceeds and operating revenues) in divestments, including BSI-Banca della Svizzera Italiana and Adler & Co. Ltd. Personnel, general and administrative expenses Operating expenses before depreciation and amortization decreased by 6% to CHF 2.6 billion from CHF 2.8 billion in 1997. As with operating income, expenses were affected by divestments. Eliminating the personnel, general and adminis- trative expenses associated with the normal oper- ations of divestments, expenses decreased 1% to CHF 2.5 billion in 1998. The major shift in Private Banking headcount in 1998 took place in Switzerland. The sale of BSI led to a reduction of 802. Headcount figures for Switzerland per end of 1998 amounted to 5,092 (including Private Banks). Outside Switzerland staff for the Private Banking Division are in the following geographic areas – Rest of Europe 1,278, the Americas 629 and Asia / Pacific 635. Depreciation and amortization / taxes Depreciation and amortization increased by 17% to CHF 256 million in 1998, whereas taxes increased from CHF 561 million in 1997 to CHF 737 million in 1998, in line with the pre-tax results. Assets under management Despite the merger and volatile markets, the Private Banking Division achieved a net AuM inflow. The inflow of new money from new and existing clients exceeded client defections and withdrawals by CHF 8 billion. While market developments in the third quarter interrupted the 10 Review of Businesses Private Banking 1997 Change (%) 6,215 59 6,156 2,773 218 2,991 3,165 561 2,604 0 2,604 2,100 48 610 7,862 5,859 2,003 16 ) (56 ) 17 ) (6 ) 17 ) (4 ) 37 31 38 – 38 (29 ) 0 (3 ) (13 ) 27 1998 2,088 5,135 7,223 26 7,197 2,605 256 2,861 4,336 737 3,599 0 3,599 1,500 46 607 7,634 5,092 2,542 CHF million Private banks 1 Other business areas Total operating income Less: Credit loss expenses Assets under Management Development CHF billion 0 1 6 0 4 – s t n e m t s e v i D 8 + y e n o m w e n l a t o T 5 3 6 + – 7 0 6 Total e c n a m r o f r e P s t c e f f e y c n e r r u C Personnel, general and administrative expenses Depreciation and amortization Total Segment performance before tax Tax expense / (benefit) Segment performance after tax Less: Minority interests Total 31.12.97 Total 31.12.98 Net profit / (loss) Regulatory equity used (avg) Cost / income in % 2 Assets under management (bn) Headcount of which: Switzerland of which: Rest of world Assets under Management Advisory vs. Discretionary 100% 80% 60% 40% 20% 0% 25% 23% 75% 77% 31.12.98 31.12.97 1997 Total: CHF 610 billion1 1998 Total: CHF 607 billion Discretionary Advisory 1 Before 1998 divestments of CHF 40 billion Assets under Management by Currency 100% 80% 60% 40% 20% 0% 26% 22% 6% 29% 17% 30% 21% 5% 27% 17% 31.12.98 31.12.97 1997 Total: CHF 610 billion1 1998 Total: CHF 607 billion CHF DEM GBP USD Others 1 Before 1998 divestments of CHF 40 billion 1 Includes sales profit and operating income from divested companies. 2 Before credit loss expense. positive development in AuM performance over the first half of the year, positive fourth-quarter performance helped to yield a full-year increase in AuM attributable to performance and curren- cies of CHF 29 billion. AuM at Private Banking were also affected by divestments, which accounted for a reduction of CHF 40 billion in AuM. Eliminating these items, assets under management grew by CHF 37 billion and stood at CHF 607 billion at year-end 1998. As can be seen from the accompanying graph, 25% of Private Banking’s AuM portfolio is in dis- cretionary AuM, a proportion which has been increasing over time and which generates higher levels of fee and commission income. The distri- bution of asset classes between accounts, bonds, mutual funds, and equities is well spread. Alloca- tion of AuM among the major currencies as of 31 December 1998 was weighted more strongly towards the USD, DEM and GBP, while the CHF portion declined below the USD. Looking to the development of AuM, we expect the following trends as clients continue to seek higher returns, and in line with our strategy to strengthen our business in the domestic private banking markets outside of Switzerland: – an increasing proportion of discretionary AuM – a movement out of deposit accounts into higher- yielding products – market growth that is higher in the domestic private banking markets than in the traditional international private banking markets. Merger and Other Initiatives in 1998 Merger on track and successful In Switzerland, the merger is moving ahead as planned. The new management structure was announced in early 1998. Unified services and a new price structure were introduced at the offi- cial merger date on 29 June 1998. The client segmentation process is on track and the transfer of client business between the Private Banking and Private and Corporate Clients is well underway. UBS is very careful to extend every effort in meeting our clients needs during this transfer process, which we expect to be completed by the end of 1999. Client segmen- tation will enable Private Banking to become more focused on the clients’ needs and to dedicate additional resources to selected segments of high- net-worth individuals. The migration process, i.e. the transfer of data to one new IT platform, was successfully completed in the main international centers (New York, Singapore, Hong Kong, London). In Switzerland, the size and complexity of the 11 Review of Businesses Private Banking Assets under Management by Asset Class 100% 80% 60% 40% 20% 0% 9% 26% 32% 16% 17% 8% 24% 34% 19% 15% 31.12.98 31.12.97 1997 Total: CHF 610 billion1 1998 Total: CHF 607 billion Accounts Equities Bonds UBS mutual funds Others 1 Before 1998 divestments of CHF 40 billion Definition: Equities and Bonds exclude UBS mutual funds. UBS mutual funds include UBS investment funds, UBS fund account and UBS Brinson and Warburg Dillon Read Funds. Others include Money Market, UBS Medium-term Notes, Derivatives, other mutual funds not managed by UBS, and Metals. UBS Investment Funds Development Swiss-authorized funds only CHF billion 3 5 1 8 3 + – 5 7 1 y c n e r r u C e c n a m r o f r e P 7 1 + w o l f n i y e n o m t e N 31.12.97 31.12.98 business required a much higher degree of prep- aration. After several test runs were success- fully concluded, the full migration is planned to take place in five steps in the first half of 1999. Private Banking recognized clearly from the outset of the merger that some client defections would occur. This risk was taken very seriously, and therefore careful monitoring and focused management processes were put in place. Client defections could obviously not be completely pre- vented, but the risk was successfully mitigated. As a result, the inflow of new AuM substantially exceeded AuM losses from client defections, and the same applies to the number of clients. The new business model The Private Banking Division has used the merger as an opportunity to develop a new busi- ness model to better serve an increasingly demanding client base in a more efficient manner: – The merger provided the unique opportunity to create a large and very targeted client segment of high-net-worth individuals. The client advisors are principally organized by respective markets, which allows them a higher level of client focus. Flexible new “client servicing teams” can now be assembled to bring together the highest level of customized expertise to meet our clients’ increasingly sophisticated needs. – Tightened focus on the operations surrounding our core products and services will increase our efficiency in engineering and executing sophis- ticated individual wealth management solu- tions. It is this “vertical integration” of the busi- ness that will allow us to achieve economies of scale and scope. – The new business area encompassing six Private Banks in Switzerland operating under their own names continues to offer an alternative to those clients that are attracted by the individual atmosphere and service of a small Private Bank, while they will benefit from the backing and support of one of the world’s largest and best- capitalized banks. – Following a “no-redundancy principle”, Pri- vate Banking is becoming more efficient by leveraging off the specific divisional competen- cies highlighted through an integrated UBS Group concept. This gives UBS a significant advantage against the competition. – Private Banking’s performance incentive systems are increasingly designed to reward entrepre- neurial talent and initiative within the division. Investment funds business As a result of the merger, UBS has become the number one fund provider both in Europe and in Switzerland. At the end of 1998, assets under management of UBS Investment Funds amounted to CHF 175.2 billion, an increase of 14.7% for the year. Product owners of mutual funds in the UBS Group are Private Banking, UBS Brinson and Warburg Dillon Read. Private and Corporate Clients offers Private Banking Division’s mutual fund product range to its clients. “UBS Invest- ment Funds” is the label for the Private Banking Division’s core range of public open-end mutual funds. During the course of the year, we simplified our administration structure in Switzerland and in Luxembourg by reducing operations to one company in each location. Further fund activities – administration and / or local and regional dis- tribution of our funds within the bank and with third parties – are dealt with by our fund units in Germany, Italy, Jersey, the USA, the Cayman Islands, Japan, Taiwan and Hong Kong. In addition, we have re-calibrated and renamed a number of funds, and we made inten- sive preparations for the merging of the funds of the two former banks. These mergings will come into effect in 1999, when we adapt our fund range to the introduction of the Euro. It is our aim to implement these changes in a customer- friendly manner and as swiftly as possible. Major Awards Won by UBS Investment Funds in 1998 Award Best Overall Management Group over 5 years Best Bond Management Group over 5 years 48 different awards for individual funds in their respective fund categories or markets Source Standard & Poor’s, Micropal Standard & Poor’s, Micropal Standard & Poor’s, Micropal, Lipper, BOPP ISB 12 UBS Investment Funds by Fund Category Swiss-authorized funds only 100% 80% 60% 40% 20% 0% 20% 26% 24% 20% 7% 3% 16% 33% 26% 17% 5% 3% The risk-controlled management style of our portfolio managers has led to consistently good performance results which is demonstrated by a high number of awards given to our funds. The transparent fee structure (all-in-fee) and the clear positioning of our fund range has enhanced its attractiveness to the investing community at large. Strategic Initiatives 31.12.98 31.12.97 A holistic, client-oriented model 1997 Total: CHF 153 billion 1998 Total: CHF 175 billion Asset allocation funds Money market funds Bond funds Equity funds Capital preservation funds Real estate funds1 1 UBS has a 50% interest in the SIP Real 1 estate funds The private banking industry is undergoing fun- damental changes. Traditional private banking client preferences of security and stability are giving way to demands for more sophisticated and per- formance-oriented solutions which are far-reaching in nature. Thus, comprehensive wealth manage- ment solutions in the client’s own market are mov- ing towards the forefront of client preferences. Two initiatives have developed from these trends. First, we are looking at a wider and deep- er penetration of our services and products into our existing client base. We aim to extend our services and products to better cover our clients’ total net wealth through comprehensive wealth management solutions. By the same token, we are seeking to meet our clients’ customized, sophisti- cated needs by developing individualized servic- es, and additionally by utilizing Warburg Dillon Read as an essential supplier of an expanded range of advanced products. Second, the Private Banking Division is com- mitted to a strategy of developing the domestic private banking market outside of Switzerland. This strategy will allow us not only to tap money previously inaccessible to us, but also to tap money flowing back to, or no longer flowing out of, those markets. Therefore, value creation is entirely accretive to the current core franchise of Review of Businesses Private Banking Swiss private banking, which is intact and which we will aggressively preserve with major invest- ments in people and in technology. Balancing organic growth in various com- petitively-fragmented markets against a number of select acquisitions around the world, Private Banking is on course to increase significantly AuM and revenues from the domestic private banking business outside of Switzerland. Prof- itable domestic businesses already exist in the UK, US and Canada. Our start-ups in Italy and Japan are progressing better than planned and so is the conversion in Germany (Schröder Münchmeyer Hengst AG) and in Australia (Potter Warburg Securities Ltd.). Our offices in Spain opened just after year-end 1998, and the ones in France are ready to come on-line as soon as regulatory approval is achieved. Private Bank- ing to commit substantial resources in terms of management’s time and investment capital to achieve significant growth of the domestic businesses, as we view these strategies as essential to achieving sustained profitability in the private banking industry in the medium term. In addition Private Banking will continue to analyze a range of select acquisi- tion opportunities. The Group’s potential acqui- sition budget is mainly focused on Private Banking. is determined Outlook We expect organic growth of AuM in our new domestic units outside of Switzerland, as well as from selected acquisitions in targeted markets. Due to start-up costs, however, their net contri- bution will remain limited. Thus, the Private Banking Division expects to grow 1999 net prof- it by expansion of its business, improved servic- es and the synergy effects of the merger. 13 Review of Businesses Warburg Dillon Read Warburg Dillon Read Warburg Dillon Read Business Profile / Mission has established itself as the leading European investment bank and the most truly international of the global top tier. Following the merger and the market turbulence of the third quarter, the division reassessed all its business activities and designated those on which it would focus going forward. Manage- ment believes that these businesses have sustainable competitive advantages and can be operated to serve the global client base in a manner which enhances the considerable franchise of Warburg Dillon Read. 14 Warburg Dillon Read is the investment bank- ing division of the UBS Group. Delivering debt and equity financing, advisory services, global research, securities and foreign exchange execu- tion, and risk management services to major cor- porations, institutions, and public entities around the world, Warburg Dillon Read has established itself as the leading European invest- ment bank among the top tier of investment banks globally. Warburg Dillon Read is a “narrowly defined” investment bank compared to its major global competitors. This is because some of the elements generally found in a broader investment bank – private clients, institutional asset management, and private equity – reside within the other divi- sions of UBS. In addition to its role as franchise manager within the Group for institutions, cor- porations and sovereigns, a significant function of Warburg Dillon Read is providing products, execution and transaction processing to the other asset gathering activities of UBS. Warburg Dillon Read clearly focuses on both its external clients and its very substantial internal clients, providing each category with the same professional prod- ucts and services. The cost savings for the Group are significant. Our “home markets”, meaning those in which we are in the very top few firms in advisory, pri- mary issuance, research, and secondary sales and trading, are the UK, Switzerland and Australia. In the United States and Japan, cross-border trans- actional flows are our mainstay. At the same time, with a listed equity market share of over 2% in the United States, we also have significant domestic presence in secondary sales and trading of securities in the largest of the world’s market- places and a very credible presence in domestic advisory and debt and equity underwriting. Achieving a position among the global top tier of investment banks with this business mix demonstrates that Warburg Dillon Read is the most truly international of the leading investment banks. While some competitors list the pursuit of international opportunities as part of their strat- egy, we consider every undertaking, wherever the location, to be part of our single global business. It is difficult to define the international element of our business given that no one nationality accounts for more than 25% of our employees. Review of Results Business priorities Warburg Dillon Read generated a post-tax loss of CHF 706 million in 1998, following a profit of CHF 1.1 billion in 1997. After an excellent first half in 1998, we expe- rienced a very difficult third quarter, as did many competitors. As reported in the Review of Risk Management and Control Section on pages 33–35, principal contributors to this were the exposure to the hedge fund Long Term Capital Management (LTCM) and the positions in the Global Equity Derivatives portfolio which pre- dated the merger. Warburg Dillon Read’s pre-tax losses on these were CHF 793 million and CHF 762 million, respectively, in 1998. The Review of Risk Management and Control Section summa- rizes the remaining exposure to these positions. Other contributors to the poor third-quarter performance were more within our control. These included losses on structural positions such as short Swiss equity volatility in the longer maturities. Although a good job had been done in decreasing this position between the merger and the time of the market turmoil, it still was a large exposure which proved costly. This particular exposure, an adjunct to the large role that we fulfill in the Swiss market, can be expected to suffer during market disloca- tions. However, we expect our role to be reward- ing over the cycle, and much of the third-quarter loss was recouped during the fourth quarter. We also experienced losses on credit exposures in tradable assets and the loan portfolio in Russia and other emerging markets. These losses, cou- pled with the view that the changed market envi- ronment would have more long-lasting repercus- sions, caused Warburg Dillon Read’s senior man- agement to conduct a fundamental review of the division’s business activities and priorities, with particular emphasis on the Fixed Income Area. Each of the major business activities was assessed as to whether it was supportive of the franchise of Warburg Dillon Read or the UBS Group and whether it could be justified on an expected risk / return basis. Activities meeting both requirements were designated as core busi- nesses of Warburg Dillon Read. Those activities failing one or both tests were identified for exit or designated as non-core. Non-core businesses, while remaining within Warburg Dillon Read for financial reporting, are being run down or dis- Revenues by Region (1998) 14% 20% CHF million Corporate finance Equities Fixed income Treasury products Total operating income Less: Credit loss expenses Total Personnel, general and administrative expenses Depreciation and amortization 66% Total Segment performance before tax Tax expense / (benefit) Segment performance after tax Less: Minority interests Europe Americas Asia/Pacific Revenues by Client Type (1998) 6% Net profit / (loss) Regulatory equity used (avg) Return on equity Cost / income in % 1 Headcount of which: Switzerland of which: Rest of world 1 Before credit loss expense. 1998 1,665 2,572 399 2,351 6,987 500 6,487 6,984 524 7,508 (1,021) (306) (715) (9) (706) 13,300 (5) 107 13,794 2,502 11,292 Review of Businesses Warburg Dillon Read 1997 Change (%) 10,888 300 10,588 8,714 595 9,309 1,279 213 1,066 0 1,066 13,600 8 85 18,620 3,304 15,316 (36 ) 67 (39 ) (20 ) (12 ) (19 ) (180 ) (244 ) (167 ) (166 ) (2 ) (168 ) (26 ) (24 ) (26 ) 39% 55% posed of as appropriate and prudent. The core businesses of Warburg Dillon Read are deemed to have sustainable competitive advantages, and we expect to operate them profitably so as to pro- duce shareholder-value-enhancing returns. Activities identified for rapid position run- down and exit include: – Commodities Trading (Energy, Base Metals, Institutional Corporates Government/Supranational organizations Revenue by Type of Activity (1998) Electricity) – Project Finance – Non-structured Asset-backed Finance – Conduit Finance – Lease Finance – Distressed Debt Trading 1% 24% 75% Customer Market making Proprietary Also, two activities have been designated non- core and will be operated separately from our main businesses. These are: – Those loans and commitments which are not part of the tradable asset portfolio (loan trad- ing), not issued in conjunction with the Lever- aged Finance business or which are in excess of the limits for credit exposure to our clients. The non-core loan portfolio will be separated from the core activities of Warburg Dillon Read. It will be managed to zero in an economically sen- sible fashion. – Global Trade Finance which, while operating successfully, is a business that with the excep- tion of the Swiss corporate business is not core to any division of UBS. Various strategic and operational alternatives for this business are being investigated which will ensure that client service is maintained. Additionally, those risks of the Global Equity Derivatives book which we do not consider part of the core activities of Equities will be managed by Warburg Dillon Read under an agreement with Corporate Center. Note that this does not mean that we are ceasing all Global Equities Deriv- atives dealing. In fact, we have enhanced our abil- ity to meet the risk management needs of clients by establishing a team that delivers solutions across both equity and interest rate products. We believe that this activity can be operated pru- dently to yield attractive risk-adjusted returns. Results Warburg Dillon Read generated a post-tax loss of CHF 706 million in 1998. Excluding the losses of CHF 793 million from LTCM and CHF 762 million on the Global Equity Derivatives Portfolio reported under the business areas Fixed Income and Equities respec- tively, Warburg Dillon Read would have pub- lished a pre-tax profit which was disappointing but in line with industry trends. In this context the demands of the merger should also be borne in mind. 15 Review of Businesses Warburg Dillon Read Headcount by Region (1998) 19% 27% 54% Total: 13,794 employees Europe Americas Asia/Pacific Equity Analysts by Region (1998) 30% 49% 21% Total: 546 analysts Europe Americas Asia/Pacific 16 Corporate Finance exceeded expectations, as a result of high levels of M&A activity and a record amount of business in equity and equity- linked issues. Equities, after a strong first half, experienced a difficult trading background in the second half, when extreme levels of volatility were encoun- tered. High levels of commission and income on new issues were achieved. Fixed Income revenues were depressed prima- rily by losses in Russia and other emerging mar- kets. Very healthy primary bond activity driven by Warburg Dillon Read’s strong placing capa- bilities was offset by other activities performing marginally below expectation. Treasury Products performed well in 1998. An exceptional Short Term Interest Rates result, large- ly due to an efficient implementation of centralized netting, was partially offset by proprietary foreign exchange losses and low Precious Metals revenues. Proprietary trading, owing both to poor results in 1998 and our strategic de-emphasis over the last few years, made a negligible contri- bution to total revenues in 1998. Personnel, general and administrative expens- es have benefited from a faster reduction in head- count than anticipated and a consequent reduc- tion in personnel and related costs. Depreciation and amortization costs include the write-down of goodwill in investments in emerging markets ventures following the strate- gic review of Warburg Dillon Read’s businesses and markets. Non-core The Non-Core Loan portfolio and the Global Trade Finance business together generated rev- enues of CHF 388 million and profit before tax of CHF 54 million, and utilized regulatory equi- ty of approximately CHF 3 billion. Significant Events in 1998 Merger impact The merger of Swiss Bank Corporation and Union Bank of Switzerland had a significant impact on the investment banking business, owing to an extensive product / service overlap in the two organizations. This resulted in a rationalization of enormous magnitude.Although not without some extremely difficult interim patches, these rational- izations all were identified and the investment banking merger accomplished in 1998. Headcount, which totaled 18,620 in the two in- vestment banking activities at the time of the merg- er announcement, stood at13,794 at year-end 1998. As a result of the merger, Warburg Dillon Read can point to an enhanced position in a number of areas compared to that enjoyed by either prede- cessor firm. In the Americas, combining the respective operations improved the platform substantially; inter alia our research coverage increased to over 70% of the S&P 500 compa- nies. In Europe the merger reinforced the leading position in Equities which Warburg Dillon Read previously enjoyed. Globally, our distribution and origination power was markedly enhanced. The review of business priorities discussed pre- viously also led to a realignment of core activities among the newly-defined business areas of Trea- sury Products and Equities & Fixed Income. The former includes all our foreign exchange busi- nesses, both spot and derivatives, as well as our short-term interest rate and repo activities. Equi- ties & Fixed Income includes both our Equity and Fixed Income businesses, including derivatives. The alignment of our product areas into these main groupings was driven primarily by com- monality of clients, logistics requirements, and risk characteristics. For example, Treasury Prod- ucts encompasses markets which are generally the most commoditized, which present the great- est opportunity for creating automated delivery paths to link individual market makers with clients and which most depend on processing and pricing efficiency to be competitive. LTCB joint venture In the first half of 1998, Warburg Dillon Read launched a joint investment banking venture in Japan with the Long-Term Credit Bank of Japan, Ltd. (LTCB), as envisaged under the alliance between Swiss Bank Corporation and LTCB announced in 1997. Unfortunately, against the backdrop of a deepening banking crisis in Japan, LTCB subsequently became the first bank to be nationalized under new government legislation. Under these extraordinary circumstances, it proved necessary for Warburg Dillon Read to ter- minate the alliance and to negotiate the buy-out of LTCB’s interests in the joint venture. Warburg Dillon Read then re-launched successfully our wholly-owned investment banking businesses in Review of Businesses Warburg Dillon Read Japan under the Warburg Dillon Read brand, a business which secured and continues to enjoy significant economic benefits from the alliance in terms of goodwill and business flows. Logistics, Euro and Year 2000 The logistical requirements created by the merger were enormous for Warburg Dillon Read. As noted elsewhere in this Financial Report, an early decision was made to adopt within Switzer- land the systems platform of Union Bank of Switzerland and elsewhere in the world the plat- form of SBC Warburg Dillon Read. This decision permitted a rapid focusing on the necessary migra- tions and enabled financial reporting and risk con- trol to operate effectively as early as the first day following the effective legal merger. As noted, inte- gration of the infrastructure in Switzerland is ongoing and is planned to be completed in 1999. In the face of the many “run the business” logis- tical requirements spawned by the merger, we are pleased to be able to report that these requirements were managed without a loss of focus on the Euro and Year 2000 programs. The Euro preparation concluded successfully when all Warburg Dillon Read activities were able to function as expected after the critical year-end conversion weekend. Our top priority remains to complete the Year 2000 program equally successfully in 1999. Strategic Initiatives Although Warburg Dillon Read’s 1998 results were unsatisfactory in purely financial terms, as the above review shows, the impact of the extraordinary items should not obscure some significant accomplishments that provide confi- dence going forward. Proven strengths Augmented by the merger, our Equities busi- ness ranks among the top firms globally and con- tinued to win accolades for both research and exe- cution. It will continue to provide full service to the major investing institutions of the world across all equity markets with any significance for asset allocation. The strength of this global base will enable our business to grow in the US at least as fast as US competitors are growing in Europe. In equity-linked primary issuance (convert- ibles) Warburg Dillon Read was the global leader in 1998 by a wide margin. The division was num- ber two across both equity and equity-linked issuance, including US domestic activity. The accomplishments of our Equity Capital Markets Group reflect both the global reach and sector strengths of our partnered Corporate Finance and Equities businesses. We intend to expand these capabilities by investing selectively in global sectors, with emphasis on the US, when- ever skilled analysts and bankers can be found to complement existing strengths. Our sector strengths also are apparent in the continuing successes of our advisory franchises. Our Corporate Analysis and Structuring Team augments this by providing a market-driven approach to the analysis of debt / equity structur- ing that is unique in the industry. We have maintained our long standing leader- ship in Eurobonds by topping the league tables for the eighth consecutive year. The main area of expansion will now be the Euro-zone markets. We already lead our home markets, and we are the top European securities house in primary issues. A priority of our Fixed Income business is to use capital more efficiently, thus supporting the division’s aim of reducing its capital requirement. To this end, the Fixed Income business will seek to act primarily as an intermediary rather than as a principal, by exploiting its portfolio management capabilities in both loan and security products and by leveraging its growing credit distribution capabilities, which include credit derivatives. Corporate Finance and Fixed Income are active in two “joint ventures”. The first is Lever- aged finance, a business area that, although large- ly US-based today, holds much promise in Europe with its nascent high-yield markets. This initiative is supported by investment in high-yield research. The second joint venture, the Debt Capital Mar- kets Group, covers the marketing, origination and structuring of all products in this category. Both joint ventures are well positioned to capitalize on the opportunities afforded by the developing Euro-based, pan-European capital markets. In their more commoditized marketplace, our Treasury Products businesses continue to take the role of market maker and lead liquidity provider. Efficiencies from electronic price distri- bution and deal capture are increasingly impor- tant. We will continue to build upon established platforms. 17 Review of Businesses Warburg Dillon Read 18 Challenges With the division’s resources and focus on core businesses, we believe that we can compete successfully with the industry leaders in most markets for most products around the globe. The key challenges lie in certain areas of the US marketplace and the Euro-zone, notably in Germany. We further believe that our aims are achiev- able without a corporate-level acquisition and that at most we will enhance our capabilities selectively by adding a few small teams. We will focus on serving our corporate and sovereign client bases and on achieving top-three supplier status with an expanded number of major insti- tutional investors. These plans can be accomplished while assum- ing less risk than either of our predecessor firms. We have already reached our reduced market risk target, having operated in recent months far below our VaR limit, which was down to CHF 600 million at the 1998 year-end. Counterparty risk fell significantly during 1998 and will con- tinue to decline at the same pace or faster in 1999. In Warburg Dillon Read, as in other invest- ment banks, the logistics functions are increas- ingly important to productivity and competitive- ness. These functions account for a growing pro- portion of total production and distribution costs. The trend is most pronounced for stan- dardized products with their heavy reliance on efficient operations and technology, but the same tendency is apparent in all product and distribu- tion activities. We are looking for improved com- petitiveness from enhanced processes implement- ed through more efficient partnerships between the business and the logistics functions. Increasingly we think successful exploitation of the Internet will be a prerequisite for success in investment banking. Within Warburg Dillon Read, Internet efforts are focused on clients and distribution, trading and risk management, pro- 1998 Warburg Dillon Read Selected Awards Corporate Finance Magazine Top Banks of the Year – Investment Bank of the Year – Equity-Linked House of the Year Corporate Finance Magazine Deals of the Year – Equity-Linked Offering of the Year – Swiss Life GEMMS – Equity-Linked Offering of the Year – Bell Atlantic (runner-up) – Equity Offering (Privatization) of the Year – Swisscom – Syndicated Loan Deal of the Year – GEC – Buyout of the Year – Investcorp / Watmoughs & BPC Euromoney Poll of Polls Overall winner of the Poll of Polls – No.1 Underwriting – No.1 Trading – No.1 Advisory Euromoney Awards for Excellence – Best Eurobond Trading House (4th consecutive year) – Best Securities Firm in Western Europe (5th consecutive year) – Best Securities Firm in the UK (2nd consecutive year) – Best Securities Firm in Switzerland (4th consecutive year) – Best Foreign Securities House in the US (2nd consecutive year) Euromoney Deals of the Year – Best International Euro Issue – Republic of Italy – Best Equity-Linked Issue – Bell Atlantic (CWC) – Best High-Grade Corporate Issue – KPN – Best IPO – Swisscom – Best Financial Institution Issue – Associates Corporation of North America – Best International Syndicated Loan – GEC Euromoney / Global Investor European Broker Survey – Best Overall European Sectoral Research – Best Pan-European Equity Research – Best Pan-European Equity Execution Global Investor FX Survey – No.1 Best Advice on Spot Trading – No.1 Best Sales Coverage International Financing Review Review of the Year – European Equity House of the Year – Equity-Linked House of the Year – European Equity-Linked House of the Year – European Equity-Linked Issue of the Year – Swiss Life GEMMS – Privatization Issue of the Year – Swisscom – Deutschmark Bond of the Year – KPN International Financing Review Asia Review of the Year – Australian Equity House of the Year (2nd consecutive year) – Australian Domestic Bond House of the Year Review of Businesses Warburg Dillon Read duction and logistics. In each of these three areas, initiatives are co-ordinated with those of other UBS divisions with a view to leveraging the entire Group’s asset gathering and servicing capa- bilities. Outlook Global consolidation and the continued with- drawal of former aspirants to global status are by no means spent forces in the investment banking sector. This said, we believe that attractive oppor- tunities exist for investment banks worldwide, opportunities that will outlast any continuing disruptions in the short term. Among the factors driving such opportunities are market deregula- tion, economic globalization, increasing empha- sis on shareholder value, industrial consolida- tion, the rising volume of investable funds, and accelerating technological change. Buoyed by these trends, the growth of the finan- cial services industry has outpaced that of its host economies throughout the 1990s. While we expect the global investment banking revenue pool to continue growing, overall compound annual growth rates cannot be relied upon to match those of recent years. Further, short-term fluctuations and regional variations will inevitably affect the performance of all investment banks. We expect the revenue pool to grow more strongly in Europe than in other regions over the next few years, thanks in part to Euro-driven cor- porate restructuring, a shift towards equity investment, and the nascent high-yield market. Warburg Dillon Read is uniquely positioned to take advantage of this growth. In the US, the combination of high valuations, low inflation, and continued economic growth leaves equity prices sensitive to unexpected news. Volatility is therefore expected to remain high in the US and elsewhere. Asia excluding Japan is unlikely to stage a rapid recovery from the current weak conditions in the banking and commercial sectors. We therefore have reduced our front office head- count significantly in the region in line with the size of expected opportunities. In the short term, such opportunities should come mainly from corporate restructuring and a shift from bank finance to the international capital markets. We have also scaled back our activities in other emerging markets including Latin America and Eastern Europe. 19 Review of Businesses Private and Corporate Clients Private and Corporate Clients Our objective is to Business Profile / Mission Statement become the most profi- table bank for private, business and corporate clients in Switzerland by maintaining our leading market position. Furthermore, we are seeking to increase our return on equity to a level of 18%. 