UBS AG
Annual Report 2002

Plain-text annual report

ab Financial Report 2002 The Concept: Gardens We have chosen a number of distinct gardens from around the world as the pictorial theme for our annual reporting products this year. Gardens are the product of imagination, expertise and careful attention to detail. Celebrated gardens evolve from inspired ideas that are developed with consistent and relentless dedication over years – and even generations. Tofuku-ji (Kyoto, Japan) Laid out in 1939 by Mirei Shigemori, a famous garden builder, the gardens were arranged in four quarters around the Hojo, one of the main buildings in the Tofuku-ji Temple. Originally founded in 1235 and reconstructed in 1890, Tofuku-ji was the head temple of the Rinzai sect of Zen Buddhism. When he designed the garden, Shigemori’s intention was to combine the simplicity of Zen during the Kamakura period with the abstract constructions of modern art. Site of Reversible Destiny-Yoro Park (Gifu, Japan) Located in a section of Yoro Park, the Site of Reversible Destiny, which opened in 1995, is an innovative park and architectural “intervention” conceived by artists Shusaku Arakawa and Madeline Gins. Their intention was to illustrate the concept of deconstruction by using the traditional idea of a garden as a labyrinth for a series of physical meetings. Visitors are given directions for use when entering – most of which are rather original and unconventional. The site’s basic structure is a large oval basin with various archipelagos of different sizes overlapped by pairs of hemispherical craters and mounds linked by a number of maze-like winding paths. Barnsley House Garden (Cirencester, Gloucestershire, UK) Designed in the early 1950s by Rosemary Verey (OBE), a leading exponent of the classic English Arts and Crafts country garden style, Barnsley House Garden is a four and a half acre garden bounded on three sides by a high 18th century wall which divides the garden into different areas of interest. Set around Verey’s 17th century home, the garden also includes a gothic summer house, a classical temple, a sculpture by Simon Verity and furniture by Charles Verey. Features of the garden itself include a knot garden that was laid out in 1975, a herb garden and the renowned Laburnum Walk (with yellow laburnum falling onto purple alliums). La Geria (Lanzarote, Canary Islands, Spain) La Geria, known as the “wine road” of Lanzarote, passes through the moun- tains of Chupaderos and Guadilama. It is directly bordered by lava fields and vineyards, a unique feature of the overall landscape. The grapes, which produce Malvasia wine, grow on vines that are protected from winds by small curving walls. Royal Botanic Gardens (Peradeniya, Sri Lanka) One of the four colonial botanic gardens of the British Empire, Peradeniya’s history goes back to 1821. The basic idea behind the founding of the garden in the 19th century was to transfer the concept of an English landscape garden to a tropical environment. Despite that, one part of the garden was left to achieve a “tame jungle” effect, whereby branches are left uncut, and dead tree trunks left to lie. Contents Profile Introduction UBS Group Financial Highlights UBS Group Our Business Groups Sources of Information about UBS Information for Readers Group Financial Review Group Results Review of Business Group Performance Introduction UBS Wealth Management & Business Banking UBS Global Asset Management UBS Warburg UBS PaineWebber Corporate Center UBS Group Financial Statements UBS AG (Parent Bank) Additional Disclosure Required under SEC Regulations 1 2 3 4 5 8 19 20 35 36 42 52 57 66 72 77 179 193 Introduction The Financial Report 2002 forms an essential part of our reporting portfolio. It includes the audited Financial Statements of the UBS Group for 2002 and 2001, prepared according to International Financial Reporting Standards (IFRS) and reconciled to the United States’ Generally Accepted Accounting Principles (US GAAP), and the audited financial statements of UBS AG (the “Parent Bank”) for 2002, prepared according to Swiss Banking Law requirements. It also contains a discussion and analysis of the financial and business performance of the UBS Group and its Business Groups, and addi- tional disclosures required under Swiss and US regulations. The Financial Report should be read in conjunction with the other information published by UBS, described on pages 5 and 6. We hope that you will find the information in our reporting docu- ments useful and informative. We believe that UBS is among the leaders in corporate disclosure, but we would be very interested to hear your views on how we might improve the content and presen- tation of our information portfolio. Mark Branson Chief Communication Officer UBS AG 1 Profile UBS Group Financial Highlights 1 Operating expenses/operating income before credit loss expense. CHF million, except where indicated For the year ended 31.12.02 31.12.01 31.12.00 % change from 31.12.01 Income statement key figures Operating income Operating expenses Operating profit before tax Net profit Cost / income ratio (%) 1 Cost / income ratio before goodwill (%) 1, 2 Per share data (CHF) Basic earnings per share 3 Basic earnings per share before goodwill 2, 3 Diluted earnings per share 3 Diluted earnings per share before goodwill 2, 3 Return on shareholders’ equity (%) Return on shareholders’ equity 4 Return on shareholders’ equity before goodwill 2, 4 34,121 29,577 4,544 3,535 86.2 79.0 2.92 4.73 2.87 4.65 8.9 14.4 37,114 30,396 6,718 4,973 80.8 77.3 3.93 4.97 3.78 4.81 11.7 14.8 36,402 26,203 10,199 7,792 72.2 70.4 6.44 7.00 6.35 6.89 21.5 23.4 (8) (3) (32) (29) (26) (5) (24) (3) CHF million, except where indicated As at 31.12.02 31.12.01 31.12.00 % change from 31.12.01 Balance sheet key figures Total assets Shareholders’ equity Market capitalization BIS capital ratios Tier 1 (%) 5 Total BIS (%) Risk-weighted assets Invested assets (CHF billion) Headcount (full-time equivalents) Long-term ratings 7 Fitch, London Moody’s, New York Standard & Poor’s, New York 1,181,118 38,991 1,253,297 43,530 1,087,552 44,833 79,448 105,475 112,666 11.3 13.8 238,790 2,037 69,061 AAA Aa2 AA+ 11.6 14.8 253,735 2,448 69,9856 AAA Aa2 AA+ 11.7 15.7 273,290 2,445 71,0766 AAA Aa1 AA+ (6) (10) (25) (6) (17) (1) Earnings adjusted for significant financial events and pre-goodwill 2, 8 CHF million, except where indicated For the year ended 31.12.02 31.12.01 31.12.00 % change from 31.12.01 Operating income Operating expenses Operating profit before tax Net profit Cost / income ratio (%) 1 Basic earnings per share (CHF) 3 Diluted earnings per share (CHF) 3 Return on shareholders’ equity (%) 4 33,894 27,117 6,777 5,529 79.5 4.57 4.50 13.9 37,114 29,073 8,041 6,296 77.3 4.97 4.81 14.8 36,402 25,096 11,306 8,799 69.2 7.28 7.17 24.3 (9) (7) (16) (12) (8) (6) 2 Excludes the amortization of goodwill and other intangible assets. 3 For EPS calculation, see Note 8 to the Financial Statements. 4 Net profit/average shareholders’ equity excluding dividends. 5 Includes hybrid Tier 1 capital, please refer to Note 29e in the Notes to the Financial Statements. 6 Klinik Hirslanden was sold on 5 Decem- ber 2002. The Group headcount does not include the Klinik Hirslanden head- count of 2,450 and 1,839 for 31 Decem- ber 2001 and 31 December 2000, respectively. 7 See the Capital strength section on pages 10 and 11 of the UBS Handbook 2002/2003. 8 Details of significant financial events can be found in the Group Financial Review section. The segment results have been restated to reflect the new Business Group struc- ture and associated management accounting changes implemented during 2002. All results presented include PaineWebber from the date of acquisition, 3 Novem- ber 2000. 2 UBS Group UBS is one of the world’s leading financial firms, serving a discerning global client base. As an organi- zation, we combine financial strength with a global culture that embraces change. We are the world’s leading provider of wealth management services and one of the largest asset managers globally. In the investment banking and securities businesses, we are among the select bracket of major global houses. In Switzerland, we are the clear market leader serving corporate and retail clients. As an integrated firm, we create added value for our clients by drawing on the combined resources and expertise of all our businesses. Our first priority is always our clients’ success and we put advice at the heart of our relationships with them. We take the time to understand the unique needs and goals of each of our clients. Our priority is to provide premium quality services to our clients, giving them the best possible choice by supple- menting best-in-class solutions we develop ourselves with a quality-screened selection of products from others. With head offices in Zurich and Basel, and more than 69,000 employees, we operate in over 50 coun- tries and from all major international financial centers. Our global physical presence is complemented by our strategy of offering clients products and services via a variety of different channels – from the traditional retail bank branch to sophisticated, interactive online tools, helping us to deliver our services more quickly, widely and cost-effectively than ever before. 3 Profile Our Business Groups All our Business Groups are in the top echelons of their sectors globally and are committed to vigor- ously growing their franchises. UBS Wealth Management & Business Banking UBS Wealth Management & Business Banking is the world’s leading wealth management business and the leading corporate and retail bank in Switzerland. Almost 3,300 private banking client advisors, working from offices around the world, provide a comprehensive range of in-house and third party products and services customized for wealthy individuals. The Business Banking unit, holding roughly a quarter of the Swiss lending market, offers comprehensive banking and securities services for 3.5 million individuals and 180,000 corporate clients in Switzerland as well as 5,000 financial institutions worldwide. UBS Global Asset Management UBS Global Asset Management is a leading institutional asset manager and mutual fund provider, with invested assets of CHF 557 billion. It offers a broad range of asset management services and products for institutional clients and financial intermediaries across the world. UBS Warburg UBS Warburg is a global investment banking and securities firm. Consistently placing in the top tier of major industry rankings, it is a leading player in the global primary and secondary markets for equity and fixed income products. In investment banking, it provides first-class advice and execution capabilities to its client base worldwide. Sharply client-focused, it provides innovative products, top- quality research and comprehensive access to the world’s capital markets for its corporate and insti- tutional clients and for the rest of UBS. UBS PaineWebber UBS PaineWebber is the fourth largest private client business in the US, with a client base of over 2 million private investors – focused on the most affluent in the country. Its network of almost 9,000 financial advisors manage CHF 584 billion in invested assets and provide sophisticated wealth management services to their clients. Corporate Center The role of the Corporate Center is to ensure that the Business Groups operate as a coherent and effective whole, in alignment with UBS’s overall corporate goals. The scope of Corporate Center’s activities covers financial and capital management, risk management and control, branding, com- munication, legal advice and human resources management. 4 Sources of Information about UBS This Financial Report contains our audited Financial Statements for the year 2002 and the related detailed analysis. You can find out more about UBS from the sources shown below. Publications This Financial Report is available in English and German. (SAP-R/3 80531-0301). Annual Review 2002 Our Annual Review contains a short description of UBS, what our vision and values are, as well as a summary review of our performance in the year 2002. It is available in English, German, French, Italian and Spanish. (SAP-R/3 80530-0301). Handbook 2002/2003 Our Handbook 2002/2003 contains a detailed description of UBS, its strategy, organization and the businesses that make it up. It is available in English and German. (SAP-R/3 80532-0301). Quarterly reports We provide detailed quarterly financial reporting and analysis, including comment on the progress of our businesses and key strategic initiatives. These quarterly reports are available in English. How to order reports Each of these reports is available on the internet at: www.ubs.com/investors, in the “Financials” section. Alternatively, printed copies can be ordered, quoting the SAP number and the language preference where applicable, from UBS AG, Information Center, CA50-XMB, P.O. Box, CH-8098 Zurich, Switzerland. E-information tools for investors Website Our Investors and Analysts website at www.ubs.com/investors offers a wide range of information about UBS, including our financial reporting, media releases, UBS share price graphs and data, corporate calendar and divi- dend information and copies of recent presen- tations given by members of senior management to investors at external conferences. Our internet-based information is available in English and German, with some sections in French and Italian. Messenger service On the Investors and Analysts website, you can register to receive news alerts about UBS via Short Messaging System (SMS) or e-mail. Messages are sent in either English or German and users are able to state their preferences for the topics of the alerts received. Results presentations Senior management present UBS’s results every quarter. These presentations are broadcast live over the internet, and can be downloaded on demand. The most recent results webcasts can be found in the “Financials” section of our Investors and Analysts website. UBS and the environment The Handbook 2002/2003 contains a summary of UBS environmental policies as part of the Corporate Responsibility section. More detailed information is available at: www.ubs.com/ environment Form 20-F and other submissions to the US Securities and Exchange Commission We file periodic reports and submit other infor- mation about UBS with the US Securities and Exchange Commission (SEC). Principal among these filings is the Form 20-F, our Annual Report filed pursuant to the US Securities Exchange Act of 1934. Our Form 20-F filing is structured as a “wrap-around” document. Most sections of the filing are satisfied by referring to parts of this 5 Profile Handbook or to parts of the Financial Report 2002. However, there is a small amount of addi- tional information in the Form 20-F which is not presented elsewhere, and is particularly targeted at readers in the US. You are encouraged to refer to this additional disclosure. You may read and copy any document that we file with the SEC on the SEC’s website, www.sec.gov, or at the SEC’s public reference room at 450 Fifth Street NW, Washington, DC, 20549. Please call the SEC at 1-800-SEC-0330 (in the US) or at +1 202 942 8088 (outside the US) for further information on the operation of its public reference room. You may also inspect our SEC reports and other information at the New York Stock Exchange, Inc., 20 Broad Street, New York, NY 10005 and the American Stock Exchange LLC, 86 Trinity Place, New York, NY 10006. Much of this additional information may also be found on the UBS website at www.ubs.com/investors, and copies of docu- ments filed with the SEC may be obtained from UBS’s Investor Relations team, at the addresses shown on the following page. Corporate information The legal and commercial name of the com- pany is UBS AG. The company was formed on 29 June 1998, when Union Bank of Switzerland (founded 1862) and Swiss Bank Corporation (founded 1872) merged to form UBS. UBS AG is incorporated and domiciled in Switzerland and operates under Swiss Company Law and Swiss Federal Banking Law as an Aktiengesellschaft, a corporation that has issued shares of common stock to investors. The addresses and telephone numbers of our two registered offices and principal places of business are: Bahnhofstrasse 45, CH-8098 Zurich, Switzer- land, telephone +41-1-234 11 11; and Aeschenvorstadt 1, CH-4051 Basel, Switzerland, telephone +41-61-288 20 20. UBS AG shares are listed on the SWX Swiss Exchange and traded through the latter’s major- ity-owned virt-x trading platform. UBS shares are also listed on the New York Stock Exchange and the Tokyo Stock Exchange. 6 Switchboards For all general queries. Zurich London New York Hong Kong +41 1 234 1111 +44 20 7568 0000 +1 212 821 3000 +852 2971 8888 UBS Investor Relations Our Investor Relations team supports institutional, professional and retail investors from offices in Zurich and New York. www.ubs.com/investors Zurich Hotline: Christian Gruetter Mark Hengel Catherine Lybrook Oliver Lee Fax +41 1 234 4100 +41 1 234 4360 +41 1 234 8439 +41 1 234 2281 +41 1 234 2733 +41 1 234 3415 New York Hotline: Richard Feder Christopher McNamee Fax +1 212 713 3641 +1 212 713 6142 +1 212 713 3091 +1 212 713 1381 UBS AG Investor Relations G41B P.O. Box CH-8098 Zurich, Switzerland UBS Americas Inc. Investor Relations 135 W. 50th Street, 9th Floor New York, NY 10020, USA sh-investorrelations@ubs.com UBS Group Media Relations Our Group Media Relations team supports global media and jour- nalists from offices in Zurich, London, New York and Hong Kong. Zurich London New York Hong Kong www.ubs.com/media +41 1 234 8500 +44 20 7567 4714 +1 212 713 8391 +852 2971 8200 sh-gpr@ubs.com sh-mr-london@ubsw.com sh-mediarelations-ny@ubsw.com sh-mediarelations-ap@ubs.com UBS Shareholder Services UBS Shareholder Services, a unit of the Company Secretary, is responsible for the registration of the Global Registered Shares. It is split into two parts – a Swiss register, which is main- tained by UBS acting as Swiss transfer agent, and a US register, which is maintained by Mellon Investor Service as US transfer agent (see below). US Transfer Agent For all Global Registered Share related queries in the USA. www.melloninvestor.com Hotline Fax +41 1 235 6202 +41 1 235 3154 calls from the US calls outside the US +1 866 541 9689 +1 201 329 8451 UBS AG Shareholder Services – GUMV P.O. Box CH-8098 Zurich, Switzerland sh-shareholder-service@ubs.com c/o Mellon Investor Services Overpeck Centre 85 Challenger Road Ridgefield Park, NJ 07660, USA shrrelations@melloninvestor.com UBS listed its Global Registered Shares on the New York Stock Exchange on 16 May 2000. Prior to that date UBS operat- ed an ADR program. See the Frequently Asked Questions (FAQs) section at www.ubs.com/investors for further details about the UBS share. 7 Profile Information for Readers The discussion and analysis in the Group Financial Review and Review of Business Group Performance should be read in conjunction with the UBS Group Financial Statements and the related notes, which are shown in pages 77 to 177 of this document. Parent Bank Pages 179 to 190 contain the financial statements for the UBS AG Parent Bank – the Swiss company, including branches worldwide, which owns all the UBS Group companies, directly or indirectly. Except in those pages, or where otherwise explic- itly stated, all references to “UBS” refer to the UBS Group and not to the Parent Bank. Accounting standards The UBS Group Financial Statements have been prepared in accordance with Internation- al Financial Reporting Standards (IFRS). As a US listed company, UBS Group provides a description in Note 39 to the UBS Group Financial Statements of the significant differences which would arise were our accounts to be pre- sented under the United States Generally Ac- cepted Accounting Principles (US GAAP), and a detailed reconciliation of IFRS shareholders’ equity and net profit to US GAAP. Major differ- ences between Swiss Federal Banking Law requirements and IFRS are described in Note 38 to the UBS Group Financial Statements. Except where clearly identified otherwise, all of UBS Group’s financial information presented in this document is presented on a consolidated basis under IFRS. The Parent Bank’s financial statements are prepared in order to meet Swiss regulatory requirements and in compliance with Swiss Federal Banking Law. All references to 2002, 2001 and 2000 refer to the UBS Group and the Parent Bank’s fiscal years ended 31 December 2002, 2001, and 2000, respectively. The Financial Statements for the UBS Group and the Parent Bank for each of these periods have been audited by Ernst & Young Ltd., as described in the Report of the Independent Auditors on page 177 and the Report of the Statutory Auditors on page 189. Changes to accounting presentation The segment reporting shown in Note 2 to UBS Group Financial Statements has been restat- ed to reflect the reorganization of the Group in 2002. See the “Review of Business Group Performance” on page 35 for details of changes since the 2001 presentation. PaineWebber merger Except where otherwise stated, all 2000 figures for UBS Group throughout this report include the impact of the merger with Paine Webber Group, Inc., which was completed on 3 No- vember 2000. Under purchase accounting rules, the results for 2000 reflect PaineWebber’s income and expenses for two months only, from 3 No- vember 2000 until 31 December 2000. Restructuring provision After the merger of Swiss Bank Corporation and Union Bank of Switzerland was completed on 29 June 1998, we began integrating the opera- tions of the two predecessor banks. This process included streamlining operations, eliminating duplicate information technology infrastructure, and consolidating banking premises. We estab- lished a restructuring provision of CHF 7 billion to cover UBS’s expected costs associated with the integration process. In December 1999, we recognized an additional pre-tax restructuring charge of CHF 300 million because of the merger. We completed the integration and restructur- ing process relating to the merger as of 31 De- cember 2001 and released the remaining CHF 21 million of the restructuring provision to the income statement. 8 Critical accounting policies Basis of preparation and selection of policies We prepare our Financial Statements in accor- dance with IFRS, and provide a reconciliation to generally accepted accounting principles in the United States (US GAAP). When feasible, we reduce the differences between our Financial Statements under the two standards by applying accounting policies that are in accordance with both sets of standards. This approach limits (but does not completely eliminate) the range of elec- tive accounting treatments available to us, but there are still rules under both standards which require us to apply judgement and make estimates in preparing our Financial Statements. The more significant of these accounting treatments are dis- cussed in this section, as a guide to understanding how their application affects our reported results and our disclosure. A broader description of the accounting policies we employ is shown in Note 1 to the UBS Group Financial Statements. The existence of alternatives and the applica- tion of judgement mean that any selection of dif- ferent alternatives or estimates would cause our reported results to differ. We believe that the choices we have made are appropriate, and that our Financial Statements therefore present our financial position and results fairly, in all mate- rial respects. The alternative outcomes discussed below are presented solely to assist the reader in understanding our Financial Statements, and are not intended to suggest that other alternatives or estimates would be more appropriate. Many of the judgements which we make in applying accounting principles depend on an assumption, which we believe to be correct, that UBS maintains sufficient liquidity to hold posi- tions or investments until a particular trading strategy matures – i.e. that we do not need to realize positions at unfavorable prices in order to fund immediate cash needs. Liquidity is discussed in more detail on pages 81 to 84 of the Hand- book 2002/2003. Profit and loss impact UBS’s strategy is to attempt to minimize the profit and loss volatility that can be caused by unrealized gains and losses on recognized finan- cial assets and liabilities carried at fair value. Upon implementation of IAS 39, UBS elected to record changes in fair value of financial assets classified as “available-for-sale” directly in share- holders’ equity rather than in earnings. Changes to shareholders’ equity With the implementation of IAS 39 we identified “Gains/losses not recognized in the income state- ment” as a separate section within shareholders’ equity. Within this we show three subsections, “Foreign currency translation” (which was an existing line in shareholders’ equity, reported in previous years) and two additional subsections introduced as a result of the adoption of IAS 39 on 1 January 2001, and which are “Unrealized gains/losses on available-for-sale investments”, and “Changes in fair value of derivative instru- ments designated as cash flow hedges”. Both subsections had opening balances: – the opening balance of “Unrealized gains/ losses on available-for-sale investments” was a net increase of CHF 1,577 million, net of taxes, on 1 January 2001 due to unrealized mark-to-market gains on financial invest- ments classified as available for sale which were principally attributable to private equity investments, but which also included other financial investments held by the Group. – the opening balance of “Changes in fair value of derivative instruments designated as cash flow hedges” was a net loss of CHF 380 mil- lion, net of taxes, on 1 January 2001 due to unrealized mark-to-market losses on deriva- tives designated as cash flow hedges. These losses were previously recorded in the balance sheet as part of “Deferred losses”. All movements within these categories are now recorded each year in the statement of changes in equity. Recognition and measurement of financial instruments On 1 January 2001, UBS Group adopted the accounting standard IAS 39: recognition and measurement of financial instruments. The prin- cipal effects of the standard on our accounts are outlined as follows. Financial instruments – fair value Our trading portfolio assets and liabilities are recorded at fair value on the balance sheet, with changes in fair value recorded as trading income in the income statement. Key judgements affect- ing this accounting policy relate to how we deter- mine fair value for such assets and liabilities. 9 Profile For substantially all of our portfolios, fair values are based on quoted market prices for the specific instrument, comparisons with other highly similar financial instruments, or the use of models. Valuation models are used primarily to value credit derivatives and certain equity and fixed income derivatives. Where valuation models are used to compute fair values, or where they are used in our control functions for inde- pendent risk monitoring, they must be validated and periodically reviewed by qualified personnel independent of the area that created the model. There are a variety of factors that are con- sidered by our models, including time value and volatility factors, counterparty credit quality, activ- ity in similar instruments in the market, adminis- trative costs over the life of the transaction, and liquidity/market volume considerations, among others. Changes in assumptions about these fac- tors could affect the reported fair value of financial instruments. However, because these factors can change with no correlation to each other, it is not possible to provide a meaningful estimate of how changes in any of these factors could affect report- ed fair value of the portfolio as a whole. As a result of the potential variability in com- puted fair values, valuation adjustments are an integral part of the valuation process and are applied consistently from period to period. Establishing valuations inherently involves the use of judgement, and management also applies its judgement in establishing reserves against indicated valuations for aged positions, deterio- rating economic conditions (including country- specific risks), concentrations in specific indus- tries, types of instruments or currencies, market liquidity, model risk itself, and other factors. Despite the fact that a significant degree of judgement is required in order to establish fair values in some cases, management believes the fair values recorded in the balance sheet and the changes in fair values recorded in the income statement are reasonable, based on a number of controls and procedural safeguards we employ. Before models are used, they are certified by our independent control function, called Quanti- tative Risk Management. We then generally employ “back-testing” procedures to test model outputs with actual data and apply our models consistently from one period to the next, while also searching for comparative market prices for additional verification. Hedge accounting. IAS 39 allows a company to apply hedge accounting if it fully complies with the specified hedge criteria. One of the goals of a hedg- ing program is to reduce volatility of fair values by entering into a hedging transaction where changes in fair values of the hedging transaction offset changes in the fair values of the hedged item. Due to cost and other considerations, a transaction may not be hedged over its entire life, or a dynam- ic hedging strategy may be used whereby different transactions are designated as the hedging transac- tion at different times. However, if the hedged item is one that would normally not be recorded at fair value (for instance if it is held at cost less impair- ment), but the hedging instrument is of a sort that would normally be accounted for at fair value, there could be substantial differences in the profit and loss effect for the two items during specific accounting periods, although over the whole life of the instrument these would be expected to balance out. We believe that, in such cases, not applying hedge accounting could lead to misinterpretations of our results and financial position, since hedging transactions could have a material impact on reported net profit in a particular period. In principle, we apply hedge accounting whenever we meet the criteria of IAS 39 so that our Financial Statements clearly reflect the eco- nomic hedge effect obtained from the use of these instruments. However, in connection with eco- nomically hedging selected credit risk exposures we have entered into credit default swaps (CDS) that include conditions that prevent their quali- fying for hedge accounting under IAS 39. CDSs are derivative instruments carried on our balance sheet at fair value with changes in fair value recorded in net trading income. This may add volatility to our net trading income results, and the impact may be either positive or negative in a particular period. The use of CDSs coupled with not applying hedge accounting may also add volatility to net profit because changes in fair value of a CDS and any credit loss expense relat- ing to the hedged exposure may well be recorded in different periods. Typically, the credit rating of a company that ultimately defaults on its obliga- tions deteriorates gradually over a period of time. Such deterioration is reflected in a gradual increase in fair value of the related CDS, resulting in trading income gains being recorded. On the other hand, a credit loss expense is not recorded until the claim is deemed to be impaired, or if an 10 undrawn commitment is expected to be drawn without prospect of full repayment. This timing mismatch between recognizing income from increases in the fair value of a CDS and recogniz- ing expense for credit losses may introduce period-to-period volatility in net profit. In addi- tion, the positive effect of CDSs on reducing credit losses is not reflected as a reduction in reported credit loss expense. In 2002, UBS recorded mark-to-market gains of CHF 226 million on CDSs that hedge existing credit risk exposures without recording a corre- sponding credit loss expense. Had our CDSs qualified for hedge accounting, we could have deferred recognition of gains on the CDSs until the underlying claim became impaired. Unless we decide to settle CDSs prematurely, and thus realize the mark-to-market gains, for example because we believe that we will ultimately not incur a credit loss on the hedged exposure, these mark-to-market gains may be offset by losses in future periods. This may occur either because the fair value of the CDS will decrease or because a credit loss is incurred on the hedged exposure. Applying hedge accounting means that changes in the fair values of designated hedging instruments affect reported net profit in a period only to the extent that each hedge is ineffective. Alternatively, if we were to choose not to apply hedge accounting, the entire change in fair value of the designated hedging instruments in each individual reporting period would be reported in net income for that period, regardless of the economic effectiveness of the hedge. For our fair value hedges, not applying hedge accounting would have resulted in a pre-tax gain of CHF 951 million in 2002 and a pre-tax gain of CHF 319 million in 2001. For our cash flow hedges, the respective amounts are a pre-tax gain of CHF 326 million for 2002 and a pre-tax loss of CHF 79 million for 2001. Please refer to Note 1(v) to the UBS Group Financial Statements for further information on hedge accounting. Financial investments – available-for-sale UBS has classified some of its financial assets, including investments not held for trading purpos- es, as available-for-sale. This classification is based on our determination that these assets are not held for the purpose of generating short-term trading gains, but rather for mid-to-long-term capital appreciation. If we had originally decided that these were trading assets, or if we were to reclas- sify these assets as trading assets, changes in fair value would then have to be reflected in income rather than shareholders’ equity. The amount of unrealized gains or losses on the balance sheet date is disclosed in the statement of changes in equity in the UBS Group Financial Statements. Companies held in our private equity port- folio are not consolidated in UBS’s Financial Statements. This treatment has been determined after considering such matters as liquidity, exit strategies and degree and timing of our influence and control over these investments. We classify our private equity investments as financial investments available-for-sale, and carry them on the balance sheet at fair value, with changes in fair value being recorded directly in equity. However, unrealized losses that are not expected to be recoverable within a reasonable time period are recorded in our income statement as impairment charges. Since quoted market prices are generally unavailable for these compa- nies, fair value is determined by applying recog- nized valuation techniques, which require the use of assumptions and estimates. The valuation of our investments is derived by application of our valuation policy in a detailed quarterly invest- ment by investment review involving the business and control functions. Our standard valuation method is to apply multiples of earnings that are observed for comparable companies. These mul- tiples depend on a number of factors and may fluctuate over time. However the geographic, stage and sector diversity of the portfolio means that the valuations of these positions may not move uniformly based on the changing econom- ic environment. Although judgement is involved, we believe that the estimates and assumptions made in determining the fair value of each invest- ment are reasonable and supportable. Since there are no general estimates or assumptions underly- ing the determination of fair value, but instead fair value is determined on a case-by-case basis, it is not possible to provide any meaningful esti- mate of the impact on earnings of variations in assumptions and estimates. In addition, the determination of when a decline in fair value below cost is not recoverable within a reasonable time period is judgemental by nature, so profit and loss could be affected by differences in this judgement. We generally con- sider investments as impaired if a significant 11 Profile decline in fair value below cost extends beyond the near term, unless it is readily apparent that an investment is impaired, in which case this would result in an immediate loss recognition. Goodwill and other intangible assets We regularly review assets that are not carried at fair value for possible impairment indications. If impairment indicators are identified, we make an assessment about whether the carrying value of such assets remains fully recoverable. When making this assessment, we compare the carrying value to the market value, if available, or the value in use. Value in use is determined by dis- counting expected future net cash flows generat- ed by an asset or group of assets to present value. Determination of the value in use requires man- agement to make assumptions and use estimates. We believe that the assumptions and estimates used are reasonable and supportable in the exist- ing market environment, but different ones could be used which would lead to different results. The single most significant amount of goodwill relates to the acquisition of PaineWebber. The val- uation model used to determine the fair value of UBS PaineWebber is sensitive to changes in the assumptions about the discount rate, growth rate and expected cash flows (i. e. assumptions about the future performance of the business). Adverse changes in any of these factors could lead us to record a goodwill impairment charge. In the fourth quarter of 2002, we took the decision to move all our businesses to the single UBS brand name. That decision necessitated the writeoff of the carrying value of the intangible asset related to the PaineWebber brand name, which resulted in a charge of CHF 953 million net of tax. Had we not made the decision to abandon the PaineWebber brand name, the writeoff would not have been made as it would not have been deemed impaired. Allowances and provisions for credit losses UBS classifies a claim as impaired if the book value of the claim exceeds the present value of the cash flows actually expected in future periods – interest payments, scheduled principal repay- ments, or other payments due (for example on derivatives transactions or guarantees), including liquidation of collateral where available. UBS has established policies to ensure that the carrying values of impaired claims are determined on a consistent and fair basis, especially for those impaired claims for which no market estimate or benchmark for the likely recovery value is avail- able. Future cash flows considered recoverable are discounted to present value in accordance with IAS 39. A provision is then recorded for the prob- able loss on the claim in question and charged to the income statement as credit loss expense. Each case is assessed on its merits, and the workout strategy and estimate of cash flows con- sidered recoverable are independently approved by the Credit Risk Control function. Although judgement is involved, we believe that the esti- mates and assumptions made in determining provisions and allowances on each individual impaired claim are reasonable and supportable. Since there are no general estimates or assump- tions underlying the determination of allowances and provisions, but instead, as noted above, these allowances and provisions are determined on a case-by-case basis, it is not possible to provide any meaningful estimate of