20 The Private and Corporate Clients Division, measured in terms of assets under management as well as in terms of the loan portfolio, is the leading bank in Switzerland. Our year-end 1998 assets under management amounted to CHF 434 billion, of which 53% was from our Private and Business Clients business area, 41% from the Corporates business area and the remaining 6% from the Operations (Banks) business area. The volume of our loan portfolio amounted to CHF 165 billion of which mortgages accounted for around 75%. Our position in the Swiss market and our ready access to other divisions enables us to offer a comprehensive range of state-of-the-art products and services to our diversified client base. As of year-end 1998, our client base consisted of more than 4.4 million private and investment clients, some 180,000 small- and medium-sized business- es plus more than 10,000 large corporates. In addition, we provide payment and custodial serv- ices to some 1,800 banking institutions located throughout the industrialized world. A strategic review identified the potential to expand our business beyond Switzerland’s bor- ders in order to take advantage of the growing opportunities associated with Euroland. To this end, we have finished the initial analysis and are pursuing the realization of our objectives. Review of Results Summary 1998 was a year of major change for the Pri- vate and Corporate Clients Division. The merger brought about new challenges which required an outstanding effort from our managers and employees. Through their tremendous contribu- tion, we were able to achieve both our integration and business-related objectives, resulting in a very successful year despite the highly competi- tive environment. Our integration process con- tinues on track and will be completed during the remainder of 1999. Full-year 1997 and 1998 results have been restated to provide an accurate comparison of our results in light of the client business transfer which took place between Pri- vate and Corporate Clients and Private Banking. Net profit after tax increased by 21% to CHF 754 million compared to the prior year level of CHF 621 million. The improvement was mainly due to significant cost cuts of 4%. This resulted in an enhanced cost / income ratio of 70%, which compares favorably with the 1997 ratio of 74%. Furthermore, the improved financial result and reduction in equity utilization contributed to a higher RoE of 9.1% versus 7.2% in 1997. Operating income Operating income increased slightly by CHF 20 million from CHF 7,005 million in 1997 to CHF 7,025 million in 1998. Margin improve- ments from risk-adjusted pricing were offset by divestments of Prokredit and Aufina. Operating expenses Operating expenses decreased 4%, or CHF 210 million, to CHF 4,947 million over the peri- od due to management’s rigorous attention to efficiency enhancement and the rapid realization of merger-related synergies. Headcount for the period decreased 6%, or 1,598, to 24,043 year-on-year. Of the overall headcount reduction, some 980 were mainly attributable to the sale of Bosslab and Prokredit. We closed around 34 duplicate branch locations during the latter half of the year. Our ability to reduce costs further was impaired by the need to maintain a high level of outside contractors associated with the introduc- tion of the Euro and the upcoming Year 2000 con- version. Efforts in this regard ensured that we had a trouble-free Euro conversion on 1 January 1999. Loan portfolio After some interdivisional client shifts, the loan portfolio amounted to CHF 165 billion at year-end 1998. Accounting for about 75% of the division’s portfolio, mortgages are a core element of our business. The remaining 25% of the Swiss portfo- lio consists primarily of commercial loans. The mortgage portfolio is broken down into about two-thirds fixed-rate mortgages, which represent a low interest rate risk. Furthermore, some 50% of all mortgages relate to low-risk single-family homes. More detail can be found in the Review of Risk Management and Control on pages 37–38. The recovery portfolio was reduced by a net CHF 3 billion to CHF 26 billion by the end of 1998. This consisted of around CHF 10 billion of settled cases partially offset by some CHF 7 bil- lion new workout positions. Assets under Management by Business Area (1998) 6% CHF million Private and business clients Corporate clients Operations (banks) Others (e.g. Systor) Total operating income Less: Credit loss expenses Total 41% Personnel, general and administrative expenses Depreciation and amortization 53% Total Total: CHF 434 billion Private and business clients Corporate clients Operations (banks) AuM for private and business clients and for corporate clients include accounts and custody. AuM in opera- tions (banks) include accounts only. Segment performance before tax Tax expense / (benefit) Segment performance after tax Less: Minority interests Net profit / (loss) Regulatory equity used (avg) Cost / income in % 1 Assets under management (bn) Headcount of which: Switzerland of which: Rest of world 1 Before credit loss expense. 1998 4,785 1,728 448 64 7,025 1,170 5,855 3,999 948 4,947 908 154 754 0 754 8,250 70 434 24,043 23,989 54 Review of Businesses Private and Corporate Clients 1997 Change (%) 7,005 1,092 5,913 4,305 852 5,157 756 135 621 0 621 8,600 74 398 25,641 25,581 60 0 7 (1 ) (7 ) 11 (4 ) 20 14 21 – 21 (4 ) 9 (6 ) (6 ) (10 ) Assets under management Assets under management rose by CHF 36 billion to CHF 434 billion. This increase was due to, in roughly equal amounts, the net inflow of assets and positive equity markets over full-year 1998. Significant Events in 1998 Merger on track and successful Our ambitious integration plan remains on track with all major tasks expected to be com- pleted before year-end. The following tasks were completed during the year: – Rebranding / Client Communication: We have completed our rebranding both internally and externally. Furthermore, we harmonized our pri- cing and product ranges and were able to offer these to our clients by August 1998. This major effort was accompanied by the need to adapt the related information technology (IT) systems. – Technical and Operational Migration: A deci- sion to utilize a common IT Platform (ABA- CUS) was taken in January 1998 which permit- ted an early start to the major technical and operational migration. The rapid conversion allowed us to successfully migrate the first 100,000 clients in November of last year and establish the basis for migrating the remaining clients to ABACUS in 1999. – Redesign of Distribution Network: We closed 34 duplicate branch locations throughout Switzerland during the year and have identified additional branches to be closed in 1999. Fur- thermore, we are broadening our offer of alter- native distribution channels such as telephone and Internet banking. – Client and Employee Retention: Client defec- tions resulting from the merger have remained within the anticipated 5% range. Employee turnover, on the other hand, reached an average rate of approximately 14% for the year com- pared to the prior year’s 12% rate. This trend has now been reversed and employee turnover is on the decrease. The merger going forward A number of significant integration steps remain to be completed. Based on progress so far, and the comprehensive preparatory work, we are confident that we will complete our projects within the estab- lished deadlines. Efforts to minimize further client and employee defections will continue. 21 Review of Businesses Private and Corporate Clients 35% Assets under Management by Asset Class (1998) 6% 17% 20% 22% Total: CHF 434 billion Customer accounts Bonds Equities Mutual funds Other custody accounts 22 Strategic Initiatives European asset gathering Initiative for small- and medium-sized enterprises (SMEs) At the time of the merger, UBS announced the “SME Initiative Switzerland”. This initiative is a targeted response to the main challenges facing SMEs, namely the lack of adequate equity capital. At the outset, UBS made some CHF 150 mil- lion available to qualified SMEs. During the sec- ond half of 1998, this amount was further increased to a total of CHF 335 million funded by EIBA and the venture capital initiative of for- mer Swiss Bank Corporation. Three vehicles are being utilized for distribution, namely Aventic AG, UBS Startcapital and a seed fund for sup- porting high-technology development. – Aventic AG is a wholly-owned UBS Group sub- sidiary with equity capital of CHF 30 million and access to some CHF 245 million of credit lines. It was formed in August 1998 and invests in innovative SMEs through equity stakes or by providing venture capital. Its Board is com- posed mainly of people from outside the bank in order to ensure the necessary flexibility and independence in its decision making. – To assist in the start-up phase of new compa- nies, UBS has launched a new range of products for up-and-coming entrepreneurs. The aim is to provide equity capital combined with start-up loans as well as necessary additional services to support management activities. These clients are served out of newly-created competence centers within our Private and Business Clients Business Area. – A seed fund has been established to facilitate the transfer and realization of promising tech- nology from Switzerland’s universities. This autonomous vehicle was created to assist in promoting the development of new high-tech firms in Switzerland and is actively involved with universities and other institutions. The rapid growth in demand for investment and retirement products within Europe repre- sents a significant opportunity. Growing wealth levels, the consolidation of Europe and uncer- tainty over the stability of state pension schemes, are some of the reasons why a cross-border prod- uct offering is attractive. Furthermore, an increasing number of investors are turning to channels such as the Internet and telephone to conveniently provide them with information and the ability to buy and sell securities and other financial products. UBS, with core competencies in asset manage- ment, investment and long-term savings prod- ucts, as well as proven client servicing capabilities and the appropriate technology, is well-placed to capitalize on these developments and offers these services outside of its traditional home market. As a global bank with in-house access to com- prehensive and high-quality research, representa- tions on all major stock exchanges, a well-recog- nized brand and exceptional technology, UBS has a significant opportunity to embark upon a tech- nology-based expansion. Outlook For 1999, we expect to continue our improve- ment in net profit. This will be achieved by real- izing our strategic projects which consist of clear- ly-defined initiatives and further enhancing the efficiency of our businesses. We are highly confident about reaching our long-term objectives despite the continuing inte- gration process, the highly competitive environ- ment and the anticipation of only a moderate upswing in the Swiss economy. Review of Businesses 23 Review of Businesses UBS Brinson UBS Brinson UBS Brinson posted a Business Profile / Mission Statement strong performance in 1998 against a volatile market backdrop. Global revenue growth was generally healthy and was achieved with moderate growth in costs. Given the depth and breadth of our new resources, the merger and other client- driven strategic initiatives completed during the year should position us well for further growth. Our 1999 outlook is posi- tive, although competition and market conditions are likely to remain chal- lenging. 24 UBS Brinson is responsible for the institution- al asset management businesses of the UBS Group. We invest globally for a world-wide client base consisting of institutional investors such as pension funds, public funds and central banks. On behalf of Private Banking, we also manage the UBS Investment Funds of the UBS Group. UBS Brinson is one of the largest institutional asset managers in the world. We employ a total of almost 1,500 people at our headquarters in Chicago and our offices in Bahrain, Basel, Frank- furt, Geneva, Hong Kong, London, Melbourne, New York, Paris, Rio de Janeiro, Singapore, Syd- ney, Tokyo and Zurich. In the United States, the United Kingdom and Switzerland, we are among the industry leaders. We have over CHF 360 bil- lion in institutional assets under management, with an additional CHF 171 billion in mutual funds managed for Private Banking. Institutional asset management mandates are typically awarded on the basis of investment style, performance track records and client service. UBS Brinson’s goal is therefore to deliver sustained value-added investment performance relative to client-mandated benchmarks. Our asset allocation strategies are based on comprehensive proprietary research in the major equity, fixed income and cur- rency markets around the world. Our method is to identify periodic discrepancies between market price and investment value and turn them to our clients’ advantage. Our global presence means that we are thoroughly familiar with local client needs and regulatory environments. While applying local knowledge to meet our clients’ specific needs, we leverage our research capability globally. The resulting superior service quality is the basis for building strategic partnerships with our clients. The institutional asset management business, though subject to intense competition, has the potential to deliver attractive returns. Capital requirements are minimal, thus favouring a high return on equity. Revenues take the form of fees, which are closely correlated to the size of the assets under management. Earnings streams are conse- quently less volatile and more predictable. The growth potential for the business is impressive: institutional assets currently run to some CHF 17 trillion worldwide – by 2002 they are expected to reach CHF 25 trillion. Rising security market lev- els are a factor, but so are demographics. In many regions, notably Japan, Europe and also North America, the average age of the population is ris- ing and so is the need to make provisions for grow- ing future pension requirements. With our strate- gy built on a global platform with a local delivery focus, we are well-placed to continue to build our franchise in the markets of our choice. Review of Results Summary The division’s performance rose 11% pre-tax year-on-year. Excluding non-cash items, the divi- sion posted a very strong increase of 24% in oper- ating profits before tax. The favorable perform- ance stemmed primarily from good revenue growth overall with lower costs as the division rationalized its post-merger infrastructure and partially held in check its longer-term investments. Against a volatile market backdrop, the division’s accomplishments during the year were impressive: – The successful integration of the Union Bank of Switzerland and Swiss Bank Corporation busi- nesses to create a diversified, global divisional platform unique in the industry. – Expanded co-operation with Private Banking helping to further realize the extensive business synergies between the two businesses. – The purchase of the Long-Term Credit Bank of Japan’s (LTCB) asset management business sig- nificantly bolstering our institutional asset presence in Japan. All of these events represent significant mile- stones in fulfilling our long-term strategy. Revenues Growth in new assets under management, our acquisition in Japan and positive market per- formance contributed to a 12% increase in oper- ating income over the prior year. Institutional revenue growth was generally positive across the globe. An added boost to revenue came from an increased asset flow from Private Banking. These positive developments were partially offset by a decline in Phillips & Drew revenue due to short- term performance issues and a very competitive UK marketplace. Total costs Total costs for the division increased by 12% due to goodwill charges on LTCB in Japan and the Employees by Region (1998) 6% 7% CHF million Phillips & Drew business area UBS Brinson business area Total operating income Less: Credit loss expenses Total 30% 57% Total Personnel, general and administrative expenses Depreciation and amortization Total: 1,497 employees Europe, Middle East and Africa The Americas Japan Asia, excluding Japan Total Institutional Assets under Management by Business Area 100% 80% 60% 40% 20% 0% 34% 66% 39% 61% 31.12.98 31.12.97 1997 Total: CHF 373 billion 1998 Total: CHF 360 billion Phillips & Drew business area UBS Brinson business area Total Institutional Assets under Management by Client Location (1998) Segment performance before tax Tax expense / (benefit) Segment performance after tax Less: Minority interests Net profit / (loss) Regulatory equity used (avg) Cost / income in % Assets under management (bn) Brinson BA institutional AuM Phillips & Drew BA institutional AuM UBS investment funds AuM Headcount of which: Switzerland of which: Rest of world payment of the remaining obligation to Brinson Partners in the US. Merger synergies enabled the Swiss headcount to be scaled back 11% while, outside of Switzerland, expansion in Europe and the acquisition in Japan resulted in a 15% overall increase in headcount during the year. The division continues to focus on control- ling cost efficiency while making selective investments in IT and infrastructure. IT devel- opment efforts are currently underway in the investment management, operations and busi- ness development areas aimed at increasing the efficiency and control of our global resources. In the next year, we will also be developing our Internet facilities further for our clients. 3% 7% Net profit 34% 56% Total: CHF 360 billion Europe, Middle East and Africa The Americas Japan Asia, excluding Japan Combined with an increase in divisional pre- tax performance of 11%, the slight decrease in the effective tax rate for the division from 32% to 29% resulted in an after-tax increase in profits of 16%. Assets under management Divisional assets under management increased by 11% overall before considering the apprecia- tion of the Swiss franc during the year. After the currency impact, growth in assets was a more moderate 5% year-on-year in Swiss franc terms. Similarly, growth in the Brinson area assets under Review of Businesses UBS Brinson 1997 Change (%) 1,040 0 1,040 593 44 637 403 127 276 0 276 50 61 504 228 145 131 1,364 298 1,066 12 – 12 3 143 12 11 1 16 – 16 100 5 4 (16 ) 31 10 (11 ) 15 1998 326 837 1,163 0 1,163 608 107 715 448 128 320 0 320 100 61 531 238 122 171 1,497 266 1,231 management was up 10% before taking into account exchange rate movements (or 4% after the currency impact). Partially offsetting Brinson business area growth, Phillips & Drew showed a net decline in assets under management. Brinson business area Brinson growth in assets under management resulted about equally from new business, acqui- sitions and performance.The US, Switzerland and Japan accounted for the major share of business gained as new and existing clients showed con- tinued confidence in the post-merger Brinson in UBS Brinson Portfolios and their Corresponding Indices Performance characteristics since inception (1981) in USD Annual Return (%) 20 18 16 14 12 10 U.S. Equity Portfolio U.S. Equity Index Global (Ex-U.S.) Equity Portfolio Global Securities Portfolio Global Securities Market Index Global (Ex-U.S.) Bond Portfolio Global (Ex-U.S.) Equity Index U.S. Bond Portfolio U.S. Bond Index Global (Ex-U.S.) Bond Index 4 6 8 10 12 Volatility (%) 1 14 16 18 20 1 Annualized standard deviation of monthly logarithmic returns Note: Performance figures are gross of fees 25 Review of Businesses UBS Brinson UBS Brinson Business Area Institutional AuM by Client Mandate (1998) 6% UBS Brinson Investment Performance Global Securities Global Securities Markets Index Global equities MSCI World Equities Index 29% 40% US Equities Wilshire 5000 Global bonds Salomon World Government Bond Index US fixed income Salomon Brothers BIG Index 3-year 12.46 14.42 18.85 18.06 23.77 25.24 8.79 6.20 7.46 7.29 5-year 12.17 13.63 16.11 16.06 22.24 21.78 8.51 7.85 7.54 7.30 10-year 12.82 12.45 14.70 11.11 20.03 18.11 10.22 8.97 9.73 9.31 25% Total: CHF 238 billion Equity Asset allocation Fixed income Private markets Phillips & Drew Business Area Institutional AuM by Client Mandate 100% 80% 60% 40% 20% 0% 72% 11% 17% 73% 11% 16% 31.12.98 31.12.97 1997 Total: CHF 145 billion 1998 Total: CHF 122 billion Asset allocation Bonds Equities 26 managing their institutional monies. In addition, the buyout of our joint venture partner LTCB in Japan bolstered our presence significantly, mak- ing us the third-largest foreign institutional asset manager in that market with a strong platform for future growth. Characterized by our global geographic pres- ence and strong mandate diversification, our business stands apart from our competitors in the resources and the skill set we can leverage on our clients’ behalf. The relative mix of our mandates has remained consistent during the year, although we continue to explore alternative asset invest- ment opportunities that we believe may comple- ment our existing businesses and add value for our clients. The long-term performance of our portfolios clearly demonstrates our value-added investment philosophy. Relative to the benchmarks, we have periodically under-performed against certain benchmarks on a short-term basis. During 1998, our long-term value-oriented philosophy some- times appeared at odds with a market focused narrowly on short-term events. The overvaluation of world equity markets persisted in 1998, but we are confident that these markets will revert to their natural fundamental underpinnings and that our basic investment framework remains sound. The timing of this reversion remains, of course, the uncertain factor. Phillips and Drew Business Area Phillips & Drew is the third-largest asset man- ager in the UK marketplace with a business prin- cipally specialized in equity and balanced portfo- lios. A competitive, mature marketplace, com- bined with market sentiment favouring passive managers as robust equity markets continue to ignore long-term fundamentals, has made for a challenging environment for the business to grow in. These factors combined with relative under- performance of its balanced portfolios have resulted in a decline of assets under management on a year-on-year basis. Focusing on the funda- mentals of investment process and client service, and evolving its structure and services in response to the marketplace, management continues to maintain a favourable outlook for the future. Merger and Other Initiatives in 1998 1998 was a significant year for UBS Brinson. From a divisional perspective, the prior resources of Union Bank of Switzerland and Swiss Bank Corporation were fully rationalized and inte- grated without major disruption to client service. Enabling us to establish a global platform in significantly less time than we could build it our- selves, the merger has given us the opportunity to obtain a distinct competitive advantage for growing our business further. Apart from the merger, two other significant milestones occurred in 1998: the buyout of the LTCB joint venture in Japan and the establish- ment of Private Banking Investment Services. The buyout of LTCB was critical as it gives us a significant platform from which to build our institutional business in Japan further while still allowing us to be regarded as a foreign manager – a factor which in the current economic climate in Japan is beneficial to us. Private Banking Investment Services was also established during 1998. Private Banking Invest- Review of Businesses UBS Brinson ment Services works closely with Private Banking to enable their clients to receive institutional- quality investment products and advice which are delivered through the traditional Private Banking channel – an arrangement that benefits clients and shareholders alike. Strategic Initiatives Our longer-term strategy revolves around being responsive to three key changes in market dynamics: slower aggregate future growth in home markets, structural changes in global pen- sion schemes and continuing globalization and consolidation of the asset management business: – Slower future growth in our home markets (US, UK and Switzerland) requires that we leverage existing relationships with consulting firms, enter into strategic partnering efforts with multinational corporations and tap into the reservoir of existing clients of other UBS divi- sions. – Structural changes in global pension schemes require that we tailor our response in Anglo- Saxon defined-contribution markets, consoli- date our position in Japan, and accelerate pres- ence and establish strategic positions in devel- oping European and Latin American markets. – Continuing global consolidation will give rise to opportunities for alliances, acquisitions and expansion of investment capabilities that will be explored as a means to enhance shareholder and client value. The merger in 1998 was clear- ly a very significant step in this direction. Outlook With the merger year behind us, our key chal- lenge at UBS Brinson will be to continue to focus on the equation of philosophy, process and peo- ple which has made us so successful. We must provide to our clients continuous value-added investment performance over the long term and superior client service. Superior client service, as measured by external consultants, means the fol- lowing things to us: timely and accurate informa- tion to clients, excellent co-ordination with client custodian banks, and positioning ourselves as an advisor, not just a manager, to our clients’ aggre- gate portfolios. While markets are likely to remain volatile in 1999, we expect good overall growth in cash flow earnings. Regionally, we anticipate relatively strong growth in Europe and Japan with com- petitive yet reasonable growth in the Americas. Over the medium term, we expect further com- petitive intensification as newer and ever larger entrants wish to exploit the modest capital amounts required and lower volatility of earn- ings implied by this business. Our strong client base and geographic diversity as well as the inherent synergies we have with Private Banking and the rest of the Group give us a competitive edge few can match. 27 Review of Businesses UBS Capital UBS Capital UBS Capital is one of Business Profile / Mission few private equity operations with a truly global presence. It continued to be a significant income generator for the UBS Group in 1998, confirm- ing its growing impor- tance within the bank. UBS Capital is well- positioned for continued success given the quality of its teams and the potential to unlock Group synergies. 1998 Portfolio (book value) by Sector (direct investments) 3% 3% 4% 5% 8% 9% 47% 10% 11% Manufacturing Retail Post and telecommunication Software, consultancy and supply Transport, storage and communication Automobile rentals Radio/TV activities Real estate, rental and other services Others 28 The private equity business continued to be a significant income generator for the UBS Group in 1998. UBS Capital delivered excellent results confirming its growing importance within the bank. Favorable economic conditions coupled with high levels of stock market liquidity throughout most of the year in Western markets facilitated disposals from the portfolio. New investments continued at an increased rate. With the strong flows of capital into the private equity industry, competition for attractive opportunities remained fierce. However, UBS Capital is well- positioned for continued success given the quali- ty of teams now in place and the potential to unlock Group synergies. Actively adding value UBS Capital is one of few private equity oper- ations with a truly global presence. Its network of 13 teams of local professionals covers over 30 countries in Western Europe, the Americas and Asia Pacific. The business benefits strongly from its integrated position in the UBS Group, which offers particular synergies with Private Banking and Warburg Dillon Read. UBS Capital aims to make majority equity investments in established unlisted companies. The main focus of its investments is later-stage financ- ing, such as management buy-outs, expansion or replacement capital. The business’ seasoned pro- fessionals actively participate with management in developing the potential of a company over the medium term, thereby maximizing shareholder value. By using the local knowledge and industry expertise of its teams combined with a risk-con- scious approach to investing, UBS Capital has built a globally-diversified portfolio with superior returns and annual average loss rates among the lowest in the industry. An area of increased focus in Europe is family businesses facing succession issues where UBS Capital is able to bring a flexible approach to structuring a transaction coupled with a reputa- tion for professionalism in its business. Review of Results The result for 1998 was excellent as the gener- ally favorable conditions in Western markets allowed for many disposals from the portfolio. Net revenues after write-downs for 1998 increased 19%, or CHF 93 million, to CHF 585 million from CHF 492 million in 1997. This increase was generated largely by disposals of investments by the Swiss, US, Benelux and Nordic teams. Although the operating costs as a percentage of revenues increased slightly in 1998, they remained low at 27%. Continuing from its strong first-half results, UBS Capital increased pre-tax profits by 12%, or CHF 47 million, to CHF 428 million in 1998. These results also reflect the lower divestment activity of the fourth quarter compared to other quarters, when, as expected, the portfolio cycle did not offer as many exit opportunities. Net profit after tax increased 9%, or CHF 34 million, to CHF 413 million over the year. The financial crises in emerging markets around the world during the year had little imme- diate impact on the value of UBS Capital’s investments, with the portfolio predominantly focused on the US and Western Europe and only weighted 7% in Latin America and 2% in Asia. The portfolio continues to expand in line with expectations and had a book value at year-end of approximately CHF 1.8 billion. The year-end semi-annual portfolio review and valuation resulted in a market value of around CHF 2.7 bil- lion providing unrealized gains at year-end 1998 estimated at about CHF 0.9 billion, or 50% of the total portfolio book value. New investments in 1998 amounted to around CHF 0.8 billion. Headcount increased as the business has devel- oped particularly in Europe and Latin America. Staff losses due to the merger were minimal and have had no noticeable impact on operations. Discussion of operations Merger The merger process was smoothly completed in 1998. UBS Capital successfully integrated the Swiss-based SBC Equity Partners into its Euro- pean operations and the team contributed signif- icantly to the 1998 result. The establishment of new linkages with the other businesses of the Group is also bearing fruit. As a consequence of the merger, UBS Capital lost its grandfathered status in the US, which allowed direct equity investments in the US with voting Review of Businesses UBS Capital 1998 1997 Change (%) 585 0 585 152 5 157 428 15 413 0 413 250 27 122 36 86 492 0 492 108 3 111 381 2 379 0 379 200 23 90 35 55 19 – 19 41 67 41 12 > 100 9 – 9 25 36 3 56 1998 Portfolio (book value) by Investment Stage 2% 2% 18% CHF million Total operating income Less: Credit loss expenses Total Personnel, general and administrative expenses Depreciation and amortization Total Segment performance before tax Tax expense / (benefit) Segment performance after tax Less: Minority interests Net profit / (loss) Regulatory equity used (avg) Cost / income in % Headcount of which: Switzerland of which: Rest of world 17% 61% Management buy-out Replacement capital Expansion capital – late stage Expansion capital – early stage Others 1998 Portfolio (book value) by Geography 7% 2% 40% 51% North America Europe Latin America Asia/Pacific 1998 Portfolio Unrealized Gain CHF billion 3 2 1 0 1 n b 9 . 0 n b 7 . 2 n b 8 . 1 n b 3 . 1 i n a g d e z i l a e r n U 7 9 . 2 1 . 1 3 e u a v l k o o B 8 9 . 2 1 . 1 3 e u a v l k o o B 8 9 . 2 1 . 1 3 e u a v l t e k r a M 1 0.8 bn private equity *0.1 bn equity-related instruments rights of up to 25% in larger transactions. UBS Capital continues to evaluate its options with regard to this important market and will implement a new structure in 1999. This is not expected to signifi- cantly impact earnings in the time frame up to 2002. Strategic initiatives The increasing awareness of private equity as an attractive asset class for fund managers, cou- pled with the growing efforts by industry in Europe to restructure and embrace the share- holder value principle, has further improved the opportunities for investment and hence the funds being made available to invest in this sector. Competition for potential investments remains fierce. Despite the increased competition, UBS Capital is well-positioned to leverage its unique strategic advantages. UBS Capital intends to maximize the propri- etary deal flow that exists within the UBS Group through further developing its internal linkages. Using primarily the Group’s own funds for investing allows UBS Capital to pursue a value strategy that differs from that of its competitors. The business is not forced to meet target spend rates but pursues transactions only if they offer fair value over an investment cycle. With its successful and highly-qualified net- work of teams, UBS Capital is well-positioned to be a key player in this rapidly expanding business world-wide. It will focus on continuing growth in Western Europe and North America as well as seizing select value opportunities in Latin Ameri- ca and Asia / Pacific. UBS Capital is committed to utilizing its glob- al network of teams to combine local expertise and resources as required. In doing so, it aims to provide tailor-made solutions for cross-regional and cross-border transactions, which are gaining in importance world-wide. Based on these competitive strengths, UBS Capital plans to gradually increase the annual investment rate, targeting a portfolio book value of approximately CHF 4 billion by the end of 2002, while achieving further diversification in the timing and geography of earnings streams. Outlook 1999 In 1999, UBS Capital plans to strengthen the existing business and to maintain a global market presence and a well-diversified portfolio of investments. While the current portfolio’s aging profile is anticipated to offer fewer divestment opportunities over the coming year than it did over the past two years, the business is targeting to add CHF 800 million of new investments to the portfolio in 1999 and remain a strong con- tributor to UBS Group results going forward. 29 Review of Businesses Corporate Center Corporate Center The Corporate Center encompasses Group level functions which cannot be devolved to the divisions. Additionally, the Corporate Center plays an active role with regard to funding, capi- tal and balance sheet management, and with regard to risk management. (See Review of Risk Management and Control and Review of Asset and Liability Management.) For 1998 the Corporate Center posted a pre- tax loss of CHF 1,029 million versus a pre-tax profit of CHF 260 million in 1997. The two major items which negatively impact- ed on the Corporate Center result were CHF 842 million for the settlement relating to the role of Swiss banks during and after World War II and CHF 367 million relating to the write-off on Long Term Capital Management, explained in the Review of Risk Management and Control. See Management Accounting policies on pages 8–9 and Review of Risk Management and Control for explanations of the link between the credit expense line and the Group Financial Statements. Serving the UBS Group, the Corporate Center reports directly to the CEO and provides centralized services such as Legal Support, Com- munications and Human Resources. In addition, the Corporate Center CHF million Operating income Less: Credit loss expenses embraces the functions Total reporting to the Chief Personnel, general and administrative expenses Depreciation and amortization Financial, Chief Risk and Chief Credit Officers. Total Segment performance before tax Tax expense / (benefit) Segment performance after tax Less: Minority interests Net profit / (loss) Regulatory equity used (avg) Headcount of which: Switzerland of which: Rest of world 30 1998 296 (745) 1,041 2,085 (15) 2,070 (1,029) 317 (1,346) 4 (1,350) 6,350 921 821 100 1997 518 (173 ) 691 381 50 431 260 357 (97 ) 16 (113 ) 4,150 1,599 1,561 38 Review of Risk Management and Control Review of Risk Management and Control Risk exposure is integral Introduction to UBS’s business and extends beyond just market and credit risks. The highest standards of risk identification, risk management and risk control are indispensable to the success, repu- tation, and continuing strength of UBS. Thus, UBS is committed to developing and apply- ing best market practice to all risk activities. 