the impact on earn- ings of variations in assumptions and estimates. Further details on this subject are given in Note 1(l) to the UBS Group Financial Statements and in the “Risk analysis” section of the Handbook 2002/2003, on pages 59 to 77. Securitizations and Special Purpose Entities UBS sponsors the formation of Special Purpose Entities (SPEs) primarily for the purpose of allowing clients to hold investments, for asset securitization transactions, and for buying or selling credit protection. In accordance with IFRS we do not consolidate SPEs that we do not con- trol. As it can sometimes be difficult to determine whether we exercise control over an SPE, we have to make judgements about risks and rewards as well as our ability to make opera- tional decisions for the SPE in question. In many instances, elements are present that, considered in isolation, indicate control or lack of control over an SPE, but when considered together make it difficult to reach a clear conclusion. In such cases the Group generally consolidates an SPE. UBS has a comprehensive process for moni- toring and controlling the creation and running of SPEs, designed to ensure that they are created only for purposes connected with our business, which includes the facilitation of client invest- ment objectives, that any change of terms or status, such as the activation of a dormant SPE, 12 is appropriate and that the SPEs and their assets and liabilities are properly recorded, if consoli- dated. UBS manages the risk of consolidated SPEs in the same way as for any other subsidiary. Unconsolidated SPEs are treated like any other unaffiliated counterparty, under normal credit risk principles. Principal types of SPE used by UBS SPEs used to allow clients to hold investments are structures that allow one or more clients to invest in an asset or set of assets which are gener- ally purchased by the SPE in the open market and not transferred from UBS. The risk or reward of the assets held by the SPE resides with the clients. Typically, UBS will receive service and commis- sion fees for creation of the SPE, or because it acts as investment manager, custodian or in some other function. These SPEs range from mutual funds to trusts investing in real estate, for example UBS Alter- native Portfolio AG, which provides a vehicle for investors to invest in a diversified range of alter- native investments through a single share. The majority of our SPEs fall into this category. SPEs created for client investment purposes are not consolidated. SPEs used for securitization. SPEs for securiti- zation are created when UBS has assets (for example a portfolio of loans) which it sells to an SPE. The SPE in turn sells interests in the assets as securities to investors. Consolidation of these SPEs depends on whether UBS retains the risks and rewards of the assets in the SPE. We do not consolidate SPEs for securitization if UBS has no control over the assets and no longer retains any significant exposure (gain or loss) to the returns, including liquidation, on the assets sold to the SPE. This type of SPE is a bankruptcy-remote entity – if UBS were to go bankrupt, the holders of the securities would clearly be owners of the assets, while if the SPE were to go bankrupt, the securities holders would have no recourse to UBS. In some cases UBS does retain exposure to some of the returns from the assets sold to the SPE – for example first loss on a loan portfolio. In these cases we consolidate the SPE and then derecognize the assets to the extent that we do not have exposure. SPEs for credit protection are set up to allow UBS to sell the credit risk on portfolios, that may or may not be held by UBS, to investors. They are pri- marily to allow UBS to have a single counterparty (the SPE) which sells credit protection to UBS. The SPE in turn has investors who provide it with cap- ital and participate in the risks and rewards of the credit events that it insures. SPEs used for credit protection are generally consolidated. Equity compensation Currently IFRS does not specifically address the recognition and measurement of equity-based compensation plans, including employee option plans. Extensive literature on accounting for options granted to employees exists under US GAAP, which permits a company to elect either the intrinsic value method or the fair value method. Under the intrinsic value method, if the exercise price of options granted is equal to or greater than the fair value of the underlying equity at grant date, no compensation expense need be recorded. Under the fair value method, an amount would be computed for such options and charged to compensation expense. For IFRS, UBS records as compensation expense only the intrinsic value at grant date, if any, of options granted to employees. Subsequent changes in value are not recognized. Had we recognized the fair value of stock option grants as compensation expense, net income would have been lower by the follow- ing amounts: CHF 690 million in 2002, CHF 347 million in 2001, and CHF 158 million in 2000. Further information on UBS equity com- pensation plans is disclosed in Note 32 to the UBS Group Financial Statements. In November 2002, the International Accounting Standards Board issued ED2, “Share-based payments”, which is expected to become effective in January 2004. ED2 in its current form would require a different recognition method of compensation expense for the fair value of stock options granted than that applied to determine the amounts disclosed above. Deferred tax Deferred tax assets arise from a variety of sources, the most significant being: a) tax losses that can be carried forward to be utilized against profits in future years; b) expenses recognized in the books but disallowed in the tax return until the associated cash flow occurs; and c) valuation changes of assets which need to be tax-effected 13 Profile for book purposes but are taxable only when the valuation change is realized. UBS records a valuation allowance to reduce its deferred tax assets to the amount that it believes can be realized in its future tax returns. Our valuation allowance is based on the assess- ment of future taxable income and our tax planning strategies. At each balance sheet date, existing assessments are reviewed and, if neces- sary, revised to reflect changed circumstances. The magnitude of the valuation allowance is significantly influenced by our own forecast of future profit generation, which drives the extent to which we will be able to utilize the deferred tax assets. Were we to be more optimistic or pessimistic when forecasting future taxable prof- its we would record a lower or higher valuation allowance, which would have a direct impact on earnings. Additionally, changes in circumstances may result in either an increase or a reduction of the valuation allowance, and therefore net income, depending on an adverse or favorable change in the factors that impact the recognized deferred tax assets. See Note 21 to the UBS Group Financial Statements for further details. Segment reporting The policies used to prepare our segment report- ing affect the split of our income and expenses between the different Business Groups. Although the application of rules different from the ones we currently use would lead to altered net profit results in the Business Groups, they would have no effect on the total Group profit number. The most significant of these policies is the treatment of credit loss expense. If we had not applied the concept of expected loss in calculat- ing the credit loss expense for each Business Group, Corporate Center would have incurred a significantly higher loss in all periods presented, UBS Warburg would have achieved a better result in 2002 but slightly lower profit in both 2001 and 2000, and UBS Wealth Management & Business Banking would have had a modestly better result in 2002 preceded by a significantly higher profit in both 2001 and 2000. The con- cept of expected credit loss is explained in more detail in the “Management accounting” section of this report on pages 36 to 41, which includes a table which reconciles the expected credit loss amount charged to the Business Groups with the actual IFRS credit loss. Analysis of adjusted key figures and results We analyze UBS’s performance on a reported basis determined in accordance with IFRS. Additionally, we provide comments and analysis on an adjusted basis which excludes from the reported amounts certain items we term signi- ficant financial events (SFEs). An additional adjustment we use in our results discussion is the exclusion of the amortization of goodwill and other acquired intangible assets. These adjustments reflect our internal analysis approach where SFE-adjusted figures before goodwill/intangibles amortization are used to assess past performance against peers and to estimate future growth potential. In particular, our financial targets have been set in terms of adjusted results, excluding SFEs and goodwill/ intangibles amortization, and all the analysis provided in our management accounting is based on operational SFE-adjusted performance. Significant financial events For performance analysis, in particular to com- pare our financial results with previous periods and with peers, we use figures adjusted for signi- ficant financial events (SFEs). This helps us to illustrate the underlying operational performance of our business, insulated from the impact of one-off gains or losses outside the normal run of business, and provides a better basis for our internal performance assessment and planning. A policy approved by the Group Executive Board defines which items may be classified as SFEs. In general an item that is treated as a SFE is: – Non-recurring – Event-specific – Material at Group level – UBS-specific, not industry-wide and is not a consequence of the normal run of business. Examples of items that we would treat as SFEs include the gain or loss on the sale of a significant subsidiary or associate, such as the sale in 2002 of Klinik Hirslanden and Hyposwiss, or the restruc- turing costs associated with a major integration, such as the merger with PaineWebber in 2000. SFEs are not a recognized accounting concept under IFRS or US GAAP, and are therefore not reflected as such in the UBS Group Financial Statements. We clearly identify all adjusted fig- ures as such, and clearly disclose both the pre-tax 14 amount of each individual significant financial event, and the net tax benefit or loss associated with all the SFEs in each period, allowing the reader to reconcile adjusted figures to the report- ed ones. Where tables in the Business Group reporting show adjusted figures, we also include a table showing the reported figures. SFEs during 2000 and 2002 are shown in the table below and described in more detail below. There were no SFEs in 2001. – In first quarter 2002, we realized a pre-tax gain of CHF 155 million from the sale of the private bank Hyposwiss. – In fourth quarter 2002, we recorded a non- cash pre-tax writedown of CHF 1,234 million related to the PaineWebber brand, an intangi- ble asset. It was recorded following our deci- sion to move to a single UBS brand. This change in our brand strategy was announced in November 2002 and we will effectively introduce the single brand in June 2003. – In fourth quarter 2002, we realized a pre-tax gain of CHF 72 million from the sale of Klinik Hirslanden, a private hospital group. – During 2000, we recorded restructuring charges and provisions of CHF 290 million pre-tax relating to the integration of Paine- Webber into UBS. – In 2000 UBS recognized an additional pre-tax provision of CHF 150 million in connection with the US Global Settlement of World War II-related claims. Previously, we had estab- lished a provision of CHF 842 million (in 1998) and one of CHF 154 million (in 1999) relating to this claim. Amortization of goodwill and other intangibles In addition to IFRS figures, we discuss our Group result excluding the amortization of goodwill and other intangibles. The same adjustment is used also for our Group financial targets, includ- ing earnings per share. At UBS, we believe that equity values are driven by future cash flows. IFRS rules currently require that goodwill is amortized over its estimated useful life regardless of whether its economic value is maintained or even increased. Furthermore, goodwill is an asset that does not need to be replaced at the end of its life. Consequently, amortization charges do not represent cash outflows and are not an economic cost. Therefore we believe they are not relevant for assessing the value created for our share- holders. In our financial reporting, we clearly identify all figures that exclude amortization charges for goodwill and other intangibles and refer to them as “pre-goodwill” figures. Reported figures including amortization charges are always disclosed and precede pre-goodwill disclosure. Significant Financial Events CHF million For the year ended Operating income as reported Gain on disposal of Hyposwiss Gain on disposal of Klinik Hirslanden Adjusted operating income Operating expenses as reported Writedown of PaineWebber brand name US Global Settlement Fund provision PaineWebber integration costs Adjusted operating expenses 31.12.02 34,121 (155) (72) 33,894 29,577 (1,234) 28,343 Adjusted operating profit before tax and minority interests 5,551 Tax expense Tax effect of significant financial events Adjusted tax expense Minority interests Adjusted net profit Adjusted net profit before goodwill 678 239 917 (331) 4,303 5,529 31.12.01 37,114 37,114 30,396 30,396 6,718 1,401 1,401 (344 ) 4,973 6,296 31.12.00 36,402 36,402 26,203 (150) (290) 25,763 10,639 2,320 100 2,420 (87) 8,132 8,799 15 Profile Risk factors As a global financial services firm, UBS’s businesses are affected by the external environment in the markets in which we operate. Different risk factors can impact our ability to effectively carry out our busi- ness strategies or can directly affect our earnings. Due to the factors described below and to other influences beyond our control, UBS’s revenues and operating profit have been and are likely to continue to be subject to a measure of variability from period to period. Therefore UBS’s revenues and operating profit for any par- ticular period may not be indicative of sus- tainable results, may vary from year to year and may affect our ability to achieve UBS’s strategic objectives. Fluctuations in interest rates, equity prices, foreign currency rates and other market variables A substantial part of our business consists of taking trading and investment positions in the debt, currency, equity, precious metal and energy markets and in private equity, real estate and other assets. The value of these assets can be adversely affected by fluctuations in financial mar- kets. While we selectively utilize hedging techniques to mitigate these risks, these hedging techniques may not always be completely effective. More details on our risk management approach are provided in the “Market risk” section in the Hand- book 2002/2003. Because we prepare our accounts in Swiss francs, changes in currency exchange rates, particularly between the Swiss franc and the US dollar, may have an effect on the earnings that UBS reports (as revenues in US dollars represent the major part of our non-Swiss franc income). Our approach in managing this risk is explained in the “Currency management” section of the “Group Treasury” chapter in the Hand- book 2002/2003. In addition, changes in financial mar- ket structures can affect our earnings. For example, the euro’s introduction in 1999 affected foreign exchange markets in Europe by reducing the extent of for- eign exchange dealings among member countries and prompting a greater har- monization of financial products. Move- ments in interest rates can also affect our results as net interest income is affected by changes in interest rates. Interest rate movements can also affect our fixed income trading portfolio and the invest- ment performance of our asset manage- ment businesses. Furthermore, income in many of our businesses, such as investment banking, wealth and asset management, is often directly related to client activity levels. As a result, our income is also susceptible to the adverse effect of a sustained market down- turn or significant deterioration of investor sentiment. Asset-based revenues generated in our wealth and asset management busi- nesses depend on the levels of client assets which can be adversely affected by a dete- rioration of market valuations. Market values and volumes may be affected by a broad range of issues beyond our control, such as geopolitical events, the possibility of war, terrorism, inflation and economic developments such as recession or depression globally or in particular regions. Counterparty risks The results of our credit-related activities (including loans, commitments to lend, other contingent liabilities such as letters of credit, derivative products such as swaps and options) would be adversely affected by any deterioration in the credit- worthiness of our counterparties and the ability of clients to meet their obligations. The credit quality of our counterparties may be affected by various factors, such as an economic downturn, lack of liquidity, or unexpected political events, and as a result these events could cause us to incur greater losses. 16 In general, we aim to avoid risk concen- trations in our credit portfolio. We believe that the incurred losses are adequately cov- ered by our allowances and provisions. Additionally, we make active use of credit protection. A detailed discussion of credit risk and our approach to managing this risk can be found in the “Risk Analysis” section of the “Risk Management and Control” chapter in the Handbook 2002/ 2003. If our risk management and control measures prove inadequate or are not effec- tive, then credit losses could have a mate- rial adverse effect on our income and the value of our assets. Consequential risk All our businesses are dependent on our ability to process a large number of com- plex transactions across many and diverse markets in different currencies and subject to many different legal and regulatory regimes. UBS’s systems and processes are designed to ensure that the risks associated with our activities, including those arising from process error, failed execution, fraud, systems failure, failure of security and physical protection are appropriately con- trolled. However, if our system of internal controls is ineffective in identifying and remedying these risks, we will be exposed to operational failures that could result in losses. A detailed discussion of our ap- proach in management and control of these risks can be found in the “Con- sequential risk” section of the “Risk Management and Control” chapter in the Handbook 2002/2003. Competitive forces We face intense competition in all aspects of our business. In our various lines of busi- ness, we compete, both domestically and internationally, with asset managers, retail and commercial banks, private banking firms, investment banking firms, brokerage firms and other investment services firms. We face intense competition not only from firms competing locally in particular lines of business, but also from global financial institutions that are comparable to us in size and breadth. In addition, the trend towards consoli- dation in the global financial services industry is creating competitors with broader ranges of product and service offerings, increased access to capital, and greater efficiency and pricing power. We expect these trends to continue and competition to increase in the future. Our competitive strength will depend on the ability of our businesses to adapt quickly to significant market and indus- try trends. Other risks arising from our global presence We operate in over 50 countries, and earn income and hold assets and liabilities in many different currencies and are subject to many different legal and regulatory regimes. Changes in local tax or legal regu- lations may affect our clients’ ability or willingness to do business with us. Country, regional and political risks may increase market and credit risk. Political, economic and social deterioration in a country or region, including that arising from local market disruptions, currency crises, terrorism or the breakdown of mon- etary controls, may adversely affect the ability of clients or counterparties located in that region to obtain foreign exchange or credit and, therefore, to satisfy their obliga- tions towards us. As a truly global financial services company, we are also exposed to economic instability in emerging markets. As discussed under the “Country risk” sec- tion of the “Risk Management and Con- trol” chapter in the Handbook 2002/2003, we have in place a system of controls and procedures to mitigate this risk. However, if these controls fail to properly identify and appropriately respond to country risk, we may suffer large losses resulting in a negative impact on our results of opera- tions and financial condition. 17 18 Group Financial Review 19 Group Financial Review Group Results Group Results UBS Group Performance Against Targets For the year ended 31.12.02 31.12.01 31.12.00 RoE (%) as reported before goodwill and adjusted for significant financial events 1 Basic EPS (CHF) as reported before goodwill and adjusted for significant financial events 1 Cost / income ratio (%) as reported before goodwill and adjusted for significant financial events 1 Net new money, private client units (CHF billion) 2, 3 Private Banking UBS PaineWebber Total 8.9 13.9 2.92 4.57 86.2 79.5 16.6 18.5 35.1 11.7 14.8 3.93 4.97 80.8 77.3 24.64 33.2 57.8 21.5 24.3 6.44 7.28 72.2 69.2 1.24 14.55 15.7 RoE1 (%) Cost/income ratio1 (%) 30 25 20 15 10 5 0 e g a r e v A 9 9 0 0 0 2 0 0 Q 2 0 0 Q 3 1 0 0 2 1 0 Q 1 1 0 Q 2 2 0 0 2 1 0 Q 4 80 75 70 65 60 e g a r e v A 9 9 0 0 0 2 0 0 Q 2 0 0 Q 3 1 0 0 2 1 0 Q 1 1 0 Q 2 2 0 0 2 1 0 Q 4 Basic EPS1 (CHF) Net new money, private client units 2, 3 (CHF billion) 1 Excludes the amortization of goodwill and other intangible assets and adjusted for significant financial events. 2 Private Banking and UBS PaineWebber. 3 Excludes interest and dividend income. 4 Calculated using the former definition of assets under management up to and including second quarter 2001. 5 Calculated using the former definition of assets under management in 2000. 8 7 6 5 4 3 2 1 0 20 60 50 40 30 20 10 0 e g a r e v A 9 9 0 0 0 2 0 0 Q 2 0 0 Q 3 1 0 0 2 1 0 Q 1 1 0 Q 2 2 0 0 2 1 0 Q 4 e g a r e v A 9 9 0 0 0 2 0 0 Q 2 0 0 Q 3 1 0 0 2 1 0 Q 1 1 0 Q 2 2 0 0 2 1 0 Q 4 Invested Assets and Net New Money CHF billion UBS Group Invested assets Net new money 1 31.12.02 31.12.01 31.12.00 2002 2001 2000 2,037 2,448 2,445 36.9 102.0 (49.5) UBS Wealth Management & Business Banking 2 Private Banking Business Banking Switzerland UBS Global Asset Management Institutional Wholesale Intermediary UBS Warburg UBS PaineWebber 688 205 279 278 3 584 791 215 328 344 1 769 798 239 323 319 1 765 16.6 3.7 (0.6) (1.8) 0.5 18.5 24.63 9.23 6.2 28.7 0.1 33.2 1.23 2.73 (70.8) 2.9 14.54 1 Excludes interest and dividend income. 1 July 2002. Prior-period figures have been restated accordingly. and including second quarter 2001. 2 Calculated based on the new structure for UBS Wealth Management & Business Banking effective 3 Calculated using the former definition of assets under management up to 4 Calculated using the former definition of assets under management in 2000. 2002 UBS made significant progress in 2002. After the successful integration of PaineWebber in 2001, we continued to expand our investment banking capabilities, especially in the US, and to build up our European wealth management business. Our achievements should be viewed in the context of last year’s environment, which was one of the most challenging seen in the financial industry during the post-war era. Extensive corrections in major global equity markets, depressed market levels, low corporate activity, and broadly subdued investor optimism reflected uncertainty about eco- nomic and political developments. However, our businesses were remarkably resilient and competi- tive in view of the general conditions they faced in 2002. Strict cost discipline and focus on growth across the firm helped us expand our market posi- tion in a period where many in the financial indus- try were forced to re-assess the basic assumptions about their business. Our clients made substantial new investments into our private client businesses, and we significantly improved our investment banking market share. Despite market develop- ments, the relative operational performance in our core businesses remained strong and we benefited from our prudent attitude to risk and our tight management of costs. Net profit UBS’s 2002 net profit was CHF 3,535 million, down 29% from CHF 4,973 million in 2001. This full-year profit was impacted by several items which we call significant financial events (SFEs): the non-cash after-tax writedown of the value of the PaineWebber brand, which reduced profit by 21%, and the impact of sales of subsidiaries, which added 6% to profit. Excluding these effects, and before goodwill amortization, net profit fell by 12% between 2001 and 2002. Return on equity, also affected by the brand writedown, was 8.9% in 2002, down from 11.7% a year earlier. In the same timeframe, basic earnings per share were CHF 2.92, 26% lower than a year earlier while the cost/income ratio was 86.2%, an increase of 5.4 percentage points from 2001. Group targets We focus on four key performance targets, designed to ensure that UBS delivers continually improving returns to its shareholders. – We seek to increase the value of UBS by achieving a sustainable, after-tax return on equity of 15–20%, across periods of varying market conditions. – We aim to increase shareholder value through double-digit average annual percentage growth of basic earnings per share (EPS), across periods of varying market conditions. – Through cost reduction and earnings enhance- ment initiatives, we aim to reduce UBS’s cost/ income ratio to a level that compares positively with best-in-class competitors. 21 Group Financial Review Group Results Net Interest and Trading Income CHF million For the year ended Net interest income Net trading income Total net interest and trading income Breakdown by business activity: Net income from interest margin products Net income from trading activities Net income from treasury activities Other 1 Total net interest and trading income 31.12.02 31.12.01 31.12.00 % change from 31.12.01 10,546 5,572 16,118 5,275 10,605 1,667 (1,429) 16,118 8,041 8,802 16,843 5,694 11,529 1,424 (1,804 ) 16,843 8,130 9,953 18,083 5,430 12,642 762 (751 ) 18,083 31 (37) (4) (7) (8) 17 21 (4) 1 Principally external funding costs of the Paine Webber Group, Inc. acquisition. – We aim to achieve a clear growth trend in net new money in the private client businesses (Private Banking and UBS PaineWebber). The first three targets are all measured pre- goodwill amortization, and adjusted for signifi- cant financial events. Our performance against these targets in 2002 reflects the extremely difficult market conditions. Before goodwill and adjusted for significant financial events: – Our return on equity for 2002 was 13.9%, down from 14.8% a year ago and slightly below our target range of 15–20%. The lower average level of equity, which was 6% lower because of our ongoing share buyback programs, partially offset the market-related decline in earnings of 12%. – Basic earnings per share for 2002 were CHF 4.57, a decline of 8% from 2001. The 12% decline in profit was partially offset by the reduced average number of shares outstand- ing. Without the buyback programs, our earn- ings per share in 2002 would have been 9% lower. – The cost/income ratio increased to 79.5% from 77.3%. Ongoing cost initiatives across all our businesses could not fully counteract the drop in revenues due to the declining market activity levels and subdued levels of transactional and corporate activity as well as ongoing private equity writedowns. Net new money in the private client units (Private Banking and UBS PaineWebber) dropped from CHF 57.8 billion in 2001 to CHF 35.1 bil- lion in 2002. The drop was mainly due to difficult market conditions, which were accentuated by the Italian tax amnesty. Results Operating income Total operating income fell to CHF 34,121 mil- lion in 2002 from CHF 37,114 million in 2001. Adjusted for the divestment of Hyposwiss and Klinik Hirslanden, total operating income in 2002 was CHF 33,894 million, a drop of 9% from 2001. The decline was mainly due to the difficult market environment, less favorable trading conditions and a weakening of investor sentiment. Falling market levels affected asset- based revenues while our private equity business continued to record losses due to ongoing poor valuation and exit conditions. Net interest income and net trading income. Net interest income of CHF 10,546 million in 2002 was 31% higher than in 2001. Net trading income declined 37% from CHF 8,802 million in 2001 to CHF 5,572 million in 2002. In addition to income from interest margin- based activities (loans and deposits), net interest income includes income earned as a result of trading activities (for example, coupon and divi- dend income). This component is volatile from period to period, depending on the composition of the trading portfolio. In order to provide a better explanation of the movements in net inter- est income and net trading income, we analyze the total according to the business activities that give rise to the income, rather than by the type of income generated. Net income from interest margin products was CHF 5,275 million in 2002, down 7% from CHF 5,694 million a year earlier, mostly reflect- ing lower interest margins on savings and cash 22 IFRS Actual Credit Loss Expense / (Recovery) CHF million For the year ended 31.12.02 31.12.01 31.12.00 % change from 31.12.01 UBS Wealth Management & Business Banking UBS Warburg UBS PaineWebber Corporate Center Total 241 (35) 15 (15) 206 123 360 15 0 498 (695 ) 562 3 0 (130 ) 96 0 (59) accounts, as well as mortgages because of the extremely low interest rate environment. This was accentuated by the decline of the US dollar and euro, which caused the Swiss franc equiva- lent of US dollar interest rate revenues to drop. Over the full year, net income from trading activities fell by 8% from CHF 11,529 million in 2001 to CHF 10,605 million in 2002. Equities revenues, at CHF 2,794 million in 2002, dropped from the year earlier, reflecting worsening market conditions and lower client activity, although we recorded better results in our US equity business, where we continue to gain market share. At CHF 6,041 million in 2002, fixed income trading rev- enues were lower than a year earlier, when they benefited from a buoyant trading environment due to the coordinated interest rate cuts by major central banks during the second half of 2001. This change in environment and lower revenues from our Investment Grade Credit and High Yield businesses were partially offset by better results in our Principal Finance and Emerging Market businesses. Additionally, the full-year trading result of our fixed income business profited from unrealized gains of CHF 226 million relating to credit default swaps (CDS) hedging existing credit exposures in the loan book. Our use of CDSs as hedging instru- ments for our loan book is only one part of our overall management approach to trading credit risk. The “Critical accounting policies” section on page 9 in this report and the “Capital and Risk Management” section of our Handbook 2002/2003 contain further information on how we use CDSs to hedge our credit exposure. Over the full year, our foreign exchange trading rev- enues, at CHF 1,500 million, increased slightly, due to increased volumes and spreads. Net income from treasury activities was CHF 1,667 million in 2002, an increase of 17% over 2001, reflecting higher income from our invested equity, a drop in funding costs as well as higher unrealized gains on derivatives used to economi- cally hedge interest rate risk related to structured notes issued. Other net trading and interest income showed a loss of CHF 1,429 million compared to a loss of CHF 1,804 million in 2001. This drop was mainly due to lower goodwill funding costs, which reflected the weakening of the US dollar against the Swiss franc, lower funding costs for our private equity portfolio as well as the reclas- sification of some revenues previously reported as income from trading activities. Credit loss expense. In 2002 credit loss expens- es amounted to CHF 206 million, compared to CHF 498 million in 2001. Throughout 2002, the global credit environ- ment continued the downward trend observed in 2001. Concerns regarding the sustainability of the global economic recovery have increased. Combined with rising geopolitical tensions, the outlook for corporate profits has weakened. Financial market development during the year was characterized by heightened investor risk aversion, with pronounced tiering by credit qual- ity, resulting in higher-risk corporate and sover- eign borrowers facing increasingly difficult financing conditions. Against this background, and in stark contrast to the very challenging credit environment, UBS Warburg achieved a strong credit performance with net credit loss recoveries of CHF 35 million, compared to credit loss expense of CHF 360 mil- lion in 2001 and CHF 562 million in 2000. This excellent performance was the result of minimal exposures to new defaults plus the recovery of country provisions for emerging markets expo- sures which were repaid or sold during 2002. Corporate bankruptcies in Switzerland have reversed a five-year falling trend and climbed by 10.8% during the year. In our case, this negative development did not come as a surprise and has largely been compensated by the measures we have 23 Group Financial Review Group Results Net Fee and Commission Income CHF million For the year ended 31.12.02 31.12.01 31.12.00 % change from 31.12.01 Underwriting fees Corporate finance fees Brokerage fees Investment fund fees Fiduciary fees Custodian fees Portfolio and other management and advisory fees Insurance-related and other fees Total securities trading and investment activity fees Credit-related fees and commissions Commission income from other services Total fee and commission income Brokerage fees paid Other Total fee and commission expense 2,134 848 5,987 4,033 300 1,302 4,065 417 19,086 275 1,006 20,367 1,349 797 2,146 2,158 1,339 6,445 4,276 355 1,356 4,650 538 1,434 1,772 5,742 2,821 351 1,439 3,666 111 21,117 17,336 307 946 310 802 22,370 18,448 1,281 878 2,159 1,084 661 1,745 Net fee and commission income 18,221 20,211 16,703 (1) (37) (7) (6) (15) (4) (13) (22) (10) (10) 6 (9) 5 (9) (1) (10) undertaken to improve the asset quality of our domestic credit portfolio. The gradual slowdown of the Swiss economy and our success in substan- tially reducing our impaired portfolio have, how- ever, resulted in a lower level of recoveries com- pared to previous years. This largely explains the increase of our credit loss expense in UBS Wealth Management & Business Banking to CHF 241 million, compared to CHF 123 million in 2001. Group credit loss expense in 2002 amounted to CHF 206 million, compared to CHF 498 mil- lion in 2001 and to a net recovery of CHF 130 mil- lion in 2000. The exceptional result in 2000 was helped by favorable economic conditions in Switzerland which, for UBS Wealth Management & Business Banking, resulted in substantial write- back of credit loss provisions taken in earlier periods. For further details on our risk management approach, how we measure credit risk and the development of our credit risk exposures, please see the “Capital and Risk Management” chapter of our Handbook 2002/2003. Net fee and commission income for full-year 2002 was CHF 18,221 million, a decline of 10% compared to a year earlier, due to a drop in most revenue categories. which increased by 67% compared to a year ear- lier. However, this was offset by a much lower result in our equity underwriting business due to the markedly lower market activity. Corporate Finance fees fell by 37% to CHF 848 million, reflecting lower market activity and a significant drop in the global fee pool compared to 2001. Despite that, we were again able to improve our market position, increasing our full-year share of the market from 4.4 % in 2001 to 5.0% in 2002. Net brokerage fees dropped by 10% to CHF 4,638 million in the period due to much lower client activity in 2002, reflecting the more diffi- cult market environment. However, we increased our market share as overall market volumes decreased at a sharper rate. Investment fund fees remained resilient and dropped just 6% to CHF 4,033 million. The drop was partially due to the lower asset base due to much lower markets, and because of falling sales-based commissions with investors reluctant to commit to new investments. Custodian fees, at CHF 1,302 million in 2002, were down 4% from CHF 1,356 million, princi- pally due to lower market values and, conse- quently, average asset levels. Underwriting fees, at CHF 2,134 million, dropped only 1% from 2001, reflecting the strong revenues from our fixed income business, The drop in portfolio and other management and advisory fees from CHF 4,650 million in 2001 to CHF 4,065 million reflects lower aver- 24 Headcount1 (full-time equivalents) 31.12.02 31.12.01 31.12.00 Change in % 31.12.01 UBS Wealth Management & Business Banking Private Banking Business Banking Switzerland UBS Global Asset Management UBS Warburg Corporate and Institutional Clients UBS Capital UBS PaineWebber Corporate Center Group total thereof: Switzerland 28,930 10,488 18,442 3,346 16,037 15,964 73 19,563 1,185 69,061 27,972 29,469 10,249 19,220 3,281 15,690 15,562 128 20,413 1,132 69,985 29,163 30,272 9,835 20,437 2,860 15,391 15,262 129 21,567 986 71,076 30,095 (2) 2 (4) 2 2 3 (43) (4) 5 (1) (4) 1 Klinik Hirslanden was sold on 5 December 2002. The Group headcount does not include the Klinik Hirslanden headcount of 2,450 and 1,839 for 31 December 2001 and 31 December 2000, respectively. age asset levels and third-party fees due to the dif- ficult market environment. At CHF 417 million in 2002, insurance-relat- ed and other fees decreased by 22% from a year earlier. This drop was mainly due to a decrease in insurance sales volumes in UBS PaineWebber mirroring the more difficult market environment. Credit-related fees and commissions dropped by 10% from CHF 307 million to CHF 275 million reflecting lower revenues from guarantees as well as a drop in revenues from documentary credits. Other income showed a loss of CHF 12 mil- lion compared to a gain of CHF 558 million a year earlier. Higher impairment charges for UBS Capital’s private equity investments and other financial investments were only partially offset by gains from disposals of financial investments and of the Klinik Hirslanden and Hyposwiss subsidiaries. Operating expenses In full-year 2002, total operating expenses, at CHF 29,577 million, decreased by 3% from CHF 30,396 million in 2001 because of lower personnel expenses as well as falling general and administrative expenses, reflecting our ability to adjust our costs in line with revenue develop- ments. The decline was accentuated by the fall of the US dollar, UK sterling and euro against the Swiss franc. This drop was partially offset by the CHF 1,234 million charge for the writedown of the PaineWebber brand. Without the writedown, the drop in total operating expenses would have been 7%. Full-year personnel expenses dropped by 7% to CHF 18,524 million in 2002 due to much lower performance-related compensation expens- es and lower salaries, and a reduction in head- count, especially