32 Following the investigation and thorough analysis of the circumstances surrounding the third-quarter trading losses, and in particular the losses associated with the Long Term Capital Management (LTCM) transaction, UBS’s Board of Directors (BoD) commissioned a review of UBS’s overall risk profile together with its risk management and control processes and pro- cedures. A parallel review was also initiated in Warburg Dillon Read at the same time to con- sider the extent to which the changed market circumstances required a reassessment of the business priorities. The results of that review are reported separately in the Warburg Dillon Read section of this report. The overall result of the risk review was encouraging, since it did not identify any signifi- cant new risk concentration or previously un- identified risk management issues. The principal conclusion of the risk review was that UBS should continue to implement a fully-integrated approach to risk management and control covering all material risks and all aspects of UBS’s business. In late 1998, the BoD and the Group Execu- tive Board (GEB) endorsed the findings of the risk review and agreed upon the following areas as the principal priorities for attention: – to further incorporate operational risks into the risk management and control process – to reinforce existing efforts to ensure the com- pleteness and accuracy of data which support the risk management decision-making process – to ensure that assessments of the risk/return potential of particular business activities fully take into account all relevant risk considerations – to ensure that there is a structured process in place throughout the Group to assess the risks in new business activities – to reorient UBS’s approach to measuring and limiting risk exposures towards potential loss in extreme conditions as well as more normal conditions. The UBS Risk Framework As an integral part of the risk review, UBS has also reviewed and updated its risk policy frame- work which sets the overall guidelines for risk management and control at UBS. The policy framework, which covers all material risks, emphasizes the importance of distinguishing between the following functions within the risk management process: – risk management, which is defined as managing UBS’s exposure to risk within the overall guide- lines and limits approved by the BoD. Ensuring the adherence to these guidelines and limits is the responsibility of the management of the business divisions and individual business lines; – logistics, which are the separately constituted operational functions, including financial con- trol, operations and IT, that exercise an essen- tial control function when processing the trans- actions entered into by the divisions; – risk control, which are the independent risk control functions reporting to the Chief Risk Officer (CRO) and the Chief Credit Officer (CCO) and which verify the business areas’ compliance with corporate risk policies. UBS approaches risk-taking first and foremost by recognizing that an effective process for man- aging and controlling risk is indispensable to UBS’s continued success. Effectively managing and controlling risk depends on a sound process for identifying the risks which UBS faces, as well as establishing a comprehensive set of limits and procedures to control these risks. UBS puts these limits and procedures in place to ensure that its exposure to risk is consistent with its risk appetite and risk bearing capacity and with its assessment of management’s capabilities to manage and control the risks in an effective manner. In this context, internal capabilities, such as the availa- bility of suitable IT processing systems and staff knowledge and experience, and the external envi- ronment are taken into consideration. UBS places particular emphasis on its procedures for analyz- ing the risks in new business activities and for undertaking large or complex transactions. The BoD sets UBS’s risk limits by assessing the Group’s risk appetite and risk-bearing capacity. UBS’s risk appetite is a measure of the risk which the BoD believes the Group requires in order to deliver satisfactory long-term growth and return on equity. This potential risk is represented by absolute statistical loss levels (value at risk) that are consistent with the budgeted annual earnings of the relevant business units. In addition, the BoD sets limits on the poten- tial stress loss which UBS could face in extreme, but unlikely situations based on its risk-bearing Review of Risk Management and Control capacity. The determination of potential stress loss takes into account UBS’s overall earnings capacity, and is set to protect the Group from unacceptable damage to annual earnings, divi- dend-paying ability, business viability and its rep- utation. The BoD reviews the risk appetite and the risk-bearing capacity on a regular basis con- sidering changes in market conditions. The GEB actively monitors potential losses for a series of pre-determined stress scenarios and actively alters the limit for each scenario in circumstances that indicate higher-than-normal risk to a given stress event. A further important element of the risk process at UBS is the management structure through which the risk management and control process operates. The overall responsibility for implementing the risk framework lies with the GEB, which allocates risk limits to the divisions and which regularly monitors the development of UBS’s risk profile at the Group level. Within the GEB, the Chief Risk Officer and the Chief Credit Officer are responsible for ensuring that consistent policies and procedures are established across the Group for measuring, managing and reporting the risks, which are approved by the GEB and the BoD, and communicated throughout the organi- zation. The Market and Credit Risk Control functions, which report directly to the CRO and CCO respectively, are independent from the busi- ness and are staffed by senior and experienced employees located in the respective business divi- sions as well as at the Corporate Center. In addi- tion, close co-operation on a day-to-day basis UBS Risk Management and Control Framework between the credit risk and market risk control functions ensures appropriate checks and bal- ances in the daily business. Each division also has Risk Management Committees which involve senior business man- agers together with representatives of the risk control functions. These committees are chaired by the CEO of each division and are an integral part of the business management process. The Risk Management Committees ensure that there is an ongoing review of the risk profile of the division in respect of all the material risks it faces, evaluate the risk in new business initiatives and in large or complex transactions and propose to the GEB changes in risk policies and limits affecting the divisions. Further Group Internal Audit, which reports directly to the Chairman of the BoD, reviews and evaluates the effectiveness of the Risk Policy Framework and the related internal control sys- tem to verify that all policies and procedures are complied with and that risk profile data in all reports is accurate. Group Internal Audit also reviews and evaluates the independence of the Corporate Risk Control functions. Long Term Capital Management and the Global Equity Derivatives Portfolio On 24 September 1998, UBS announced that as a result of the market turmoil in the wake of the Russian crisis it was expecting to report a loss during the third quarter. The reported loss for the Board of Directors Group Internal Audit y c i l o P k s i R Group Executive Board Corporate Center CRO & CCO Corporate Risk Control Warburg Dillon Read Warburg Dillon Read Credit Risk Control Market Risk Control Private & Corporate Clients UBS Private Banking Private Banking Private & Corporate Clients UBS Brinson UBS Brinson UBS Capital UBS Brinson – Divisional Risk Management Committees – Divisional Logistics Functions t i d u A l a n r e t n I t n e m e g a n a M k s i R I n d e p e n d e n t R i s k C o n t r o l I n t e r n a l A u d i t 33 Review of Risk Management and Control quarter announced in October was CHF 911 million. The principal reasons for this were UBS’s exposures to the hedge fund, Long Term Capital Management, which resulted in a post-tax loss of CHF 987 million and to the Global Equities Derivatives Portfolio, which resulted in a post-tax loss of CHF 659 million at year-end. Long Term Capital Management (LTCM) In the case of LTCM, the loss arose from a structured transaction which was entered into by Union Bank of Switzerland in 1997. Under this transaction, UBS sold an option which gave the right to purchase shares in the LTCM fund at a predetermined price over a seven-year period. In order to hedge the risk of this option, UBS held shares to the value of USD 800 million in the LTCM fund to create an incrementally risk neu- tral position. Separate from the structured trans- action, a further direct equity investment of USD 266 million was made in the fund, based on the enormous demand for such investments by insti- tutional and private clients, and the consensus expectation of high returns from this fund in par- ticular. In normal market conditions, the struc- tured transaction would behave in a controlled manner. However, in the event of extreme market movements leading to a discontinuous decline in the fund’s value, the structured transaction could not be effectively hedged and, in fact, resulted in a large loss on the transaction. The problems at LTCM have been extensively documented. In summary, at the time of the Russian crisis in September 1998, LTCM had invested in a number of “convergence strategies”, which would have been profitable for the fund if the prevailing differentials between the prices of different securities had diminished. However, the spreads widened suddenly and significantly, leav- ing LTCM with mark-to-market losses which largely wiped out the fund’s equity capital. This resulted in the loss which was announced by UBS in October. In addition, as with most other large investment banks, UBS had provided significant fully collateralized financing to LTCM against its substantial securities holdings. Because of the risk of further losses in the event of a forced liquida- tion of the LTCM assets, UBS agreed to par- ticipate in a co-ordinated exercise to recapitalize LTCM to ensure an orderly release of the financ- ing exposures, and as an additional benefit, allowing UBS to maximize the value of the remaining equity investments which would have otherwise been wiped out in a liquidation scenario. Under this arrangement UBS injected a further USD 300 million of equity into LTCM and assumed a position on a newly-established Man- agement Board of LTCM which is overseeing the orderly management of LTCM’s activities. This investment was made only after analysis of the LTCM portfolio. It revealed that in large part, the positions held by LTCM possessed significant potential for future profits, but their ultimate level of leverage combined with extreme market volatility had eroded the capital base needed to support the portfolio. UBS management is confi- dent that the fund now has sufficient capital to withstand future market turmoil and therefore return the capital injection in approximately 24 months. Following these events, UBS has a residual exposure to LTCM arising from its new equity investment as well as its original equity holdings. The relative stabilization of trading conditions since the end of the third quarter has allowed LTCM to recover some of its earlier losses. More- over, the wind-down of LTCM’s positions is being managed in a way that is designed to minimize the risk to LTCM’s shareholders. As a result, UBS regards the downside risk in this posi- tion as limited. Global Equity Derivatives Portfolio (GED) The other major contributory factor to the third-quarter losses related to the GED business. This portfolio consists of a number of structured equity derivative transactions which were entered into as part of an earlier strategic initiative to develop a leading position in this market. This portfolio was analyzed at the time of the merger when it was recognized that it contained a num- ber of positions which, though appropriately hedged over the longer term, possessed the poten- tial for significant short-term variance. Conse- quently, when equity market volatilities increased significantly as a result of the market turmoil in the third quarter, an unrealized loss on the value of the portfolio became necessary. UBS will continue to actively manage the expo- sure associated with this portfolio in order to min- imize the risk of further adverse effects on earn- ings. However, given that the average maturity of the transactions in the portfolio is about three years, it will take some time to wind down this 34 Review of Risk Management and Control exposure, and during this time the portfolio will continue to be exposed to adverse moves in equity markets. Nevertheless, UBS believes that the mark- to-market losses which were incurred in the third quarter represent extreme circumstances and the potential range of losses for this portfolio in such circumstances is within UBS’s overall stress loss limits (see Market Risk section on pages 40–41). Analysis by Risk Categories In its risk policy framework, UBS has identi- fied a number of risk factors as being of particu- lar significance to its business. The following dis- cussion together with the Review on Asset and Liability Management outlines the major trends and developments during the year with respect to the key risks which UBS faces. 1 Credit Risk Credit risk is the risk of loss resulting from the default of an obligor or counterparty (banks, corporations, non-bank financial institutions, public entities/governments and private individu- als). At UBS, credit risk includes counterparty and country transfer risk, as well as settlement risk. Credit risk is inherent in traditional banking products, such as loans and conditional contracts to lend money in the future (commitments) or contracts to support clients’ obligations to third parties (e. g. letters of credit), as well as in deri- vative contracts and other traded products, such as bonds. In view of the significance of credit risk to UBS, the approval of new transactions giving rise to credit risk plays a central part in UBS’s risk control process. Only a limited number of highly- experienced senior credit professionals indepen- dent from the business are entrusted with author- ity to approve transactions. Such authorities are differentiated by amount, counterparty rating, tenor and other parameters. UBS measures its exposure to credit risk based on a statistical analysis of the probability of de- fault relating to each of its client categories. For this purpose, UBS categorizes all its counter- parties as well as the countries where it under- takes business on the basis of a fourteen-point rating scale with a specified default probability attached to each rating class. Loans are classified as “Non-Performing” as soon as a payment of interest and / or commission and / or installment is overdue for 90 days. The adequacy of allowances and provisions for both counterparty credit risk and for country transfer risk is regularly assessed and booked in accor- dance with the guidelines of International Accounting Standards. Specific allowances are created as and when a particular counterparty’s and /or country’s creditworthiness is impaired. UBS Group Loan Portfolio Summary by Division (1998) CHF million Private & Corporate Clients 31.12.98 Private Banking 31.12.98 Warburg Dillon Read 31.12.98 Corporate Center 31.12.98 Total 31.12.98 Total 31.12.97 Total loans and advances (performing and non-performing loans) Principal amount of loans outstanding (gross amount) 164,840 24,133 141,686 Allowance and provisions for credit losses 11,844 66 3,063 2 Loans, net of allowances for credit losses 152,996 24,067 139,058 Non-performing loans (NPL) 14,003 68 1,645 Ratios Allowance and provisions for credit losses in % of non-performing loans Non-performing loans in % of gross loans outstanding Allowance and provisions for credit losses in % of gross loans outstanding 84.6 97.1 186.2 8.5 7.2 0.3 0.3 1.2 2.2 305 5 300 0 n/a 0.0 1.6 330,964 353,240 14,978 1 16,2131 316,421 337,499 15,717 16,664 95.3 97.3 4.7 4.5 4.7 4.6 1 Of which CHF 435 million relating to contingent liabilities (1997: CHF 472 million). 2 Of which CHF1,450 million relating to country risk provisions. 35 Review of Risk Management and Control Total Credit Risk Exposure and Expected Loss by Division (1998) Total Credit Risk Exposure CHF 614 billion Total Expected Loss CHF 1,696 million 27% 5% 68% 29% 2% Private and Corporate Clients Private Banking Warburg Dillon Read 69% Exposure is defined as Gross Loans to Banks and Customers, Contingent Liabilities, Unutilized Irrevocable Commitments, OTC Derivatives (positive Replacement Value), without Security Lending, without Tradable Assets. A particular focus for UBS credit analysis in 1998 was the prospective effect of the Year 2000 IT challenge on the credit standing of UBS’s clients. As a result, the Chief Credit Officer initiated an extensive assessment of the Year 2000 readiness of the most important international clients as well as of some 10,000 corporate clients in Switzerland. The results of this review are covered in more detail in the discussion of the Year 2000 problem (pages 43–44) at the end of this section. Since the merger, UBS has been engaged in a rigorous process of reassessing its international credit activities to ensure that the risk / reward profile of its lending business is consistent with UBS’s long-term strategic objectives. This review which is discussed further in the Warburg Dillon Read section (pages 14–19) resulted in a reduc- tion in the overall size of the international credit portfolio from CHF 268 billion to CHF 175 bil- lion in 1998. A further reduction is planned going forward, bringing the overall size of the inter- national portfolio closer to our medium-term target level of CHF 60 to CHF 100 billion. From a Group perspective, the asset quality re- mains satisfactory. Total non-performing loans of CHF 15.7 billion represented 4.7% of total loans, of which 95.3% were covered by allowances and provisions for credit losses of CHF 15 billion. Moreover, within the Private and Corporate Clients Division the reported coverage ratio of 84.6% remains conservative since the bulk of the non- performing loans were in the form of mortgage lending and the underlying property has residual value. The table on page 35 summarizes the current status of the loan portfolio by division. When assessing the results of the individual business divisions in the Management Accounts, each division is charged for the credit risk it assumes based on a statistical estimate of the expected loss in its portfolio. Differences between the expected loss and the credit loss expenses actually incurred in the reporting period are balanced through the Corporate Cen- ter account. The graph above shows the annual expected loss per division in relation to the total portfolio of the Group. The expected loss in the Warburg Dillon Read portfolio is significantly lower than that in the Private and Corporate Clients Divi- sion, reflecting the fact that the Warburg Dillon Read portfolio consists primarily of internation- al wholesale business of high credit quality, whereas the Private and Corporate Clients port- folio is concentrated in the Swiss middle and retail market. Portfolio composition UBS actively manages the composition of its credit risk portfolio, and seeks to avoid excessive concentration to any one obligor, industry, rating class, product or geographical location. In view of the distinctly different segments, the following discussion of the portfolio is segregated into the major divisions: Warburg Dillon Read As depicted in the graph on the top of page 37, over 92% of the Warburg Dillon Read credit risk exposure is to counterparties which are of invest- ment grade quality (C5 and better rated). 36 Review of Risk Management and Control Distribution of Warburg Dillon Read Credit Risk Exposure by Counterparty Rating Class (1998) in % of total portfolio 40% 35% 30% 25% 20% 15% 10% 5% 0% AAA “Investment Grade” Categories AA A BBB BBB– BB+ C1 C2 C3 C4 C5 C6 BB C7 BB– C8 B+ C9 B D0 B– CCC-C D “Speculative Grade” Categories D D1 D2 D3 D4 UBS OTC Derivatives Exposure by Product Type and Maturity (1998) in % of total portfolio 40% 35% 30% 25% 20% 15% 10% 5% 0% 0–1 year 1–5 years >5 years Interest rates Foreign exchange Precious metals Equity/Index Commodities Exposure is defined as OTC Deriva- tives (positive gross replacement values), secured and unsecured. Exposure is defined as Gross Loans to Banks and Customers, Contingent Liabilities, Unutilized Irrevocable Commitments, Unsecured OTC Derivatives (gross replacement value + add-on), Tradable Assets (net long) without Security Lending. In line with its investment banking strategy, two-thirds of the Warburg Dillon Read exposure is to the financial intermediation industry. The remainder is well-diversified, with the public sector accounting for some 6%. The lending portfolio is of high credit quality, with the non- investment grade exposure restricted to high-yield and leveraged finance transactions. In view of the particular risks involved in over- the-counter (OTC) derivative contracts, UBS maintains careful control over all OTC exposures entered into and limits this business to top-qual- ity counterparties. The largest part (37.6%) of such contracts have a residual maturity of less than one year and in most cases the maximum tenor is below seven years. (Refer to Note 28 on page 85 for a detailed breakout of instruments and tenors.) Longer-dated contracts constitute exceptions to policy and are available to sover- eign counterparties or counterparties of the high- est credit quality only. Certain long-dated trans- actions were also assumed as part of the Global Equity Derivatives (GED) business. Under the current post-merger business policy, UBS contin- ues to deal with certain hedge funds provided its exposure is fully collateralized either by cash or by government bonds of particular OECD coun- tries. Private and Corporate Clients Division This segment represents the UBS domestic home market for small- and medium-sized cor- porate and retail clients. With the introduction of risk-adjusted pricing following the merger, the rating process and the quality of counterparty ratings gained increased importance. While the Distribution of Private and Corporate Clients Credit Risk Exposure by Counterparty Rating Class (1998) in % of total portfolio 40% 35% 30% 25% 20% 15% 10% 5% 0% AAA “Investment Grade” Categories AA A BBB BBB– BB+ C1 (S&P rating mapped to corresponding UBS master scale) C4 C3 C2 C5 C6 BB C7 BB– C8 B+ C9 B D0 CCC-C D B– “Speculative Grade” Categories D D1 D2 D3 D4 Exposure is defined as Gross Loans to Banks and Customers, Contingent Liabilities, Unutilized Irrevocable Commitments, Unsecured OTC Derivatives (gross replacement value + add-on), without Tradable Assets and Security Lending. 37 Review of Risk Management and Control Private and Corporate Clients Mortgage Portfolio by Type of Property (1998) 23% 28% 49% Residential (single-family homes) Residential (multi-family homes) Commercial Mortgage loan utilizations are broken down by collateral type. Private and Corporate Clients Credit Risk Exposure by Industries (1998) 3% 3% 5% 5% 10% 10% 44% 20% Private households Construction and real estate Manufacturing Others* Financial intermediation Wholesale and retail Hotels and restaurants Public administration * includes health and social work, * community, social and personal * services, transport, storage and * communications. Exposure is defined as Gross Loans to Banks and Customers, Contingent Liabilities, Unutilized Irrevocable Com- mitments, Unsecured OTC Derivatives (gross replacement value + add-on), without Tradable Assets and Security Lending. 38 quality of the entire loan portfolio continues to show the impact of the recessionary environment in Switzerland of the past seven years at the tail end of the rating scale, about 58% of the per- forming part of the loan portfolio is judged to be of investment grade quality (C5 and better-rated). The concentration of exposures in the rating class C5 reflects to a large extent our exposure to the residential mortgage market in Switzerland. In terms of industry distribution the Private and Corporate Clients portfolio continues to be domi- nated by loans extended to private households, of which about 91% are in the form of mortgages. The improving macroeconomic environment during 1998 is evident in a further decline of the Swiss bankruptcy rate. Coupled with a continu- ing low interest rate scenario and a stable outlook we expect an improvement of the overall Swiss loan portfolio in 1999. Private Banking Private Banking credit risk exposure of CHF 30.2 billion consists of collateralized lending and trading products of CHF 25.7 billion and mort- gages on single-family homes of CHF 4.5 billion. Eligible collateral for any Private Banking exposure is limited to cash, money market claims and precious metals as well as marketable and negotiable securities, all of which are to be duly pledged and assigned to UBS. Specific haircuts (margins) apply to different categories of col- lateral in different countries. Due to the sub- stantial stock market decline in August and September 1998, margin calls were initiated and – in cases where those were not honored – adequate allowances created. The overall quality of this portfolio is very high. Swiss Bankruptcy Rates (1977–1998) in % of total registered companies 1.4% 1.2% 1.0% 0.8% 0.6% 0.4% 0.2% 0.0% 7 7 9 1 0 8 9 1 5 8 9 1 0 9 9 1 5 9 9 1 8 9 9 1 Source: Creditreform, SHAB Number of bankruptcies from registered firms divided by total number of registered companies. Country risk As a result of the global character of its business, Warburg Dillon Read incurs transfer risk exposure to a wide range of economies. UBS’s definition of country exposure includes all cross-border positions of loans, derivative products and traded products as well as UBS Group internal cross-border positions. 96% of such cross-border exposure relates to major OECD countries rated S0–S2 (corresponding to public ratings of AAA–A+), where the risk of default is deemed negligible. The remaining 4% risk exposure to emerging markets is closely monitored on an ongoing basis and within stringent risk limits (country ceilings) approved by the BoD. In addition, all new transactions with counterparties located in these countries require sign-off by the respective country risk managers in addition to the standard counter- party credit approval. UBS Selected Emerging Markets Exposures (1998) CHF million Indonesia Russia Argentina, Brazil, Colombia, Ecuador, Peru, Venezuela Mexico Malaysia, Philippines, South Korea, Thailand Total exposure Tradable assets 1 Trade finance 2 Allowan- Financial ces & pro- visions risk 3 Coverage Reduction of total of finan- exposure cial risk in % since 1997 824 339 5,542 2,634 2,939 22 128 90 317 183 43 116 2,923 498 759 95 2,529 1,819 161 2,595 500 91 485 94 358 66 96 19 5 14 ( 969 ) ( 1,097 ) ( 1,782 ) ( 266 ) ( 1,791 ) 1 Equity and fixed income products in the trading book, marked-to-market daily. 2 Letters of credit, export credits, short-term advances in financing of exports and imports. 3 Includes all balance sheet lending (including money market lending) as well as derivatives and repos. Review of Risk Management and Control UBS Transfer Risk Exposure by Country Rating Classes (1998) 100% = CHF 882 billion 100% = CHF 32 billion loss severity is significantly lower than in the case of longer-dated exposures. UBS is confident that the current provisioning level for the most affect- ed economies is suitably conservative. 1% 35% 20% Settlement risk 4% 96% Industrial (S0–S2) Emerging (S3–S14) 44% Latin America Asia Pacific Europe, Middle East, Africa Others Transfer Risk includes Loans, Contingent Liabilities, Deriva- tives Products (gross replacment value + add-on) and Tradable Assets, to both third parties and intergroup companies. Following the Asian crisis in the second half of 1997, UBS had already taken active steps to limit new business in all emerging markets and to reduce its existing emerging market exposures prior to the crisis spreading to Russia and Latin America in the second half of 1998. Total emerging markets expo- sure was thus reduced by CHF 5 billion or about 14% from the end of 1997 onwards. During the same period, country ceilings previously available for business with emerging countries were reduced by 30%. UBS’s approach to country risk manage- ment follows the guidelines of the Swiss Bankers’ Association which allow banks to evaluate provi- sion levels for transfer risk based on their own port- folio scenarios. UBS has established specific scenar- ios for each country which assess the current and future probability of a default due to country risk incidents or country-specific systemic risks on a regular basis. The appropriate provisioning level is then determined by taking into account the type of product involved as well as the loss severity in- herent in each product. Events in a number of emerging markets in the second half of the year including in particular the declaration by Russia in August 1998 of a mora- torium on all government debt repayments caused UBS to increase its country risk provisions substantially. The table on page 38 provides an overview of the status of emerging market exposures and pro- visioning levels as at year-end 1998 together with a quantification of the exposure reductions achieved since the beginning of the year. UBS’s exposure to emerging markets includes a large share of short-term trade finance, where the Settlement risk is defined as the risk that a counterparty fails to deliver cash or securities or to honor third-party payments upon conclusion of a transaction. UBS measures, manages and controls settle- ment risk by way of counterparty-specific settle- ment risk limits in accordance with standards set by the Bank for International Settlements for all Foreign exchange, Precious metal and Cross- currency rates swap trades. The settlement risk analysis graph shows the average daily settlement volumes together with the total annualized expected loss assigned for settlement risk. Exposure reductions are achieved through the use of bilateral netting agreements and other mitigating techniques. The significant reduction of net expected loss in the fourth quar- ter was the result of a successful re-negotiation of netting and other arrangements with target clients immediately following the legal merger. Settlement Risk Analysis (1998) M P & X F ) d e z i l a u n n A ( s e s s o L d e t c e p x E n o i l l i m F H C n i 120 100 80 60 40 20 0 120 100 80 60 40 20 0 M P & X F l s e m u o V y l i a D e g a r e v A n o i l l i b F H C n i 8 9 l u J 8 9 g u A 8 9 t p e S 8 9 t c O 8 9 v o N 8 9 c e D Settlement risk residual expected losses Settlement risk reduction achieved Average daily settlement volume Classified credit portfolio The Classified credit portfolio consists of posi- tions where there is a high probability of partial or full loss to UBS. The portfolio includes positions rated D2 (“substandard”), D3 (“doubtful”) and D4 (“loss”), reflecting an increasing degree of loss severity. Typically, substandard exposures carry allowances for credit risk of up to 20%, doubtful exposure of up to 80% and loss exposure of 100% of the unsecured portion. 89% of the Clas- 39 Review of Risk Management and Control Summary of Classified Credit Risk Exposure (1998) CHF million Private and Corporate Clients Warburg Dillon Read Private Banking Corporate Center Total sified credit portfolio is attributed to the Private and Corporate Clients Division, 10% to Warburg Dillon Read. The remaining 1% relates to sundry positions managed directly by the Corporate Center. UBS maintained the conservative approach of both predecessor banks in assessing and managing its credit risk portfolio. As part of the harmoniza- tion of the credit loss methodology of the two predecessor banks, the previously established ACRA reserve of CHF 2.1 billion of Swiss Bank Corporation was earmarked for specific provi- sioning needs of the Private and Corporate Clients and the Warburg Dillon Read portfolios. As the recovery units started their assessment work at an accelerated pace after the legal merger was con- summated, all but CHF 300 million of these Spe- cial Reserve pools, including the Special Reserve pool created by the former Union Bank of Switzer- land, were allocated to specific positions of the previously defined workout portfolios as well as to country risk provisions. In the international portfolio, the rapid deteri- oration of emerging market economies caused a substantial increase in individual counterparty allowances and write-offs and / or country provi- sions, primarily in Asian markets, in Russia and to a smaller extent in Latin America. Overall credit risk costs amounted to CHF 4.3 billion, of which CHF 3.3 billion was funded from existing allowances, resulting in a net credit loss expense of CHF 951 million. Substandard (D2) Doubtful (D3) Loss (D4) Total 4,688 958 0 117 5,763 6,602 954 14 26 7,582 13,553 896 1 12 24,843 2,808 15 155 14,461 27,806 2 Market Risk Market risk is the risk which UBS faces as a result of adverse movements in the value of its foreign exchange, marketable securities and derivatives positions. UBS incurs market risk mainly through its trading activities, which are centered in the Warburg Dillon Read Division. UBS measures its exposure to market risk using the framework of expected loss, statistical loss and stress scenario loss as indicated in the chart on page 41. In the context of market risk, expected losses are the value adjustments made to the portfolio to adjust for price uncertainties resulting from a lack of market liquidity or the absence of a reliable market price for a particular instrument. Statistical loss is measured based on a value at risk (VaR) methodology, which is also used to calculate the regulatory capital require- ment for UBS’s market exposure. Stress scenario loss is defined as the risk of an extreme market move affecting particular predefined market vari- ables. In order to keep UBS exposure to market risk within acceptable boundaries, the BoD has set limits on the Group’s exposure to particular stress scenarios. UBS calculates the value at risk associated with its exposure to market risk and consequently also its regulatory capital requirement using the his- torical simulation technique. Value at risk is cal- culated both on a 1-day 99% confidence interval and a 10-day 99% confidence interval, and the latter is used both for internal limits setting and Credit Risk Costs by Division (1998) CHF million Counterparties Countries Total risk costs Funded through: Risk Pool UBS 96 Risk Pool SBC 96 (ACRA) Net credit loss expense Private & Corporate Clients Warburg Dillon Read Private Banking 2,980 – 2,980 1,331 1,252 397 812 422 1,234 – 728 506 48 – 48 – – 48 Total 3,840 422 4,262 1,331 1,980 951 40 Review of Risk Management and Control Expected, Statistical and Stress Scenario Loss Warburg Dillon Read Revenue and VaR (1998) Risk- adjusted outcome Expected outcome Outcome with predefined statistical probability e m o c t u o f o y c n e u q e r F Description of exposure type Measurement methodology Risk control action Expected loss Statistical loss «Outcome» Stress scenario loss Income Loss Expected cost of exposure to risk Average expected loss Acceptable exposure to possibility of loss Exposure to extreme events Value at risk methodology Stress loss scenario analysis Charged to P/L Controlled by use of VaR limits Protection provided by stress loss limits for calculating regulatory capital. The calculation incorporates both the risk from general market moves such as moves in foreign exchange rates, equity indices and market interest rates as well as the risk from price movements that are specific to an individual issuer. A simplified process was put in place from mid-February to estimate the value at risk for the combined exposures of Union Bank of Switzerland and Swiss Bank Corporation. A com- plete value at risk estimation process was however operational as from the date of the merger. UBS’s daily trading profit and loss and market risk exposure following the merger reflects the sig- nificant volatility which occurred in financial mar- kets between August and October. This was pri- marily associated with the Russian crisis in Sep- tember as a result of which emerging market debt traded at extremely low levels which in turn led to Warburg Dillon Read Daily Revenue Distribution (1998) Frequency in number of days CHF million 200 0 –200 –400 –600 –800 –1000 –1200 –1400 Six months ended 31 December 1998 10-day VaR 1-day VaR 1-day Revenue Capital unprecedented spikes in equity volatilities. The subsequent record one-day move in the USD / JPY exchange rate contributed further to market volatilities. During this period of adverse trading conditions there were three days when the daily loss exceeded the one-day value-at-risk measure. In response to these market conditions, UBS reduced its risk appetite and risk exposure. As a result, despite the widespread increase in the volatility of market prices, UBS’s overall VaR utilization fell from CHF 260 million at the end of June to CHF 214 million at year end. While UBS uses a value-at-risk measure as the principal measure of its exposure to day-to-day movements in market prices, the experience during the third quarter underlines the fact that these measures are not designed to give an indication of the scale of loss that could occur in the unusual case of extreme market moves. For this reason, UBS supplements its value-at-risk numbers with a system of stress loss simulations in order to moni- tor its potential exposure to this type of market 40 35 30 25 20 15 10 5 0 <–150 –150 to –120 –120 to –90 –90 to –60 –60 to –30 –30 to 0 0 to 30 30 to 60 60 to 90 90 to 120 120 to 150 >150 Revenue in CHF million Six months ended 31 December 1998 41 Review of Risk Management and Control Illustrative UBS Stress Scenario Market Moves Country Foreign exchange Europe North America Japan Emerging markets Price +/– 10% +/– 5% +/– 15% +/– 40% Interest rates Libor/Govt. + – 100 bps +/– 120 bps +/– 100 bps + 500 / – 300 bps Equity Price +/– 15% +/– 15% +/– 25% +/– 40% (+) = Market appreciation. (–) = Market depreciation. shock. These measures seek to assess the scale of loss which UBS might face in the event of large movements in a range of market prices such as equity indices, foreign exchange rates and interest rates. In the light of the events of the third quarter, UBS has revised the range of price changes which it uses to calculate the exposure to stress loss and has revised the relevant limit structures. UBS has a consistent set of predefined large price movements (shocks) which apply to all the major risk factors to which UBS is exposed. A sample list of the type of price changes which are used as the basis for calculating stress losses is shown in the above table. UBS also analyses the loss which it might face in the event of certain predefined combinations of adverse market moves. These scenarios, which are kept under constant review, include previous significant adverse market movements such as the European Monetary Union (EMU) crisis of 1993 and the more recent Asian and Russian crises as well as other possible combinations of events which might arise in the future. The purpose of this analysis is to ensure that the possible losses which UBS would face as a result of sharp adverse market moves remain within the overall stress loss limits which UBS has set for its exposure to market risk. 3 Operational Risks In addition to the risks discussed above, UBS recognizes the existence of a number of other risks which affect its business and which are often referred to as “operational risks”. At UBS we seek to identify the main factors which might adverse- ly affect the volatility of the Group’s earnings and to manage each of these factors through the es- tablishment of common Group-wide risk policies and measurement methodologies. The particular elements of operational risk which we have iden- tified and which are covered by this process are operations risk (sometimes referred to as transac- tion processing risk), legal risk, compliance risk, liability risk, information technology risk, key personnel risk and physical and crime risk. Following the announcement of the merger at the end of 1997, it was clear that UBS faced three challenges that would significantly increase its ex- posure to operations risk within a very short time horizon: the integration of the two banks’ organi- zations and infrastructures, the Euro implementa- tion and Year 2000 remediation.In order to address these challenges, a decision was reached at an early stage about the system architecture which would be employed following the merger. UBS has chosen to use the former Union Bank of Switzerland oper- ating platform within Switzerland and the SBC Monitoring Operations Risk in Warburg Dillon Read – Illustrative Statistics (1998) Number of fails / Nostro breaks Number of trades Jan Feb Mar Apr May Jun Jul Aug Sep Oct Nov Dec Fails Nostro breaks Trade volume 42 Review of Risk Management and Control Warburg Dillon Read platform outside Switzer- land. Following these decisions, a project manage- ment structure was established in each division to oversee the management of the three initiatives. Integration UBS recognized at the outset that there were significant risks associated with the merger process particularly in Private and Corporate Clients and Warburg Dillon Read. The approach adopted in managing these risks in Private and Corporate Clients is discussed on page 21. In Warburg Dillon Read the integration process placed significant demands on the IT infrastructure and overall transaction processes. The principal risk drivers were seen as being the significant increase in transaction volumes and the effect of staff instability on the control environ- ment surrounding the business processes. The recognition of this increase in potential risk meant that senior logistics and business management carried out a preemptive risk assessment and implemented a series of risk mitigation initiatives. Throughout this period the existence of a robust reporting framework within Warburg Dil- lon Read provided full transparency both pre- and post-integration, enabling operational risks to be identified and dealt with promptly. In addi- tion, before the integration date an assessment was made of the financial impact of the increased risk. This led to heightened management aware- ness of the potential cost of the integration process. These costs were realized in the course of 1998 or provided for in most locations and this process will be extended to all locations in 1999. The chart on page 44 shows an example of the types of key risk indicators which form part of the operations risk reporting framework. Euro and Year 2000 In addition to the need to manage the risks aris- ing from the merger, UBS also recognized the strategic importance of actively managing the inherent risks associated with the introduction of the Euro and the Year 2000 problem. Conse- quently, we accorded a very high priority to the work which was necessary to prepare for both of these events. Throughout 1998, projects were under way in each of the four divisions on both the Euro and the Year 2000. In addition, the risk issues associated with these projects were reviewed on a monthly basis by a Group-wide committee chaired by the Chief Risk Officer. Overall expen- diture on these two projects in 1998 amounted to CHF 169 million for the Euro and CHF 493 mil- lion for Year 2000 (projected cost for 1999: CHF 38 million and CHF 362 million, respectively). In preparation for the Euro conversion, a number of detailed dress rehearsals were con- ducted in the course of November and December 1998. As a result, the introduction of the Euro at the start of 1999 progressed extremely smoothly in all divisions. The work to amend the operating systems was undertaken according to plan. There were no material operational problems once deal- ing in the Euro started on 4 January 1999, put- ting UBS in a strong position to handle Euro busi- ness and to focus on other strategic initiatives. In the context of the Year 2000, UBS also made substantial progress in the course of 1998 in reme- diating and testing its own software and hardware. As the table on the page 44 shows, by the end of 1998, over 60% of the work on UBS’s critical sys- tems worldwide had been completed. UBS expects that work on the remaining critical systems will be substantially completed by mid-1999. However, UBS is also aware that the successful transition to the Year 2000 is dependent on UBS’s own suppliers and customers also having made appropriate preparations. In this context, UBS has taken an active role in encouraging its key suppli- ers to address the Year 2000 issue as actively as possible. As indicated on page 36, UBS has also undertaken an extensive review of its credit expo- sure both within Switzerland and internationally in order to assess the extent to which UBS might be exposed to loss in the event that its customers were themselves adversely affected by Year 2000- related issues. In the case of international cus- tomers where UBS has concerns about the cus- tomer’s preparedness, if after further investigation these have not been satisfactorily resolved, UBS will take appropriate measures to mitigate its risk. A similar review process is being undertaken to ensure that banks and depositories which UBS uses to conduct its international securities and payments activities are suitably prepared. Within Switzerland where UBS has a significant exposure to small and medium-sized enterprises Private and Corporate Clients Division is engaged in a program of customer awareness to encourage these customers to take the necessary steps to address the Year 2000 problem. In addition UBS will be undertaking a broad customer information 43 Review of Risk Management and Control Year 2000 Quantitative Progress Assessment for UBS 1 as at 31 December 1998; in % Phase Organization plans Current status Forecast 6.98 9.98 12.98 3.99 6.99 6.98 9.98 12.98 12.98 3.99 6.99 9.99 12.99 Developing a stra- tegic approach Creating organiza- tional awareness Assessing actions and developing detailed plans Renovating sys- tems, applications and equipment Validating renovation through testing Implementing tested, compliant systems 1 Mission critical systems. 