in UBS PaineWebber and Busi- ness Banking Switzerland. The drop was further accentuated by lower recruitment, training and contractor costs across the firm, reflecting our continued cost control initiatives. Finally, the result was helped by a weaker US dollar against the Swiss franc. Personnel expenses are managed on a full-year basis with final fixing of annual performance- related payments in the fourth quarter. Over the full year, approximately 42% of this year’s per- sonnel expenses were bonus or other variable compensation, down from 43% last year. Average variable compensation per head in 2002 was 8% lower than in 2001. We did not build up any significant overca- pacity during the peak of the last business cycle, and have therefore been able to reduce head- count gradually as economic conditions weak- ened – without resorting to drastic cuts. UBS Group headcount dropped by 924 from 69,985 to 69,061, as we streamlined processes and struc- tures at the same time as we expanded our capa- bilities in areas with positive growth potential. In full-year 2002, general and administrative expenses, at CHF 7,072 million, were down from CHF 7,631 million a year earlier. Strict cost con- trol in all our businesses led to a drop in nearly all cost categories. The biggest declines were in telecommunication, IT, outsourcing and brand- ing expenses. This was partially offset by higher legal and security provisions including a glo- bal settlement charge of CHF 111 million (USD 80 million) regarding equity research in the US. 25 Group Financial Review Group Results At CHF 1,614 million in 2001, depreciation fell by 6% to CHF 1,521 million in 2002 mainly due to lower depreciation charges for machines and equipment. Amortization of goodwill and other intangible assets increased from CHF 1,323 million in 2001 to CHF 2,460 million in 2002, due to the write- down of the PaineWebber brand name following our decision made in fourth quarter 2002 to move to a single brand. Tax We incurred a tax expense of CHF 678 million in 2002, down from CHF 1,401 million in 2001. This corresponds to an effective tax rate of 15% in 2002. Adjusted for significant financial events, our 2002 tax expense of CHF 917 million reflects an effective tax rate of 16.5%, well below 2001’s rate of 21%. The decline is mainly driven by significantly lower progressive tax rates in Switzerland, the ability to benefit from tax loss carry-forwards in the US and UK and a higher proportion of earnings generated in lower tax jurisdictions. PaineWebber merger-related costs In 2002, UBS incurred amortization expenses of CHF 2,005 million on goodwill and intangible assets resulting from the acquisition of UBS PaineWebber, while funding costs amounted to CHF 988 million. The amortization includes a non-cash writedown of CHF 1,234 million for the PaineWebber brand name that had been held as an intangible asset on our balance sheet. The writedown was due to a strategic decision announced in November 2002, to move all our businesses to the single UBS brand in June 2003. After the writedown, the remaining Paine- Webber-related intangible assets on our balance sheet amount to CHF 2,334 million. These intan- gibles continue to be carried net of tax. As part of the merger, UBS agreed to make retention payments to PaineWebber financial advisors, senior executives and other staff, sub- ject to these employees’ continued employment and other restrictions. The payments vest over periods of up to four years from the merger in November 2000 and the vast majority of them are paid in the form of UBS shares. Because these payments are a regular and continuing cost of the business, they are not treated as significant finan- cial events. Personnel expenses in 2002 include retention payments for key PaineWebber staff of USD 261 million (CHF 405 million). Dividend For 2002, we plan to pay a normal dividend to our shareholders after having made use of the possibility to make a tax efficient distribution in 2000 (for the fourth quarter only) and 2001 in the form of par value reductions. The Board of Directors will recommend at the Annual General Meeting on 16 April 2003 that UBS should pay a dividend of CHF 2.00 per share for the 2002 financial year, a level on par with last year’s CHF 2.00 distribution. If the dividend is approved, the ex-dividend date will be 17 April 2003, with payment on 23 April 2003 for shareholders of record on 16 April 2003. Balance sheet Total assets were CHF 1,181 billion on 31 De- cember 2002, down CHF 72 billion, or 6%, from CHF 1,253 billion on 31 December 2001. The balance sheet shrank because of the weakening of the US dollar and UK sterling against the Swiss franc, falling by 17% and 8% in the period respectively. Cash and balances with central banks were CHF 4 billion on 31 December 2002, down from CHF 21 billion on 31 December 2001. Most of the decline was due to a drop in the deposits held with the Bank of Japan. The strong increase seen in 2001 in our cash and balance levels held with central banks was related to a change in the structure of our Japanese financial assets trig- gered by the negative short-term interest rates in that country. In 2002, however, the level of cash and cash balances returned to a normal level. Assets due from banks increased to CHF 32 billion on 31 December 2002 from CHF 28 billion at 31 December 2001, reflecting higher time deposits. Trading-related assets (cash collateral on secu- rities borrowed, trading portfolio assets and reverse repurchase agreements), dropped by CHF 26 billion from 31 December 2001 to 31 December 2002. A significant part of this change reflects the weakening of the US dollar against the Swiss franc and lower volumes in trading portfolio assets due to the more difficult 26 market environment. The drop was partially off- set by an increase in reverse repurchase agree- ments, due to higher volumes in our mortgage- backed securities business in the US, which bene- fited from the low interest rate levels for home mortgages. Loans, net of allowances for credit losses, declined from CHF 227 billion on 31 December 2001 to CHF 212 billion on 31 December 2002. Business Banking Switzerland as well as UBS Warburg’s Corporate and Institutional Clients business unit continued to reduce their recovery portfolios. The drops were accentuated by the declining value of the US dollar against the Swiss franc. Financial investments decreased from CHF 29 billion on 31 December 2001 to CHF 8 billion on 31 December 2002, reflecting a decrease in debt instruments of public authorities and money market papers, and reduced positions in private equity investments, mainly due to impairment losses. On 31 December 2002, goodwill and other intangible assets were CHF 14 billion, CHF 5 bil- lion lower than on 31 December 2001. The drop was mainly due to the writedown of the Paine Webber brand and the fall of the US dollar against the Swiss franc. Total liabilities decreased 6%, from CHF 1,206 billion on 31 December 2001 to CHF 1,139 billion on 31 December 2002. Liabilities due to banks dropped 22% to CHF 83 billion, reflecting a decrease in funding required for related business activity. Amounts due to customers decreased by CHF 27 billion to CHF 307 billion, because of the devaluation of the US dollar and UK sterling against the Swiss franc. The drop was somewhat offset by an expansion of trading-related liabilities (cash collateral on securities lent, repurchase agreements and trad- ing portfolio liabilities) which together increased by CHF 5 billion during 2002. Debt issued de- creased CHF 27 billion to CHF 129 billion on 31 December 2002, largely due to decreased issuance of money market paper that reflected lower funding needs. UBS’s long-term debt portfolio remained unchanged at CHF 57 billion on 31 December 2002. During 2002, CHF 17 billion in long-term debt was issued while CHF 15 billion reached maturity or were redeemed early. The remaining change was due to foreign currency impacts, mainly the strengthening of the Swiss franc against the US dollar. We believe the maturity profile of our long-term debt portfolio is well balanced to match the maturity profile of our assets. Shareholders’ equity decreased CHF 5 billion, or 10%, from 31 December 2001 to 31 December 2002. The increase in retained earnings was more than offset by the effect of the par value reduction and the repurchase of own shares in 2002. UBS maintains a significant percentage of liquid assets that can be converted into cash on relatively short notice in order to meet short-term funding needs without adversely affecting UBS’s ability to conduct its ongoing businesses. These liquid assets include reverse repurchase agree- ments and cash collateral on securities borrowed, marketable corporate debt and equity securities and a portion of UBS’s loans secured primarily with real estate. The value of UBS’s collateralized receivables and trading portfolio will fluctuate depending on market conditions. The individual components of UBS’s total assets, including the proportion of liquid assets, may vary signifi- cantly from period to period due to changing client needs, economic and market conditions and trading strategies. Cash flows In the twelve-month period to December 2002, cash equivalents decreased by CHF 33,915 mil- lion, principally as a result of financing activi- ties, which generated negative cash flow of CHF 32,470 million. A cash outflow of CHF 26,206 million resulted from the repayment of money market paper, CHF 5,605 million from movements in treasury shares and derivative activity in own equity, with CHF 2,509 million resulting from a capital repayment by par value reduction. The issuance of long-term debt of CHF 17,132 million and repayments of CHF 14,911 million brought a net cash inflow of CHF 2,221 million. Operating cash inflows (before changes in operating assets and liabilities and income taxes paid) amounted to CHF 8,192 million. Cash of CHF 10,021 million was used to fund the net increase in operating assets, while a net increase in operating liabilities generated cash inflows of CHF 37 million. Payments to tax authorities were CHF 572 million. 27 Group Financial Review Group Results Investing activities generated cash inflow of CHF 1,381 million. Divestments of financial investments contributed CHF 2,153 million while the sale of Hyposwiss and Klinik Hirs- landen brought in CHF 984 million, both partially offset the CHF 1,763 million of cash outflow for the purchase of property and equip- ment. Outlook 2003 As 2003 begins, the environment continues to be a challenging one. Uncertainty over economic developments and market direction, and rising geopolitical concerns are affecting investor sentiment and therefore transaction lev- els, and are holding back a significant recovery in corporate activity. Therefore, we do not expect to see an immediate pick-up in our financial per- formance, as depressed asset levels, low levels of investor activity and possible deterioration of the credit environment weigh on our revenues. Any recovery in the latter part of this year remains simply unpredictable. Because of this, we will continue to monitor our cost base carefully, investing selectively in our strategic priorities. Our prudent manage- ment of resources over the last several years leaves us excellently positioned for further com- petitive gains. 2001 Net profit Our net profit for the year 2001 was CHF 4,973 million, 36% less than the CHF 7,792 mil- lion achieved in 2000, reflecting the much more difficult market environment in 2001. The merger with PaineWebber resulted in much higher goodwill amortization expense in 2001 than in 2000. Pre-goodwill, net profit for the year was CHF 6,296 million, 26% lower than achieved in the much stronger markets of 2000 and 28% lower if adjusted for significant financial events. Return on equity in 2001 was 11.7%, com- pared to 21.5% a year earlier. In 2001, basic earnings per share were CHF 3.93, against CHF 6.44 a year earlier. The cost/income ratio was 80.8% in 2001, up from 72.2% in 2000. Group targets Before goodwill and adjusted for significant financial events: – Our return on equity for 2001 was 14.8%, only just below our target range of 15–20%. Although this is lower than the 24.3% that we achieved in 2000, it represented a solid per- formance when set in the context of the trading environment. Our return on equity in 2000 was boosted by extremely high returns in the exuberant markets of the first half-year, while 2001 saw much weaker eco- nomic and stock market performance com- bined with higher average equity resulting from the acquisition of PaineWebber in fourth quarter 2000. – Basic earnings per share fell 32% to CHF 4.97 in 2001 from 2000. Despite the decline, 2001’s result was still 21% higher than that achieved in 1999. The number of outstanding shares at the outset of 2001 was higher than during most of 2000 because of share issuance to fund the merger with PaineWebber. An ongoing share buyback program, however, caused the number of outstanding shares to fall to below their pre-merger level by 31 December 2001. – The cost/income ratio rose from 69.2% to 77.3%, reflecting lower revenues, the poor performance of our private equity portfolio in 2001 and the influence of the relatively high cost/income ratio typical of UBS Paine- Webber’s business. Despite this rise, operating expenses remained under tight control, with decreases from 2000 levels in UBS Wealth Management’s Business Banking Switzerland business unit and UBS Warburg’s Corporate and Institutional Clients business unit, as well as a clear reduction throughout the year of costs at UBS PaineWebber. Our disciplined approach to both compensa- tion and non-personnel expenses allowed us to continue investing in the future growth of our key businesses. The percentage of revenue that we devoted to rewarding our staff remained almost unchanged since 2000 in our most impor- tant businesses, reflecting a substantial decrease in bonus payments. Our asset-gathering activities have delivered very strong results in 2001, with inflows in the private client units (Private Banking and UBS 28 PaineWebber) of CHF 57.8 billion, compared to CHF 15.7 billion in 2000. Across the whole Group, we attracted a total of CHF 102.0 billion in net new money, as clients increasingly value the quality of our advice and the breadth and depth of our wealth management capabilities. Results Operating income Operating income was 2% higher in 2001 than in 2000, at CHF 37,114 million, with the effect of much more difficult market conditions offset by the addition of UBS PaineWebber’s businesses. There were no significant financial events that affected operating income in either 2001 or 2000. Net interest income was 1% lower than in 2000, at CHF 8,041 million, compared to CHF 8,130 million in 2000, and net trading income was 12% lower than in 2000 at CHF 8,802 mil- lion, compared to CHF 9,953 million in 2000. Various factors can alter the mix between net interest income and net trading income between periods. As well as income from interest margin based activities (for example loans and deposits), net interest income includes some income earned as a result of trading activities (such as coupon and dividend income). This component is volatile from period to period, depending on the compo- sition of the trading portfolio. Furthermore, the classification of income aris- ing from positions and their offsetting economic hedging transactions may be different. In fourth quarter 2001, this effect was particularly pro- nounced, as a result of the significant fall in short-term USD interest rates which substantial- ly reduced our borrowing costs, while improving net interest income for the quarter. Our overall interest rate exposures were limited by hedging transactions using derivative instruments. As the USD rates fell, these economic hedges generated mark-to-market losses recorded in fixed income net trading income, offsetting a portion of the gains in net interest income. In order to provide a better explanation of the movements in net interest income and net trading income, we produce the disclosure shown on page 22 which sums net interest income and net trading income, and then analyzes the total according to the business activities which gave rise to the income, rather than by the type of income generated. Net income from interest margin products increased 5% from CHF 5,430 million in 2000 to CHF 5,694 million in 2001, driven by the inclusion of UBS PaineWebber. Net income from trading activities was CHF 11,529 million in 2001, 9% lower than the CHF 12,642 million achieved in 2000. Falling interest rates and increased volatility in debt markets in 2001 led to a very strong year for fixed income and foreign exchange trading, but equity trading revenues suffered from much lower market vol- umes, increased volatility and reduced arbitrage opportunities. Net income from treasury activities was 87% higher than in 2000, at CHF 1,424 million, reflecting two main factors: – increased income from our invested equity, as a result of the expansion of our capital base since the PaineWebber merger, and changes in the investment portfolio’s maturity structure leading to an increase in average interest rates; – improved currency management results due to introduction of a new economic hedging strategy and some one-off gains. Other net trading and interest income princi- pally reflects the costs of goodwill funding, with the CHF 1,053 million increase in cost from CHF 751 million in 2000 to CHF 1,804 million in 2001 mainly due to goodwill funding costs aris- ing from the acquisition of PaineWebber. Credit loss expense. In 2001 credit loss expenses amounted to CHF 498 million, com- pared to a net recovery of CHF 130 million in 2000. The global credit environment declined rapidly throughout 2001, with overall default rates as high as during the last major global reces- sion in 1991. The phenomenon of investment grade companies falling into restructuring and default within a very short period of time became very prominent in the United States during 2001, and subsequently spread to Europe. In this dif- ficult and challenging environment we focused on ensuring that our counterparty ratings are rapidly adjusted to reflect the changing econom- ic situation. At the same time, we increased the frequency of sector and geographic rating reviews. In UBS Warburg, the ongoing strategy of actively hedging credit exposure kept new provi- 29 Group Financial Review Group Results sions to a relatively low level, resulting in an actual credit loss expense of CHF 360 million in 2001, compared to CHF 562 million in 2000. Corporate bankruptcies in Switzerland reached their lowest level since the early 1990s, and we successfully improved the credit quality of our domestic portfolio in recent years. The level of recoveries of previously existing provisions, however, declined compared to the somewhat exceptional levels of 2000, reflecting less robust growth in the Swiss economy towards the end of 2001, following the global economic slowdown. As a result, the trend of net recoveries of loan loss provisions observed in the previous year was reversed and credit loss expenses increased accordingly during 2001, although remaining below the long-term trend. Credit loss expense in UBS Wealth Management & Business Banking in 2001 was CHF 123 million, compared to a net recovery of CHF 695 million in 2000. Net fee and commission income was CHF 20,211 million in 2001, up 21% from 2000 and at a record level, reflecting the inclusion of UBS PaineWebber and the introduction of higher fees for investment funds. Without UBS PaineWebber, net fee and commission income would have dropped 7%, driven by much lower brokerage fees and a reduction in corporate finance fees, with increases in market share during the year achieved against a background of much reduced market activity. Underwriting fees increased 50%, from CHF 1,434 million in 2000 to CHF 2,158 million in 2001. The majority of this increase was due to UBS PaineWebber, whose extensive retail net- work in the US provides a strong platform for distribution of both bonds and equities. UBS PaineWebber has a significant US munici- pal securities business. It completed the largest deal in its history in fourth quarter 2001, raising USD 1.9 billion for the New Jersey Transit Trust Fund Authority, and helping to push it into first place in the league table rankings for fourth quarter 2001, and second place for the whole of 2001. The mortgage-backed securities business in the US also benefited from the combination of UBS’s franchise and capital strength with existing PaineWebber expertise. UBS Warburg ranked first in US residential mortgage-backed securities in 2001, according to Thomson Financial Data. Equity underwriting was depressed in 2001, as volatile and uncertain markets reduced is- suance. However, UBS’s league table rankings improved, from seventh in international equity new issues in 2000 to second in 2001, according to Dealogic EquitywarePlus. Even excluding the contribution from UBS PaineWebber, equity underwriting revenues increased by CHF 77 mil- lion, or 7%, from 2000. Although our corporate finance league table rankings were disappointing, down from sixth in 2000 for completed global mergers and acquisi- tions, to eighth in 2001, we outperformed 2000 in terms of market share, with full-year analysis showing us with a 4.4% share of fees, compared to 3.6% in 2000. Despite this, Corporate Finance fees were down 24%, from CHF 1,772 million in 2000 to CHF 1,339 million in 2001, reflecting the much more difficult market environment this year. Net brokerage fees rose 11% from CHF 4,658 million in 2000 to CHF 5,164 million in 2001, driven by the inclusion of UBS Paine- Webber. Without the contribution from UBS PaineWebber, net brokerage fees would have fallen by about 17% compared to 2000, reflect- ing the much lower trading volumes experienced in almost all major markets worldwide in 2001. Investment fund fees rose 52% from CHF 2,821 million in 2000 to CHF 4,276 million in 2001, driven by the inclusion of UBS Paine- Webber. Excluding UBS PaineWebber, invest- ment fund fees would have increased by CHF 268 million, mainly reflecting a change in the pricing structure for UBS Investment Funds, introduced in January 2001, which brought charges up to market levels. Custodian fees, at CHF 1,356 million in 2001 were down 6% from 2000’s level of CHF 1,439 million, principally reflecting lower aver- age assets in Private Banking in Switzerland. Portfolio and other management and advisory fees increased 27% from CHF 3,666 million in 2000 to CHF 4,650 million in 2001, due to the addition of UBS PaineWebber. Excluding UBS PaineWebber, there would have been a slight decline from 2000, as a full-year’s contribution from the O’Connor business in UBS Asset Management (created in June 2000) was more than offset by the effect of lower average assets on managed account fees. Insurance related and other fees increased substantially from CHF 111 million in 2000 to CHF 538 million in 2001, with almost all this increase due to UBS PaineWebber, where the 30 biggest contribution came from the deferred annuities business. Other income fell 62% from CHF 1,486 mil- lion in 2000 to CHF 558 million in 2001, reflect- ing the very difficult conditions in the private equity market in 2001, which led to minimal opportunities for divestment and much greater levels of writedowns than last year. Operating expenses In light of lower revenues in 2001, cost control was a key focus of all our management teams, as we maintained strong discipline on both person- nel and non-personnel costs, particularly in the Corporate and Institutional Clients and Business Banking Switzerland business units, bringing their operating expenses to record low levels. Total operating expenses increased 16% from CHF 26,203 million in 2000 to CHF 30,396 mil- lion in 2001, driven by the inclusion of UBS PaineWebber. Excluding significant financial events in 2000 and UBS PaineWebber, costs fell 7%, as performance-related compensation de- clined, and non-personnel costs were tightly managed. The principal significant financial events affecting the comparison of operating expenses are the CHF 150 million additional provision for the US Global Settlement of World War II- related claims, recorded in 2000 in General and administrative expenses, and CHF 290 mil- lion of costs from the integration of Paine- Webber, also recorded in 2000. Of this CHF 290 million, CHF 118 million was charged to Personnel expenses, CHF 93 million to General and administrative expenses and CHF 79 million to Depreciation. Personnel expenses in 2001 reflect consider- able reductions in bonus and performance- related compensation, with average variable compensation per head down 23%, ensuring that overall compensation ratios for 2001 were kept in line with 2000’s ratio in our core businesses. However, the inclusion of CHF 5,178 million of UBS PaineWebber personnel expenses more than offset the reduction in performance-related pay, bringing the total to CHF 19,828 million, 16% up from 2000. Approximately 43% of personnel expenses were bonus or other variable compen- sation, down from 48% last year. UBS Group headcount fell by 2% from 71,076 at 31 December 2000 to 69,985 at 31 December 2001, principally reflecting the effect of successful cost control efforts at UBS Wealth Management & Business Banking’s Business Banking Switzerland business unit and UBS PaineWebber, although that was slightly off- set by the effect of acquisitions in UBS Global Asset Management and further hiring for the European wealth management initiative. General and administrative expenses in- creased by 13% from CHF 6,765 million in 2000 to CHF 7,631 million in 2001 reflecting a full- year’s costs for UBS PaineWebber, which more than offset the absence of the one-off charges and provisions recorded in 2000. General and administrative expenses in 2000 included a final provision of CHF 150 million related to the US Global Settlement of World War II-related claims, and CHF 93 million of PaineWebber integration costs, which were both treated as significant financial events. Excluding these provisions and the extra costs in 2001 due to the inclusion of UBS PaineWebber, general and administrative expenses would have been almost unchanged in 2001 compared to 2000. Depreciation and amortization increased 29% from CHF 2,275 million in 2000 to CHF 2,937 million in 2001, driven primarily by the goodwill amortization resulting from the merger with PaineWebber. Tax UBS Group incurred a tax expense of CHF 1,401 million in 2001, down from CHF 2,320 million in 2000. This corresponds to an effective tax rate of 21% in 2001, compared to 23% in 2000. This relatively low rate results from significantly lower tax in Switzerland, reflecting the effect of lower profits triggering lower progressive tax rates, and a change in the geographical earnings mix of the Group. PaineWebber merger-related costs In 2001, UBS incurred amortization costs of CHF 846 million on goodwill and intangible assets resulting from the acquisition of UBS PaineWebber, while goodwill funding costs amounted to CHF 763 million. As part of the merger, UBS agreed to make retention payments to PaineWebber financial advisors, senior executives and other staff, sub- ject to these employees’ continued employment and other restrictions. The payments vest over 31 Group Financial Review Group Results periods of up to four years from the merger and the vast majority of them will be paid in the form of UBS shares. Because these payments are a regular and continuing cost of the business, they are not treated as significant financial events. Personnel expenses in 2001 include retention payments for key PaineWebber staff of USD 284 million (CHF 482 million) for the full year. Dividend For 2001, we again made a tax-efficient distribu- tion of capital to our shareholders rather than paying a dividend. On 10 July 2002, we made a distribution of CHF 2.00 to shareholders for the financial year 2001 which reduced the par value from CHF 2.80 to CHF 0.80. This is consistent with the total per share distribution to share- holders of CHF 2.03 in 2000. Cash flows In the twelve-month period to December 2001, cash equivalents increased by CHF 22,889 mil- lion, principally as a result of financing activities, which generated positive cash flow of CHF 18,103 million. CHF 24,226 million from the issuance of money market paper was offset by CHF 6,038 million for treasury shares and treas- ury share contract activity as well as CHF 683 million for capital repayments. Operating activities generated positive cash flow of CHF 12,873 million. Of this amount, CHF 4,973 million resulted from net profit, CHF 27,306 million from a net increase in amounts due to and from banks, a net increase in amounts due to customers and loans of CHF 42,813 mil- lion and a net cash inflow of CHF 19,470 million from repurchase and reverse repurchase agree- ments and cash collateral on securities borrowed and lent. These were offset by CHF 78,456 mil- lion from an increase in the size of the trading portfolio. Investing activities generated negative cash flow of CHF 7,783 million, CHF 5,770 million of which were from the purchase of financial investments and CHF 2,021 million from the purchase of property and equipment. 32 33 34 Review of Business Group Performance 35 Review of Business Group Performance Introduction Introduction 1 All figures have been adjusted for signi- ficant financial events. 2 In management accounts, statistically derived actuarial expected loss adjusted by deferred releases rather than the net IFRS actual credit loss is reported for each business unit (see Note 2 to the Financial Statements). 3 Excludes the amortization of goodwill and other intangible assets. Reporting by Business Unit 1 CHF million except where indicated For the year ended Income Credit loss (expense) / recovery 2 Total operating income Personnel expenses General and administrative expenses Depreciation Amortization of goodwill and other intangible assets 4 Operating expenses / operating income Total operating expenses before credit loss expense. 5 Excludes interest and dividend income. 6 Calculated using the former definition of assets under management up to and including second quarter 2001. 7 For informational purposes only. These pre-tax amounts have not been recorded in the Income statement. For details on the fair value calculation, refer to Note 32e to the Financial Statements. Business Group performance before tax Business Group performance before tax and goodwill 3 Additional information Cost / income ratio before goodwill (%) 3, 4 Net new money (CHF billion) 5 Invested assets (CHF billion) Fair value of employee stock options granted 7 Headcount (full-time equivalents) Private Banking Business Banking Switzerland 31.12.02 31.12.01 31.12.02 31.12.01 7,279 (28) 7,251 2,083 2,158 125 111 4,477 2,774 2,885 60 16.6 688 58 10,488 7,696 (37 ) 7,659 1,947 2,038 151 109 4,245 3,414 3,523 54 24.66 791 10,249 5,494 (286) 5,208 2,727 159 355 0 3,241 1,967 1,967 59 3.7 205 38 18,442 5,792 (567 ) 5,225 2,878 396 465 0 3,739 1,486 1,486 65 9.26 215 19,220 Management accounting The discussion in this chapter reviews UBS’s 2002, 2001 and 2000 results by Business Group and business unit. Our management reporting systems and poli- cies determine the revenues and expenses directly attributable to each business unit. Internal charges and transfer pricing adjustments are reflected in the performance of each business unit. Inter-business unit revenues and expenses. Revenue sharing agreements are used to allocate external customer revenues to Business Groups on a reasonable basis. Transactions between Business Groups are conducted at arms length. Inter-business unit charges are recorded as a reduction to expenses in the business unit pro- viding the service. Corporate Center expenses are allocated to the operating business units, to the extent that it is appropriate. relating to balance sheet products is calculated on a fully funded basis. In a second step, busi- ness units are additionally credited with the risk- free return achieved on the average regulatory equity used. Commissions are credited to the business unit with the corresponding customer relationship, with revenue sharing agreements for the alloca- tion of customer revenues where several business units are involved in value creation. Regulatory equity is allocated to business units based on their average regulatory capital requirement during the period. Only utilized equity is taken into account, although we add an additional financial buffer of 10% above the individually determined business unit regulatory capital requirement. The remaining equity, which mainly covers real estate, and any other unallocated equity, remains at the Corporate Center. Net interest income is apportioned to busi- ness units based on the opportunity costs of funding their activities. Net interest income Headcount includes trainees and staff in man- agement development programs, but not con- tractors. 36 UBS Global Asset Management Corporate and Institutional Clients UBS Capital UBS PaineWebber Corporate Center 31.12.02 31.12.01 31.12.02 31.12.01 31.12.02 31.12.01 31.12.02 31.12.01 31.12.02 31.12.01 1,953 0 1,953 946 513 37 270 1,766 187 457 77 (2.4) 557 44 3,346 2,218 0 2,218 1,038 569 46 286 1,939 279 565 75 34.9 672 3,281 14,100 (128) 13,972 7,784 2,314 381 364 10,843 3,129 3,493 15,587 (112 ) 15,475 8,258 2,586 454 402 11,700 3,775 4,177 74 72 (1,602) 0 (1,602) 94 64 1 0 159 (872 ) 0 (872 ) 96 64 2 0 162 (1,761) (1,761) (1,034 ) (1,034 ) 567 15,964 15,562 15 73 128 5,561 (13) 5,548 4,245 1,263 149 457 6,114 (566) (109) 102 18.5 584 73 19,563 6,391 (18 ) 6,373 5,019 1,441 124 502 7,086 (713 ) (211 ) 103 33.2 769 20,413 1,315 249 1,564 645 601 473 24 1,743 (179) (155) 800 236 1,036 592 537 372 24 1,525 (489) (465) 32 1,185 1,132 Changes to disclosure since 2001 Business unit structure We implemented a new Business Group struc- ture at the start of 2002, under which UBS PaineWebber became a separate Business Group. In the previous structure, UBS Paine- Webber was reported as one of UBS Warburg’s business units. Accordingly, goodwill and other intangible assets relating to the merger of UBS and PaineWebber were reported in the UBS Warburg Business Group and not reflected in the results of its individual business units. On the separation of UBS PaineWebber from UBS Warburg, the goodwill and intangible assets were assigned to the different Business Groups that have benefited from the merger with PaineWebber. That means that they have been assigned to the new UBS PaineWebber Business Group, to UBS Warburg’s Corporate and Institutional Clients business unit and to a lesser extent to UBS Global Asset Management and to the Private Banking business unit. Associated amortization expense and net funding charges are now being charged to each business unit in proportion to the share of goodwill and intangi- ble assets assigned. At the same time, UBS transferred UBS Paine- Webber’s non-US client business to Private Banking. Finally, O’Connor, originally jointly launched by UBS Global Asset Management and UBS Warburg, became entirely part of UBS Global Asset Management. Our reporting structure also reflects the revised business portfolio of the UBS Wealth Management & Business Banking Business Group, formerly UBS Switzerland. As of 1 July 2002, the business serving high-end affluent clients was transferred from the former Private and Corporate Clients (PCC) unit to Private Banking. The Business Group now comprises the following business units: – Private Banking, which includes the full pri- vate banking business and the high-end af- fluent clients segment that were previously part of the PCC business unit. 37 Review of Business Group Performance Introduction UBS Group Reporting structure in 2002 UBS AG UBS Wealth Management & Business Banking UBS Global Asset Management UBS Warburg UBS PaineWebber Private Banking Corporate & Institutional Clients Business Banking Switzerland UBS Capital Provide the whole range of financial services in an exclusive and very individualized format Corporate Center – Business Banking Switzerland, consisting of the individual and corporate clients businesses of the former PCC business unit. New disclosure has been added for the private banking business, with separate income data and key performance indicators (KPIs) for the Inter- national Clients (clients domiciled outside of Switzerland) and Swiss Clients (clients domiciled in Switzerland) businesses. While none of this restructuring had an impact on the Group, we have restated prior periods for all business units affected to reflect these changes. During the first half of 2003, we will create a new holding company to incorporate GAM, our specialist asset management firm, as well as our five independent private banks – Cantrade (Zurich), Banco di Lugano (Lugano), Ferrer Lullin (Geneva), Bank Ehinger (Basel), and Armand von Ernst (Bern). The new company will be held at the Corporate Center, with the struc- ture, effective from 1 January 2003, to be reflect- ed in our financial reporting effective from the first quarter 2003 onwards. We will release fig- ures for 2000, 2001, and 2002 reflecting these changes prior to the publication of first quarter 2003 results. Other management accounting changes In 2002 we implemented additional changes in our management accounting that required us to restate prior periods for the business units affected: – We simplified our allocation of Corporate Center costs to the Business Groups. In the past certain central costs were allocated pro- portionally to UBS business units. Since 1 January 2002, these charges have been restricted to services that are provided directly under explicit Service Level Agreements. – On 1 January 2002, we changed the way in which we calculate regulatory equity allocated to the business units, adjusting the leverage ratio (ratio of BIS Tier 1 capital excluding hybrid capital to BIS total capital) for non- goodwill items. This change in allocation also affects the interest earned on regulatory equity. – On 1 January 2002, we reclassified certain client assets of the Business Banking Switzer- land business unit as custody-only, which required a restatement of the business unit’s invested assets. – From 1 October 2002, recurring fees at UBS PaineWebber were redefined to include alter- native investment fees, fees from UBS Global Asset Management and other advisory fees that were not formerly included in the defini- tion. These changes align the UBS Paine- Webber definition of recurring fees with the asset-based fee definition applied to the Private Banking business. We now uniformly charac- terize this type of revenue as “recurring fees” – both in Private Banking and UBS PaineWebber. Additional disclosure in 2002 In our management accounting, the expense for equity-based compensation plans – including employee option plans – is recorded at the intrin- sic value of the instruments at grant date. To enhance transparency, for every business unit and Business Group we now disclose the additional compensation expense we would have incurred in 2002 had we recognized the fair value of stock option grants. On a Group level, this additional expense would have been CHF 827 million in 2002 (CHF 690 million after-tax). Further details on the accounting treatment of equity-based compensation can be found in the section “Critical accounting policies” on page 13 and in Note 32e to the UBS Group Financial Statements. 