100 100 100 100 94 98 99 100 89 95 98 99 100 58 76 95 99 100 52 68 87 89 98 100 24 64 88 96 100 21 41 68 74 93 100 20 54 79 92 100 17 38 61 69 89 97 99 100 program to provide the necessary information to reassure customers and counterparties about UBS’s own preparedness. This includes a website (http://www.ubs.com/y2k.html) which provides updated information on the UBS program in accordance with the standard for self disclosure established by the Global 2000 Co-ordinating Group. Despite the efforts that UBS is taking on its own account to limit its risk to Year 2000 related prob- lems, as an internationally active bank with activ- ities in a large number of countries, UBS is depend- ent on the preparations which are under way in these countries to ensure that the critical elements of the country’s infrastructure on which the finan- cial sector depends such as electricity, water and telecommunications supply are able to handle the Year 2000 date change satisfactorily. Our analysis shows that the state of awareness and preparation varies significantly from country to country. For this reason, UBS has taken a leading role in estab- lishing the Global 2000 Co-ordinating Group which is encouraging governments and key suppli- ers to address these issues as actively as possible. At the same time, since it is not possible for any firm to state that complete Year 2000 compliance has been achieved, and thus to guarantee the effec- tiveness of its remediation efforts, UBS recognizes the importance of preparing for the probability that some problems will arise in the transition to Year 2000. Accordingly, in the course of 1999, UBS will be devoting significant efforts to ensure that its con- tingency arrangements are as robust as possible. Measuring operational risks As an integral part of the Risk Management Framework UBS is in the process of introducing a generic operational risk modelling framework (which is illustrated in the simplified chart below). The framework, which consists of a number of sophisticated techniques, will provide a means to more accurately assess the level of risks faced and ensure that it is in line with UBS’s risk appetite and risk-bearing capacity. In addition, it can provide the foundation for evaluating the risk transfer mechanisms available to UBS. In particular, this approach enables UBS to evaluate whether the insurance market offers an appropriate option for transferring part of its operational risks. Generic Operational Risk Management Framework Risk modelling approach groups risks into Risk categories and identifies Exposure determining factors Risk measures Stress scenario loss Statistical loss Expected loss Risk management activities Monitor exposure Monitor limits Optimize risk profile Improve processes Obtain insurance 44 Review of Asset and Liability Management Review of Asset and Liability Management With its centralized approach to asset and lia- bility management, UBS ensures cost-efficient funding on a global scale for all UBS entities and adequate liquidity to ful- fill payment obligations even in periods of finan- cial stress. Other benefits include optimal allocation of capital to comply with Funding, capital and balance sheet manage- ment activities are centrally managed to optimize UBS’s financial resources. Centralizing Group- wide internal and external treasury functions provide the following advantages: – Overall Group funding costs are as low as possible. – Liquidity management within the Group is opti- mized. – Interest rate management is based on standard- ized risk processes and transfer pricing to allow cost-efficient risk management. – Currency management is optimized by capturing the netting potential of the Group’s foreign currency positions. – Regulatory capital requirements can be efficient- ly managed at all levels. The overarching goals shaping the basic funding, liquidity, interest rate, capital and foreign exchange management policies are: – Continued stability in financing. – Fostering the long-term, forward-looking man- agement of risk positions in the CFO area. regulatory requirements, – Compliance with legal and regulatory require- as well as efficient man- ments. agement of interest-sen- Funding and Liquidity Management sitive assets and liabilities, and exchange risk. 46 The aim of liquidity management is to ensure sufficient liquidity to repay debt in a timely man- ner, while preserving the option of exploiting potential strategic market opportunities. In order to comply at all times with its payment obliga- tions, UBS prudently manages its liquidity posi- tion for different scenarios, taking stress factors into due consideration. UBS analyzes the evolution of the liquidity profile over a time-frame of three months, with the heaviest emphasis on the first two weeks. The analysis gives assurance that the current liquidity position should be more than adequate to cover short-term liabilities even in difficult conditions. A significant stock of highly liquid and redis- countable securities is maintained that can be converted into cash at short notice at no signifi- cant market loss to the bank. Liability management ensures a cost-efficient and continuous financing of the balance sheet. The funding strategy is based on a broad array of sources, diversified by geographical, product, cur- rency, maturity, and other factors. This results in a well-balanced portfolio of liabilities that generates stable financing and helps the bank ride out mar- ket disruptions. To reduce reliance on unsecured short-term borrowing, short-term funding relies increasingly on collateralized borrowing, that is, repurchase and securities lending transactions. During 1998, UBS issued senior medium- and long-term debt totalling CHF 8.4 billion, compared to CHF 8.3 billion in 1997. Market turmoil during the months August, September and October made it difficult to raise more funding at the target costs. During 1998 medium- and long-term debt totalling CHF 4.7 billion matured. There was no issuance of lower Tier 2 debt this year, compared to CHF 2.9 billion in 1997. The bank did launch two asset- backed transactions, “Eisberg” and “TELL”, by which a loan portfolio of USD 2.5 billion and a mortgage portfolio of CHF 250 million were secu- ritized, releasing regulatory capital. Interest Rate Management including differences Interest rate risk is inherent to most UBS busi- nesses. Interest rate risks arise from a variety of in the timing factors, between the contractual maturity or repricing of assets, liabilities and derivative instruments. Net interest income is affected by changes in market interest rates, given that the repricing character- istics of loans and other interest-earning assets do not necessarily match those of deposits, other borrowings and capital. In the case of floating- rate assets and liabilities, UBS is also exposed to basis risk, which is the difference in repricing characteristics of two floating rate indices, such as the savings rate and six-month LIBOR. In addition, certain UBS products have embedded options that affect their pricing and principal. The CFO Area manages the Group’s non-trad- ing interest rate risk. With regard to interest rate risk, the Board of Directors reviews and approves risk management policies, risk limits and the con- trol framework. We have established a compre- hensive interest rate risk management process that identifies and monitors non-trading interest rate risk. A key element of this process is that it allows only a limited number of authorized busi- ness units to actively manage interest risk. The UBS approach is to capture all interest rate risks at business origination and allocate them either to Warburg Dillon Read’s trading book or to the Corporate Center’s bank book. This process is Review of Asset and Liability Management formalized by a Group-wide funds transfer pricing system, based on the following principles: – Synergies between the divisions are utilized whenever possible. – The interest rate risks of front units in all divi- sions are transfer-priced to central books by a uniform funds transfer pricing system at inter- nal bid/ask rates. – Interest rate risks are transferred whenever pos- sible directly into Warburg Dillon Read’s trad- ing book. – Interest rate risks associated with client busi- ness with undefined maturities are hedged by pooled transactions via the Corporate Center. – All interest rate risks which are neither product- nor trading-related are consolidated in the Corporate Center (such as the funding of bank premises). The above principles are implemented by segregating all transactions into three categories: (1) client business with fixed maturities (such as fixed-term mortgages), (2) client business with undefined maturities (such as saving accounts), and (3) non-interest-bearing or non-business bal- ance sheet items (such as bank premises, share- holders’ equity). Client business with fixed maturities: UBS policies require all transactions with determined roll-over or maturity dates to be matched back- to-back with Warburg Dillon Read’s trading book. IT systems ensure the on-line link between the client and the internal hedge transaction. This allows UBS to increase efficiency by capturing the netting potential between balance sheet and trad- ing products. In this way, fixed-rate balance sheet products become part of the trading book. Because the trading book positions are regulated by the Market Risk Management department of the Chief Risk Officer Area and Warburg Dillon Read, they are no longer subject to balance sheet management in the CFO Area. Client business with undefined maturities: These products have no contractual maturity date, their interest rates are not directly market- linked, and they may have various embedded options. Therefore, back-to-back hedges fail due to the lack of adequate hedging products and indices. To solve this problem, UBS has created replicating portfolios to approximate the cash flow behavior of these positions. Their function is to mirror the risk profile of complex, non- maturing client accounts and to translate them into portfolios of revolving fixed-rate trans- actions. Any core deposit behavior then becomes transferable and manageable. All replicating portfolios are pooled in the Corporate Center. The replicating portfolios are updated month- ly by adding new aggregated tranches to the maturing ones. Counterparties to the Corporate Center are either the divisions (such as Private Banking and Private and Corporate Clients for saving deposits) or service entities such as Corpo- rate Real Estate. Corporate Center itself hedges the bank book by means of internal transactions with the Warburg Dillon Read trading book. Owing to the large size of these transactions, these risks cannot be hedged instantly. Therefore, the CFO Area is also subject to risk limits in the process of bridging any mismatches between the replicating (benchmark) portfolios and the effec- tive hedge portfolios at Warburg Dillon Read. Resulting gains or losses are reported on an ac- crual basis in the financial statements. Non-interest-bearing or non-business balance sheet items: In contrast to the above-mentioned client businesses, non-interest-bearing or non- business balance sheet items, such as real estate and investments, bear no explicit interest rate risk. This is due to the fact that these items have neither a contractual maturity nor any link to market rates. Therefore, the effective maturities of these items are determined by the Group Exec- utive Board, which takes a strategic view on their assumed term to divestment. On the basis of this decision, all these items are also replicated by benchmark portfolios so as to initiate the respec- tive funding activity at the Corporate Center. The Group Executive Board also decides how to invest the bank’s equity, and the period of that investment. As at 31 December 1998 the bank’s equity has been invested in a portfolio of fixed- rate deposits with an average duration of 1.9 years. The net interest income of the bank is therefore affected by the actual average interest rate generated by these replicating portfolios. Currency Management As UBS operates in a CHF accounting envi- ronment, pays CHF dividends, and reports on a CHF basis, the CFO Area manages UBS on a CHF operational basis. Based on this, the corpo- rate currency management is designed as follows: 47 Review of Asset and Liability Management 48 Key Capital Figures and Ratios 31.12.1997 30.6.1998 31.12.1998 BIS Tier 1 capital (CHF million) BIS Total capital (CHF million) BIS Risk-weighted assets (CHF million) BIS Tier 1 ratio (in %) BIS Total capital ratio (in %) 28,749 43,089 345,904 8.3 12.6 30,549 44,085 345,680 8.8 12.8 28,299 40,385 288,296 9.8 14.0 Translation (balance sheet) currency risk: For- eign assets (business unit or non-financial assets) must be capable of being divested at any time without negative currency impacts. To eliminate foreign exchange impacts on investments/divesti- tures of such assets, UBS match-funds foreign currency assets in the respective currency. The match-funding principle is also applied to foreign investments (or foreign investments in third companies). This strategy, together with consistent foreign dividend / capital repatriation, ensures that UBS equity is invested in CHF. Transaction (revenues / costs) currency risk: As a management principle, internal budgets (expres- sed in CHF) must be comparable to current results (expressed in CHF) which means that a stabilized currency environment must be provid- ed for the management of the bank. The budget- ed annual foreign currency net profits in local (reporting) currency are managed centrally against the CHF within the given directives of the Group Executive Board. As UBS is managed on a global functional basis, the corresponding budget rates (implied from the budgeted annual foreign currency net profits in CHF) are used for the per- formance measurement of the divisions/business units during the financial year. This ensures that for internal comparability the reference currency is CHF for all divisions. During the year, actual results are continuously monitored and major budget deviations must be communicated to the CFO Area for adjustments to the opening posi- tions to enable the CFO Area to take the neces- sary pro-active steps to cover any open currency positions. Capital Management UBS manages its capital to maintain a Bank for International Settlements (BIS) Tier 1 ratio of 8.5% – 9.0%. UBS is in a healthy position with regard to its capital goals. Should additional cap- ital be required, it can be raised easily, thanks to the bank’s capital structure. UBS is regulated by the Swiss Federal Banking Commission (FBC) which has stricter capital requirements than the BIS. As a consequence, UBS’s risk-weighted assets according to the FBC rules are significantly higher than the internationally accept- ed BIS standards demand. Therefore, additional Tier 2 capital has been raised on occasion to satis- fy FBC requirements, although UBS satisfies the BIS requirement with its Tier 1 capital base alone. As can be inferred from the above table, UBS’s BIS Tier 1 ratio increased by 1.5 percentage points to 9.8% as of 31 December 1998 year-on-year. The significant reduction in the second half was mainly due to a reduction of the risk-weighted asset base following a down-sizing of the in- ternational loan book. (For more detailed infor- mation see also page 94, Note 34e Capital Adequacy.) Divisional capital allocation With regard to steering the divisions, UBS has a sophisticated value-at-risk system for trading risk in place at the divisional level. In addition, looking beyond capital allocation on a regula- tory level, we are continuously evolving models for economic capital allocation to provide a more consistent approach and a more meaning- ful basis for capital allocation than regulatory capital. Treasury stock Positions in treasury stock are held mainly to cover employee share plans and future acquisi- tions. Additionally, within the capital manage- ment process, treasury stock is one of the drivers used to fine-tune the capital requirement to BIS Tier 1 ratio targets. UBS will consider investments in its own shares for equity amounts exceeding its target BIS Tier 1 ratio range (8.5% – 9%). UBS Group Financial Statements UBS Group Financial Statements Table of Contents Financial Statements Table of Contents Group Financial Review Financial Statements Income statement Balance sheet Statement of changes in equity Statement of cash flows Notes to the Financial Statements 52 56 56 57 58 59 60 1 2 3 4 Summary of the significant accounting 60 policies and principles 64 Harmonization of accounting policies Segment reporting by business division 65 Segment reporting by geographical location 66 Income statement 5 6 7 8 Net interest income Net fee and commission income Net trading income Other income, including income from associates Operating expenses Earnings per share 9 10 Balance sheet: assets 11 Money market paper 12a Due from banks and loans to customers 12b Allowance for credit losses 12c Non-performing loans 13 Cash collateral on securities borrowed and lent Repurchase and reverse repurchase agreements Trading portfolio Financial investments Investments in associates Property and equipment Intangible assets and goodwill Other assets 14 15 16 17 18 19 20 50 67 67 67 68 68 69 69 70 70 70 71 72 73 73 73 74 74 75 75 75 UBS Group Financial Statements Table of Contents Balance sheet: liabilities 21 22 23 24 25 Due to banks and customers Long term debt Other liabilities Provisions, including restructuring provision Income taxes 75 75 76 79 79 80 Balance sheet: equity 26 Minority interests 27 Shareholders’ equity Off balance sheet and other information 28 29 30 31 32 33 34 Derivative instruments Pledged assets Fiduciary transactions Commitments and contingent liabilities Operating lease commitments Litigation, including Holocaust Financial instruments risk position Interest rate risk (a) Credit risk (b) Currency risk (c) Liquidity risk (d) (e) Capital adequacy (BIS) Fair value of financial instruments Retirement benefit plans and other employee benefits Equity participation plans Related parties Post balance sheet date events Significant subsidiaries and associates Significant currency translation rates Swiss banking law requirements The Year 2000 challenge 35 36 37 38 39 40 41 42 43 Report of the Group Auditors 81 81 81 83 83 86 86 87 88 88 89 89 90 92 93 94 95 97 99 100 100 101 103 104 105 106 51 UBS Group Financial Statements Group Financial Review Group Financial Review Overview – UBS Group realized a profit after taxes and minorities of CHF 3.0 billion in 1998. This compares to CHF 4.8 billion for the prior year, excluding the after-tax impact of the 1997 restructuring provision. – UBS’s return on equity for 1998 is 10.3%, com- pared to 14.5% in 1997 (adjusted for after-tax impact of the restructuring provision). – Total net operating income fell 10%, or CHF 2.6 billion, to CHF 22.3 billion in 1998. Excep- tional revenue losses incurred from Long Term Capital Management (LTCM) and other excep- tional items in trading income offset positive developments in net fee and commission income and the exceptional gain on the sale of BSI. – Total operating expenses before restructuring provision decreased 2%, or CHF 378 million, to CHF 18.3 billion year-on-year. This includes a CHF 842 million provision for the US settle- ment regarding the role of Swiss banks during and after World War II, as well as a total of CHF 662 million in costs associated with the Year 2000 and Euro projects. Merger-related cost reductions are estimated to have exceeded CHF 1 billion. – The cost-income ratio increased to 78.4% in 1998 from 71.2% in 1997 (adjusted for after- tax impact of restructuring provision). – Group-wide assets under management in- creased by a remarkable 4%, or CHF 60 bil- lion, to CHF 1.6 trillion, despite third-quarter market turbulence and some negative impact from the merger. Income Statement Net interest income Overall, net interest income showed a decline of approximately 4%, or CHF 274 million, to CHF 6.7 billion, year-on-year. The two major contributory factors are the divestitures of Prokredit and Aufina in Switzerland and a lower rate of return on invested equity. Credit loss expense The credit loss expense decreased by 26% to CHF 951 million in 1998 from CHF 1,278 mil- lion in 1997. The credit loss expense improved because of positive developments in the overall Swiss economic situation and tightened credit procedures at both predecessor banks in the past. This was offset in part by the rapid deterioration in emerging market economies which caused a substantial increase in individual counterparty allowances and/or country provisions. Total risk costs increased to CHF 4,262 million in 1998 from CHF 3,720 million in 1997. Total risk costs were funded by previously established allowan- ces of CHF 3,311 million in 1998 versus CHF 2,456 million in 1997. All but CHF 300 million of both predecessor banks’ 1996 Special Review Pools have been allocated to specific positions of the previously-defined workout portfolios. For more detailed information please see the discussion and table in the Review of Risk Man- agement and Control on pages 39–40. Net fee and commission income Net fee and commission income increased 3%, or CHF 392 million, to CHF 12.6 billion over 1997. Generally stable asset-related fees – includ- ing investment fund unit fees, portfolio and other management and advisory fees, custodian fees and fiduciary fees – increased around 23% as a result of strong marketing efforts, assets-under- management growth, and certain first-time con- solidations. Brokerage fees fell 12%, or CHF 475 million, to CHF 3.7 billion partly due to disappointing condi- tions in the second half and partly due to contin- ued conscious efforts to transfer revenue sources toward asset-related rather than transaction-relat- ed business through pricing and other measures. Underwriting and corporate finance fees remained mostly stable at CHF 1.6 billion. Income from credit-related fees and commis- sions decreased by 30%, or CHF 234 million, to CHF 559 million as emerging market exposures were reduced. Net trading income Net trading income fell by 68% to CHF 1,750 million compared to the prior year. Principal con- tributors to this were the exposure to the hedge fund Long Term Capital Management (LTCM) and the positions in the Global Equities Deriva- tives (GED) book. Please see the Review of Risk Management and Control for more detailed information. The reduction in net trading income was driv- en by the loss in fixed income due to the full-year 52 UBS Group Financial Statements Group Financial Review LTCM write-down of CHF 793 million and other losses in emerging markets. Equities fell 35% to CHF 0.7 billion as a result of the negative impact of the CHF 762 million in full-year 1998 losses from the GED portfolio. Foreign exchange and banknotes declined 23% to CHF 1.8 billion. Pre- cious metals and commodities also showed a decline of 89% to CHF 28 million due mainly to the wind-down of the latter business in Warburg Dillon Read (see pages 14–19). Other income, including income from associates Other income increased 50%, or CHF 744 mil- lion, to CHF 2.2 billion. Net income from invest- ments in financial assets increased strongly. The most significant contributory factor were gains on the divestment of several subsidiaries, including CHF 1.0 billion from BSI-Banca della Svizzera Italiana. Investment income from property, gains on the sale of private equity investments (UBS Capital), and net income from associated compa- nies also all showed significant increases. Eliminating the gain from the sale of BSI, other income would have fallen 18%, or CHF 270 mil- lion. This is mostly because of the remaining CHF 367 million write-down on LTCM and the write- down of CHF 75 million on the cross-sharehold- ing position with Long-Term Credit Bank of Japan. Personnel expenses Personnel expenses showed a substantial decrease of 15%, or 1.7 billion, to CHF 9.8 bil- lion in 1998. Decreases in personnel expenses were due to a significant headcount reduction resulting from the merger, several divestments and also to lower levels of incentive compensa- tion charged to the Income Statement on account of disappointing results. General and administrative expenses General and administrative expenses in- creased 24%, or CHF 1.3 billion, year-on-year. The reasons for this are, firstly, the CHF 842 mil- lion provision for the US settlement regarding the role of Swiss banks during and after World War II and, secondly, total costs associated with the Year 2000 and Euro projects (around 60% of a total CHF 662 million is booked under general and administrative expenses). Merger benefits have yet to be fully realized as the physical con- solidation of premises within Switzerland only started in the second half of 1998. Depreciation and amortization Depreciation and amortization increased 4%, or CHF 63 million, to CHF 1.8 billion over 1998. The reduction in property and equipment depre- ciation was more than offset by regular and some accelerated amortization of goodwill on several acquisitions including Brinson Partners, Bruns- wick in Russia and Omega in Brazil. Tax expense UBS Group incurred a tax expense of CHF 1,045 million. The effective tax rate is higher than in 1997 due to tax losses in locations where no tax benefit could be booked, as well as signif- icant deferred tax expenses arising from amorti- zation of deferred tax assets associated with the restructuring provision, allowances for credit losses and other provisions. Restructuring provision At the time of the merger, a restructuring pro- vision of CHF 7 billion was established to cover expenses resulting from reductions in personnel, elimination of duplicate IT infrastructures, merg- ing of bank premises and various other restruc- turing costs. Restructuring Provision Usage During 1998 CHF million Personnel Private and Corporate Clients Warburg Dillon Read Private Banking UBS Brinson UBS Capital Corporate Center Group total 82 1,750 104 14 2 72 2,024 IT 468 293 32 4 797 Premises Other Total usage 31.12.1998 11 4 252 267 156 339 7 437 939 717 2,382 147 18 2 761 4,027 53 During 1998, CHF 4 billion of the provision was utilized. CHF 2 billion were for personnel- related measures, including severance payments for redundancies made during the year, and spe- cial payments and lock-in agreements to maintain stability in the workforce during the vital inte- gration period. In addition, our budgets assumed a merger-related shortfall of investment banking net income in 1998. This shortfall did materialize in the third quarter and, in accordance with plan, the restructuring provision was utilized to fund a certain amount of performance-related compen- sation. CHF 797 million was applied toward inte- gration projects and write-offs of equipment no longer used, mostly at Warburg Dillon Read and Private and Corporate Clients. CHF 267 million was applied to the write-down in value of prem- ises no longer used, and CHF 939 million was for additional costs associated with exiting certain businesses, as well as merger administration costs. A full divisional breakout is shown above. UBS sees the CHF 7 billion as sufficient to cover merger-related expenses and expects to fully utilize this amount over the next two years. Balance Sheet Assets During 1998, total assets decreased by 13%, or CHF 142 billion to CHF 944.1 billion for three major reasons. First, UBS Group conscious- ly reduced its credit risk exposure mainly to international counterparties, which is reflected in a decrease of the total loan portfolio by 6%, or CHF 21 billion. The trading portfolio has been decreased by 23%, or CHF 48 billion in the sec- ond half of 1998 as a result of adjusting UBS mar- ket risk appetite. Market conditions also affected a change in our customers’ risk appetite. Further- more, financial investments decreased 46%, or CHF 5.8 billion, as a result of the sale of non-core businesses and the realization of certain private equity investments. Liabilities Due to customers decreased 9%, or CHF 28 billion, to CHF 275 billion. This is mainly caused by clients reallocating funds to other investment products due to low interest rates and the impact of the lower USD against the Swiss franc; a minor part of the decrease is due to client defections. Shareholders’ equity Shareholders’ equity increased by 5%, or CHF 1.5 billion, to CHF 32.4 billion in 1998 before dividend payments. Treasury shares amounted to CHF 1.5 billion in 1998, a decrease of 25% or CHF 500 million, year-on-year. Please refer to the capital management section of the Review of Assets and Liability Management Section on page 48. UBS Group Financial Statements Group Financial Review 54 UBS Group Financial Statements 55 UBS Group Financial Statements Financial Statements Financial Statements UBS Group Income Statement CHF million Operating income Interest income Less: Interest expense Net interest income Less: Credit loss expense Total Net fee and commission income Net trading income Other income, including income from associates Total Operating expenses Personnel General and administrative Depreciation and amortization Total Operating profit before restructuring costs and tax Restructuring costs Operating profit / (loss) before tax Tax expense / (benefit) Group profit / (loss) Less: Minority interests Net profit / (loss) Basic earnings per share (CHF) Diluted earnings per share (CHF) Note 1998 1997 Change % 5 6 7 8 9 9 9 25 26 22,835 16,173 6,662 951 5,711 12,626 1,750 2,241 22,328 9,816 6,617 1,825 18,258 4,070 4,070 1,045 3,025 ( 5) 3,030 14.31 14.23 23,669 16,733 6,936 1,278 5,658 12,234 5,491 1,497 24,880 11,559 5,315 1,762 18,636 6,244 7,000 ( 756 ) ( 105 ) ( 651 ) 16 ( 667 ) ( 3.18 ) ( 3.18 ) ( 834 ) ( 560 ) ( 274 ) ( 327 ) 53 392 ( 3,741 ) 744 ( 2,552 ) ( 1,743 ) 1,302 63 ( 378 ) ( 2,174 ) ( 4 ) ( 3 ) ( 4) ( 26 ) 1 3 ( 68 ) 50 ( 10 ) ( 15 ) 24 4 ( 2 ) ( 35 ) ( 7,000 ) ( 100 ) 4,826 1,150 3,676 ( 21 ) 3,697 17.49 17.41 – – – – – – – 56 UBS Group Financial Statements Financial Statements UBS Group Balance Sheet CHF million Note 1998 1997 Change % Assets Cash and balances with central banks Money market paper Due from banks Cash collateral on securities borrowed Reverse repurchase agreements Trading portfolio Positive replacement values Loans, net of allowance for credit losses Financial investments Accrued income and prepaid expenses Investments in associates Property and equipment Intangible assets and goodwill Other assets Total assets Total subordinated assets Liabilities Money market paper issued Due to banks Cash collateral on securities lent Repurchase agreements Trading portfolio liabilities Negative replacement values Due to customers Accrued expenses and deferred income Long term debt Other liabilities Total liabilities Minority interests Shareholders’ equity Share capital Share premium account Less: Treasury shares Foreign currency translation differences Retained earnings Total shareholders’ equity Total liabilities, minority interests and shareholders’ equity Total subordinated liabilities 11 12 13 14 15 28 12 16 17 18 19 20 21 13 14 28 21 22 23, 24, 25 26 27 3,267 18,390 68,495 91,695 141,285 162,588 169,936 247,926 6,914 6,627 2,805 9,886 2,210 12,092 4,638 36,353 66,582 82,656 216,355 210,738 149,538 270,917 12,693 7,712 2,724 10,964 1,430 13,114 (1,371 ) (17,963 ) 1,913 9,039 (75,070 ) (48,150 ) 20,398 (22,991 ) (5,779 ) (1,085 ) 81 (1,078 ) 780 (1,022 ) 944,116 1,086,414 (142,298 ) 496 2,357 (1,861 ) 51,527 85,716 19,171 137,617 47,033 205,080 274,850 11,232 50,783 27,722 55,600 159,634 14,140 191,793 68,215 170,162 302,516 9,956 54,284 28,154 (4,073 ) (73,918 ) 5,031 (54,176 ) (21,182 ) 34,918 (27,666 ) 1,276 (3,501 ) (432 ) 910,731 1,054,454 (143,723 ) 990 1,033 (43 ) 4,300 13,740 1,482 (456) 16,293 32,395 4,296 13,260 1,982 (111 ) 15,464 30,927 4 480 (500 ) (345 ) 829 1,468 944,116 1,086,414 (142,298 ) 13,652 14,375 (723 ) (30 ) (49 ) 3 11 (35 ) (23 ) 14 (8 ) (46 ) (14 ) 3 (10 ) 55 (8 ) (13 ) (79 ) (7 ) (46 ) 36 (28 ) (31 ) 21 (9 ) 13 (6 ) (2 ) (14 ) (4 ) 0 4 (25 ) 311 5 5 (13 ) (5 ) 57 UBS Group Statement of Changes in Equity CHF million 1998 1997 Shareholders’ equity at beginning of the year as previously reported by the combining banks: Former Union Bank of Switzerland Former Swiss Bank Corporation Total Changes at beginning of the year due to the harmonization of accounting policies Shareholders’ equity at beginning of the year restated for harmonization of accounting policies Currency translation differences Net profit / (loss) Dividends paid Capital increase / (repayment) Acquisition of Treasury Shares, cost Disposal of Treasury Shares, cost Premium on disposal of Treasury Shares Options and shares issued Premium from options and convertible bonds Reclassification of minority interests Other Total movements in shareholders’ equity during the year – – – – 22,707 11,742 34,449 (293 ) 30,927 34,156 (345) 3,030 (2,201) 4 (2,796) 3,296 369 0 111 0 0 (1,217) (44 ) (667 ) (800 ) (795 ) (3,172 ) 1,892 129 50 358 (175 ) (5 ) (2,518 ) Shareholders’ equity at the end of the year 32,395 30,927 UBS Group Financial Statements Financial Statements 58 UBS Group Statement of Cash Flows CHF million Cash flow from operating activities Net profit / (loss) Adjustments to reconcile to cash used in operating activities Non cash items included in net profit / (loss): Depreciation and amortization Provision for credit losses Income from associates Net gains included in cash flows from investing activities Increase / (decrease) in operating assets: Net due from (or to) banks Reverse repurchase agreements Trading portfolio Loans due to (or from) customers Accrued income, prepaid expenses and other assets Net increase / (decrease) in operating liabilities: Money market paper issued Repurchase agreements Accrued expenses, deferred income and other liabilities Net cash used in operating activities Cash flow from investing activities Purchase of investments in subsidiaries and associates Purchase of property and equipment Disposal of subsidiaries and associates Disposal of property and equipment Net (increase) / decrease in financial investments Net cash flow from (used in) investing activities Cash flow from financing activities Net movements in Treasury Shares Capital increase Capital repayment Dividends paid Premium on capital increase Issue of long-term debt Repayment of long-term debt Net cash flow from (used in) financing activities Effects of exchange rate differences Net increase / (decrease) in cash equivalents Cash and cash equivalents, beginning of year Cash and cash equivalents, end of year Cash and cash equivalents comprise: Cash and balances with central banks Money market paper Bank deposits maturing in less than 3 months Income taxes paid UBS Group Financial Statements Financial Statements 1998 3,030 1,825 951 (301) (1,803) (65,172) 66,031 41,488 (5,626) 2,107 (4,073) (49,145) 1,444 (9,244) (1,202) (1,818) 1,422 1,138 6,134 5,674 869 4 0 (2,201) 111 5,566 (9,068) (4,719) (386) (8,675) 92,354 83,679 3,267 18,390 62,022 733 1997 (667 ) 1,762 1,278 (432 ) (438 ) 22,503 (52,440 ) (38,388 ) 2,865 (1,385 ) 23,303 24,594 6,852 (10,593 ) (1,349 ) (1,785 ) 765 1,101 (731 ) (1,999 ) (1,151 ) 50 (795 ) (800 ) 358 17,155 (9,105 ) 5,712 (571 ) (7,451 ) 99,805 92,354 4,638 36,353 51,363 1,185 59 UBS Group Financial Statements Notes to the Financial Statements 60 Notes to the Financial Statements Note 1 Summary of the Significant Accounting Policies and Principles a) Basis of accounting The consolidated financial statements are stat- ed in Swiss francs, the currency of the country in which UBS is incorporated. The consolidated financial statements have been prepared in accor- dance with and comply with International Accounting Standards. UBS AG was formed on 29 June 1998 when Swiss Bank Corporation and Union Bank of Switzerland merged. The UBS consolidated financial statements were prepared using the pooling of interests method of accounting. Due to the merger, the Group harmonized its accounting policies which have then been retrospectively applied for the restatement of comparative infor- mation and opening retained earnings at 1 Janu- ary 1997. b) Consolidation method The Group consolidated financial statements comprise those of the parent company and its subsidiaries presented as a single economic enti- ty. Subsidiaries are companies which are directly or indirectly controlled by the Group. Sub- sidiaries acquired during the year are consolidat- ed from the date control passes. Companies which are acquired and held with a view to their subsequent disposal are recorded at the lower of cost or market value as financial investments. The effects of intra-group transactions are eliminated in preparing the Group financial statements. Equity and net income attributable to minority interests are shown separately in the balance sheet and income statement respectively. c) Offsetting Financial assets and financial liabilities are presented separately. Assets and liabilities are offset only when the Group has a legal right to offset amounts with the same counterparty, and transactions are expected to be settled on a net basis. d) Trade date/settlement date accounting When the Group becomes party to a contract in its trading activities it recognizes from that date (“trade date”) any unrealized profits and losses arising from revaluing that contract to fair value. These unrealized profits and losses are rec- ognized in the income statement. In addition to the trade date, spot and forward trading transactions involve a subsequent date (“settlement date”), which can vary between a number of days to many months. On the settle- ment date, the terms of the contract are fulfilled and a resulting financial asset or liability is rec- ognized on the balance sheet at the fair value of the consideration given or received. e) Foreign currency translation Foreign currency transactions are recorded at the rate of exchange on the date of the transac- tion. At the balance sheet date, monetary assets and liabilities denominated in foreign currencies are reported using the closing exchange rate. Exchange differences arising on the settlement of transactions at rates different from those at the date of the transaction, and unrealized foreign exchange differences on unsettled foreign curren- cy monetary assets and liabilities, are recognized in the income statement. Assets and liabilities of foreign entities are translated at the exchange rates at the balance sheet date, while income statement items and cash flows are translated at average rates over the year. Differences resulting from the use of these dif- ferent exchange rates are recognized directly in Currency translation differences within Sharehold- ers’ Equity. f) Business and geographical segments Business segments: for management purposes the Group is organized on a world-wide basis into five major operating businesses. The divisions are the basis upon which the Group reports its pri- mary segment information. Financial informa- tion on business segments is presented in Note 3. Intersegment transfers: Segment revenue, seg- ment expenses and segment performance include transfers between business segments and between geographical segments. Such transfers are accounted for at competitive market prices charged to unaffiliated customers for similar services. Those transfers are eliminated on con- solidation. The business and geographical segments are presented in accordance with IAS 14, Segment