38 Seasonal characteristics Our main businesses do not show significant seasonal patterns – except for UBS Warburg’s Corporate and Institutional Clients business unit, where revenues are impacted by the seasonal characteristics of general financial market acti- vity and deal flows in investment banking. When discussing quarterly performance, we therefore compare UBS Warburg’s results of the reported quarter with those achieved in the same period of the previous year. For all other Business Groups, results are compared with the previous quarter. Considering the impact of UBS Warburg’s performance on Group results, we discuss quar- terly performance at Group level by comparing it with the same quarter in the previous year. Client / invested assets reporting When reporting on client assets, we show two assets metrics: client assets and invested assets: – Client assets represent all client assets man- both the investment management unit and the distribution unit, and double counted in Group totals. For example, a mutual fund provided by UBS Global Asset Management but sold by Private Banking will be counted as invested assets in both business units, as they both provide an independent service to their respective client, add value and generate revenues. This approach is in line with our open architecture strategy and allows us to accurately reflect the actual per- formance of our individual businesses. On a Group level, approximately CHF 290 bil- lion in invested assets were double counted in 2002 out of total invested assets of CHF 2,037 billion (in 2001, approximately CHF 310 billion were double counted out of a total of CHF 2,448 billion in invested assets). The major- ity of assets that are double counted represent institutional funds managed by UBS Global Asset Management and distributed by UBS Wealth Management & Business Banking and UBS PaineWebber. aged by or deposited with UBS. Credit loss expense – Invested assets is a more restrictive term and includes all client assets managed by or deposited with UBS for investment pur- poses only. Invested assets are our central measure and exclude all assets held for purely transactional purposes. It includes, for example, managed institutional assets, mutual funds, discretionary and advisory private client portfolios, and pri- vate client securities or brokerage accounts, but excludes wholesale custody-only assets, corre- spondent banking assets and transactional cash or current accounts. Non-bankable assets (e. g. art collections) and interbank deposits are excluded from both measures. Net new money is defined as the sum of the acquisition of invested assets from new clients, the loss of invested assets due to client defection and inflows and outflows of invested assets from existing clients. Interest and dividend income as well as the effects of market or currency move- ments as well as acquisitions and divestments are excluded from net new money. This definition was introduced in 2001. Because of that, invested assets on 31 December 2000 were restated according to the new definition. Where products are created in one Business Group, but sold in another, they are counted in Credit loss expense represents the charges to the profit and loss account relating to amounts due to UBS from loans and advances, over-the- counter (OTC) derivatives and off-balance sheet products that are considered impaired or uncol- lectable (for more information, please refer to Note 11 to the UBS Group Financial Statements of this report). We determine the amount of credit loss expense in UBS’s financial accounts and in the business unit reporting on different bases. In the Group income statement, we report UBS’s results according to IFRS. Under these standards, credit loss expense is the total of net new allowances and direct writeoffs less recoveries. These actual losses are recognized and charged to the income statement in the period when they arise. By contrast, in our segment and business unit reporting, we apply an approach to the measure- ment of credit risk which reflects the average annual cost that management anticipates will arise from transactions existing today that may become impaired in the future. The basis for measuring these inherent risks in the credit port- folios is the concept of “expected loss” (further information on page 60 in the “Risk Analysis” section of the Handbook 2002/2003). Over the 39 Review of Business Group Performance Introduction Business Group Credit Loss Charge CHF million For the year ended 31.12.02 Actuarial expected loss Deferred releases Credit loss expense charged to the Business Groups IFRS actual credit loss expense UBS Wealth Management & Business Banking UBS Warburg UBS PaineWebber Corporate Center 569 (255 ) 314 241 126 2 128 (35) 13 0 13 15 (15) Balancing item charged as Credit loss expense in Corporate Center Total 708 (253) 455 206 (249 ) longer term, the expected loss should equal the actual credit loss expense, although the latter is more erratic, in both timing and amount. Therefore, in business unit reporting, in addition to the expected loss, we also charge or refund the difference between actual credit loss expense and expected loss, amortized over a three-year period. With this deferred charging mechanism we not only make Business Groups ultimately accountable for any credit losses they suffer but also give them the incentive to align their credit decisions and risk-adjusted pricing with the medium-term risk profile of their credit trans- actions. The sum of this “deferral” and the expected loss makes up the Credit loss expense charged in our segment and business unit reporting. We reconcile the difference between the credit loss expense in UBS’s income statement (the actual loss) and the credit loss expense shown in business unit reporting (expected loss plus defer- ral), by recording a balancing item in Corporate Center. We also show the allocation of actual credit loss expense to the business units in the footnotes to Note 2a of the UBS Group Financial Statements. Key performance indicators On Group level, we focus on a consistent set of long-term financial targets defined across periods of varying market conditions and designed to ensure that UBS delivers continuously improving returns to shareholders (see pages 21 and 22 of this report). At the Business Group or business unit level, performance is measured with careful- ly chosen key performance indicators (KPIs). These do not carry explicit targets, but are indi- cators of the business units’ success in creating value for shareholders. They reflect the key driv- ers of each unit’s core business activities and include both financial metrics, such as the cost/income ratio, and non-financial metrics, such as invested assets or the number of client advisors. KPIs are an important part of our business planning process. They are used identically for internal performance measurement and external reporting. This ensures that management have a clear responsibility to lead their businesses towards achieving success in the Group’s key value drivers and avoids any risk of managing to purely internal performance measures. Reconciliation of Business Group Credit Loss Charge to IFRS Actual Credit Loss Expense / (Recovery) CHF million For the year ended UBS Wealth Management & Business Banking UBS Warburg UBS PaineWebber Corporate Center Total Credit loss charge IFRS actual credit loss expense 31.12.02 31.12.01 31.12.00 31.12.02 31.12.01 31.12.00 314 128 13 0 455 604 112 18 0 734 785 243 3 0 1,031 241 (35) 15 (15) 206 123 360 15 0 498 (695) 562 3 0 (130) Balancing item in Corporate Center (249) (236 ) (1,161 ) 40 Indicative Tax Rates For the year ended 31 December 2002 UBS Wealth Management & Business Banking Private Banking Business Banking Switzerland UBS Global Asset Management UBS Warburg Corporate and Institutional Clients UBS Capital UBS PaineWebber Business Group tax rates Indicative Business Group and business unit tax rates are calculated on an annual basis based on the results and statutory tax rates of the finan- cial year. These rates are approximate calcula- tions, based upon the application to the year’s adjusted earnings of statutory tax rates for the locations in which the Business Groups oper- ated. These tax rates therefore give guidance on the tax cost to each Business Group of doing business during 2002 on a stand-alone basis, without the benefit of tax losses brought for- ward from earlier years. Tax rate Pre-Goodwill 19 18 20 22 38 31 3 37 The indicative tax rates are presented “pre- goodwill”. They give an indication of what the tax rate would have been if goodwill were not charged for accounting purposes. It is the sum of the tax expense payable on net profit before tax and goodwill in each location, divided by the total net profit before tax and goodwill. However, the tax rates post-goodwill are higher than the pre-goodwill rates, because in some jurisdictions there are limitations on the tax deductibility of amortization costs. Please note that these tax rates are not neces- sarily indicative of future tax rates for the busi- nesses or UBS Group as a whole. 41 Review of Business Group Performance UBS Wealth Management & Business Banking UBS Wealth Management & Business Banking In 2002, Private Banking’s pre-tax profit adjusted for SFEs was CHF 2,774 million, a 19% decline from 2001. Business Banking Switzerland’s profit before tax was CHF 1,967 million, up 32% from the previous year. Private Banking continues to attract net new money with fur- ther strong inflows in our European wealth management initiative. In Business Banking Switzerland, operating expenses fell 13%, and were at their lowest level since 1999. Business Group reporting CHF million, except where indicated For the year ended Income Credit loss expense 1 Total operating income Personnel expenses General and administrative expenses Depreciation Amortization of goodwill and other intangible assets Total operating expenses Business Group performance before tax Business Group performance before tax and goodwill 2 Additional information Regulatory equity allocated (average) Cost / income ratio (%) 3 Cost / income ratio before goodwill (%) 2, 3 Fair value of employee stock options granted 31.12.02 31.12.01 31.12.00 % change from 31.12.01 12,928 (314) 12,614 4,810 2,317 480 111 7,718 4,896 5,007 8,800 60 59 964 13,488 (604 ) 12,884 4,825 2,434 616 109 7,984 4,900 5,009 9,400 59 58 14,355 (785 ) 13,570 5,151 2,478 633 81 8,343 5,227 5,308 10,150 58 58 (4) (48) (2) 0 (5) (22) 2 (3) 0 0 (6) Business Group reporting adjusted for Significant Financial Events CHF million, except where indicated For the year ended 31.12.02 31.12.01 31.12.00 % change from 31.12.01 Income Credit loss expense 1 Total operating income 12,7735 (314) 12,459 13,488 (604 ) 12,884 Personnel expenses General and administrative expenses Depreciation Amortization of goodwill and other intangible assets Total operating expenses Business Group performance before tax Business Group performance before tax and goodwill 2 (5) (48) (3) 0 (5) (22) 2 (3) (3) (3) 14,355 (785 ) 13,570 5,151 2,3986 5616 81 8,191 5,379 5,460 57 56 4,810 2,317 480 111 7,718 4,741 4,852 60 60 4,825 2,434 616 109 7,984 4,900 5,009 59 58 Georges Gagnebin Chairman UBS Wealth Management & Business Banking Marcel Rohner CEO UBS Wealth Management & Business Banking 1 In management accounts, statistically derived actuarial expected loss adjusted by deferred releases rather than the net IFRS actual credit loss is reported in the Business Groups (see Note 2 to the Financial Statements). 2 Excludes the amortization of goodwill and other intangible assets. 3 Operating expenses / operating income before credit loss expense. 4 For informational purposes only. These pre-tax amounts have not been recorded in the Income statement. For details on the fair value calculation, refer to Note 32e to the Financial Statements. 5 Excludes significant financial event: Income, CHF 155 million (Gain on disposal of Hyposwiss). 6 Excludes significant financial events: General and administrative expenses, CHF 80 million and Depreciation, CHF 72 million (PaineWebber integration costs). Additional information Cost / income ratio (%) 3 Cost / income ratio before goodwill (%) 2, 3 42 Review of Business Group Performance UBS Wealth Management & Business Banking Private Banking Business unit reporting CHF million, except where indicated For the year ended Income Credit loss expense 3 Total operating income Personnel expenses General and administrative expenses Depreciation Amortization of goodwill and other intangible assets Total operating expenses Business unit performance before tax Business unit performance before tax and goodwill 4 KPIs Invested assets (CHF billion) Net new money (CHF billion) 5, 6 Gross margin on invested assets (bps) 7 Cost / income ratio (%) 8 Cost / income ratio before goodwill (%) 4, 8 Cost / income ratio before goodwill and excluding the European wealth management initiative (%) 4, 8 Client advisors (full-time equivalents) 3,291 3,043 31.12.02 31.12.01 31.12.00 % change from 31.12.01 8,402 (35 ) 8,367 2,030 2,0192 1452 55 4,249 4,118 4,173 798 1.2 105 51 50 5,890 550 7.5 107 7,2791 (28) 7,251 2,083 2,158 125 111 4,477 2,774 2,885 688 16.6 98 62 60 53 7,696 (37 ) 7,659 1,947 2,038 151 109 4,245 3,414 3,523 791 24.6 97 55 54 48 5,2291 493 19.1 100 186 28 7.6 551 5,498 555 23.2 99 140 16 5.6 370 2,050 2,198 2,512 195 (2.5) 95 236 1.4 92 248 (6.3 ) 100 (5) (24) (5) 7 6 (17) 2 5 (19) (18) (13) 1 8 (5) (11) 1 33 75 49 (7) (17) 3 1 Excludes significant financial event: Income, CHF 155 million (Gain on disposal of Hyposwiss). 2 Excludes significant financial events: General and administrative expenses, CHF 80 million and Depreciation, CHF 72 million (PaineWebber integration costs). 3 In management accounts, statistically derived actuarial expected loss adjusted by deferred releases rather than the net IFRS actual credit loss is reported in the Business Groups (see Note 2 to the Financial Statements). Private Banking – International Clients Income Invested assets (CHF billion) Net new money (CHF billion) 5 Gross margin on invested assets (bps) 7 European wealth management initiative (part of Private Banking – International Clients) Income Invested assets (CHF billion) Net new money (CHF billion) 5 4 Excludes the amortization of goodwill and Client advisors (full-time equivalents) other intangible assets. 5 Excludes interest and dividend income. 6 Calculated using the former definition of assets under management up to and including second quarter 2001. 7 Income / average invested assets. Private Banking – Swiss Clients Income Invested assets (CHF billion) Net new money (CHF billion) 5, 6 Gross margin on invested assets (bps) 7 8 Operating expenses / operating income before credit loss expense. Additional information As at 31.12.02 31.12.01 31.12.00 % change from 31.12.01 9 For informational purposes only. These pre-tax amounts have not been recorded in the Income statement. For details on the fair value calculation, refer to Note 32e to the Financial Statements. Client assets (CHF billion) Regulatory equity allocated (average) Fair value of employee stock options granted Headcount (full-time equivalents) 836 3,100 589 10,488 949 3,550 10,249 2,600 9,835 (12) (13) 2 43 Review of Business Group Performance UBS Wealth Management & Business Banking Components of Operating Income Private Banking derives its operating income principally from: – fees for financial planning and wealth management services; – fees for investment management services; and – transaction-related fees. Private Banking’s fees are based on the market value of invested assets and the level of transaction-related activity. As a result, Private Banking’s operating income is affected by such factors as fluctuations in invested assets, changes in market conditions, investment performance and in- flows and outflows of client funds. Significant Financial Events In 2002, we decided to streamline our private banking activities in the region of Zurich and therefore sold our Hyposwiss subsidiary to the Cantonal Bank of Saint Gall. The transaction involved the transfer of 132 employees and CHF 6.4 billion in invested assets and generated a pre- tax gain of CHF 155 million which we treated as a significant financial event in 2002. This gain does not appear in the 2002 adjusted business unit result above. Following the merger with PaineWebber in 2000, our strategy for extending our wealth man- agement services in Europe was re-assessed and focus shifted to more affluent clients than those originally targeted by the so-called “e-services” initiative. This change in strategy resulted in a charge of CHF 80 million to general and administrative expenses due to the closure of the infrastructure related to the initiative and a charge of CHF 72 million to depreciation due to the writeoff of the system used. Both amounts form part of the PaineWebber integration costs, which were treated as significant financial event in 2000, and as a result these costs do not appear in the adjusted business unit results above. There were no significant financial events that affected this business unit in 2001. The results in the discussion below exclude significant financial events. 2002 Key performance indicators For the full year, net new money inflows totaled CHF 16.6 billion, down from the 2001 result of CHF 24.6 billion. Excluding the net outflow of over CHF 8 billion related to the Italian tax amnesty, the net new money result was essen- tially unchanged. International clients invested net new money of CHF 19.1 billion in 2002, down by only CHF 4.1 billion from a year earlier despite the Italian tax amnesty. This excellent underlying result in these difficult markets was due to the continued success of our European wealth management initiative as well as signi- ficant inflows from clients in Asia and the Americas. Net new money (CHF billion) 30 25 20 15 10 5 0 0 0 0 2 1 0 0 2 2 0 0 2 In the year to 31 December 2002, invested assets fell 13% to CHF 688 billion, mainly due to the steep drop in global equity markets as well as the 17% drop in the US dollar against the Swiss franc. Some 38% of Private Banking’s invested assets are denominated in US dollars. Invested assets (CHF billion) 1000 750 500 250 0 31.12.00 31.12.01 31.12.02 Private Banking – International Clients Private Banking – Swiss Clients Gross margin on invested assets remained resilient and rose by 1 basis point to 98 basis 44 points. Assets as well as revenues fell in 2002 from the already depressed 2001 levels. The split of the margin remained unchanged from 2001 with 72% of the margin stemming from recurring revenue and 28% from transactional fees. Gross margin on invested assets (bps) 120 100 80 60 40 20 0 0 0 0 2 1 0 0 2 2 0 0 2 Pre-goodwill cost/income ratio (%) 80 70 60 50 40 30 0 0 0 2 1 0 0 2 2 0 0 2 Over the full year, the pre-goodwill cost/ income ratio increased from 54% in 2001 to 60% in 2002, reflecting the ongoing investment in our European wealth management initiative as well as the strong decline in asset-based revenues. Excluding the European wealth management initiative, our cost/income ratio increased from 48% in 2001 to 53% in 2002. European wealth management Early in 2001 we launched the European wealth management initiative, designed to expand our market share in the five countries of France, Germany, Italy, Spain and the UK, key markets that cover about 80% of Europe’s investable assets. Our strategy is focused on wealthy clients, with services designed primarily for those with more than EUR 500,000 of investable assets, developed with a clear commitment to open architecture and the provision of a full range of “best-of-breed” investment products. Progress so far has been promising with net new money inflows into our domestic European network for full-year 2002 totaling CHF 7.6 bil- lion, up 36% from last year’s intake of CHF 5.6 billion. The inflow in 2002 reflects an annual growth rate in net new money of 48%. For full- year 2002, income from our European wealth management initiative was CHF 186 million, 33% or CHF 46 million above the 2001 level, reflecting the success of our business expansion program. Net new money European wealth management (CHF billion) 8 6 4 2 0 1 0 0 2 2 0 0 2 We hired a total of 181 client advisors in 2002, bringing the total at 31 December 2002 to 551. We remain committed to growing our pres- ence in our European target markets and will continue to invest in qualified advisory staff at a rate determined by the market environment and business opportunities. Client advisors European wealth management (full-time equivalents) 600 550 500 450 400 350 300 1 0 . 