reporting, as revised 1997. UBS Group Financial Statements Notes to the Financial Statements g) Securities borrowing and lending Securities borrowed and lent that are collater- alized by cash are included in the balance sheet at amounts equal to the collateral advanced or received. Income arising from the securities lending and borrowing business is recognized in the income statement on an accrual basis. h) Repurchase and reverse repurchase transactions The Group enters into short-term purchases of securities under agreements to resell and sales of securities under agreements to repurchase sub- stantially identical securities. Securities, which have been sold subject to a repurchase agreement, continue to be recognized in the balance sheet and are measured in accordance with the accounting policy for trading balances or finan- cial assets as appropriate. The proceeds from the sale of these securities are treated as liabilities and included in Repurchase Agreements. Securities purchased subject to commitments to resell at a future date are treated as loans against that security and are included in Reverse Repurchase Agreements. Interest earned on reverse repurchase agree- ments and interest incurred on repurchase agree- ments is recognized as interest income and inter- est expense respectively over the life of each agreement. i) Trading portfolio The trading portfolio consists of debt and equity securities as well as of precious metals held to meet the financial needs of our customers and to take advantage of market opportunities. The trading portfolio is carried at fair value. Short positions in securities are reported as Trading portfolio liabilities. Realized and unrealized gains and losses, net of related transaction expenses, are recognized as Net trading income. Net trad- ing income also includes interest and dividend income as well as the funding costs for holding these positions. j) Loans and the allowance for credit losses Loans are initially recorded at cost. For loans originated by the bank, the cost is the amount lent to the borrower. For loans acquired from a third party the cost is the fair value at the time of acquisition. Interest income on an unimpaired loan is rec- ognized on an accrual basis. Interest includes the amount of amortization of any discount or pre- mium between the cost of a loan and its amount at maturity and the amortization of any loan fees and costs. An impairment in a loan is recognized when it becomes probable that the bank will not be able to collect all amounts due according to the con- tractual terms of the loan agreement. The carry- ing amount of the loan is reduced to its estimat- ed realizable value through a specific allowance. The impairment is recognized as an expense for the period. Loans are stated at their principal amount net of any allowance for credit losses. A loan is classified as non-performing when the contractual payments of principal and/or interest are in arrears for 90 days or more. After the 90 day period the recognition of interest income ceases and a charge is recognized for the unpaid and accrued interest receivable. A write-off is made when all or part of a loan is deemed uncollectible or in the case of debt for- giveness. Write-offs are charged against previ- ously established allowances and reduce the prin- cipal amount of a loan. Recoveries of loans writ- ten off in an earlier period are included in income. k) Financial investments Financial investments are debt and equity securities held for the accretion of wealth through distribution such as interest and dividends and for capital appreciation. Financial investments also include real estate held for sale. Debt securities held to maturity are carried at amortized cost. If necessary, the carrying amount is reduced to its estimated realizable value. Inter- est income on debt securities, including amorti- zation of premiums and discounts, is recognized on an accrual basis and reported as Net interest income. Financial investments held for sale are carried at the lower of cost or market value. Reductions to market value and reversals of such reductions up to cost as well as gains and losses on disposal are included in Other income. Interest earned and dividends received are included in Net interest income. Private Equity investments are carried at cost less write-downs for a non-temporary impair- ment in value. Reductions of the carrying amount and reversals of such reductions as well as gains 61 UBS Group Financial Statements Notes to the Financial Statements and losses on disposal are included in Other income. l) Investments in associates Investments in associates in which the Group has a significant influence are accounted for by the equity method. Investments in which the Group has a significant influence, but which are acquired and held with a view to their subsequent disposal are included in financial investments and recorded at the lower of cost or market value. Investments in companies where the parent company does not hold a significant influence are recorded at cost less value adjustments for per- manent declines in value. Interests in jointly controlled entities are reported using the equity method and recorded under investments in associates. m) Property and equipment Property and equipment includes properties, computer and telecommunications equipment as well as other equipment, fixtures and fittings. Property and equipment is carried at cost less accumulated depreciation. Property and equipment is depreciated on a straight-line basis over their estimated useful lives as follows: Buildings Not exceeding 50 years Furnishings and fixtures Not exceeding 10 years Leasehold and building improvements Equipment Not exceeding 10 years Not exceeding 5 years Major renewals and improvements are capi- talized, while maintenance and repairs are recog- nized as expenses as incurred. Building improve- ments are recorded under buildings, whereas leasehold improvements are recorded under equipment and furniture. n) Goodwill Goodwill represents the excess of the cost of an acquisition over the fair value of the Group’s share of the net assets of the acquired subsidiary or associate at the date of acquisition. Good- will is recognized as an asset and is amor- tized using the straight-line basis over its esti- mated useful economic life, normally 5 years and not more than 20 years. Goodwill and fair value adjustments arising on the acquisition of foreign subsidiaries are treated as local currency balances and are retranslated into Swiss francs at the closing rate at subsequent balance sheet dates. Negative goodwill is deferred and recognized in the income statement on a systematic basis over its estimated period of benefit, normally five years and not more than 20 years. o) Income taxes Income tax payable on profits, based on the applicable tax laws in each jurisdiction, is recog- nized as an expense in the period in which profits arise. The tax effects on income tax losses avail- able for carry-forward are recognized as an asset when it is probable that future taxable profit will be available against which those losses can be uti- lized. Deferred tax liabilities are recognized for tem- porary differences between the carrying amounts of assets and liabilities in the Group balance sheet and their amounts as measured for tax purposes, which will result in taxable amounts in future periods. Deferred tax assets are recognized for in temporary differences which will result deductible amounts in future periods, but only to the extent it is probable that sufficient taxable profits will be available against which these dif- ferences can be utilized. Deferred tax assets and liabilities are meas- ured at the tax rates that are expected to apply to the period in which the asset will be realized or the liability will be settled. Current and deferred tax assets and liabilities are offset when they arise from the same tax reporting group and relate to the same tax authority and when the legal right to offset exists. Current and deferred taxes are recognized as tax income or expense except for deferred taxes recognized or disposed of on the acquisition or disposal of a subsidiary. p) Own shares and options on own shares In the normal course of its equity trading and market making activities, the Group buys and sells UBS shares and options on those shares. These shares are held in Trading Assets similar to other trading securities, and are carried at fair value. Changes in fair value and dividends received on UBS shares in the trading portfolio are recognized as Net trading income. 62 UBS Group Financial Statements Notes to the Financial Statements In addition the Group holds its own shares for non-trading purposes, for instance employee compensation schemes and other strategic pur- poses. These shares are recorded within Treasury Stock and are deducted from Shareholders’ Equi- ty. Gains and losses on sales of Treasury Stock are recognized in Share Premium. Dividends relating to Treasury Stock shares are not recognized. Options on own shares for strategic purposes are recorded at market value under positive and negative replacement values. Gains and losses thereon are recognized in the share premium account. q) Retirement benefits The Group operates a number of funded re- tirement benefit plans which include characteris- tics of both defined benefit and defined contribu- tion plans. The Group’s minimum contributions to such plans are determined under the terms of the plan but the Group may be required to pro- vide additional funding, if necessary, to meet the level of benefits set out in the plan rules. Inde- pendent actuarial valuations are used to estimate the present value of the promised retirement ben- efits and of the plans assets. The Group also operates a number of defined contribution plans. Contributions to such plans are recognized as expenses in the period to which they relate. r) Derivative instruments Derivative instruments are carried at fair value on the balance sheet. The Group enters into derivative transactions including swaps, futures and option contracts in interest rate, foreign exchange, equity, precious metal and commodity markets. Fair values are obtained from quoted market prices, discounted cash flow models and option pricing models as appropriate. The fair values of derivative instruments are shown in the balance sheet as positive and negative replace- ment values. Gains and losses, realized and unre- alized, are recognized in net trading income as they arise. Valuation adjustments to cover credit and market liquidity risks as well as future administration costs have been made. Transactions in derivative instruments entered into for hedging of non trading positions are rec- ognized in the income statement on the same basis as to the underlying item being hedged. 63 Note 2 Harmonization of Accounting Policies The business combination of Union Bank of Switzerland and Swiss Bank Corporation was accounted for under the pooling of interest method of accounting. Under the pooling of interest method of accounting, a single uniform set of accounting policies was adopted and applied to all periods presented. As a result of harmonizing these policies, adjustments were required for the accounting for treasury shares, netting of balance sheet items, repurchase agree- ments, depreciation and employee share schemes. The impact on the financial statements is shown in the table below. Details of the shares issued to effect the pooling of interests are shown in Note 27. CHF million Shareholders’ equity as at 1 January 1997 Former Union Bank of Switzerland Former Swiss Bank Corporation Total Shareholders’ equity as previously reported Impact of accounting policy harmonization Shareholders’ equity restated as at 1 January 1997 Net loss for the 12 month period ended 31 December 1997 Former Union Bank of Switzerland Former Swiss Bank Corporation Total as previously reported Impact of accounting policy harmonization Net loss restated for the 12 month period ended 31 December 1997 Total assets as at 31 December 1997 Former Union Bank of Switzerland Former Swiss Bank Corporation Total assets as previously reported Impact of accounting policy harmonization Total assets restated as at 31 December 1997 1997 22,707 11,742 34,449 ( 293) 34,156 ( 129) ( 248) ( 377) ( 290) ( 667) 577,576 438,948 1,016,524 69,890 1,086,414 UBS Group Financial Statements Notes to the Financial Statements 64 UBS Group Financial Statements Notes to the Financial Statements Note 3 Segment Reporting by Business Division For the year ended 31 December 1998 Private Banking Warburg Private & Dillon Corporate Clients Read UBS Brinson UBS Corporate Center Capital CHF million Operating income Less: Credit loss expense 1 Total Personnel, general and administrative expenses Depreciation and amortization Total Segment performance before tax Tax expense / (benefit) Segment performance after tax Less: Minority interest Net profit / (loss) 7,223 26 7,197 2,605 256 2,861 4,336 737 3,599 0 3,599 6,987 500 6,487 6,984 524 7,508 (1,021) (306 ) (715) (9 ) (706) 7,025 1,170 5,855 3,999 948 4,947 908 154 754 0 754 Group Total 23,279 951 296 (745 ) 1,041 22,328 2,085 (15 ) 16,433 1,825 2,070 18,258 (1,029) 317 (1,346) 4 4,070 1,045 3,025 (5 ) (1,350) 3,030 585 0 585 152 5 157 428 15 413 0 413 1,163 0 1,163 608 107 715 448 128 320 0 320 800 724 Other information as at 31 December 1998 107,772 Total assets 2 Total liabilities 2 106,197 685,921 675,041 173,028 164,865 1,800 1,513 (25,205 ) (36,619 ) 944,116 911,721 1 In order to show the relevant divisional performance over time, adjusted expected loss figures rather than the net credit loss expense are reported for all business divisions. The statistically derived adjusted expected losses reflect the inherent counterparty and country risks in the respective portfolios. The difference between the statistically derived adjusted expected loss figures to the financially booked net credit loss expenses at Group level is reported in the Corporate Center. The divisional breakdown of the net credit loss expense of CHF 951 million as of December 1998 is as follows: Private Banking CHF 48 million, Warburg Dillon Read CHF 506 million, Private and Corporate Clients CHF 397 million. 2 The funding surplus / requirement is reflected in each division and adjusted in Corporate Center. To enable a more meaningful analysis of UBS’s results, the above business group results have been pre- sented on a management reporting basis. Consequently, internal charges and transfer pricing adjust- ments have been reflected in the performance of each business group. The basis of the reporting reflects the management of the business within UBS Group. For the year ended 31 December 1997 Private Banking Warburg Private & Dillon Corporate Clients Read UBS Brinson UBS Corporate Center Capital CHF million Operating income Less: Credit loss expense 1 Total Personnel, general and administrative expenses Depreciation and amortization Total Segment performance before tax Tax expense / (benefit) Segment performance after tax Less: Minority interest Net profit / (loss) 6,215 59 6,156 2,773 218 2,991 3,165 561 2,604 0 2,604 10,888 300 10,588 8,714 595 9,309 1,279 213 1,066 0 1,066 7,005 1,092 5,913 4,305 852 5,157 756 135 621 0 621 1,040 0 1,040 593 44 637 403 127 276 0 276 492 0 492 108 3 111 381 2 379 0 379 Group Total 26,158 1,278 518 (173 ) 691 24,880 381 50 431 260 357 (97) 16 (113) 16,874 1,762 18,636 6,244 1,395 4,849 16 4,833 1 Basically the same methodology as for the year 1998 Segment Reporting is applied. Due to the unavailability of some pre-merger data, management estimates had to be used. The results do not take into account the merger provision and the merger impact to taxes. The net loss of the whole Group including these items would be CHF (667) million. Private Banking and Pri- vate and Corporate Clients figures for 1997 were restated in order to properly reflect the new client segmentation (transfer of investment clients from Private Banking to Private and Corporate Clients). 65 UBS Group Financial Statements Notes to the Financial Statements Note 4 Segment Reporting by Geographical Location The geographical analysis of operating income, total assets and capital investment given below is based on the location of the office in which the transactions and assets are recorded. Because of the global nature of financial markets, the Group’s business is managed on an integrat- ed basis world-wide, with a view to profitability by product line. The geographical analysis of operating income, total assets and capital invest- ment is provided in order to comply with Inter- national Accounting Standards, and does not fairly reflect the way the Group is managed. Management believes that analysis by business division, as shown in Note 3 to these financial statements, is a more meaningful representation. For the year ended 31 December 1998 Total operating income Share % CHF m CHF m 221,945 409,780 216,989 95,402 75 8 11 6 Total assets Share % Capital investment Share % CHF m 24 43 23 10 234 767 513 304 13 42 28 17 100 100 944,116 100 1,818 Switzerland Europe / Africa / Middle East Americas Asia / Pacific Total 16,838 1,691 2,548 1,251 22,328 66 UBS Group Financial Statements Notes to the Financial Statements Income Statement Note 5 Net Interest Income CHF million 1998 1997 Interest income Interest earned on loans and advances to banks Interest earned on loans and advances to customers Interest from finance leasing Interest income from financial investments Dividend income from financial investments Other Total Interest expense Interest on amounts due to banks Interest on amounts due to customers Interest on medium and long-term debt Less: Refinancing costs for trading positions Total Total 7,361 14,111 60 293 79 931 22,835 7,879 9,890 5,045 6,641 16,173 6,662 4,031 17,565 90 460 38 1,485 23,669 7,247 10,074 4,468 5,056 16,733 6,936 Note 6 Net Fee and Commission Income CHF million 1998 1997 Credit-related fees and commissions Guarantee and letter of credit commissions Other Total Security trading and investment activities fees Underwriting and corporate finance fees Brokerage fees Fiduciary fees Custodian fees Portfolio and other management and advisory fees Investment funds Other 282 277 559 1,694 3,670 349 1,386 3,335 1,778 110 343 450 793 1,645 4,145 375 1,188 2,549 1,457 233 Total 12,322 11,592 Commission income from other services Total Commission expense Brokerage fees paid Other Total Total 776 704 327 1,031 12,626 784 694 241 935 12,234 67 Note 7 Net Trading Income CHF million Foreign exchange and bank notes Fixed income Equities Precious metals / commodities Total 1998 1,765 ( 762) 719 28 1,750 1997 2,306 1,843 1,098 244 5,491 Interest and dividends derived from the trading portfolio are included within Net trading income. The funding costs for holding these trading positions are charged to Net trading income and credited to Interest expense. Note 8 Other Income, including Income from Associates CHF million 1998 1997 Investments in financial assets (debt and equity) Net income from disposal of private equity investments Net income from disposal of other financial assets Gains / (losses) from revaluation of financial assets Subtotal Net income from disposal of consolidated subsidiaries Total Investments in property Net income from disposal of properties held for resale Gains / (losses) from revaluation of properties held for resale Subtotal Net income from properties, excluding properties held for resale Total Investments in associates Net income from investments in associates Gains / (losses) from the disposal of investments in associates Total Other Total 587 398 ( 556) 429 1,149 1,578 33 ( 106) ( 73) 328 255 377 ( 30) 347 61 2,241 418 338 ( 16 ) 740 154 894 20 ( 90 ) ( 70 ) 99 29 231 44 275 299 1,497 UBS Group Financial Statements Notes to the Financial Statements 68 UBS Group Financial Statements Notes to the Financial Statements 1998 7,203 535 421 614 201 842 9,816 822 390 820 759 262 537 1,792 1,235 6,617 1,483 342 1,825 18,258 1998 3,030 1997 8,932 365 536 580 143 1,003 11,559 830 460 819 794 306 528 1,464 114 5,315 1,623 139 1,762 18,636 1997 ( 667 ) 214,855,064 3,057,586 213,497,120 3,862,118 211,797,478 209,635,002 14.31 ( 3.18 ) 3,030 211,797,478 ( 667 ) 209,635,002 296,272 847,140 288,145 0 212,940,890 209,923,147 14.23 ( 3.18 ) Note 9 Operating Expenses CHF million Personnel expenses Salaries and bonuses Contractors Insurance and social contributions Contributions to retirement benefit plans Employee share plans Other personnel expenses Total General and administrative expenses Occupancy Rent and maintenance of machines and equipment Telecommunications and transportation Administrative expense Marketing and public relations Travel and entertainment Professional fees, including IT outsourcing Other Total Depreciation and amortization Property and equipment Intangible assets and goodwill Total Total operating expenses before restructuring Note 10 Earnings per Share Basic earnings per share calculation Net profit for the year (CHF million) Weighted average shares outstanding: Registered ordinary shares (nominal CHF 20) Less: Treasury Shares Weighted average shares for basic earnings per share (nominal CHF 20) Basic earnings per share (CHF) Diluted earnings per share calculation Net profit for the year (CHF million) Weighted average shares for basic earnings per share (nominal CHF 20) Add: Potential ordinary shares resulting from the issuance of outstanding options Potential ordinary shares relating to employee plans Weighted average shares for diluted earnings per share (nominal CHF 20) Diluted earnings per share (CHF) The weighted average number of shares is calculated based upon the average outstanding shares at the end of each month. All share amounts, including comparatives, are restated in terms of new UBS shares. 69 UBS Group Financial Statements Notes to the Financial Statements 70 Balance Sheet: Assets Note 11 Money Market Paper CHF million Swiss government treasury notes and bills Money market placements Other bills and cheques Total thereof eligible for discount at central banks 1998 9,568 8,262 560 18,390 16,512 1997 11,142 21,977 3,234 36,353 15,143 Note 12a Due from Banks and Loans to Customers The composition of the loan portfolio and the allowance for credit losses by type of exposure as at 31 December was as follows: CHF million Banks Less: Allowance for credit losses Total Non-banks Mortgages Other loans Subtotal Less: Allowance for credit losses Total Total net of allowance for credit losses thereof subordinated 1998 69,543 1,048 68,495 140,785 120,636 261,421 13,495 247,926 316,421 133 1997 67,310 728 66,582 146,802 139,128 285,930 15,013 270,917 337,499 146 The composition of the loan portfolio by geographical region based on the location of the borrower as at 31 December was as follows: CHF million Switzerland Europe / Africa / Middle East Americas Asia / Pacific Subtotal Less: Allowance for credit losses Total net of allowance for credit losses 1998 187,223 56,043 44,556 43,142 330,964 14,543 316,421 1997 353,240 15,741 337,499 UBS Group Financial Statements Notes to the Financial Statements Note 12a Due from Banks and Loans to Customers (continued) The composition of the loan portfolio by type of collateral was as follows: CHF million Secured by mortgages Collateralized by securities Guarantees and other collateral Unsecured Subtotal Less: Allowance for credit losses Total net of allowance for credit losses 1998 145,247 13,185 27,953 144,579 330,964 14,543 316,421 1997 153,235 11,278 33,482 155,245 353,240 15,741 337,499 Note 12b Allowance for Credit Losses The allowance for credit losses developed as follows: CHF million Balance at beginning of year Write-offs Recoveries Increase in for credit loss allowances Net foreign exchange and other adjustments 1 Balance at end of year 1 Includes allowance for doubtful interest of CHF 423 million. Specific Country risk provision allowances 14,566 2,312 59 710 70 13,093 1,175 9 1 422 (139) 1,450 Total 1998 1997 15,741 2,321 60 1,132 (69) 17,531 4,120 442 1,432 456 14,543 15,741 As at 31 December the aggregate allowances and provisions were apportioned and displayed as follows: CHF million As a reduction of due from banks As a reduction of loans to customers Subtotal Included in other business risk provision related to commitments and contingent liabilities and other Total aggregated allowances and provisions for credit losses 1998 1,048 13,495 14,543 435 14,978 1997 728 15,013 15,741 472 16,213 71 Note 12c Non-Performing Loans An analysis of changes in non-performing loans is presented in the following table: CHF million Non-performing loans at beginning of year Net additions Write-offs Non-performing loans at end of year 1 Estimate based on harmonization of non-performing loan methodology. 1998 16,664 1,861 2,808 15,717 The non-performing loans by type of exposure as at 31 December were as follows: CHF million Banks Non-banks Mortgages Other Subtotal Total non-performing loans 1 Estimate based on harmonization of non-performing loan methodology. 1998 204 9,280 6,233 15,513 15,717 19971 16,664 19971 16,664 The non-performing loans by geographical region based on the location of the borrower were as follows: CHF million Switzerland Europe / Africa / Middle East Americas Asia / Pacific Total non-performing loans 1 Estimate based on harmonization of non-performing loan methodology. 1998 14,023 352 1,066 276 15,717 1997 15,238 1 510 821 95 16,664 When principal and interest are overdue by 90 days, loans are classified as non-performing, the recognition of interest income ceases and a for recognized against charge income is the unpaid interest receivable. Non-performing loans are written down to their estimated recov- erable amount. Unrecognized interest related to such loans totalled CHF 423 million. UBS Group Financial Statements Notes to the Financial Statements 72 UBS Group Financial Statements Notes to the Financial Statements Note 13 Cash Collateral on Securities Borrowed and Lent CHF million Cash collateral by counterparties Banks Customers Total 1998 Securities borrowed 1998 Securities lent 1997 1997 Securities Securities lent borrowed 68,186 23,509 91,695 5,337 13,834 19,171 79,289 3,367 8,472 5,668 82,656 14,140 Note 14 Repurchase and Reverse Repurchase Agreements CHF million Agreements split by counterparties Banks Customers Total 1998 Reverse repos 1998 1997 Repos Reverse repos 1997 Repos 107,565 33,720 77,942 59,675 149,170 67,185 102,964 88,829 141,285 137,617 216,355 191,793 Note 15 Trading Portfolio Trading assets are carried at fair value. The following table presents the carrying value of trading account assets as at 31 December. CHF million Debt instruments Listed instruments (excluding own notes) Own medium-term notes Other unlisted instruments Total Equity instruments Listed instruments (excluding own shares) Own shares 1 Unlisted instruments Total Precious metals Total thereof eligible for discount at central banks 1 Number of registered shares 8,078,419 (1997: 598,495 [UBS], 3,034,660 [SBC]). 1998 1997 86,548 608 15,519 102,675 49,848 3,409 841 54,098 5,815 162,588 82,265 115,517 130 11,735 127,382 75,851 2,345 1,912 80,108 3,248 210,738 106,530 The Group trades debt, equity, precious met- als, foreign currency and derivatives to meet the financial needs of its customers and to generate revenue through its trading activities. Note 28 provides a description of the various classes of derivatives together with the related volumes used in the Group’s trading activities, whereas Notes 13 and 14 give further details about Re- pos and Reverse Repos and Securities Lent and Borrowed. 73 UBS Group Financial Statements Notes to the Financial Statements 74 Note 16 Financial Investments CHF million Debt instruments Listed Unlisted Total Equity instruments Listed Unlisted Total Private equity investments Properties held for resale Total thereof eligible for discount at central banks 1998 1,880 547 2,427 400 1,048 1,448 1,759 1,280 6,914 544 1997 5,386 3,227 8,613 699 866 1,565 1,286 1,229 12,693 4,213 The following table gives additional disclosure in respect of the valuation methods used. CHF million Valued in accordance with the accrual method Debt instruments Valued at the lower of cost or market value Debt instruments Equity instruments Properties held for resale Total Valued at cost less value adjustments for other than temporary impairments Private equity investments Total 1998 Book value Market value 1997 Book value Market value 1,530 1,551 8,613 8,687 897 1,448 1,280 3,625 1,759 6,914 907 1,552 1,369 3,828 2,574 7,953 – 1,565 1,229 2,794 – 1,574 1,229 2,803 1,286 12,693 1,903 13,393 Note 17 Investments in Associates CHF million Investments in associates (equity method) Other investments (carried at cost) Total Carrying amount at end of 1997 Equity share of profits Write-offs Additions Carrying amount at Disposals end of 1998 2,542 182 2,724 225 225 5 5 59 138 197 205 131 336 2,621 184 2,805 UBS Group Financial Statements Notes to the Financial Statements Note 18 Property and Equipment CHF million Bank premises 1 Other properties Equipment and furniture 2 Total 3 Accumulated depreciation at end of 1997 3,943 573 5,446 9,962 Historical cost 11,377 1,797 7,752 20,926 Carrying amount at end of 1997 7,434 1,224 2,306 10,964 Additions Disposals Depreciation, write-offs 109 152 1,552 1,813 617 133 56 806 354 97 1,634 2,085 Carrying Accumulated amount depreciation at end of 1998 at end of 1998 6,572 1,146 2,168 9,886 4,096 656 3,867 8,619 1 Depreciation of current year before release of CHF 121 million against restructuring provision. 2 Depreciation of current year before release of CHF 481 million against restructuring provi- sion. 3 Fire insurance value of property and equipment is CHF 14,941 million (1997: CHF 16,160 million). Note 19 Intangible Assets and Goodwill CHF million Intangible assets Goodwill Total Accumulated amortization at end of 1997 257 1,025 1,282 Historical cost 513 2,199 2,712 Carrying amount at end of 1997 256 1,174 1,430 Additions Disposals Amortization, write-offs Carrying Accumulated amount amortization at end of 1998 at end of 1998 59 1,307 1,366 19 225 244 44 298 342 252 1,958 2,210 301 1,323 1,624 During the year we purchased the remaining partnership interests in Brinson as well as UBS Brinson Asset Management Co. Ltd in Tokyo, Bank Omega (now Banco Warburg Dillon Read SA) in Brasil and a participation in Phildrew Ventures in London. The most significant disposal is the sale of UBS Asset Management (France) SA. Note 20 Other Assets CHF million Deferred tax assets 1 Settlement and clearing accounts Other Total 1 Additional tax information is provided in Note 25. Balance Sheet: Liabilities Note 21 Due to Banks and Customers CHF million Due to banks Amounts due to customers in the form of savings or deposits Other amounts due to customers Total due to customers Total 1998 1,205 5,542 5,345 12,092 1997 2,074 4,562 6,478 13,114 1998 85,716 79,723 195,127 274,850 360,566 1997 159,634 87,343 215,173 302,516 462,150 75 UBS Group Financial Statements Notes to the Financial Statements Note 22 Long Term Debt Publicly placed bond issues of UBS AG (parent company) outstanding at the end of 1998 Year of issue Interest rate in % Remarks Maturity Premature redemption possible Currency Amount in millions 1980 1986 1986 1989 1990 1990 1990 1990 1990 1990 1991 1991 1991 1991 1991 1991 1991 1991 1992 1992 1992 1992 1993 1993 1993 1993 1993 1993 1993 1994 1994 1994 1994 1994 1995 1995 1995 1995 1995 1995 1995 1995 1995 1995 1995 1995 1995 1995 1995 1995 1995 1995 1995 1995 1996 1996 3.750 5.000 3.000 6.375 7.000 7.250 0.000 7.500 0.000 6.750 7.500 7.000 5.000 7.000 7.000 4.250 6.750 6.750 7.250 7.000 7.500 7.000 4.750 4.875 4.000 3.500 5.125 3.000 2.750 6.250 2.000 4.500 5.000 5.375 7.000 8.000 5.250 8.750 5.750 4.500 8.750 5.500 6.750 7.375 7.500 4.500 7.000 2.500 4.000 5.625 5.000 5.250 5.000 4.375 3.500 2.000 Subordinated Subordinated Subordinated Subordinated Subordinated Subordinated Subordinated Subordinated Subordinated Subordinated Subordinated Subordinated Subordinated Subordinated Subordinated Subordinated Subordinated Subordinated Subordinated Subordinated Subordinated Subordinated Subordinated Subordinated Subordinated Subordinated Subordinated Subordinated Subordinated Subordinated 25.9.2000 10.2.2011 17.9.2001 21.12.1999 15.2.2000 15.3.2000 31.3.2020 7.6.2002 31.12.2019 31.7.2000 15.2.2003 4.9.2001 15.4.2001 20.2.2001 16.5.2003 25.6.2004 28.6.2001 20.9.2001 10.1.2004 6.2.2002 10.7.2002 16.10.2002 8.1.2005 3.3.2003 31.3.2003 31.3.2003 15.7.2001 26.11.2003 1.12.2000 6.1.2004 4.1.1999 5.5.1999 20.6.2000 7.9.2001 5.1.2000 17.2.1999 20.6.2003 20.6.2005 8.12.1999 21.12.2000 18.12.2025 15.2.2005 15.07.2005 15.7.2015 15.7.2025 21.11.2005 15.10.2015 18.10.2004 7.2.2005 13.4.2005 7.11.2006 18.7.2005 24.8.2005 7.11.2002 18.1.2000 23.8.2002 – 10.2.2001 17.9.1999 – – – – – – – 15.2.2001 – – 20.2.1999 16.5.2001 – 28.6.1999 20.9.1999 10.1.2002 – – – 8.1.2003 – – – – – – – – – – – – – – – – – – – – – – – – – – – – – – – – – CHF CHF CHF CHF CHF CHF CHF CHF CHF CHF CHF CHF CHF CHF CHF CHF CHF CHF CHF CHF CHF CHF CHF CHF CHF CHF CHF CHF CHF USD CHF CHF CHF CHF DEM USD CHF GBP DEM CHF GBP CHF USD USD USD CHF USD JPY CHF CHF CHF CHF CHF CHF CHF CHF 100 250 200 60 300 300 59.2 300 351 300 300 250 60 300 200 300 50 20 150 200 200 200 200 200 200 200 30 200 200 300 250 225 300 200 400 200 200 250 500 300 150 150 200 150 350 300 300 5,000 150 150 250 200 250 250 200 300.5 1, 17 2, 17 17 3, 17 17 17 3, 4, 17 17 3, 5, 17 18 17 17 17 18 18 18 18, 20 18, 21 17 18 18 18 18 18 18 18 18, 21 18 18 6, 17 18 18 18 18 6, 17 6, 17 6, 17 6, 17 6, 17 6, 17 6, 17 17 7, 17 7, 17 7, 17 17 7, 17 3, 6, 17 18 18 18 18 18 18 6, 17 6, 9, 17 For footnotes see next page. 76 UBS Group Financial Statements Notes to the Financial Statements Note 22 Long Term Debt (continued) Publicly placed bond issues of UBS AG (parent company) outstanding at the end of 1998 Year of issue Interest rate in % Remarks Maturity Premature redemption possible Currency Amount in millions 1996 1996 1996 1996 1996 1996 1996 1996 1996 1996 1996 1996 1996 1996 1996 1996 1996 1996 1997 1997 1997 1997 1997 1997 1997 1997 1997 1997 1997 1997 1997 1997 1997 1997 1997 1998 1998 1998 1998 1998 1998 1998 1998 1998 1998 1998 1998 1998 1998 1998 1998 3.000 6.000 4.750 6.500 6.250 4.000 4.000 7.250 7.750 1.500 5.750 5.750 3.250 4.250 3.625 3.125 2.500 7.250 7.375 6.000 10.625 6.500 15.000 6.750 1.000 1.250 1.000 1.750 1.000 1.750 1.500 8.000 5.750 7.375 5.875 9.150 9.700 10.250 9.000 11.500 10.000 7.500 1.625 7.000 7.500 8.000 8.000 5.750 1.000 1.000 3.500 Subordinated Subordinated Subordinated Subordinated Subordinated Subordinated Subordinated Subordinated Subordinated Subordinated 7.2.2001 29.3.1999 31.12.1999 16.7.1999 18.10.2002 14.2.2006 18.4.2002 3.9.2006 3.9.2026 20.11.2003 9.12.1999 9.12.2006 20.12.2002 6.2.2006 10.4.2001 22.12.1999 20.12.2000 15.7.2006 15.6.2017 24.7.2000 28.1.1999 4.7.2002 10.3.1999 25.2.2000 17.9.2002 5.11.2002 7.8.2002 30.4.2001 15.3.2001 25.7.2001 14.1.2003 8.1.2007 12.3.2007 26.11.2004 18.8.2009 27.3.2000 27.4.2000 8.9.2000 14.9.2000 9.10.2000 21.12.2000 11.5.2001 14.5.2003 18.5.2001 10.7.2001 3.8.2001 17.8.2001 18.3.2002 17.2.2003 12.3.2003 27.8.2008 Footnotes 1 Floating rate 2 At 1021/2% 3 Private placement 4 Issue price 17.45% 5 Issue price 19.27% 6 Issued by UBS Jersey Branch 7 Issued by UBS New York Branch 8 Convertible into SMI Index 9 With options on Nikkei 225 Index 10 Convertible into UBS Industrial Basket 11 Convertible into European Bank Basket 12 Convertible into European Insurance shares Basket 13 Convertible into Life Sciences Basket 14 Convertible into Eurotrack 100 Index 15 Convertible into Nikkei 225 Index 16 Indexed to UBS Currency Portfolio 17 Issued by former SBC 18 Issued by former UBS 19 Issued by UBS London Branch 20 Formerly Commercial Bank of Soleure 21 Formerly Regiobank beider Basel 22 Convertible into shares of ENI 23 Convertible into shares of Pirelli 24 GOAL on Daimler shares 25 GOAL on Rück shares 26 GOAL on CSG shares 27 GOAL on Pepsico shares 28 Convertible into UBS Oil Basket 29 GOAL on Novartis shares 30 GOAL on Roche GS 31 GOAL on UBS shares 32 GOAL on Zürich shares 33 Convertible into FTSE Index 34 Convertible into UBS Dutch Corporate Basket – – – – – – – – – – – – – – – – – – – – – – – – – – – – – – – – – – – – – – – – – – – – – – – – – – – USD USD DEM USD USD CHF CHF USD USD CHF USD DEM CHF CHF CHF CHF CHF USD USD USD CZK USD ZAR GBP DEM DEM DEM USD DEM USD DEM GBP DEM GBP FRF ITL ITL DEM CHF CHF USD CHF USD CHF CHF CHF CHF USD XEU NLG CHF 6, 17 6, 17 6, 17 6, 17 6, 17 17 17 7, 17 7, 17 6, 8, 17 6, 17 6, 17 17 18 18 18 18 7, 18 7, 17 6, 17 6, 17 6, 17 6, 17 6, 17 6, 10, 17 6, 11, 17 6, 12, 17 6, 13, 17 6, 14, 17 6, 15, 17 6, 16, 17 18, 19 18, 19 18, 19 18, 19 6, 22 6, 23 6, 24 6, 25 6, 26 6, 27 6, 25 6, 28 6, 29 6, 30 6, 31 6, 32 6 6, 33 6, 34 250 200 400 300 250 200 200 150 300 45 400 500 350 250 400 400 300 500 300 200 1,500 300 250 100 150 260 225 225 125 100 100 450 350 250 2,000 200,000 150,000 300 155 215 50 722 275 488 412.005 725 340 250 110 275 300 77 UBS Group Financial Statements Notes to the Financial Statements Note 22 Long Term Debt (continued) Publicly placed bond issues of UBS subsidiaries outstanding at the end of 1998 Year of issue Interest rate in % Remarks Maturity Premature redemption possible Currency Amount in millions 0.000 7.250 6.500 5.000 UBS Finance (Cayman Islands) Ltd., Grand Cayman 1991 1 1993 1 1994 1 1994 1 1997 1997 1997 1997 PIP on Biotech Basket GROI on Russian Basket PIP on Global Basket PIP on S & P UBS Australia Limited, Sydney 1 1997 3.250 28.2.2001 8.4.1999 7.7.1999 1.7.2000 14.5.1999 8.6.2000 20.7.1999 27.9.2000 2.10.2001 UBS Finance (Curaçao) N.V. Netherlands Antilles 1 1990 1992 1993 1995 1996 1996 1996 1997 1997 1997 1997 1998 9.125 FRN 5 9.250 6.500 2.500 6.000 2.500 2.500 0.000 2.750 5.875 0.000 8.2.2002 8.11.2002 23.8.2000 2.5.2000 30.10.2001 30.12.1999 1.3.2001 30.10.2001 29.1.2027 16.6.2002 30.12.1999 3.3.2028 UBS Bank (Canada), Toronto 1989 7.650 Solothurner Bank 1990 1991 7.25 6.5 S.G.W. Finance plc. 4 1991 13.25 S.G. Warburg Group plc 1994 1986 9.000 7.625 28.4.1999 30.5.1999 10.7.2001 21.3.2001 perpetual preference shares GBP 1.– CHF million Total bond issues Shares in bond issues of the Swiss Regional or Cantonal Banks’ Central Bond Institutions Medium-term notes Total – – – – – – – – – – – – – – – – – – – – – – GBP CAD NLG CHF USD USD USD USD 200 2 250 350 150 25.033 24.34 113.79 10 USD 100 USD USD ITL DEM DEM USD USD DEM ITL USD USD DEM 225 250 250,000 250 250 300 5 6 100 2,500,000 325 7 200 1,000 8 JPY 2,600 3 – 10.7.1999 – – CHF CHF AUD GBP GBP 45 80 60 125 10.934 42,124 2,571 6,088 50,783 Footnotes 1 Guaranteed by UBS 2 Zero coupon, issue price 36.55 % 3 Subordinated 4 Guaranteed by S.G. Warburg Group plc. 5 6 months Libor – 0.25% (minimum 5 %, maximum 8.25%) 6 Convertible into shares of Gillette Company 7 Convertible into shares of UBS 8 Zero coupon, issue price 15.68285% Protected Index Participation PIP GROI Guaranteed Return on Investment PEP GRIP Guaranteed Return on Investment Protected Equity Participation Participation 78 UBS Group Financial Statements Notes to the Financial Statements Note 23 Other Liabilities CHF million Provisions including restructuring provision 1 Tax liabilities 2 Settlement and clearing accounts Other liabilities Total 1998 7,529 2,028 9,502 8,663 27,722 1 Additional restructuring provision information is provided in Note 24. 2 Additional tax information is provided in Note 25. Note 24 Provisions, including Restructuring Provision Restructuring provision CHF million Balance brought forward at 1 January New provisions charged to income Provisions applied 1 Personnel IT Premises Other Total utilized during the year Balance at 31 December 1998 7,000 2,024 797 267 939 4,027 2,973 1 The expense categories refer to the nature of the expense rather than the income statement expense line. Other business risk provision CHF million Balance brought forward at 1 January New provisions charged to income Provisions applied Recoveries of previous write-offs 1 Balance at 31 December Total 1 Includes foreign currency translation differences and other adjustments. 1998 1,614 2,952 487 477 4,556 7,529 1997 8,614 2,690 8,601 8,249 28,154 1997 – 7,000 0 7,000 1997 1,521 177 222 138 1,614 8,614 Provision for restructuring costs At the time of the merger, it was announced that the merged bank’s operations in various locations would be combined, resulting in vacant properties, reductions in personnel, elimination of redundancies in the information technology platforms, exit costs and other costs. As a result, the individual banks estimated that the cost of the post-merger restructuring would be approxi- mately CHF 7 billion, to be expended over a period of four years. During 1998, the bank utilized CHF 4 billion of the provision. At year end 31 December 1998, the bank estimates that the remaining provision of CHF 3 billion is reasonable to cover the remaining costs associated with the merger restructuring. 79 Note 25 Income Taxes Tax liabilities CHF million Current tax liabilities Deferred tax liabilities Total 1998 1,016 1,012 2,028 1997 1,195 1,495 2,690 The table below presents the significant components of deferred tax assets and liabilities: Deferred tax assets CHF million Temporary differences on: Compensation and benefits Restructuring provision Allowance for credit losses Tax losses recognized as assets Others Deferred tax assets Deferred tax liabilities CHF million Temporary differences on: Property, equipment Investments in associates Unremitted earnings Other provisions Gains on debt and equity investment securities Others Deferred tax liabilities 1 Includes decrease due to disposal of subsidiaries. Income Translation/ 31.12.97 statement other adj. 31.12.98 58 1,100 479 234 203 2,074 18 ( 382) ( 253) ( 176) ( 94) ( 887) ( 10) – 5 4 19 66 718 231 62 128 18 1,205 Income Translation/ 31.12.97 statement other adj. 31.12.98 602 277 10 501 69 36 1,495 ( 120) 12 – ( 274) 4 ( 18) ( 396) 2 – – ( 118) 30 ( 1) 1 484 289 10 109 103 17 ( 87) 1,012 Undistributed earnings of subsidiaries for which taxes have not been provided, amounted to CHF 2,731 million and CHF 3,451 million at 31 December 1998 and 1997 respectively. No significant additional tax liability is expected to arise on any distribution of these earnings. UBS Group Financial Statements Notes to the Financial Statements 80 UBS Group Financial Statements Notes to the Financial Statements Note 25 Income Taxes (continued) Tax expense CHF million Current taxes Swiss Foreign Total current taxes Deferred taxes Income tax expense / (benefit) 1998 354 200 554 491 1,045 1997 511 419 930 ( 1,035 ) ( 105 ) A reconciliation of the expected income tax expense / (benefit) computed at the applicable rate in each jurisdiction to the effective income tax expense / (benefit) is shown in the following table: CHF million Operating profit / (loss) before income taxes Expected income tax expense at the applicable rates 1 Increase or (decrease) resulting from: Tax losses not recognized Tax losses of previous periods now recognized Non-taxable income Non-deductible expenses Adjustments related to prior years Capital taxes Deferred tax assets not recognized Income tax expense / (benefit) 1998 4,070 1,104 1,436 ( 142) ( 1,849) 172 7 93 224 1,045 1997 ( 756 ) ( 192 ) 310 ( 201 ) ( 333 ) 171 ( 27 ) 96 71 ( 105 ) 1 The expected income tax expense for the Group is an aggregate of individual amounts representing the mix of profits and losses and the applicable tax rates in each jurisdiction. The amounts and expiry dates of unused tax losses carried forward which have not been recognized as assets, are as follows: CHF million Following year Next three years After four years Total Balance Sheet: Equity Note 26 Minority Interests CHF million Minority interests in profit / (loss) Preferred stock 1 Minority interests in equity Total minority interests 1998 0 118 6,664 6,782 1998 (5) 689 306 990 1997 122 46 1,917 2,085 1997 16 870 147 1,033 1 Represents Auction Market Preferred Stock, issued by UBS Inc., New York, a subsidiary whose ordinary share capital is completely owned by UBS. 81 UBS Group Financial Statements Notes to the Financial Statements 82 Note 27 Shareholders’ Equity CHF million Issued and paid up share capital 214,976,306 ordinary registered shares of CHF 20 each, fully paid Less: Treasury shares, cost Balance as at beginning of the year Acquisitions Disposals Balance at the end of the year Total outstanding share capital Share premium account Balance at the beginning of the year restated for the harmonization of accounting policies Premium on shares issued, warrants exercised Premium on disposal of Treasury Shares Balance at the end of the year Foreign currency translation differences Balance at the beginning of the year Movements during the year Balance at the end of the year Retained earnings Balance at the beginning of the year restated for the harmonization of accounting policies Net profit / (loss) for the year Dividends paid Balance at the end of the year Total shareholders’ equity 1998 4,300 1,982 2,796 (3,296) 1,482 2,818 13,260 111 369 13,740 (111) (345) (456) 15,464 3,030 (2,201) 16,293 32,395 1997 4,296 702 3,172 (1,892 ) 1,982 2,314 13,001 130 129 13,260 (155 ) (44 ) (111 ) 16,931 (667 ) (800 ) 15,464 30,927 its On 1 October 1997, the share capital was increased from initial capitalization of CHF 50,000 by CHF 4,287,469,820 being 214,373,491 registered shares at CHF 20 each to CHF 4,287,519,820. The new shares were issued exclusively for the exchange of the existing shares of Swiss Bank Corporation and Union Bank of Switzerland. Pursuant to the merger the share- holders of both combining banks exchanged their shares for shares in the new bank. Union Bank of Switzerland shareholders received 5 reg- istered shares for each bearer share held and 1 registered share for each registered share held. Swiss Bank Corporation shareholders received 11/13 registered shares of the new bank for each Swiss Bank Corporation registered share held. UBS AG absorbed all the assets and liabilities of the combining banks. The combined share capital amounted to CHF 5,754,937,280. As a result of shares CHF 1,467,417,460 were transferred from share cap- ital to the share premium account. the exchange of There are no preferential rights and restric- tions with respect to the distribution of dividends and to the repayment of capital except that retained earnings in the amount of CHF 13,816 million (1997: CHF 12,515 million) must be held in the form of a legal reserve. In addition to the issued and paid up share capital 999,229 shares are unissued and are reserved for the employee share ownership plan and optional dividend war- rants (1997: 1,339,312 unpaid SBC ordinary reg- istered shares). A further 526,541 shares are at the disposal of the Board of Directors (1997: 70,718 UBS unissued ordinary bearer shares and 172,951 UBS unissued ordinary registered shares). These shares represent the maximum amount of shares that may be issued in the future without fur- ther approval from the shareholders. Comparative figures for the number of shares issued as at 31 December 1997 are not provided as no shares were issued by UBS AG at this date. The Swiss franc figure has been restated for comparative purposes only. Movements in the issued share capital are due to the issuance of shares to fulfill existing commitments. UBS Group Financial Statements Notes to the Financial Statements Off Balance Sheet and Other Information Note 28 Derivative Instruments Derivatives held or issued for trading purposes Most of the Group’s derivative transactions relate to sales and trading activities. Sales activi- ties include the structuring and marketing of derivative products to customers at competitive prices to enable them to transfer, modify or re- duce current or expected risks. Trading involves market making, positioning and arbitrage activi- ties. Market making involves quoting bid and offer prices to other market participants with the intention of generating revenues based on spread and volume. Positioning involves managing mar- ket risk positions with the expectation of profit- ing from favourable movements in prices, rates or indices. Arbitrage activities involve identifying and profiting from price differentials between markets and products. Derivatives held or issued for non-trading purposes The Group also uses derivatives as a part of its asset/liability management activities. The majority of derivative positions used in UBS’s asset and liability management activities are established via intercompany transactions with independently managed UBS dealer units within the Group. When the Group purchases assets and issues liabilities at fixed interest rates it subjects itself to fair value fluctuations as market interest rates change. These fluctuations in fair value are man- aged by entering into interest rate contracts, mainly interest rate swaps which change the fixed rate instrument into a variable rate instrument. When the Group purchases foreign currency issues foreign currency denominated assets, denominated debt or has foreign net investments, it subjects itself to changes in value as exchange rates move. These fluctuations are managed by entering into currency swaps and forwards. Type of derivatives The Group uses the following derivative finan- cial instruments for both trading and non-trading purposes: Swaps Swaps are transactions in which two parties exchange cash flows on a specified notio- nal amount for a predetermined period. Interest rate swap contracts generally repre- sent the contractual exchange of fixed and float- ing rate payments of a single currency, based on a notional amount and an interest reference rate. Cross currency interest rate swaps generally involve the exchange of payments which are based on the interest reference rates available at the inception of the contract on two different cur- rency principal balances that are exchanged. The principal balances are re-exchanged at an agreed upon rate at a specified future date. Forwards and futures Forwards and futures are contractual obligations to buy or sell a finan- cial instrument on a future date at a specified price. Forward contracts are effectively tailor- made agreements that are transacted between counterparties in the over-the-counter market, whereas futures are standardized contracts that are transacted on regulated exchanges. Options Options are contractual agree- ments under which the seller (writer) grants the purchaser the right, but not the obligation, either to buy (call option) or sell (put option) by or at a set date, a specified amount of a financial instru- ment at a predetermined price. The seller receives a premium from the purchaser for this right. 83 UBS Group Financial Statements Notes to the Financial Statements Note 28 Derivative Instruments (continued) Notional amounts and replacement values The following table provides the notional amounts and the positive and negative replace- ment values of the Group’s derivative transac- tions. The notional amount is the amount of a de- rivative’s underlying asset, reference rate or index and is the basis upon which changes in the value of derivatives are measured. It provides an indication of the volume of business trans- acted by the Group but does not provide any measure of risk. Some derivatives are standardized in terms of their nominal amounts and settlement dates, and these are designed to be bought and sold in active markets (exchange traded). Others are packaged specifically for individual customers and are not exchange traded although they may be bought and sold between counterparties at negotiated prices (over-the-counter or OTC instruments). Positive replacement value represents the cost to the Group of replacing all transactions with a receivable amount if all the Group’s counterpar- ties were to default. This measure is the industry standard for the calculation of current credit exposure. Negative replacement value is the cost to the Group’s counterparties of replacing all the Group’s transactions with a commitment if the Group were to default. The total positive and negative replacement values are included in the balance sheet separately. 84 UBS Group Financial Statements Notes to the Financial Statements Note 28 Derivative Instruments (continued) Term to maturity CHF million Interest rate contracts Over-the-counter (OTC) contracts Forward contracts including FRAs Swaps Options purchased Options written Exchange-traded contracts 3 Futures Options Total Foreign exchange contracts Over-the-counter (OTC) contracts Within 3 months NRV 2 PRV 1 3–12 months NRV PRV 1–5 years NRV PRV over 5 years NRV PRV Total PRV Total NRV Total notional amount CHF bn 783 3,488 233 932 4,502 327 309 6,657 465 271 6,024 615 45 36,464 2,947 29 35,799 4,476 42 38,056 3,207 23 34,758 4,427 1,179 84,665 6,852 0 1,255 81,084 0 9,845 217.7 8,544.0 1,264.8 1,254.4 12 0 7 0 0 0 1 0 2 0 0 0 0 0 0 0 14 0 7 0 732.3 77.8 4,517 5,768 7,430 6,911 39,458 40,304 41,305 39,208 92,710 92,191 12,091.0 Forward contracts Combined interest and currency swaps Options purchased Options written 3,439 2,456 4,718 498 3,009 17,168 6,493 1,718 10,123 9,455 2,683 218 278 4,626 1,945 261 5,202 619 164 4,974 604 237 5,097 604 10,375 13,775 17,390 0 10,451 15,991 0 18,610 888.4 235.4 466.8 455.1 Exchange-traded contracts 3 Futures Options Total Precious metals contracts Over-the-counter (OTC) contracts Forward contracts Options purchased Options written Exchange-traded contracts 3 Futures Options Total Equity / Index contracts Over-the-counter (OTC) contracts Forward contracts Options purchased Options written Exchange-traded contracts 3 Futures Options Total Commodity contracts Over-the-counter (OTC) contracts Forward contracts Options purchased Options written Exchange-traded contracts 3 Futures Options Total Total 1998 Total 1997 0 156 0 120 0 193 0 0 0 0 0 5 0 0 0 0 0 348 0 124 2.5 5.2 10,770 20,794 18,528 12,356 6,849 6,087 5,742 5,938 41,889 45,175 2,053.4 4,539 2,840 4,633 2,915 0 4 0 0 7,383 7,548 216 24 0 15 254 295 6 0 0 75 41 0 2 60 0 0 0 301 119 60 10 0 0 0 10 0 0 0 0 0 4,840 2,905 0 4,988 0 2,921 0 21 0 0 47.7 25.3 30.9 1.2 5.0 7,766 7,909 110.2 279 8,220 383 15,347 325 4,619 608 8,480 791 8,700 2,421 25,726 159 1,687 446 4,598 1,554 23,227 0 3,858 0 54,151 57.3 706.0 233.6 3 320 15 242 0 703 0 392 0 754 0 305 0 75 0 9 3 1,851 15 948 17.7 62.0 8,822 15,988 5,647 9,480 10,245 28,452 1,921 5,053 26,635 58,972 1,076.6 114 8 0 0 52 0 0 0 122 52 244 62 85 0 391 214 70 65 7 325 24 0 2 359 0 0 0 355 352 359 65 5 0 0 70 66 0 0 0 66 749 99 0 85 2 936 691 0 70 65 7 8.9 1.5 1.5 2.2 0.9 832 14.9 31,614 50,150 32,251 29,404 57,023 75,261 49,048 50,265 169,936 205,080 – – – – – – – – 149,538 170,162 – – 85 1 PRV: Positive replacement value. 2 NRV: Negative replacement value. 3 Exchange-traded products include proprietary trades only. UBS Group Financial Statements Notes to the Financial Statements Note 29 Pledged Assets Assets pledged or assigned as security for liabilities and assets subject to reservation of title CHF million Money market paper Mortgage loans Securities 1 Property and equipment Other Total 1998 Carrying amount 1998 Related liability 1997 Carrying amount 1997 Related liability 6,981 2,955 13,902 147 0 23,985 5 2,047 5,636 71 0 7,759 3,188 1,951 13,175 183 7 1,106 1,220 9,719 112 0 18,505 12,157 1 Excluding securities pledged in respect of securities borrowing and repurchase agreements. Assets are pledged as collateral for collateralized credit lines with central banks, loans from central mortgage institutions, deposit guarantees for savings banks, security deposits relating to stock exchange membership and mortgages on the Group’s property. Note 30 Fiduciary Transactions CHF million Placements with third party banks Fiduciary credits and other fiduciary financial transactions Total 1998 60,612 652 61,264 1997 72,852 1,392 74,244 86 UBS Group Financial Statements Notes to the Financial Statements Note 31 Commitments and Contingent Liabilities CHF million Contingent liabilities Credit guarantees and similar instruments 1 Less: Sub-participations Total Performance guarantees and similar instruments 2 Less: Sub-participations Total Irrevocable commitments under documentary credits Less: Sub-participations Total Total contingent liabilities Less: Sub-participations Total Irrevocable commitments Undrawn irrevocable credit facilities Less: Sub-participations Total Liabilities for calls on shares and other equities Total irrevocable commitments Less: Sub-participations Total Commitment credits 3 Total commitments and contingent liabilities Less: Sub-participations Total 1998 1997 22,697 5,217 17,480 12,092 216 11,876 2,942 39 2,903 37,731 5,472 32,259 82,337 26 82,311 109 82,446 26 82,420 1,807 121,984 5,498 116,486 37,306 8,274 29,032 15,371 1,002 14,369 5,824 11 5,813 58,501 9,287 49,214 76,997 554 76,443 102 77,099 554 76,545 821 136,421 9,841 126,580 1 Credit guarantees in the form of bill of exchange and other guarantees, including guarantees in the form of irrevocable letters of credit, endorsement liabilities from bills rediscounted, advance payment guarantees and similar facilities. 2 Bid bonds, performance bonds, builders’ guarantees, letters of indemnity, other performance guarantees in the form of irrevocable letters of credit and similar facilities. 3 Obligations under deferred payments, acceptance obligations. Amounts already included in the balance sheet. CHF million Overview of collateral Contingent liabilities Irrevocable commitments Liabilities for calls on shares and other equities Commitment credits Total 1998 Total 1997 Mortgage collateral Other collateral Unsecured Total 339 50 – – 389 635 14,163 19,200 – – 33,363 22,638 23,229 63,087 109 1,807 37,731 82,337 109 1,807 88,232 121,984 113,148 136,421 Commitments and Contingencies represent potential future liabilities of the Group resulting from credit facilities available to clients, but not yet drawn upon by them. They are subject to expiration at fixed dates. The Group engages in providing open credit facilities to allow clients quick access to funds required to meet their short- term obligations as well as their long-term financ- ing needs. The credit facilities can take the form of guarantees, whereby the Group might guaran- tee repayment of a loan taken out by a client with a third party; standby letters of credit, which are credit enhancement facilities enabling the client to engage in trade finance at lower cost; docu- mentary letters of credit, which are trade finance- related payments made on behalf of a client; com- mitments to enter into repurchase agreements, which are described under short-term financing; note issuance facilities and revolving underwrit- ing facilities, which allow clients to issue money 87 UBS Group Financial Statements Notes to the Financial Statements 88 Note 31 Commitments and Contingent Liabilities (continued) market paper or medium-term notes when need- ed without engaging in the normal underwriting process each time. The figures disclosed in the accompanying tables represent the amounts at risk should clients draw fully on all facilities and then default, and there is no collateral. Determination of the cred- itworthiness of the clients is part of the normal credit risk management process, and the fees charged for maintenance of the facilities reflect the various credit risks. Note 32 Operating Lease Commitments Our minimum commitments for non-cancellable leases of premises and equipment are presented as follows: CHF million Operating leases due: Not later than one year Later than one year and not later than five years Later than five years Total commitments for minimum payments under operating leases 1998 709 555 1,541 2,805 Operating expenses include CHF 797 million and CHF 829 million in respect of operating lease rentals in 1998 and 1997 respectively. Note 33 Litigation, including Holocaust Four Class Actions, in relation to what is known as the Holocaust affair, have been brought against the bank (as legal successor to SBC and UBS) in the US District Court for the Eastern District of New York (Brooklyn). A fur- ther Swiss bank has been designated as a defen- dant alongside the bank. On 12 August 1998, however, a settlement was reached between the parties which will put an end to all the litigation involved in this matter. This settlement provides for a payment by the defendant banks to the plaintiffs, under certain terms and conditions, of an aggregate amount of USD 1.25 billion. The bank’s share, USD 610 million or CHF 840 mil- lion, has been fully provided for in 1998. In addition, UBS AG and other companies within the UBS Group are subject to various claims, disputes and legal proceedings, as part of the normal course of business. The Group makes provision for such matters when, in the opinion of management and its professional advisors, it is probable that a payment will be made by the Group, and the amount can be reasonably esti- mated. All litigation provisions are included within Other Business Risks in the accompanying Group Balance Sheet. In respect of the further claims asserted against the Group of which management is aware (which, according to the principles outlined above, have not been provided for), it is the opin- ion of management that such claims are either without merit, can be successfully defended or will result in exposure to the Group which is immaterial to both financial position and results of operations. UBS Group Financial Statements Notes to the Financial Statements Note 34 Financial Instruments Risk Position Overall risk position The Group manages risk in a number of ways, principally using a value-at-risk model combined with a system of trading limits. The Group’s approach to risk management is discussed more fully in the Review of Risk Management and Control. This section presents information about the results of the Group’s management of the risks associated with the use of financial instruments. a) Interest rate risk Interest rate risk is the potential impact of changes in market interest rates on the fair values of assets and liabilities on the balance sheet and on the annual interest income and expense in the income statement. Interest rate sensitivity One commonly used method to present the potential impact of the market movements is to show the effect of a one basis point (0.01%) change in interest rates on the fair values of assets and liabilities, analyzed by time bands within which the Group is committed. This type of pres- entation, described as a sensitivity analysis, is set out below. Interest rate sensitivity is one of the inputs to the value-at-risk model used by the Group to manage its overall market risk, of which interest rate risk is a part. The table below sets out the extent to which the Group was exposed to interest rate risk at 31 December 1998. The table shows the potential impact of a one basis point (0.01%) increase in market interest rates which would influence the fair values of both assets and liabilities that are subject to fixed interest rates. The impact of such an increase in rates depends on the net asset or net liability position of the Group in each category, currency and time band in the table. A negative amount in the table reflects a potential loss to the Group due to the changes in fair values as a result of an increase in interest rates. A positive amount reflects a potential gain as a result of an increase in interest rates. Both primary and derivative instruments in trading and non-trading activities, as well as off-balance-sheet commitments are included in the table. Interest rate sensitivity position Interest sensitivity by time bands CHF thousand per basis point within 1 month 1 to 3 months 3 to 12 months CHF USD EUR GBP JPY Others Trading Non-trading Trading Non-trading Trading Non-trading Trading Non-trading Trading Non-trading Trading Non-trading 189 (23 ) (28 ) 1 (34 ) 0 10 0 (32 ) 0 11 0 (672 ) 6 93 (21 ) (22 ) (8 ) (214 ) 2 (698 ) 3 (98 ) 0 450 (350 ) 8 7 (158 ) 0 560 (18 ) (402 ) (5 ) 47 0 1 to 5 years (322 ) (7,522 ) (575 ) 72 (559 ) 48 (919 ) 130 1,002 6 (158 ) 0 over 5 years (464 ) (546 ) 1,254 1,502 339 256 491 876 263 146 (152 ) 0 Total (819) (8,435) 752 1,561 (434) 296 (72) 990 133 150 (350) 0 89 UBS Group Financial Statements Notes to the Financial Statements Note 34 Financial Instruments Risk Position (continued) a) Interest rate risk (continued) Trading The major part of the trading related interest rate risk is generated in fixed income securities trading, fixed income derivatives trading, trading in currency forward contracts and money market trading and is being managed within the value-at- risk model. Interest rate sensitivity arising from trading activities is quite sizeable in USD and Euro as these are still the predominantly traded currencies in the global interest rate markets. It should be noted that it is management’s view that an interest sensitivity analysis at a particular point in time has limited relevance on trading positions, which can vary significantly on a daily basis. Further discussion on how the interest rate risk related to the trading portfolio is managed can be found in the “Warburg Dillon Read” sec- tion of this report. Non-trading The interest rate risk related to client business with undefined maturities and non-interest bear- ing business including the strategic management of overall balance sheet interest rate exposure is managed by the Corporate Center. Significant contributors to the overall USD and GBP interest rate sensitivity were strategic long-term subordi- intentionally issues which are nated notes unswapped since they are regarded as constitut- ing a part of the Group’s equity for asset and lia- bility management purposes. At 31 December 1998 the Group’s equity was invested in a port- folio of fixed rate CHF deposits with an average duration of 1.9 years. As this equity investment is the most significant component of the CHF book, this results in the entire book having an interest rate sensitivity of CHF – 8.4 million, which is reflected in the table above. This is in line with the duration and sensitivity targets set by the Group Executive Board. Investing in shorter-term or variable rate instruments would mean exposing the earnings stream (interest income) to higher fluctuations. For further information about the management of the non-trading interest rate risk, please refer to Review of Asset and Liability Management. b) Credit risk Credit risk is the risk of loss from the default by an obligor or counterparty. This risk is managed primarily based on reviews of the financial status of each specific counterparty. Credit risk is greater when counterparties are concentrated in a single industry or geographical region. This is because a group of otherwise unrelated counterparties could be adversely affected in their ability to repay their obligations because of economic developments affecting their common industry or region. Concentrations of credit risk exist if a number of clients are engaged in similar activities, or are located in the same geographic region or have comparable economic characteristics such that their ability to meet contractual obligations would be similarly affected by changes in eco- nomic, political or other conditions. Concentra- tions of credit risk indicate the relative sensitivity of the bank’s performance to developments affect- ing a particular industry or geographic location. (b)(i) On-balance sheet assets As of 31 December 1998, due from banks and loans to customers amounted to CHF 331 billion. 56.6% of these are with clients domiciled in Switzerland. Please refer to Note 12 for a break- down by region. (b)(ii) Off-balance sheet financial instruments Credit commitments and contingent liabilities Of the CHF 122 billion in credit commitment and contingent liabilities as at 31 December 1998, 11% relate to clients domiciled in Switzer- land, 21% in Europe (excl. Switzerland) and 55% in North America. Derivatives Credit risk represents the current replacement value of all outstanding derivative contracts in a 90 UBS Group Financial Statements Notes to the Financial Statements Note 34 Financial Instruments Risk Position (continued) b) Credit risk (continued) gain position without factoring in the impact of master netting agreements or the value of any col- lateral. Positive replacement values amounted to CHF 169 billion as at 31 December 1998, before applying any master netting agreements. Based on the location of the ultimate counterparty, 8% of this credit risk amount relates to Switzerland, 47% to Europe (excl. Switzerland) and 33% to North America. 76% of the positive replacement values are with other banks. (b)(iii) Credit risk mitigation techniques Credit risk associated with derivative instru- ments is mitigated by the use of master netting agreements. A further method of reducing credit exposure arising from derivatives transactions is to use collateralization arrangements. Master netting agreements eliminate risk to the extent that liabilities to the same counterpar- ty are due to be settled after the corresponding assets are realized. The impact of master netting agreements as at 31 December 1998 is to mitigate credit risk on derivative instruments by approxi- mately CHF 68 billion. The impact can change substantially over short periods of time, because the exposure is affected by each transaction sub- ject to the arrangement. The Group subjects its derivative-related credit risks to the same credit approval, limit and monitoring standards that it uses for managing other transactions that create credit exposure. This includes evaluation of counterparties as to creditworthiness, and managing the size, di- versification and maturity structure of the port- folio. Credit utilization for all products is com- pared with established limits on a continual basis and is subject to a standard exception reporting process. 91 Note 34 Financial Instruments Risk Position (continued) c) Currency risk The Group views itself as a Swiss entity, with the Swiss franc as its functional currency. Hedging trans- actions are used to manage risks in other currencies. Breakdown of assets and liabilities by currencies CHF billion Assets Cash and balances with central banks Money market paper Due from banks Cash collateral on securities borrowed Reverse repurchase agreements Trading portfolio Positive replacement values Loans, net of allowance for credit losses Financial investments Accrued income and prepaid expenses Investments in associates Property and equipment Intangible assets and goodwill Other assets Total assets Liabilities Money market paper issued Due to banks Cash collateral on securities lent Repurchase agreements Trading portfolio liabilities Negative replacement values Due to customers Accrued expenses and deferred income Long term debt Other liabilities Minority interests Shareholders’ equity Total liabilities, minority interests and shareholders’ equity CHF 2.4 2.2 12.7 0.2 0.2 24.8 17.8 173.5 2.6 1.2 2.6 8.5 0.3 4.9 253.9 1.0 25.4 0.1 10.7 0.2 27.3 138.0 3.3 23.4 14.6 1.0 32.4 1998 USD 0.3 10.3 13.3 74.5 38.3 40.0 20.9 40.0 2.5 1.8 0.0 0.6 1.7 3.1 247.3 38.5 33.6 5.9 74.3 8.1 19.8 80.2 2.6 16.2 6.1 0.7 0.0 Other CHF 0.6 5.9 42.5 17.0 102.8 97.8 131.2 34.4 1.8 3.6 0.2 0.8 0.2 4.1 442.9 12.0 26.7 13.2 52.6 38.7 158.0 56.7 5.3 10.5 7.0 0.0 0.0 2.9 4.8 14.4 0.0 2.3 31.3 30.7 176.7 3.7 2.5 2.6 9.2 0.2 1.2 282.5 1.4 26.6 0.0 12.1 0.3 34.8 129.9 4.8 29.9 14.3 0.1 30.9 1997 USD 1.3 22.5 23.8 63.4 104.5 64.5 24.8 47.9 5.2 1.8 0.0 0.6 0.8 3.4 364.5 36.1 86.7 4.2 95.0 11.8 24.3 97.9 2.5 15.0 7.2 0.9 0.0 Other 0.4 9.1 28.4 19.3 109.5 115.0 94.0 46.4 3.9 3.4 0.1 1.1 0.4 8.4 439.4 18.1 46.3 10.0 84.7 56.1 111.1 74.7 2.7 9.3 6.7 0.0 0.0 277.4 286.0 380.7 285.1 381.6 419.7 UBS Group Financial Statements Notes to the Financial Statements 92 UBS Group Financial Statements Notes to the Financial Statements Note 34 Financial Instruments Risk Position (continued) d) Liquidity risk Contractual maturity analysis of assets and liabilities CHF billion On demand to notice 1 Subject Due within 3 mths Due between 3 and 12 mths Due between 1 and 5 years Due after 5 years – – 0.4 – – 15.7 44.4 91.7 136.8 – – 2.3 4.8 4.5 – – 0.4 1.0 – 59.5 86.8 0.4 31.6 0.3 63.8 0.8 – – 0.2 – 6.2 1.0 2.8 9.9 2.2 375.8 374.9 32.2 55.9 19.2 135.1 43.5 83.6 19.3 5.8 2.5 66.0 79.3 22.3 36.3 0.5 0.2 21.6 1.7 81.8 124.5 8.9 1.1 3.3 Assets Cash and balances with central banks Money market papers Due from banks Cash collateral on securities borrowed Reverse repurchase agreements Trading portfolio Positive replacement values Loans, net of allowance for credit losses Financial investments Accrued income and prepaid expenses Investments in associates Property and equipment Intangible assets and goodwill Other assets Total 1998 Total 1997 Liabilities Money market paper issued Due to banks Cash collateral on securities lent Repurchase agreements Trading portfolio liabilities Negative replacement values Due to customers Accrued expenses and deferred income Long term debt Other liabilities Total 1998 Total 1997 3.3 17.7 162.6 169.9 4.4 6.6 12.1 376.6 398.3 47.0 205.1 55.3 11.2 – 27.7 367.9 371.0 59.9 114.0 – – 83.5 138.5 4.2 5.7 28.1 12.8 371.1 447.1 42.2 41.8 29.7 36.5 16.3 19.6 910.7 1,054.5 Total 3.3 18.4 68.5 91.7 141.3 162.6 169.9 247.9 6.9 6.6 2.8 9.9 2.2 12.1 944.1 1,086.4 51.5 85.7 19.2 137.6 47.0 205.1 274.9 11.2 50.8 27.7 1 Deposits without a fixed term, on which notice of withdrawal or termination has not been given. (Such funds may be withdrawn by the depositor or repaid by the borrower subject to an agreed period of notice.) 93 UBS Group Financial Statements Notes to the Financial Statements Note 34 Financial Instruments Risk Position (continued) e) Capital adequacy Risk-weighted assets (BIS) CHF million Balance sheet assets Due from banks Net positions in securities 1 Positive replacement values Loans, net of allowance for credit losses Accrued income and prepaid expenses Property and equipment 2 Other assets Off-balance sheet and other positions Contingent liabilities Irrevocable commitments Forward contracts 3 Purchased options Market risk positions 4 Total risk-weighted assets 1998 Balance sheet/ nominal amount 1998 Risk- weighted amount 1997 1997 Balance sheet/ Risk- nominal weighted amount amount 244,246 28,109 169,936 305,155 6,627 9,886 12,092 37,731 82,337 4,037,720 489,005 – – 10,896 8,316 29,494 164,113 3,190 11,166 7,900 6,015 18,197 7,130 5,861 16,018 288,296 216,492 51,770 149,538 420,018 7,712 10,964 13,114 58,501 76,997 4,263,084 199,732 – – 13,485 11,859 24,622 191,860 5,848 12,938 7,512 24,863 20,873 12,258 2,199 17,587 345,904 1 Excluding positions in the trading book, these are included in market risk positions. 2 Including CHF 1,280 million (1997: CHF 1,229 million) foreclosed properties and properties held for disposal, which are recorded in the balance sheet under financial investments. 3 The risk-weighted amount corresponds to the security margin (add-on) of the contracts. 4 Value at risk according to the internal model multiplied by a factor of 12.5 to create the risk-weighted amount of the market risk positions in the trading book. BIS Capital ratios BIS capital ratio Tier 1 capital (share capital and reserves) 1998 Capital 40,385 28,299 BIS % 14.0 9.8 1997 Capital 43,089 28,749 BIS % 12.6 8.3 Among other measures UBS monitors the ade- quacy of its capital using ratios established by the Bank for International Settlements (BIS). These ratios measure capital adequacy by comparing the Group’s eligible capital with its risk-weighted positions which include balance sheet assets, net positions in securities not held in the trading book, off-balance sheet transactions converted into their credit equivalents and market risk posi- tions at a weighted amount to reflect their rela- tive risk. The capital adequacy rules require a minimum amount of capital to cover credit and market risk exposures. For the calculation of the capital required for credit risk the balance sheet assets are weighted according to broad categories of notional credit risk, being assigned a risk weight- ing according to the amount of capital deemed to be necessary to support them. Four categories of risk weights (0%, 20%, 50%, 100%) are applied; for example cash, claims collateralized by cash or claims collateralized by OECD cen- tral-government securities have a zero risk weighting which means that no capital is required to be held in respect of these assets. Uncollateral- ized loans granted to corporate or private cus- tomers carry a 100% risk weighting, meaning that they must be supported by capital equal to 8% of the carrying amount. Other asset cate- gories have weightings of 20% or 50% which require 1.6% or 4% capital. The net positions in securities not held in the trading book reflect the Group’s exposure to an issuer of securities arising from its physical hold- ings and other related transactions in that securi- ty. In addition credit equivalents are calculated for off-balance sheet transactions (contingent lia- bilities, irrevocable commitments and derivative financial instruments). The resulting amounts are 94 UBS Group Financial Statements Notes to the Financial Statements Note 34 Financial Instruments Risk Position (continued) e) Capital adequacy (continued) then weighted for credit risk using the same per- centage as for balance sheet assets. In 1998 UBS calculated its capital requirement for market risk positions, which includes interest- rate instruments and equity securities in the trad- ing book as well as positions in foreign exchange and commodities throughout the Group, using an internal value-at-risk (VaR) model. This ap- proach was introduced in the BIS 1996 market risk amendment to the Basel Accord of July 1988 and incorporated in the Swiss capital adequacy rules of the Banking Ordinance. The BIS proposal requires that the regulators perform tests of the bank internal models before giving permission for these models to be used to calculate the market risk capital. Based on exten- sive checks performed by internal and external auditors the use of the Group internal models was accepted on an interim basis by the Swiss Federal Banking Commission (FBC) in December 1997, provided that a higher multiplication fac- tor be applied during the interim period. As a result of the merger the interim permission has been extended through 1998, and the final approval by FBC is expected to be granted dur- ing 1999. Tier 1 capital consists of permanent share- holders’ equity and retained earnings less good- will and investments in unconsolidated sub- sidiaries. Tier 2 capital includes the Group’s per- petual cumulative preference shares and subordi- nated long-term debt. Note 35 Fair Value of Financial Instruments The following table presents the fair value of on- and off-balance sheet financial instruments based on the following valuation methods and assumptions. It is presented because not all finan- cial instruments are reflected in the financial statements at fair value. Fair value is the amount for which an asset could be exchanged, or a liability settled, between knowledgeable, willing parties in an arm’s-length transaction. A market price, where an active mar- ket (such as a recognized stock exchange) exists, is the best evidence of the fair value of a financial instrument. However, market prices are not avail- able for a significant number of the financial assets and liabilities held and issued by the Group. Therefore, for financial instruments where no market price is available, the fair values presented in the following table have been estimated using present value or other estimation and valuation techniques based on market conditions existing at balance sheet date. The values derived using these techniques are significantly affected by underlying assumptions concerning both the amounts and timing of future cash flows and the discount rates used. The fol- lowing methods and assumptions have been used: (a) trading assets, derivatives and other transac- tions undertaken for trading purposes, and securities lent and borrowed are measured at fair value by reference to quoted market prices when available. If quoted market prices are not available, the fair values are estimated on the basis of pricing models, or discounted cash flows. Fair value is equal to the carrying amount for these items; (b) the fair value of liquid assets and other assets maturing within 12 months is assumed to approximate their carrying amount. This assumption is applied to liquid assets and the short-term elements of all other financial assets and financial liabilities; (c) the fair value of demand deposits and savings accounts with no specific maturity is assumed to be the amount payable on demand at the balance sheet date; (d) the fair value of variable rate financial instru- ments is assumed to approximate their carry- ing amounts; (e) the fair value of fixed rate loans and mort- gages is estimated by comparing market interest rates when the loans were granted with current market rates offered on similar 95 UBS Group Financial Statements Notes to the Financial Statements 96 Note 35 Fair Value of Financial Instruments (continued) loans. Changes in the credit quality of loans within the portfolio are not taken into account in determining gross fair values as the impact of credit risk is recognized sepa- rately by deducting the amount of the allowance for credit losses from both book and fair values. The assumptions and techniques have been developed to provide a consistent measurement of fair value for the Group’s assets and liabilities. However, because other institutions may use dif- ferent methods and assumptions, such fair value disclosures cannot necessarily be compared from one financial institution to another. Fair value of financial instruments CHF billion Assets Cash and balances with central banks Money market paper Due from banks Cash collateral on securities borrowed Reverse repurchase agreements Trading portfolio Positive replacement values Loans, net of allowance for credit losses Financial investments Liabilities Money market paper issued Due to banks Cash collateral on securities lent Repurchase agreements Trading portfolio liabilities Negative replacement values Due to customers Long term debt Fair value effect on income of hedging derivatives recorded on the accrual basis Net difference between carrying value and fair value 1998 Carrying value Fair Unrealized value gain / (loss) Carrying value 3.3 18.4 68.6 91.7 141.3 162.6 169.9 248.3 5.7 51.5 86.1 19.2 137.6 47.0 205.1 275.3 51.0 3.3 18.4 68.7 91.7 141.3 162.6 169.9 250.7 6.5 51.5 86.1 19.2 137.6 47.0 205.1 275.6 53.3 4.6 36.4 66.6 82.6 216.4 210.7 149.5 270.9 11.5 55.6 159.6 14.1 191.8 68.2 170.2 302.5 54.3 0.0 0.0 0.1 0.0 0.0 0.0 0.0 2.4 0.8 0.0 0.0 0.0 0.0 0.0 0.0 0.3 2.3 1.0 1.7 1997 Fair value 4.6 36.4 66.7 82.6 216.4 210.7 149.5 272.7 12.2 55.6 159.6 14.1 191.8 68.2 170.2 302.6 56.5 Unrealized gain / (loss) 0.0 0.0 0.1 0.0 0.0 0.0 0.0 1.8 0.7 0.0 0.0 0.0 0.0 0.0 0.0 0.1 2.2 0.7 1.0 Substantially all of the Group’s commitments to extend credit are at variable rates. According- ly, the Group has no significant exposure to fair value fluctuations related to these commit- ments. Changes in the fair value of the Group’s fixed rate loans, long- and medium-term notes and bonds issued are hedged in part by derivative instruments, mainly interest rate swaps. These swaps are carried at fair value and included in derivative replacement values in the above table, with gains and losses deferred as other assets and other liabilities. Such gains and losses are shown net in the above table as fair value effect on income of hedging derivatives recorded on an accrual basis. The table does not reflect the fair values of non-financial assets and liabilities such as prop- erty (including those properties included as finan- cial investments), equipment, prepayments and accruals. The interest amounts accrued to date for respective financial instruments are included in the carrying value of the instruments. UBS Group Financial Statements Notes to the Financial Statements Note 36 Retirement Benefit Plans and Other Employee Benefits The Group has established various pension plans inside and outside of Switzerland. The major plans are located in Switzerland, Germany, Japan, UK and US. Independent actuarial valua- tions are performed for the major plans. Swiss pension plans The pension funds of the Group are set up as trusts, domiciled in Basle and Zurich. All domes- tic employees are covered. The pension funds are defined benefit plans. The pension plan benefits exceed the minimum benefits required under the Swiss Law. Contributions are paid for by the Group and the employees. The employee contributions are calculated as a percentage of the insured annual salary and are deducted monthly. The percentages deducted from the salary are depending on age and vary between 8% up to 12%. The Group contri- butions are variable and amount from 125% to 250% of the employees contributions depending on the financial situation of the pension fund. The pension plan formula is based on years of contributions and final covered salary. The bene- fits covered include retirement benefits, disabili- ty, death and survivor pension. CHF million 1998 1997 Swiss pension plans Defined benefit obligation as of 31 December Plan assets at fair value as of 31 December Plan assets in excess of benefit obligation Unrecognized net actuarial (gains) or losses Unrecognized assets (limit under art. 58 (b)) Prepaid pension cost Unfunded accrued pension cost Additional details to fair value of plan assets Own financial instruments included in plan assets Any assets used by the bank included in plan assets Retirement benefits expense Current service cost – benefits earned Interest cost on projected benefit obligation Expected return on plan assets Adjustment to limit prepaid pension cost Amortization of unrecognized prior service costs Employee contributions Actuarially determined net periodic pension cost Actual return on plan assets (%) Principal actuarial assumptions used (%) Discount rate Expected rate of return on assets p.a. Expected rate of salary increase Rate of pension increase (14,944) 17,885 2,941 (385) (2,556) 0 0 2,761 176 535 726 (856) 148 6 (185) 374 6.7 5.0 5.0 3.5–5.5 2.0 (14,431 ) 17,224 2,793 (385 ) (2,408 ) 0 0 2,202 176 524 705 (756 ) 22 (8 ) (194 ) 293 15.5 5.0 5.0 3.5–5.5 2.0 97 UBS Group Financial Statements Notes to the Financial Statements Note 36 Retirement Benefit Plans and Other Employee Benefits (continued) Foreign pension plans The foreign locations of UBS operate various pension schemes in accordance with the local reg- ulations and practices. Among these schemes are defined contribution plans as well as defined ben- efit plans. The locations with defined benefit plans of a material nature are Germany, Japan, the UK and the US. These locations together with Switzerland cover about 90% of the active work- force. Certain of these schemes permit employees to make contributions and earn matching or other contributions from the Group. The retirement plans provide benefits in the event of retirement, death, disability or employ- ment termination. The plans’ retirement benefits depend on age, contributions and level of com- pensation. The principal plans are financed in full by the Group. The funding policy for these plans is consistent with local government and tax requirements. The assumptions used in foreign plans take into account local economic conditions. The amounts shown for foreign plans reflect the net funded positions of all foreign plans. CHF million 1998 1997 Pension plans abroad Defined benefit obligation as of 31 December Plan assets at fair value as of 31 December Plan assets in excess of benefit obligation Unrecognized transition amount Unrecognized past service cost Unrecognized assets (limit under art. 58 (b)) Prepaid pension cost Unfunded accrued pension cost Movement of net liability (or asset) during the period Prepaid pension cost at 1 January Less: Net periodic pension cost for the year Employer contributions Prepaid pension cost at 31 December Currency adjustment at 31 December Prepaid pension cost at 31 December Retirement benefits expense Current service cost – benefits earned Interest cost on projected benefit obligation Expected return on plan assets Amortization of net transition (asset) or liability Adjustment to limit prepaid pension cost Immediate recognition of transition assets under IAS 8 Amortization of unrecognized prior service cost Amortization of unrecognized net (gain) / loss Effect of any curtailment or settlement Employee contributions Actuarially determined net periodic pension cost Actual return on plan assets (%) Principal actuarial assumptions used (%) Discount rate Expected rate of return on assets p.a. Expected rate of salary increase (including inflation) Rate of pension increase (2,009) 2,173 164 2 (63) (60) 43 0 36 33 43 46 (3) 43 116 140 (191) 2 2 (23) 7 (3) (8) (9) 33 5.2 (1,950 ) 2,187 237 (17 ) (160 ) (24 ) 36 0 n.a. n.a. 114 115 (147 ) (85 ) 0 0 0 0 0 (6 ) (9 ) 21.4 6.50–7.50 8.50–8.75 3.50–9.00 0.00–3.75 6.50–7.50 8.50–8.75 3.50–9.00 0.00–3.75 98 UBS Group Financial Statements Notes to the Financial Statements Note 36 Retirement Benefit Plans and Other Employee Benefits (continued) Postretirement Medical & Life Plans UBS UK and USA offer postretirement health care benefits that contribute to the health care coverage of the employees after retirement. One of the plans in the USA is partially funded. The benefit obligation in excess of plan assets amounts to CHF 93 million in 1998 (1997: CHF 100 million) and total unfunded accrued postre- tirement liabilities amount to CHF 62 million in 1998 (1997: CHF 50 million). The actuarially determined net postretirement cost is CHF 17 million in 1998 (1997: CHF 14 million). Note 37 Equity Participation Plans UBS has established various equity participa- tion plans to further align the long-term interests of managers, staff and shareholders. In addition, key personnel are awarded a proportion of their performance-related compensation in UBS sha- res, restricted for a minimum number of years. Employees have the option to invest part or all of their annual bonus in UBS shares or derivatives on UBS shares. A certain holding period applies during which the instruments cannot be sold or exercised. In addition, participants in the plan receive a restricted matching contribution of addi- tional shares or options. Shares required under the plan are bought or hedged in the market. Under another plan, employees in Switzerland are entitled to purchase a specified number of UBS shares at a predetermined discounted price each year. The number of shares that can be pur- chased depends primarily on years of service and rank. Any such shares purchased must be held for a specified period of time. Long-term stock options are granted to key employees under another plan. Participation is mandatory. These options are blocked for a cer- tain period of time during which they cannot be exercised. One half of each grant is subject to an acceleration clause after which certain forfeiture provisions lapse. One option gives the right to purchase one registered UBS share at the option’s strike price. Neither fair value nor intrinsic value of the options granted is recognized as an expense in the financial statements. Key employee stock options Number of options 1998 Weighted-average exercise price (in CHF) 1998 Number of options 1997 Weighted-average exercise price (in CHF) 1997 Options outstanding at 1 January Granted Exercised Lapsed 949,962 2,905,889 11,485 242,973 Options outstanding at 31 December 3,601,393 Options exercisable at 31 December 0 371.43 362.84 354.83 535.08 352.96 0.00 0 949,962 0 0 949,962 0 0.00 371.43 0.00 0.00 371.43 0.00 99 UBS Group Financial Statements Notes to the Financial Statements Note 38 Related Parties Related parties include the Board of Directors, the Group Executive Board, the Group Managing Board, close family members and enterprises which are controlled by these individuals. The roles and responsibilities of these bodies are explained in the Corporate Governance section. Total remuneration recognized in the income statement during the year amounted to CHF 102.8 million. Total loans and advances receiv- able were CHF 27.1 million at 31 December 1998. The number of long-term stock options outstanding from equity plans was 127,500 at the end of the year. This scheme is further explained in Note 37 Equity Participation Plans. Total amount of shares held by members of the Board of Directors, Group Executive Board and Group Managing Board were 2,317,902 as of 31 December 1998. Note 39 Post Balance Sheet Date Events On 19 February 1999 UBS AG and Swiss Life/Rentenanstalt announced their plan to ter- minate the cooperation agreement which has existed between them since 1995 by mutual con- sent. In the context of this disengagement, a num- ber of Swiss and international institutional investors will acquire the Group’s 25% equity stake at market conditions. In addition, Swiss Life/Rentenanstalt will acquire the UBS’s 50% interest in the UBS Swiss Life joint venture as well as UBS’s 49% interest in the joint real estate sub- sidiary Livit. UBS expects a net gain from these divestments of CHF 1.2–1.4 billion. 100 Note 40 Significant Subsidiaries and Associates Significant subsidiaries Company Private Banking Armand von Ernst & Cie AG Baltos Service AG Bank Ehinger & Cie AG BDL Banco di Lugano Cantrade Privatbank AG Ferrier Lullin & Cie SA HYPOSWISS, Schweizerische Hypotheken- und Handelsbank Intrag Schröder Münchmeyer Hengst AG UBS Anlage-Service GmbH UBS (Bahamas) Ltd UBS Bank (Canada) UBS (Cayman Islands) Ltd UBS Fund Holding (Luxembourg) SA UBS Fund Holding (Switzerland) AG UBS Fund Management (Japan) Co. Ltd. UBS Fund Management (Switzerland) AG UBS Fund Services (Luxembourg) S.A. UBS Invest Kapitalanlagegesellschaft mbH UBS (Italia) SpA UBS (Luxembourg) SA UBS (Monaco) SA UBS (Panama) SA UBS Trust (Canada) UBS (Trust and Banking) Ltd Warburg Dillon Read Brunswick Warburg Limited NYRE Holding Corp PT Warburg Dillon Read Indonesia SG Warburg & Co International BV SG Warburg Securities SA UBS (Argentina) S.R.L. UBS Australia Holdings Ltd UBS Australia Ltd UBS Australia Finance Ltd UBS (Brasil) Limitada UBS Beteiligungs-GmbH & Co KG UBS (East Asia) Ltd UBS Futures & Options Limited UBS Inc. UBS Lease Finance LLC UBS Limited UBS UK Limited UBS UK Holding Ltd UBS (Nederland) BV UBS Securities (East Asia) Ltd UBS Securities (Hong Kong) Ltd UBS Securities Limited UBS Securities (Pty) Ltd UBS Securities (Singapore) Pte Ltd UBS Securities Trading Limited UBS Services (Japan) Ltd UBS Services Limited UBS (Sydney) Limited UBS (USA), Inc. Warburg Dillon Read AG Warburg Dillon Read (Asia) Ltd 1 Share capital and share premium. Registered office Bern Zurich Basel Lugano Zurich Geneva Zurich Zurich Hamburg Frankfurt Nassau Toronto George Town Luxembourg Basel Tokyo Basel Luxembourg Frankfurt Milan Luxembourg Monte Carlo Panama Toronto Tokyo George Town Wilmington Jakarta Amsterdam Geneva Buenos Aires Sydney Sydney Sydney Sao Paulo Frankfurt Singapore London New York New York London London London Amsterdam Hong Kong Hong Kong London Johannesburg Singapore London London London Sydney Delaware Frankfurt Hong Kong UBS Group Financial Statements Notes to the Financial Statements Share capital in m Equity interest accumulated CHF CHF CHF CHF CHF CHF CHF CHF DEM DEM USD CAD USD LUF CHF JPY CHF CHF DEM ITL CHF FRF USD CAD JPY USD USD IDR GBP CHF USD AUD AUD AUD USD DEM SGD GBP USD USD GBP GBP GBP NLG HKD HKD GBP ZAR SGD GBP JPY GBP AUD USD DEM HKD 5.0 3.0 6.0 50.0 10.0 30.0 26.0 10.0 180.0 0.3 4.0 50.2 1 5.6 1000.0 18.0 1000.0 1.0 2.5 5.0 43,000.0 150.0 60.0 6.0 10.0 7,500.0 50.0 35.5 1 11,000.0 140.4 1 15.0 – 11.7 15.0 – – 780.0 50.0 2.0 687.2 1 16.7 396.0 609.0 360.0 24.0 250.0 20.0 10.0 6.0 3.0 24.0 41,358.5 – 12.7 798.3 304.5 20.0 100.0 100.0 100.0 100.0 100.0 100.0 100.0 100.0 100.0 100.0 100.0 100.0 100.0 100.0 100.0 100.0 100.0 100.0 64.0 100.0 100.0 100.0 100.0 100.0 100.0 50.0 100.0 85.0 100.0 100.0 100.0 100.0 100.0 100.0 100.0 100.0 100.0 100.0 100.0 100.0 100.0 100.0 100.0 100.0 100.0 100.0 100.0 100.0 100.0 100.0 100.0 100.0 100.0 100.0 100.0 100.0 101 UBS Group Financial Statements Notes to the Financial Statements Note 40 Significant Subsidiaries and Associates (continued) Significant subsidiaries (continued) Company Warburg Dillon Read (Australia) Corporation Pty Limited Warburg Dillon Read Australia Ltd Warburg Dillon Read Derivatives Ltd Warburg Dillon Read (España) SA Warburg Dillon Read (France) SA Warburg Dillon Read Futures Inc. Warburg Dillon Read (Futures + Options) Pte Ltd Warburg Dillon Read (Hong Kong) Ltd Warburg Dillon Read (Italia) S.I.M. SpA Warburg Dillon Read International Limited Warburg Dillon Read (Japan) Ltd Warburg Dillon Read LLC Warburg Dillon Read (Malaysia) Sdn. Bhd. Warburg Dillon Read Pte. Ltd. Warburg Dillon Read Securities (South Africa) (Pty) Ltd Warburg Dillon Read Securities Co. Ltd Warburg Dillon Read Securities (España) SVB SA Warburg Dillon Read Securities (India) Private Limited Warburg Dillon Read Securities Ltd. Warburg Dillon Read Securities (Philippines) Inc Warburg Dillon Read (South Africa) (Pty) Ltd Warburg Dillon Read Swap Inc. Private and Corporate Clients Aventic AG Bank Finalba AG Factors AG IL Immobilien-Leasing AG Solothurner Bank SoBa Systor AG UBS Immoleasing AG UBS Leasing AG UBS Brinson Brinson Partners Inc. Phillips & Drew Fund Management Limited Phillips & Drew Limited UBS Brinson Asset Management Co. Ltd UBS Brinson Inc. UBS Brinson Limited UBS Brinson Ltd UBS Brinson Pte Ltd UBS Brinson SA UBS Capital Crédit Industriel SA EIBA “Eidgenössische Bank“ Indelec Holding AG SBC Equity Partners AG SBC Overseas Holding BV Thesaurus Continentale Effekten-Gesellschaft Zürich UBS Capital Asia Limited UBS Capital Asia (S) Limited UBS Capital BV UBS Capital GmbH UBS Capital II LLC UBS Capital Latin America LDC UBS Capital LLC UBS Capital Partners Ltd UBS Capital S.p.A. UBS Investment Management Pte Ltd 1 Share capital and share premium. 2 In billion. Registered office Sydney Sydney Hong Kong Madrid Paris Delaware Singapore Hong Kong Milan London George Town New York Kuala Lumpur Singapore Sandton Bangkok Madrid Mumbai London Makati Sandton Stamford Zurich Glattbrugg Zurich Opfikon Solothurn Zurich Zurich Brugg Chicago London London Tokyo New York London Sydney Singapore Paris Zurich Zurich Basel Opfikon Amsterdam Zurich George Town Singapore The Hague Frankfurt Delaware George Town New York London Milan Singapore Share capital in m 23.5 61.5 20.0 200.0 150.0 12.3 1 5.5 30.0 3,500.0 808.0 1 30.0 2 1,491.4 1 0.5 3.0 2.2 400.0 2,226.0 140.0 140.0 120.0 – 140.1 30.0 40.0 5.0 5.0 50.0 5.0 3.0 10.0 – 1.0 8.0 800.0 0.5 8.8 2.5 4.0 325.1 10.0 14.0 10.0 71.7 40.0 1 30.0 5.0 1.0 220.0 1 0.1 0.1 – 0.1 6.7 50,000.0 0.5 AUD AUD HKD ESP FRF USD SGD HKD ITL GBP JPY USD MYR SGD ZAR THB ESP INR GBP PHP ZAR USD CHF CHF CHF CHF CHF CHF CHF CHF USD GBP GBP JPY USD GBP AUD SGD FRF CHF CHF CHF CHF NLG CHF USD SGD NLG DEM USD USD USD GBP ITL SGD Equity interest accumulated 100.0 100.0 100.0 100.0 100.0 100.0 100.0 100.0 100.0 100.0 50.0 100.0 100.0 100.0 100.0 100.0 100.0 75.0 100.0 100.0 100.0 100.0 100.0 100.0 100.0 100.0 100.0 60.0 100.0 100.0 100.0 100.0 100.0 100.0 100.0 100.0 100.0 100.0 100.0 100.0 100.0 100.0 100.0 100.0 100.0 100.0 100.0 100.0 100.0 100.0 100.0 100.0 100.0 100.0 90.0 102 UBS Group Financial Statements Notes to the Financial Statements Note 40 Significant Subsidiaries and Associates (continued) Significant subsidiaries (continued) Company Corporate Center UBS Finance (Cayman Islands) Limited UBS Finance (Curaçao) NV UBS Finance (Delaware) Inc. UBS Finanzholding AG UBS International Holdings BV UBS Investments (C.I.) Ltd Significant associates Company Giubergia Warburg SIM SpA, Milan Inversiones Ibersuizas S.A., Madrid Motor Columbus AG, Baden National Versicherung AG, Basel Rentenanstalt/Swiss Life AG, Zurich Telekurs Holding AG, Zurich Registered office George Town Curaçao Delaware Zurich Amsterdam George Town Share capital in m Equity interest accumulated USD USD USD CHF GBP USD 0.5 0.1 898.5 10.0 2.4 0.0 100.0 100.0 100.0 100.0 100.0 100.0 Equity interest Share capital in m 50.0% 28.9% 36.4% 28.5% 25.0% 40.9% ITL ESP CHF CHF CHF CHF 290,000.0 8,224.0 253.0 35.0 578.4 45.0 None of the above investments carry voting rights that are significantly different from the proportion of shares held. Consolidated companies: changes in 1998 New companies Aventic AG, Zurich UBS Capital (Jersey) Ltd, St. Helier Deconsolidated companies Name Adler & Co. AG Bank Prokredit AG BSI-Banca della Svizzera Italiana, Lugano Cantrade Banca Privata Lugano SA, Lugano Cantrade Investments Ltd, London Cantrade Investment Management Ltd, London UBS SA Holding (Pty) Ltd, Johannesburg UBS Securities (Pty) Ltd, Johannesburg Reason for deconsolidation Sold Sold Sold Sold Sold Sold Deregistered Deregistered Note 41 Significant Currency Translation Rates The following table shows the significant rates used to translate the financial statements of foreign entities into Swiss francs. 1 USD 1 GBP 100 DEM 100 JPY Balance sheet rate 31.12.98 31.12.97 Average rate P/L 31.12.98 31.12.97 1.38 2.29 82.19 1.22 1.46 2.41 81.24 1.12 1.45 2.41 82.38 1.11 1.45 2.37 83.89 1.19 103 UBS Group Financial Statements Notes to the Financial Statements Note 42 Swiss Banking Law Requirements The significant differences between Interna- tional Accounting Standards (IAS), which are the principles followed by the Group, and the accounting requirements for banks under Swiss laws and regulations, are as follows: Securities borrowing and lending Under IAS only the cash collateral delivered or received is recognized in the balance sheet. There is no recognition or derecognition for the securi- ties received or delivered. The Swiss requirement is to recognize the securities received or delivered in the balance sheet along with any collateral in respect of those securities for which control is transferred. Treasury shares Treasury shares is the term used to describe the holding by an enterprise, of its own equity instru- ments. In accordance with IAS treasury shares not held for trading are presented in the balance CHF million Differences in the balance sheet Securities borrowing and lending Assets Trading portfolio / Money market paper Due from banks / customers Liabilities Due to banks / customers Other liabilities (short positions settled with borrows) Treasury shares Assets Trading portfolio Financial investments sheet as a deduction from equity. No gain or loss is recognized in the income statement on the sale, issuance, or cancellation of those shares. Consid- eration received is presented in the financial state- ment as a change in equity. Under Swiss requirements, treasury shares would be carried in the balance sheet as financial investments with gains and losses on the sale, issuance, or cancellation of treasury shares reflected in the income statement. Extraordinary income and expense Under IAS most items of income and expense arise in the course of ordinary business, and extraordinary items are expected to be rare. Under the Swiss requirements, income and expense items not directly related with the core business activities of the enterprise (e.g. sale of fixed assets or bank premises) are recorded as extraordinary income or expense. 1998 1997 97,907 40,915 154,828 (16,006) 992 490 369 (1,350) (1,235) 19,675 47,021 134,911 (68,215 ) 463 1,519 129 (162 ) (114 ) 1,482 1,982 Differences in the income statement Treasury shares Reclassification of extraordinary income and expense Other income, including income from associates General administrative expenses Differences in the shareholders’ equity Treasury shares 104 UBS Group Financial Statements Notes to the Financial Statements Note 43 The Year 2000 Challenge Each of our operating divisions has estab- lished a programme to address the Year 2000 issue. The programme manager for each division reports on progress, risks and issues on a month- ly basis to the Group Year 2000/Euro Risk Com- mittee, which is headed by the Chief Risk Officer. Because of the size and complexity of the Group, and the pervasive impact of the Year 2000 issue on our systems and those of third par- ties with whom we deal, UBS has chosen to pub- lish on the Internet (www.ubs.com), under the section called “Quantitative Self Assessment”, the progress against milestones associated with the technical aspects of the Year 2000 project. This (unaudited) self assessment is consistent with the suggested reporting standard of the Global Year 2000 Co-ordinating Group of which UBS is a founding member. The self assessment indicates that UBS is well advanced in its preparation; however the nature of the Year 2000 issue means that it is not possi- ble to provide any guarantee that the Group will be unaffected by Year 2000 related issues. In view of this, UBS has already initiated con- tingency planning exercises to minimize these risks. 105 UBS Group Financial Statements Report of the Group Auditors 106 UBS AG (Parent Bank) UBS AG (Parent Bank) Table of Contents Parent Bank Result Financial Statements 109 110 110 Income statement Balance sheet 111 Statement of appropriation of retained earnings 111 Notes to the Financial Statements Additional income statement information Net trading income Extraordinary income and expenses Additional balance sheet information Value adjustments and provisions Statement of shareholders’ equity Share capital Distribution of registered shares at end of 1998 Off balance sheet and other information Assets pledged or assigned as security for own obligations, assets subject to reservation of title Fiduciary transactions Due to UBS corporate bodies / related parties Report of the Statury Auditors 112 113 113 113 113 113 114 114 114 115 115 115 115 116 UBS AG (Parent Bank) Table of Contents 108 Parent Bank Result UBS AG (Parent Bank) Parent Bank Results Income Statement Due to the planned merger of Union Bank of Switzerland and Swiss Bank Corporation, the extraordinary shareholders’ meetings of both banks decided that the financial year 1997 of the respective parent banks should cover the period until 30 September 1997 only. Thus the actual financial year of the parent bank UBS AG covers a 15-month period from 1 October 1997 to 31 December 1998. This should be borne in mind when comparing the two income state- ments. The profit of CHF 650 million for 1998 relates to CHF 3,943 million for the nine months in 1997 and reflects several strategic decisions and transactions in connection with the merger: – Income from investments in associates has increased to CHF 2,974 million from CHF 484 million in 1997 due to repatriation of capital to the parent bank. – Sundry income from ordinary activities amount to CHF 1,162 million (1997: CHF 360 mil- lion). This increase is due to harmonization of methods of calculating service charges to other companies within the UBS Group, as well as to an increase in those charges. – The events that have affected Allowances, pro- visions and losses are discussed in the com- ments to the Group Financial Statements. The amount of CHF 4,849 million (1997: CHF 1,168 million) for the parent bank includes in addition a provision of CHF 1,924 million for counterparty risks. This provision had been established at Group level in 1996 already, but it was allocated to specific counterparties at parent bank level only in 1998. – Extraordinary income of CHF 3,940 million (1997: CHF 481 million) reflects the disposal of subsidiaries and the release of provisions which are not economically necessary. Further information regarding extraordinary income and expenses can be found in the Notes to the Financial Statements. – Furthermore, the parent bank includes the restructuring provision of CHF 7,000 million in the results for the 15-month period ended 31 December 1998, whereas the Group already reflected this amount in its 1997 Financial Statements. In order to pay out a dividend of CHF 10.– per share or CHF 2,150 million and to allocate CHF 190 million to the general statutory reserve, a release of CHF 1,690 million from other reserves is proposed. Balance Sheet Total assets grew by CHF 262 billion to CHF 1,041 billion by 31 December 1998. The major part of this increase is caused by the harmoniza- tion of the accounting policies of Union Bank of Switzerland and Swiss Bank Corporation. It is in particular the consistent recognition of repur- chase agreements, reverse repurchase agreements and securities lending and borrowing that led to an increase in assets and liabilities. Note that these transactions are presented differently in the Group Balance Sheet. 109 UBS AG (Parent Bank) Financial Statements Financial Statements Income Statement CHF million Interest and discount income Interest and dividend income from financial assets Less: Interest expense Net interest income Credit-related fees and commissions Fee and commission income from securities and investment business Other fee and commission income Less: Fee and commission expense Net fee and commission income Net trading income Net income from disposal of financial assets Income from investments in associated companies Income from real estate holdings Sundry income from ordinary activities Less: Sundry ordinary expenses Other income from ordinary activities Operating income Personnel General administrative Operating expenses Operating profit Depreciation and write-offs on fixed assets Allowances, provisions and losses Profit before extraordinary items and taxes Extraordinary income Extraordinary expenses Tax expenses / (benefit) Profit for the period 1.10.1997– 31.12.1998 33,205 240 25,412 1.1.1997– 30.9.1997 17,714 291 13,363 8,033 766 9,229 687 781 9,901 383 756 2,974 38 1,162 185 4,745 23,062 7,977 6,290 14,267 8,795 815 4,849 3,131 3,940 7,046 ( 625) 650 4,642 516 5,128 408 463 5,589 3,490 229 484 30 360 51 1,052 14,773 5,346 3,241 8,587 6,186 981 1,168 4,037 481 96 479 3,943 110 UBS AG (Parent Bank) Financial Statements Balance Sheet CHF million Assets Liquid assets Money market paper Due from banks Due from customers Mortgage loans Trading balances in securities and precious metals Financial assets Investments in associated companies Tangible fixed assets Accrued income and prepaid expenses Positive replacement values Other assets Total Total subordinated assets Total amounts receivable from Group companies Liabilities Money market paper issued Due to banks Due to customers on savings and deposit accounts Other amounts due to customers Medium term note issues Bond issues and loans from central mortgage institutions Accruals and deferred income Negative replacement values Other liabilities Value adjustments and provisions Reserve for general banking risks Share capital General statutory reserve Reserve for own shares Other reserves Profit / (loss) brought forward Profit for the period Total Total subordinated liabilities Total liabilities to Group companies 31.12.1998 30.9.1997 Change % 2,876 14,610 303,032 192,429 131,788 191,578 3,010 6,153 6,840 5,293 173,020 10,318 2,819 27,712 182,354 154,318 137,615 126,132 9,349 6,376 6,854 8,012 110,184 7,349 57 (13,102 ) 120,678 38,111 (5,827 ) 65,446 (6,339 ) (223 ) ) (14 ) (2,719 62,836 2,969 1,040,947 779,074 261,873 1,236 115,140 2,356 122,988 (1,120 ) (7,848 ) 30,963 314,258 77,964 295,381 8,303 36,180 9,853 207,410 14,915 15,176 0 4,300 14,295 490 10,806 3 650 32,069 193,514 83,648 230,987 13,339 34,219 7,316 129,531 10,301 11,482 667 5,755 12,515 964 9,266 (443 ) 3,944 (1,106 ) 120,744 (5,684 ) 64,394 (5,036 ) 1,961 2,537 77,879 4,614 3,694 (667 ) (1,455 ) 1,780 (474 ) 1,540 446 (3,294 ) 1,040,947 779,074 261,873 12,528 108,666 14,429 73,176 (1,901 ) 35,490 2 (47 ) 66 25 (4 ) 52 (68 ) ) (3 0 (34 57 40 ) 34 (48 ) (6 ) (3 ) 62 (7 ) 28 (38 ) 6 35 60 45 32 (100 ) (25 ) 14 (49 ) 17 (101 ) (84 ) 34 (13 ) 48 Statement of Appropriation of Retained Earnings The Board of Directors proposes to the General Meeting of Shareholders the following appropriation: Profit for the fifteen month period as per the Income Statement Release of other reserves Retained earnings from prior years Available for appropriation Appropriation to general statutory reserve Proposed dividends Retained earnings carried forward CHF million 650 1,690 3 2,343 190 2,150 3 Dividend distribution Upon acceptance of this proposal, the dividend for 1998 will amount to CHF 10.– gross per share of CHF 20.– par value. The dividend will be paid on 27 April 1999, to registered shareholders or to their depository bank by payment order, after deduction of 35% Swiss withholding tax. 111 UBS AG (Parent Bank) Notes to the Financial Statements Notes to the Financial Statements Accounting period / Comparative figures The parent company’s accounting period cov- ers the 15 months from 1 October 1997 to 31 December 1998; and the comparative figures are for the shortened business year from 1 January to 30 September 1997. The 1997 comparative fig- ures are combined pro forma values which were prepared on the basis of the separate audited financial statements of the former UBS and SBC parent companies existing at that time. The change in the length of the accounting period was approved by the shareholders at the General Assembly meetings on 3 February 1998 (former UBS) and 4 February 1998 (SBC). Accounting and valuation principles The parent company’s accounting and valua- tion policies are in compliance with Swiss federal banking law. The accounting and valuation poli- cies are principally the same as outlined for the Group Financial Statements in Note 1: Signifi- cant Accounting Policies of the Group Financial Statements. Major differences between the Swiss federal banking law requirements and Interna- tional Accounting Standards are described in Note 42 to the Group Financial Statements. In addition, the following principles are applied for the parent bank: – Investments companies in associated Investments in associated companies are equi- ty interests which are held on a long-term basis for the purpose of the parent company’s busi- ness activities. They are carried at a value no higher than their cost price. – Property and equipment Bank buildings and other real estate are carried at cost less depre- ciation at a rate which takes account of the economic and business situation and which is permissible for tax purposes. Depreciation of computer and telecommunication equipment, as well as other equipment, fixtures and fittings is recognized on a straight-line basis over the estimated useful lives of the related assets. A credit adjustment of CHF 470 million has been made in order to harmonize the accounting policies of the merged banks. The useful lives of Property and Equipment are summarized in Note 1, Significant Accounting Policies, of the Group Financial Statements. – Extraordinary income and expenses Cer- tain items of income and expense appear as extraordinary within the Parent Bank Financial Statements, whereas in the Group Financial Statements they are considered to be operating income or expenses and appear within the appropriate income or expense category. These are separately identified below. – Taxation Deferred Tax Assets, except those relating to Restructuring Provisions, and Deferred Tax Liabilities, except for a few immaterial exceptions, are not recognized in the Parent Bank Financial Statements as it is not required by Swiss federal banking law to do so. 112 UBS AG (Parent Bank) Notes to the Financial Statements Additional Income Statement Information Net Trading Income CHF million Foreign exchange and bank notes Bonds and other interest rate instruments Equities Precious metals and commodities Total 1.10.1997– 31.12.1998 1.1.1997– 30.9.1997 2,156 ( 1,440) ( 421) 88 383 1,656 1,127 553 154 3,490 Extraordinary Income and Expenses Extraordinary income contains CHF 1,190 million from the sale of the former subsidiary Banca della Svizzera Italiana (BSI), CHF 1,336 million from release of provisions which are not economically necessary, and CHF 667 million from release of Reserves for General Banking Risks. Extraordinary expenses consist mainly of CHF 7,000 million restructuring provision which were set up in 1997 to cover the costs related to the merger of Swiss Bank Corporation and Union Bank of Switzerland. Additional Balance Sheet Information Value Adjustments and Provisions Provisions Recoveries, doubtful applied in interest, accordance Balance with their currency specified translation at 1 Oct. purpose differences 1997 New Provisions provisions released and credited to income charged to income 14,433 409 509 1,770 4,375 297 337 4,250 426 99 28 (57) 3,543 2,732 194 7,768 0 0 0 1,336 Balance at 31 Dec. 1998 14,027 2,943 394 3,895 17,121 9,259 496 14,237 1,336 21,259 5,639 11,482 667 – – 0 – – 0 – – 0 – – 6,083 15,176 667 0 CHF million Default risks (credit and country risk) Other business risks 1 Capital and income taxes Other provisions Total allowance for general credit losses and other provisions Less: Allowances deducted from assets Total provisions as per balance sheet Reserves for general banking risks 1 Provisions for litigation, settlement and other business risks. 113 UBS AG (Parent Bank) Notes to the Financial Statements Additional Balance Sheet Information (continued) Statement of Shareholders’ Equity CHF million 31.12.1998 30.9.1997 Change % Shareholders’ equity Share capital at beginning of the period General statutory reserves Reserves for own shares Other reserves Reserves for general banking risks Retained earnings / (accumulated deficit) Total shareholders’ equity at beginning of the period (before distribution of profit) – Reduction of nominal capital + Increase in General statutory reserves + Capital increase / (decrease) + Premium + Other allocations – Allocation / (release) of Reserves for general banking risks – Prior-year dividend + Profit / (loss) for the period Total shareholders’ equity as of 31 December 1998 / 30 September 1997 (before distribution of profit) of which: Share capital General statutory reserves Reserves for own shares Other reserves Reserves for general banking risks Retained earnings 5,755 12,515 964 9,266 667 3,501 6,508 12,093 583 11,228 666 (1,133 ) 32,668 29,945 (1,467) 1,467 12 82 35 (667) (2,236) 650 (753 ) 330 23 (821 ) 3,944 (753 ) 422 381 (1,962 ) 1 4,634 2,723 (1,467 ) 1,467 765 (248 ) 12 (667 ) (1,415 ) (3,294 ) (12 ) 3 65 (17 ) 0 (409 ) 9 – – (102 ) (75 ) 52 – 172 (84 ) 30,544 32,668 (2,124 ) (7 ) 4,300 14,295 490 10,806 0 653 5,755 12,515 964 9,266 667 3,501 (1,455 ) 1,780 (474 ) 1,540 (667 ) (2,848 ) (25 ) 14 (49 ) 17 (100 ) (81 ) Share Capital Issued and paid up Conditional share capital Par value No. of shares Capital in CHF Ranking for dividends No. of shares Capital in CHF 214,976,306 4,299,526,120 214,449,765 4,288,995,300 999,229 19,984,580 – – Distribution of Registered Shares at End of 1998 % of all registered shareholders Number of shares / % of shares held (1% = 2,149,763) Number of shareholders 1–100 101–1,000 1,001–5,000 5,001–10,000 10,001–50,000 50,001–100,000 100,001–2,149,762 1–2% 2–3% 3–4% 4–5% over 5% Total 126,457 61,281 5,156 569 551 98 157 3 0 0 1 0 194,273 Number of shares1 5,244,360 16,524,771 10,156,828 3,954,295 11,432,204 7,082,202 57,467,918 6,753,879 0 0 9,192,491 0 % of all registered shares 4.103 12.929 7.947 3.094 8.945 5.542 44.964 5.284 0.000 0.000 7.192 0.000 65.092 31.544 2.654 0.293 0.284 0.050 0.081 0.001 0.000 0.000 0.001 0.000 100.000 127,809,548 100.000 1 13,618,690 registered shares do not carry voting rights. 73,548,068 shares are classified as “non registered”, i.e. not entered in the share register as of 31 December 1998. 114 UBS AG (Parent Bank) Notes to the Financial Statements Off Balance Sheet and Other Information Assets Pledged or Assigned as Security for Own Obligations, Assets Subject to Reservation of Title CHF million Money market paper Mortgage loans Securities Total 31.12.1998 30.9.1997 Book value 6,956 2,410 14,852 24,218 Effective liability 0 1,602 8,883 10,485 Book value 2,265 1,687 10,778 14,730 Effective liability 517 1,250 8,924 10,691 Change in % Book value Effective liability 207 43 38 64 (100 ) 28 0 (2 ) Assets are pledged as collateral for securities borrowing and repo transactions, for collateralized cred- it lines with central banks, loans from mortgage institutions and security deposits relating to stock exchange memberships. (2 ) (20 ) (11 ) (3 ) % 33 Fiduciary Transactions CHF million Deposits with other banks with Group banks Loans and other financial transactions Total 31.12.1998 30.9.1997 Change % 46,180 1,543 479 47,234 1,937 536 (1,054 ) (394 ) (57 ) 48,202 49,707 (1,505 ) Due to UBS Corporate Bodies / Related Parties CHF million Due to UBS pension funds Loans to directors, senior executives and auditing bodies 2 1998 1,250 70 1997 1 Change 313 937 88 (18 ) (20 ) 1 Information as of 31.12.1997 2 Loans to directors, senior executives and auditing bodies include loans to members of the Board of Directors, the Group Managing Board and the Group’s official auditors under Swiss company law. This also includes loans to companies which are controlled by these natural or legal persons. 115 UBS AG (Parent Bank) Report of the Statutory Auditors 116 UBS Corporate Governance UBS Corporate Governance Corporate and Executive Bodies UBS established its orga- Corporate Governance Best Practice nizational structure in the UBS observes the principles of best practice in context of the merger with the aim of meeting the highest standards of Corporate Governance. The Cadbury Committee’s 1992 Code of Best Prac- tice and the 1998 Ham- pel Report on Corporate Governance both played a significant role in devel- oping UBS’s Corporate Governance standards. In fact, almost all these standard-setting reports’ recommendations have been implemented in UBS’s Articles of Associa- tion and Organization Regulations. At the same time, UBS – as a Swiss based company – must also comply with Swiss legal provisions. 118 the following manner: The Board of Directors (BoD) consists exclu- sively of non-executive Directors in accordance with Swiss Banking Law. The members of the Board of Directors are elected by the annual gene- ral meeting for a four-year term. In order to ensure its independence, the Chief Executive Officer is not permitted to be a member of the BoD. The appropriate and timely information on the com- pany’s affairs to the BoD members is prescribed by the Articles of Association and the Organi- zation Regulations. The BoD meets regularly, together with the Group Executive Board (GEB). At the time of the merger, there were 10 Direc- tors, of whom the Chairman and one of the Vice Chairmen were appointed on a full-time basis. Chairman Mathis Cabiallavetta resigned on 1 October 1998 after the third-quarter losses from the US hedge fund Long Term Capital Manage- ment (LTCM) were announced, as a step towards restoring confidence in the new UBS. Vice Chair- man Alex Krauer took over as Chairman. On 27 January 1999, the BoD appointed him Chairman until 2002. To support the bank’s important global aspi- rations, UBS will extend BoD membership to the international professional community. The max- imum number of Board members is twelve. The responsibilities of the BoD The BoD has ultimate responsibility for the strategic direction of the business of the UBS Group and the supervision and control of its executive management. The BoD has nominated the following com- mittees: The Audit Supervisory Board is responsible for the supervision of the internal and external audit. It is chaired by Alberto Togni. Additional members are Alex Krauer and Markus Kündig. The Audit Supervisory Board and the Head of Group Internal Audit meet four times a year to discuss and approve annual objectives and activ- ity reports of Group Internal Audit plus other matters of general policy. Important findings of Group Internal Audit are submitted to the Audit Supervisory Board. The Audit Committee, chaired by Peter Böck- li with Rolf A. Meyer as Vice Chairman and Andreas Reinhart, monitors the functional adequacy of the auditing work and the coopera- tion between internal and external audit. It supports the BoD in the supervision of the year-end closing. It normally meets two to three times a year with the Head of Group Internal Audit and representatives of the external audi- tors. The Chief Financial Officer and other members of the GEB are periodically invited for special topics. A Nomination Committee, with Alex Krauer as Chairman and Markus Kündig and Andreas Reinhart as members, has been charged with preparing nominations for new BoD members as well as for elections at the GEB level. The Chairman’s Office (Chairman and Vice Chairmen) also acts as the Remuneration Com- mittee. It fixes the remuneration of the BoD’s full- time members, the members of the GEB and of the Group Managing Board (GMB) (for details see below). The BoD decides on the individual remuneration of the part-time Board members, based on the proposals of the Remuneration Com- mittee.The total amount paid to the related parties (BoD, GEB, GMB) as well as the principles of remuneration are published in Note 38 to the Financial Statements. The Board of Directors’ activities in 1998 The designated Members of the Board of Directors had started to meet regularly prior to the legal merger on 29 June 1998. At these pre- liminary meetings, the BoD took all necessary preparatory measures to ensure UBS’s efficient start immediately after 29 June 1998. All impor- tant decisions were ratified in the first official meeting of the new BoD. The main issues addressed by the BoD during the course of 1998 (pre- and post-merger) were: – the approval of the UBS strategy – the approval of UBS’s organizational frame- work and policies – the approval of the UBS risk policy framework – the review of quarterly and year-end results, as well as plans and budgets – the settlement agreement with the claimants of the US class action suits regarding dormant accounts and World War II issues – the losses stemming from UBS’s exposure to LTCM and other market risks. UBS Corporate Governance In 1998, the BoD held 14 meetings, eleven of which were with the Group Executive Board. At a one-day seminar the GEB outlined the detailed strategy of the Group and its divisions to BoD members. Joint meetings between the BoD and the GEB provide the optimal platform for a high-level and detailed interaction between both Boards. The particular mandates of the two bodies are defined in the Articles of Association and, in detail, in the Organization Regulations. The Group Executive Board The Group Executive Board is the most senior executive body of UBS. It assumes overall respon- sibility for the development of the Group’s strate- gies, and the implementation and results thereof. The GEB comprises eight members, namely the Group CEO, the Heads of the four divisions and of the three Corporate Center Functional Areas. Four members are Swiss citizens, two US, one Dutch and one Italian. Two divisions have their head offices in Switzerland, one is in London and one in Chicago. The GEB normally convenes bi- weekly. A dominant concern of the GEB during 1998 was the successful integration of the two merged banks. Numerous fundamental decisions had to be taken, the most crucial ones being the appoint- ment of senior management and the integration of the technology infrastructures. The GEB feels comfortable in stating that the essential measures were executed successfully. The integration con- tinues to proceed at an extremely rapid pace. Another crucial concern was the definition of the risk policy and risk framework of the Group. Based on changing trends in the financial industry and a more volatile market environment, GEB members have regularly discussed strategy issues. In a special seminar at the beginning of January 1999, the GEB reassessed the strategy of the Group. The decisions, approved by the BoD on 16 January were outlined in detail at the UBS Investors’ Day on 25 January 1999. They form the basis of the Shareholders’ Letter and division- al strategy discussions in this document. In connection with the Long Term Capital Management losses (for full details please see Review of Risk Management and Control, p. 33–34), Felix Fischer, Chief Risk Officer, resigned. His function was assigned to David Solo who joined the GEB from the Executive Board of Warburg Dillon Read. David Solo was the Co-Chief Operating Officer. The Group Managing Board As of December 1998, the Group Managing Board was made up of the eight GEB members, 18 members who held office in the Divisional Executive Boards and five members who were in charge of special functions at the top level of the organization. The GMB normally meets once a year to discuss strategic and planning matters. Group Internal Audit The Group Internal Audit Department, head- quartered in Zurich, employs about 220 profes- sionals worldwide. Special attention was given to problems arising from the LTCM losses, the risks involved in equity derivatives transactions and to the risks inherent in the domestic loan portfolio. Merger-related audits were performed in various areas, and a new organization was established in Group Internal Audit. State-of-the-art audit stan- dards guarantee professional supervision and control. The BoD and the GEB are regularly informed of audit findings. The Head of Group Internal Audit, Walter Stürzinger, reports to the Chairman of the Board of Directors. He actively participates in the Audit Supervisory Board and the Audit Committee meetings. Relationship with Shareholders UBS is committed to fostering a relationship with its shareholders characterized by openness and transparency. To meet the different needs of shareholders better, corporate reporting is split into two documents. The Annual Review gives an overview of UBS’s businesses, the strengths and opportunities of the divisions and their position- ing in the market, the yearly results and some additional information about risk management and control, corporate governance, etc. The Financial Report contains all the information required by International Accounting Standards and Swiss regulations. It is designed to respond to the needs of large shareholders, institutional investors and financial analysts. 119 UBS Corporate Governance In addition to these two reporting documents, UBS publishes a Report on the Status of the Integration following the merger which may be ordered by any shareholder. Quarterly results are also reported in two formats: a short “Letter to Shareholders” explaining the relevant results achieved, and a comprehensive “Quarterly Re- port” designed for institutional investors. The Annual General Meeting of Shareholders is organized in such a way that shareholders have the opportunity to raise any question regarding the development of the company and the achieve- ments of the year under review. The members of the BoD and GEB as well as the internal and exter- nal auditors are present to answer these questions. A system of proxy votes gives shareholders the chance to express their views on any issue on the agenda at the Annual General Meeting. Corporate and Executive Bodies as of 31 December 1998 Board of Directors Group Executive Board Alex Krauer (AGM 2000)* Chairman Member of the Audit Supervisory Board Chairman of the Board of Novartis Ltd., Basel (until April 1999) Alberto Togni (AGM 2001) Vice Chairman Chairman of the Audit Supervisory Board Markus Kündig (AGM 2002) Vice Chairman Member of the Audit Supervisory Board Owner of Kündig Printers, Zug Peter Böckli (AGM 1999) Chairman of the Audit Committee Partner in the law firm Böckli, Bodmer & Partner, Basel Rolf A. Meyer (AGM 1999) Member of the Audit Committee Chairman of the Board of Ciba Specialty Chemicals Inc., Basel Marcel Ospel President and Group CEO Stephan Haeringer Deputy of the Group CEO and Division Head Private and Corporate Clients Rodolfo Bogni Chief Executive Officer of the Private Banking Division Gary P. Brinson Division Head Institutional Asset Management Johannes Antonie de Gier Chairman and Chief Executive of Warburg Dillon Read David Solo Chief Risk Officer (since 2 October 1998) Pierre de Weck Chief Credit Officer and Head Private Equity Hans Peter Ming (AGM 2000) Delegate of the Board of Directors of Sika Finanz AG, Baar Peter A. Wuffli Chief Financial Officer Andreas Reinhart (AGM 2000) Member of the Audit Committee Chairman of Volkart Brothers Holding Ltd., Winterthur Georges P. Schorderet (AGM 1999) Chief Financial Officer of SAirGroup, Zurich-Airport Manfred Zobl (AGM 2000) Chairman of the Corporate Executive Board of Swiss Life / Rentenanstalt, Zurich Secretary to the Board of Directors: Gertrud Erismann-Peyer * Term of office until AGM of the year 2000. 120 UBS Corporate Governance Group Managing Board Samuel W. Anderson Head Administration & Operations, UBS Brinson Division Luqman Arnold Chief Operating Officer, Warburg Dillon Read Peter Brutsche Head Private Banking Tokyo Richard C. Capone Regional Manager for UBS AG’s operations in the United States, Canada and Latin America; Chief Executive Officer, Warburg Dillon Read LCC Crispian Collins Chief Executive, Phillips & Drew, London (UBS Brinson Division) (since 1 September 1998) Arthur Decurtins Deputy CEO of the Private Banking Division, Head Products, Services, Logistics Jeffrey J. Diermeier Co-Head Equity Investments, UBS Brinson Division Henry Doorn, Jr. Head of Finance and Control, UBS Brinson Thomas K. Escher Business Area Head Information Technology, Private and Corporate Clients Division George M. Feiger Business Area Head Domestic Clients, Private Banking Division Georges Gagnebin Business Area Head International Clients Europe, Middle East & Africa, Private Banking Division Markus J. Granziol Global Head Equities and Rates, Warburg Dillon Read Carlo A. Grigioni Head Business Area The Americas, Private Banking Division Jürg Haller Business Area Head Corporate Clients, Private and Corporate Clients Division Eugen Haltiner Head Integration, Private and Corporate Clients Division Franklin W. Hobbs Global Head Corporate Finance, Warburg Dillon Read William W. Johnson Head Treasury Products, Warburg Dillon Read Benjamin F. Lenhardt, Jr. Head of Account Management and Business Development, UBS Brinson Division Franz Menotti Business Area Head Private and Business Clients, Private and Corporate Clients Division Urs B. Rinderknecht Group Mandates Gian Pietro Rossetti Business Area Head Domestic Clients / Swiss Clients, Private Banking Division Jean Francis Sierro Business Area Head Resources, Private and Corporate Clients Division Stephan Zimmermann Business Area Head Operations, Private and Corporate Clients Division Auditors External Auditor ATAG Ernst & Young Auditing Ltd., Basel Auditors for the Parent Bank and for the Group as prescribed by Company Law and Swiss Banking Law (term expires AGM 1999) Internal Audit Walter H. Stürzinger, Head of Internal Audit Department 121 122 UBS Group Human Resources UBS Group Human Resources Personnel at UBS 1998 was a year which Headcount Movements put considerable pressure on our staff. They met the challenge admirably, and we wish to take this opportunity to reiterate our thanks. We are aware that the success of the merger to date has to a large extent been depend- ent on the commitment of our employees. UBS employed 48,011 staff at end-1998. A geographical breakdown of employees is shown in the pie chart. During 1998, UBS experienced significant movements in headcount, predominantly as a result of the merger. The total headcount of full- time employees at UBS fell by 7,165 during 1998 from 55,176 in 1997, representing the combina- tion of the workforces of Union Bank of Switzer- land and Swiss Bank Corporation. 53% of the total reduction in staff in 1998 took place in Switzerland. The most significant reduction in relation to local workforce was in Asia (–24%), with a 19% decline in Americas and a 16% decline in Europe (excluding Switzerland). Of the 3,800 decline in staff numbers in Switzerland, some 1,500 was attributable to divestments, primarily BSI. Elsewhere in Europe the net reduction of 1,250 was largely attributa- ble to a significant restructuring in London as part of the merger. This was partially offset by new hirings and more importantly the acquisition of Schröder Münchmeyer Hengst in Germany. In the Americas the reduction of 1,100 was once again primarily due to the merger. In Asia a re- focusing of our business in the light of difficult market conditions also contributed to the decline of 870 staff. A further discussion of headcount movements can be found in the divisional re- ports. For a discussion of personnel expenses, please see the Financial Review page 53. top-down evaluation is complemented by evalu- ations from other sources: in addition to the man- ager’s evaluation, feedback might be obtained from internal clients, peers and direct reports of the evaluatee, who is also required to provide a self-evaluation. The most important feature of the process is an intensive feedback discussion between manager and evaluatee, where results and implications are reviewed and appropriate measures as well as objectives for the next evalu- ation period are agreed upon. Thus, PMM is a development and evaluation tool and its results are the basis for a number of processes and deci- sions, such as training and development, promo- tion, compensation, position and succession planning. Graduate Programs UBS is keen to attract high caliber staff in all its divisions and thereby ensure the ongoing strength, commitment and quality of manage- ment. Thus, UBS offers graduates two special entry programs: the Junior Key People (JKP) Pro- gram (all divisions and Corporate Center except WDR) and Warburg Dillon Read’s Graduate Training Program (GTP). After at least one year of working experience at UBS young and highly qualified employees can apply for the Interna- tional Mobility Program (IMP) which provides the opportunity of an assignment abroad for one to two years at one of UBS’s world-wide locations. Regional Split December 1998 Performance Measurement and Management UBS Employees by Division In 1998 a new comprehensive performance appraisal system was introduced throughout the bank. PMM which stands for performance meas- urement and management, measures individual achievements (contribution) as well as the appli- cation of knowledge, skills and personal qualities (competencies). With PMM, the conventional 68% Warburg Dillon Read Private Banking Private and Corporate Clients UBS Brinson UBS Capital Corporate Center Group total 1998 13,794 7,634 24,043 1,497 122 921 48,011 1997 18,620 7,862 1 25,641 1 1,364 90 1,599 55,176 1 Restated figures due to client segmentation. 6% 2% 10% 14% Switzerland Rest of Europe The Americas Asia Others 124 Glossary Glossary 126 A accrual basis of accounting The effects of transactions and other events are recognized when they occur, not as cash or its equivalent is received or paid, and they are record- ed in the accounting records and reported in the financial statements of the periods to which they relate. ACRA reserve Actuarial Credit Risk Accounting ACRA: methodology used by UBS for calcu- lating the expected loss on a credit or derivatives portfolio based on the statistical loss experience of rating agencies and to build up a credit pro- vision to provide for such future losses. allowance for credit losses An allowance, which in management’s estimate is adequate to provide for the credit losses inherent in the loan portfolio. The allowance for credit losses is deducted from the related asset category on the balance sheet. B Basle capital ratio A measure of the equity resources underpinning the operations of inter- nationally active banks, as set by the Basle Committee on Banking Supervision which meets at the Bank for International Settlements (BIS). Capital is broken down into core capi- tal (or Tier 1 capital) and supplemen- tary capital (Tier 2 capital). The bank’s assets are weighted from 0% to 100%. The ratio of the capital to the bank’s risk-weighted assets is the BIS capital ratio. C compliance risk The risk that the bank’s conduct of business does not comply with the applicable laws, internal or external regulations or restrictions. This includes the risk of loss resulting from the inability of the bank to meet regulatory requirements, including breaching of existing capital requirements. concentration risk The risk of loss due to creating exces- sive exposure to a particular risk or a group of risks or to a particular country, industry, currency or coun- terparty group. contract volume The contract volume corresponds to the receivable side of derivative instruments; it can be expressed in terms of the notional / nominal amount of underlying instruments or the value of the underlying asset on which the derivative instrument is based. Only derivative instruments outstanding at the balance sheet date are taken into account. defined benefit plan Amounts paid by the enterprise to such post-employment benefit plans may be determined, among others, by the employees’ remuneration and / or years of service. Actuarial risk (that benefits will cost more than expected) and investment risk (that the asset invested will be insufficient to meet expected benefits) fall in substance on the enterprise. country risk Country risk concerns potential losses on foreign creditors’ and investors’ claims that would arise from sovereign default or other restrictions on cross- border transfers of funds. Country risk also concerns the potential for losses by foreign creditors and investors arising from systemic country develop- ments such as exchange rate or asset price reductions. credit risk Risk of loss to the bank due to a counterparty unable or not willing to perform its payment obligations or other terms of contract agreed upon when business was concluded. (Note that credit risk includes e.g. transfer risk.) currency risk The risk of loss or gain due to changes in the underlying exchange rates. D deferred tax asset The amounts of income taxes recover- able in future periods in respect of: (a) deductible temporary differences between reported net income and net income for tax declaration purposes; (b) the carry forward of unused tax losses; and (c) the carry forward of unused tax credits. deferred tax liability The amounts of income taxes payable in future periods in respect of taxable temporary differences between re- ported net income and net income for tax declaration purposes. defined contribution plan Post-employment benefit plans under which an enterprise pays fixed con- tributions into a separate entity (a fund). The enterprise’s obligation is limited to the amount that it agrees to contribute. derivative financial instruments Financial instruments, such as financial options, futures, forwards, interest rate swaps and currency swaps, which create rights and obligations that have the effect of transferring between the parties to the instrument one or more of the financial risks inherent in an underlying primary financial instrument. Derivative instruments do not result in a transfer of the under- lying primary financial instrument on inception of the contract and such a transfer does not necessarily take place on maturity of the contract. E earnings per share (EPS) The amount of net profit for the period that is attributable to ordinary share- holders divided by the weighted average number of ordinary shares outstanding during the period. equity method The method to account for invest- ments, in which we have a significant influence. The investment is initially recorded at cost and adjusted there- after for the post acquisition change in the investors’ share of net assets. exchange traded Refers to standardized options and futures listed and traded on an organized exchange. expected loss Expected loss is the average predicted cost of UBS’s exposure to a particular risk factor during a given reporting period. exposure Any status (be it monetarily expressed or not) that is subject to a potential change. Glossary F fair value The amount for which an asset could be exchanged, or a liability settled, between knowledgeable, willing par- ties in an arm’s length transaction. finance lease A lease that transfers substantially all the risks and rewards incident to ownership of an asset. Title may or may not eventually be transferred. financial intermediaries Companies such as banks, securities or brokerage firms, investment com- panies, pension and mutual funds and insurance companies which facilitate the flow of funds between borrowers and lenders in the economy. forwards and futures Forwards and futures are contractual obligations to buy or sell a financial instrument on a future date at a specified price. Forward contracts are effectively tailor-made agreements that are transacted between counter- parties in the over-the-counter market, whereas futures are standardized contracts that are transacted on regu- lated exchanges. funding risk The risk of being unable to obtain funding for a portfolio of assets at appropriate market rates or of being unable to liquidate assets at appro- priate market prices. G Global Equity Derivatives (GED) Structured equity derivatives business at UBS. goodwill Any excess of the cost of the acquisi- tion over the acquirer’s interest in the fair value of the identifiable assets and liabilities acquired as at the date of the exchange transaction. group A parent and all its subsidiaries. H hedging An action which reduces risk, usually at the expense of potential reward, by use of a financial instrument or a combination of several instruments. historical simulation A methodology for calculating value at risk which revalues the reference portfolio using historically observed market prices over a predefined time period. I information technology risk The risk of loss due to inappropriate information technology. interest rate risk The risk that the value of a financial instrument will fluctuate due to changes in the underlying interest rates. International Accounting Standards (IAS) Accounting standards issued by the International Accounting Standards Committee (IASC). The objective of these standards is to improve and harmonize the accounting standards relating to the presentation of financial statements. investment funds (in the US: mutual funds) A company or financial product whose sole object is to invest its capi- tal in the shares of a wide range of companies. Under Swiss law the investment fund is an entity in which investors pool their capital for joint investment. The assets are managed by the fund’s management for the account of the investors according to the risk distribution principle. Depending on the type of investment fund, the assets may be invested in securities, money market instruments or in real estate; investments can also be made in special fund products and asset allocation funds. Swiss invest- ment funds must be invested in vari- able capital and are obliged to redeem units whenever requested. Securities funds, money market funds, real estate funds, country funds, regional funds, sector funds. Differentiation within UBS: – UBS mutual funds can be broken down into Brinson, WDR and PB funds. – UBS Investment Funds is the label for the Private Banking Division’s core range of public open-end mutual funds. K key personnel risk The risk of loss in knowledge, manage- ment capacity, experience or leader- ship due to the resignation, illness, disability or death of the bank’s key personnel. L legal risk Legal risk is the risk of loss because a contract cannot be enforced. This includes risks arising from insufficient documentation, insufficient capacity or authority of a counterparty (ultra vires, “capacity risk”), uncertain legality, and unenforceability in bank- ruptcy or insolvency. Also called Legal Enforcement Risk. liability risk The risk of loss due to the bank being held responsible for a contractual or legal claim, debt or action based, e.g., on the breach or default of a contract, commitment of a tort, viola- tion of criminal law, infringement of trade marks or antitrust action. logistics functions Separately constituted operational functions including financial control, operational and IT which excercise an essential control function when pro- cessing the transactions entered into by the divisions. loss severity Also referred to as loss given default – the amount that the bank would lose in the event that a counterparty defaults on its obligations. M margin A deposit of cash or securities taken from a client or counterparty as securi- ty against a loan or other obligation. market risk Market risk is the uncertainty to which future earnings are exposed as a result of changes in the value of port- folios of financial instruments. This risk is a consequence of the trading and investing activities in the interest rate, foreign exchange, equity and commodity markets. master netting agreement An arrangement providing for an enterprise that undertakes a number of financial instrument transactions with a single counterparty to make a single net settlement of all financial instruments covered by the agreement in the event of default on, or termina- tion of, any one contract. minority interest That part of the net results of opera- tions and of net assets of a subsidiary attributable to interests which are not owned, directly or indirectly through subsidiaries, by the parent. mutual funds Please see investment funds. N negative replacement value Negative replacement value is the cost to the Group’s conterparties of replacing all the Group’s transac- tions in a loss position if the Group were to default. netting Setting off between counterparties, on the basis of bilateral or multilateral contracts, of mutual payment obli- gations on expiry date, or in the case of default of a counterparty of un- realized profits and unrealized losses. notional amount The reference amount of the under- lying asset or index which is used as the basis for calculating the value of derivative contracts. Notional values provide an indication of the volume of derivatives business transacted by UBS but do not provide any measure of risk. O operating lease A lease other than a finance lease. operational risk The risk that deficiencies in informa- tion systems or internal controls will result in unexpected loss. This risk is associated with human error, system failures and inadequate procedures and controls. At UBS the particular elements of operational risk are oper- ations risk, legal risk, compliance risk, liability risk, information technology risk, key personnel risk and physical and crime risk. 127 Glossary 128 operations risk (otherwise referred to as transaction processing risk) The risk that the deficiencies in trans- action processing systems and the associated internal controls will result in unexpected financial loss. This risk is associated with human error, system failures and inadequate procedures / controls in the trade / transaction pro- cessing. options Options are contractual agreements under which the seller (writer) grants the purchaser the right, but not the obligation, either to buy (call option) or sell (put option) by or at a set date, a specified amount of a financial instrument at a predetermined price. The seller receives a premium from the purchaser for this right. over-the-counter (OTC) instruments Refers to financial instruments that are not traded on an organized exchange or a market that is not part of an organized exchange. OTC instruments can be created with any provisions allowed by law and accept- able to counterparties. P parent An enterprise that has one or more subsidiaries. physical and crime risk The risk of loss to the bank due to, e.g., accidents, crime, sabotage, natural catastrophes, war, riots or elementary damage (water, fire). positive replacement value Positive replacement value represents the cost to the Group of replacing all transactions in a gain position if all the Group’s counterparties were to default. This measure is the industry standard for the calculation of current credit exposure. settlement risk The risk of loss to the bank making a payment or delivery in “exchange- for-value” transactions without receiving the associated payment or delivery from the counterparty. statistical loss The loss which can be predicted with a given statistical probability. stress scenario loss The possible – although improbable and unusual – extreme scenarios which the bank should be able to absorb in the normal course of its business. subsidiary An enterprise that is controlled by another enterprise (known as the par- ent). swaps Swaps are transactions in which two parties exchange cash flows on a specified notional amount for a pre- determined period. Interest rate swap contracts generally represent the contractual exchange of fixed and floating rate payments of a single currency, based on a notional amount and an interest reference rate. Cross-currency interest rate swaps generally involve the exchange of pay- ments which are based on the interest reference rates available at the incep- tion of the contract on two different currency principal balances that are exchanged. The principal balances are re-exchanged at an agreed upon rate at a specified future date. V value at risk Value at risk is a measure of the maxi- mum loss which would be expected to occur in a given portfolio with a given level of statistical probability (e.g. 97%). Note: Value at risk does not provide an estimate of the size of loss that could occur in the remaining cases which fall outside the predefined probability. R Rates business area The fixed income business area of Warburg Dillon Read. repurchase agreement A repurchase agreement (repo) is an agreement whereby the holder of a security sells the security to a buyer / lender, with a simultaneous agree- ment to repurchase the security at a fixed future date at a stipulated price. reverse repurchase agreement A reverse repurchase agreement (reverse repo) is the purchase of a security at a specified price with an agreement to resell the same security at a specified price on a specified future date. risk appetite Amount of risk which the bank is pre- pared to accept in the normal course of business in order to deliver satis- factory long-term growth and return on equity. risk-bearing capacity Potential of the bank to absorb stress losses taking into account UBS’s overall earnings capacity. It is set to protect the Group from unacceptable damage to annual earnings, dividend- paying ability, business viability and the reputation of the bank. risk policy framework Entirety of organizational principles, methods and measures (policies, structures, processes) to manage and control risks. ROE – return on equity Net result of a reporting period divided by the average equity during the same period. S securities borrowing / lending The loan of securities on an unsecured or secured basis for which the borrower pays a fee to the lender. The borrower may re-lend the secu- rities, or use them as collateral, or to settle short sales or repos. The lender retains the beneficial ownership, and is therefore entitled to receive all coupons or dividends from the borrower during the term of the trade. UBS Share Information UBS Share Information The UBS Share in 1998 UBS Share Data Year-end registered shares in 1000 units Total shares outstanding Total shares ranking for dividend Treasury shares (average) Weighted average shares (for basic EPS calculation) Weighted average shares (for diluted EPS calculation) Per share data (basic) (CHF) Gross operating profit Group profit before taxes Net profit / loss Dividend Book value Per share data (diluted) (CHF) Gross operating profit Group profit before taxes Net profit / loss Book value Stock exchange prices 2 Year-end 1998 (CHF) High / low 1998 (29 June first trading day) (CHF) Price/net earnings (P / E) (basic) Price/book value (P / BV) (basic) Dividend yield, gross (high / low) (in percent) Total return (for full-year 1998) Total return Swiss Market Index (SMI) Total return Swiss Performance Index (SPI) Market capitalization (CHF billion) 4 Year-end % change year-on-year In % of the Swiss Market Index (SMI) In % of the Swiss Performance Index (SPI) High (20 July) Low (30 September) Trading volumes (SWX only) (CHF million) 2 Total Daily average Trading volumes (SWX only) (1000 units) 2 Total Daily average 1998 1 214,976 214,450 3,058 211,797 212,941 105.43 19.22 14.31 10.00 152.95 104.86 19.12 14.23 152.13 422 657 / 270 29.5 2.8 3 3.7 / 1.5 2.6 15.7 16.8 90.7 1.17 5 11.8 9.6 140.0 57.9 67,198 517 6 153,078 1,178 6 1 Difference between shares outstanding and shares ranking for dividend are reserved shares. 2 Trading period of UBS registered shares was 29 June until 31 December 1998. 3 Return from dividend and price changes. 4 1998 figures for new UBS shares only. 5 1997 figures on a pro forma basis. 6 Trading period 29 June until 31 December 1998 equals 150 trading days. There was a marked difference in the performance of the Swiss stock market between the first and second halves of the year. The first half saw a conti- nuation of the bull market which had been in place for over two years. In the ensuing six months, the stock market environment then deteriorated sharply as the economic crises in Asia and Russia grew suddenly acute and took their toll. This peri- od was marked by extreme volatility and increased uncertainty which at times precipitated sharp price corrections. The merger between UBS and SBC announced in early December 1997 was very favorably received by the market. The UBS share price, which had been rising continuously, gained fur- ther momentum at the end of June when the merger was legally formalized and the CHF 20 single-class share introduced. The price reached its high for the year on 20 July 1998 at CHF 657, equivalent to a market capitalization of CHF 140 billion. After fluctuating sharply in the second half as a result of the general market uncertainty 130 UBS Share Information and the losses sustained on the bank’s LTCM exposure, the share price reached a low of CHF 270 on 30 September 1998. By year-end, it had climbed back to CHF 422, equivalent to a market value of CHF 91 billion. With a daily trading volume of over 1 million shares, the UBS share is one of the three most actively traded Swiss stocks. In terms of market capitalization, UBS is one of the top five financial institutions in the world. UBS Share Price Chart 100% = 1 December 1997 UBS Market Capitalization 190% 175% 160% 145% 130% 115% 100% 85% 70% 12.97 2.98 4.98 6.98 8.98 10.98 12.98 145 135 125 115 105 95 85 75 65 55 Pressure for Holocaust settlement (16.4.98) Russian/Emerging market crisis UBS profit warning (24.9.98) Start trading of new UBS shares (29.6.98) Announcement of UBS merger (8.12.97) Recovery of markets 7 9 . 2 1 . 1 0 8 9 . 1 0 . 3 2 8 9 . 3 0 . 3 1 8 9 . 5 0 . 6 0 8 9 . 6 0 . 6 2 8 9 . 8 0 . 4 1 8 9 . 0 1 . 2 0 8 9 . 1 1 . 0 2 UBS registered (up to 29 June 1998 old UBS registered) SPI Swiss Performance Index Market capitalization in CHF billion Distribution of UBS shares registered as of 31 December 1998 Number of registered shares (1% = 1,278,095 shares) 1–100 101–1,000 1,001–5,000 5,001–10,000 10,001–50,000 50,001–100,000 >100001 Total 0–1% 1–2% 2–3% 3–4% 4–5% over 5% Total Number of shareholders % of all registered shareholders Number of % of all registered registered shares shares 126,457 61,281 5,156 569 551 98 161 65.092 31.544 2.654 0.293 0.284 0.050 0.083 5,244,360 16,524,771 10,156,828 3,954,295 11,432,204 7,082,802 73,414,288 4.10 12.93 7.95 3.09 8.94 5.54 57.45 194,273 100.000 127,809,548 100.00 194,269 3 0 0 1 0 99.997 111,863,178 6,753,879 0 0 9,192,491 0 0.002 0.000 0.000 0.001 0.000 87.53 5.28 0.00 0.00 7.19 0.00 194,273 100.000 127,809,548 100.00 As of December 31, 1998 no identified investor was holding 5% or more of the total 214 million UBS shares outstanding. Individual shareholders Legal entities Nominees, fiduciaries Total Switzerland Europe North America Other countries Total UBS employees were holding 2.8% of the shares registered. 184,917 8,649 707 194,273 181,738 9,325 960 2,250 194,273 95.19 31,023,286 4.45 65,225,537 0.36 31,560,725 24.27 51.04 24.69 100.00 127,809,548 100.00 93.55 99,135,341 4.80 19,424,727 2,894,597 0.49 6,354,883 1.16 77.57 15.20 2.26 4.97 100.00 127,809,548 100.00 131 UBS Share Information Information for Shareholders UBS Registered Shares (Par Value CHF 20), ISIN Number CH0008470921 Ticker symbols Stock exchange listings SWX (Swiss exchange) Tokyo London (Stock exchange automatic quotation SEAQ) Bloomberg UBSN SW 1264Z JP Reuters UBSZn.S UBS.T UBSZq.L Telekurs UBSN, 004 N16631, 106 847092, 182 Sponsored American Depository Receipt (ADR) program in the USA Ratio Exchange Symbol CUSIP 20 ADR’s = 1 UBS Share OTC (over the counter) UBBSY # 90261R105 Financial calendar General Meeting of Shareholders Thursday, 22 April 1999 Dividend payment date Tuesday, 27 April 1999 Publication first-quarter results 1999 Publication first-half results 1999 Thursday, 27 May 1999 Tuesday, 24 August 1999 For information contact Change of address UBS AG Shareholders’ Register P.O. Box CH-8098 Zurich, Switzerland Phone +41 1 235 62 02 Fax +41 1 235 31 54 UBS AG Investor Relations Bahnhofstrasse 45 CH-8098 Zurich, Switzerland Phone +41 1 234 87 78 Phone +41 1 234 26 02 Fax +41 1 234 34 15 100 Liverpool Street London EC2M 2RH, UK Phone +44 171 568 5207 Fax +44 171 568 5204 132 Imprint Publisher / Editing: UBS AG, Investor Relations Department Concept / Production: UBS AG, Group Management Support Languages: English, German; Copyright: UBS AG, Switzerland SAP-R / 3 80531E; CIF-Pub-Nr. 012/04601 ab UBS AG P.O. Box, CH-8098 Zurich, Switzerland P.O. Box, CH-4002 Basel, Switzerland www.ubs.com 

Continue reading text version or see original annual report in PDF format above