2 1 . 1 3 2 0 . 2 1 . 1 3 Results Private Banking’s full-year 2002 pre-tax profit, at CHF 2,774 million, fell 19% from 2001 due to the steep decline in asset-based revenues which could not be fully compensated by cost reductions as we continue to invest in our European wealth management initiative. 45 Review of Business Group Performance UBS Wealth Management & Business Banking Personnel as well as general and administra- tive expenses increased due to this strategic initiative. Performance before tax (CHF million) 5000 4000 3000 2000 1000 0 0 0 0 2 1 0 0 2 2 0 0 2 Operating income Full-year operating income was CHF 7,251 mil- lion, down 5% from CHF 7,659 million in 2001. Both non-recurring transaction revenues and recurring asset-based revenues fell from 2001. Operating expenses At CHF 4,477 million, full-year operating expenses for 2002 rose 5% from 2001, reflecting investments in our European wealth manage- ment initiative. Both personnel expenses, which rose 7% to CHF 2,083 million, as well as general and administrative expenses, up 6% at CHF 2,158 million, increased chiefly because of the invest- ments in this initiative. Full-year depreciation fell in 2002 by 17% to CHF 125 million because of lower charges for information technology equipment, which is increasingly being leased instead of bought, while goodwill amortization was CHF 111 million, up 2% from 2001. Headcount (full-time equivalents) 11 10 9 8 7 6 (in thousands) 0 0 . 2 1 . 1 3 1 0 . 2 1 . 1 3 2 0 . 2 1 . 1 3 Headcount Headcount, at 10,488 on 31 December 2002, increased by 239, mainly due to the hiring of experienced client advisors for the buildup of European wealth management activities. Overall, the number of client advisors increased by 8% to 3,291 at the end of 2002 and represented 31% of all Private Banking’s staff. 2001 Key performance indicators Net new money inflows in 2001, at CHF 24.6 billion, were CHF 23.4 billion higher than in 2000, demonstrating our success in re-energizing our asset-gathering performance, as well as our determined focus on growing our wealth man- agement franchise. In the year to 31 December 2001, invested assets fell a modest 1% despite the poor per- formance of securities markets, reflecting strong net new money growth and a relatively conser- vative asset mix. The gross margin fell from 105 basis points in 2000 to 97 basis points in 2001, clearly reflecting reduced transaction volumes, especially com- pared to the exuberant market environment in the early part of 2000. The pre-goodwill cost/income ratio increased by four percentage points from 50% in 2000 to 54% in 2001, reflecting the costs of our invest- ments in the European wealth management initiative, and weaker transaction volumes. European wealth management In 2001, our domestic European network had net new money inflows of CHF 5.6 billion, despite the relatively difficult market conditions. Opening new offices and hiring new staff is a key component of the initiative. Hiring plans progressed well in 2001, with the number of client advisors in our five target countries rising to 370 on 31 December 2001, an increase of 208 for the year. A further 40 newly hired advisors started on 1 January 2002, bringing our total hiring in 2001 to 248. Results Weaker markets than in 2000 and the costs of investing in the European wealth management initiative brought full-year pre-tax profits in 46 2001 down 17% from 2000 to CHF 3,414 mil- lion, despite a continued focus on controlling operating costs. Operating income Full-year operating income was CHF 7,659 million, down 8% from the record CHF 8,367 million in 2000. This was driven by falling transaction-based revenues, reflecting the much less active markets in 2001. Asset-based rev- enues fell only very slightly compared to 2000, despite lower average assets, reflecting our suc- cess in providing added value services to our clients. Operating expenses At CHF 4,245 million, operating expenses in 2001 were nearly unchanged from 2000. Per- sonnel expenses fell by 4% to CHF 1,947 million in 2001, reflecting lower performance-related compensation despite a 4% increase in head- count during the year. General and administrative expenses in- creased 1% from CHF 2,019 million in 2000 to CHF 2,038 million in 2001, principally reflecting the cost of investments in new product develop- ment, premises and systems in support of the European wealth management initiative. Depreciation increased from CHF 145 million in 2000 to CHF 151 million in 2001, reflecting increased investment in IT and premises. Headcount At 31 December 2001, Private Banking em- ployed 10,249 professionals, a 4% increase compared with year-end 2000, driven by recruit- ment of client advisors and support personnel for the European wealth management initiative. At 31 December 2001, client advisors represented around 30% of Private Banking’s staff. 47 Review of Business Group Performance UBS Wealth Management & Business Banking Business Banking Switzerland Business unit reporting CHF million, except where indicated For the year ended Private clients Corporate clients Other areas Income Credit loss expense 1 Total operating income Personnel expenses General and administrative expenses Depreciation Amortization of goodwill and other intangible assets Total operating expenses Business unit performance before tax Business unit performance before tax and goodwill 2 KPIs Invested assets (CHF billion) Net new money (CHF billion) 3, 4 Cost / income ratio (%) 5 Cost / income ratio before goodwill (%) 2, 5 Non-performing loans / gross loans outstanding (%) Impaired loans / gross loans outstanding (%) 31.12.02 31.12.01 31.12.00 % change from 31.12.01 3,014 2,148 332 5,494 (286) 5,208 2,727 159 355 0 3,241 1,967 1,967 205 3.7 59 59 3.6 6.0 3,185 2,263 344 5,792 (567 ) 5,225 2,878 396 465 0 3,739 1,486 1,486 215 9.2 65 65 4.8 7.7 3,520 2,217 216 5,953 (750 ) 5,203 3,121 379 416 26 3,942 1,261 1,287 239 2.7 66 66 5.5 9.4 (5) (5) (3) (5) (50) 0 (5) (60) (24) (13) 32 32 (5) Additional information As at or for the year ended Deferred releases included in credit loss expense 1 Client assets (CHF billion) Regulatory equity allocated (average) Fair value of employee stock options granted Headcount (full-time equivalents) 31.12.02 31.12.01 31.12.00 240 494 5,700 386 18,442 115 544 5,850 7,550 19,220 20,437 % change from 31.12.01 109 (9) (3) (4) 1 In management accounts, statistically derived actuarial expected loss adjusted by deferred releases rather than the net IFRS actual credit loss is reported in the Business Groups (see Note 2 to the Financial Statements). Deferred releases represent amortization of historical differences between actual credit losses and actuarial expected loss (for more information, please refer to pages 39 and 40 of the UBS Financial Report 2002). 2 Excludes the amortization of goodwill and other intangible assets. 4 Calculated using the former 5 Operating expenses / operating income before credit loss definition of assets under management up to and including second quarter 2001. 6 For informational purposes only. These pre-tax amounts have not been recorded in the Income statement. For details on the fair expense. value calculation, refer to Note 32e to the Financial Statements. 3 Excludes interest and dividend income. Components of Operating Income Business Banking Switzerland derives its operating income principally from: – net interest income from its loan portfolio and cus- tomer deposits; – fees for investment management services; – transaction fees. As a result, Business Banking Switzerland’s operating income is affected by movements in interest rates, fluc- tuations in invested assets, client activity levels, invest- ment performance and changes in market conditions. 48 Significant financial events There were no significant financial events that affected this business unit in 2002, 2001 or 2000. 2002 Key performance indicators Invested assets fell from CHF 215 billion in 2001 to CHF 205 billion in 2002 as negative market developments and the weakening of major cur- rencies against the Swiss franc were only partially offset by positive net new money inflows. In 2002, Business Banking Switzerland attracted net new money of CHF 3.7 billion, down from CHF 9.2 billion in 2001. This drop was due to smaller inflows from large corporate client accounts – a business traditionally subject to volatile inflows and outflows. For full-year 2002, the cost/income ratio was a record low 59%, 6 percentage points below the previous year’s ratio of 65%, reflecting the drop in total operating expenses to the lowest level since 1999. Pre-goodwill cost/income ratio (%) 70 65 60 55 50 45 40 0 0 0 2 1 0 0 2 2 0 0 2 Business Banking Switzerland’s loan portfolio decreased to CHF 139 billion at 31 December 2002 from CHF 146 billion at 31 December 2001, driven by lower volumes in the corporate clients area and the further reduction in the recovery portfolio from CHF 12 billion at 31 December 2001 to CHF 8.6 billion at 31 December 2002. This positive development was also reflected in the key credit quality ratios: the non-performing loan ratio declined to 3.6% from 4.8%, while the ratio of impaired loans to gross loans saw a further improvement, falling to 6.0% from 7.7%. Full-year interest income in 2002 was below the previous year mainly due to lower interest Impaired loans/gross loans (%) 10 8 6 4 2 0 0 0 . 2 1 1 3 . 1 0 . 2 1 1 3 . 2 0 . 2 1 1 3 . margins on savings and cash accounts as well as the fall in the US dollar, which caused the Swiss franc equivalent of US dollar interest rate revenues to drop. Results In 2002, full-year pre-tax profit was a record CHF 1,967 million, up 32% from 2001, achieved despite declining revenues in difficult market conditions, due to continued tight man- agement of our cost base and lower credit loss expenses. Personnel expenses dropped due to lower performance-related compensation as well as a drop in headcount whereas general and administrative expenses reached their lowest level since 1999. Performance before tax (CHF million) 2000 1500 1000 500 0 0 0 0 2 1 0 0 2 2 0 0 2 Operating income Full-year operating income was CHF 5,208 mil- lion, almost unchanged from 2001’s level of CHF 5,225 million. Interest income fell because of con- tinued pressure on margins of liability products. Trading and transactional income also declined, reflecting the difficult market environment, although these developments were mostly offset by lower credit loss expenses, which fell to CHF 49 Review of Business Group Performance UBS Wealth Management & Business Banking 286 million in 2002, down 50% from CHF 567 million in 2001. This drop reflects the continued success in improving the quality of our loan port- folio through the implementation of risk-adjusted pricing and the deferred benefit of the prior year’s better than expected credit performance. Income from Private Clients declined from CHF 3,185 million in 2001 to CHF 3,014 mil- lion in 2002, reflecting mainly a decline in inter- est income due to lower margins of liability prod- ucts due to lower market rates. In addition, fee income decreased as a result of a lower asset base and weaker client activity. Income from Corporate Clients declined 5% from CHF 2,263 million in 2001 to CHF 2,148 million in 2002 reflecting lower interest, fee and trading income due to the weak financial markets. Income from Other areas dropped by 3% to CHF 332 million in 2002 from CHF 344 million in 2001 mainly due to a methodology change regarding the treatment of revenues from corre- spondent banking clients. Operating expenses Full-year 2002 operating expenses decreased 13% from CHF 3,739 million in 2001 to CHF 3,241 million and were at their lowest level since 1999. Personnel expenses dropped 5% from CHF 2,878 million in 2001 to CHF 2,727 million in 2002, due to lower headcount. General and administrative expenses, at CHF 159 million, continued to drop and were 60% lower than the CHF 396 million recorded in 2001. This drop reflects our continuous efforts to control costs as well as higher usage of services, mainly IT, provided to other business units. Overall, the very low level of general and admin- istrative expenses is explained by the integrated business model of UBS through which Business Banking Switzerland provides a significant num- ber of services to other business units of the Group, mainly Private Banking. In accounting terms, the costs for these services are charged to the receiving unit as general and administrative expenses, offset by lower general and administra- tive expenses in the provider unit. Depreciation for full-year 2002 dropped to CHF 355 million from CHF 465 million in 2001 as information technology equipment is increas- ingly being leased instead of bought. Headcount Business Banking Switzerland’s headcount was 18,442 on 31 December 2002, a decline of 778 or 4% from 31 December 2001, as we continued to streamline processes and structures. Headcount (full-time equivalents) 21 19 17 15 (in thousands) 0 0 . 2 1 . 1 3 1 0 . 2 1 . 1 3 2 0 . 2 1 . 1 3 2001 Key performance indicators In 2001, Business Banking Switzerland attracted net new money of CHF 9.2 billion, a clear im- provement over 2000’s CHF 2.7 billion, reflect- ing improved flows from both private clients and corporate clients, where flows can be larger and more volatile. Invested assets were CHF 215 bil- lion as of 31 December 2001. Business Banking Switzerland continued to focus successfully on stringent cost control meas- ures reflected in a one percentage point decline in the full year’s pre-goodwill cost/income ratio from 66% in 2000 to 65% in 2001. This result- ed from reductions in headcount and in perform- ance-related compensation expenses. Business Banking Switzerland’s loan portfolio decreased from CHF 150 billion at 31 December 2000 to CHF 146 billion at 31 December 2001, driven by reductions in the more volatile business with banks and the further reduction in the recovery portfolio from CHF 15 billion to CHF 12 billion. The strength of the Swiss economy in the early part of 2001 and our continued successful recov- ery efforts were reflected in an improvement in key asset quality ratios since the end of 2000. The non-performing loans to total loans ratio decreased from 5.5% to 4.8% while the ratio of impaired loans to gross loans further improved from 9.4% to 7.7%. 50 Results Business Banking Switzerland enjoyed a very strong year, despite the much more difficult market conditions, with profit before tax in 2001 up 18% compared to 2000, at CHF 1,486 mil- lion. The implementation of risk-adjusted pricing and the strength of the Swiss economy in 2000 and early 2001 led to a significant increase in credit quality, while operating expenses have remained under tight control, falling 5% com- pared to 2000. Operating income Operating income in 2001 was up CHF 22 mil- lion from 2000 at CHF 5,225 million, principally reflecting the reduction in credit loss expense partially offset by the effect of weaker markets in 2001 on fee and commission income. Business Banking Switzerland has improved the quality of its loan portfolio considerably in recent years, principally through the introduc- tion of risk-adjusted pricing, leading to a lower adjusted expected loss charge in 2001 compared to 2000. In 2001, we introduced a new process for calculating the adjusted expected loss charged to the Business Groups, under which the difference between the actual IFRS credit losses and the actuarial expected loss calculated for management reporting purposes is charged or credited back to the business units over a three- year period, so that the risks and rewards over the cycle are better reflected in their results. Since actual credit losses in Business Banking Switzerland have recently been lower than the adjusted expected loss charge, this deferral process has also resulted in a lower adjusted expected loss charge (see pages 39 and 40 for further details). Together these effects led to a credit loss expense of CHF 567 million in 2001, down 24% from CHF 750 million in 2000. Income from Private Clients declined from CHF 3,520 million in 2000 to CHF 3,185 mil- lion in 2001 due to lower fee income, reflecting lower market activity levels as well as lower interest income because of liability margin pres- sure. Income from Corporate Clients increased by 2% from CHF 2,217 million in 2000 to CHF 2,263 million in 2001, reflecting higher income due to a change in the treatment of interest on impaired loans (previously recorded as a reduc- tion in credit loss expense), which more than off- set lower interest and fee income due to the weaker financial markets. Income from Other areas increased by 59% from CHF 216 million in 2000 to CHF 344 mil- lion in 2001 reflecting higher disposal revenues (the sale of TicketCorner) and higher one-off revenues from minority holdings. Operating expenses Operating expenses remain under strict control, totaling CHF 3,739 million in 2001, CHF 203 mil- lion lower than in 2000. General and administrative expenses in 2001, at CHF 396 million, were 4% higher than in 2000, principally reflecting higher liability risk provisions, partially offset by lower IT outsourc- ing costs and the continued effect of our efforts to control costs. Personnel expenses declined by CHF 243 mil- lion compared to 2000, to CHF 2,878 million, reflecting a fall in headcount of 1,217 since the end of 2000, and lower performance-related pay. Over the full year, the compensation ratio in Business Banking Switzerland was 50%, down from 52% in 2000. Depreciation increased 12% from 2000, to CHF 465 million, principally reflecting cancella- tion of previously capitalized software projects as a result of cost control measures. Goodwill amortization dropped from CHF 26 million in 2000 to zero in 2001, reflecting the writeoff of goodwill on a credit card portfolio in 2000. Headcount Business Banking Switzerland’s headcount declined by a further 6% in 2001, from 20,437 on 31 December 2000 to 19,220 on 31 December 2001, as the cost control effects from the system- atic implementation of the strategic projects portfolio and the benefits of the merger between Union Bank of Switzerland and Swiss Bank Corporation continued to be realized. 51 Review of Business Group Performance UBS Global Asset Management UBS Global Asset Management Pre-tax profit in 2002 was CHF 187 million, down 33% from 2001. The declines in equity markets throughout 2002 resulted in lower invested asset levels and subsequently, lower asset-based revenues. This decrease was partially offset by ongoing initiatives to control costs. Business Group reporting CHF million, except where indicated For the year ended Institutional fees Wholesale Intermediary fees Total operating income Personnel expenses General and administrative expenses Depreciation Amortization of goodwill and other intangible assets Total operating expenses Business Group performance before tax Business Group performance before tax and goodwill 1 KPIs Cost / income ratio (%) 2 Cost / income ratio before goodwill (%) 1, 2 Institutional Invested assets (CHF billion) Net new money (CHF billion) 4 Gross margin on invested assets (bps) 6 Wholesale Intermediary Invested assets (CHF billion) Net new money (CHF billion) 4 Gross margin on invested assets (bps) 6 31.12.02 31.12.01 31.12.00 % change from 31.12.01 899 1,054 1,953 946 513 37 270 1,766 187 457 90 77 2793 (0.6) 29 2783 (1.8) 34 1,174 1,044 2,218 1,038 569 46 286 1,939 279 565 87 75 328 6.2 37 344 28.7 32 1,242 836 2,078 941 434 49 267 1,691 387 654 81 69 323 (70.8)5 38 319 2.95 36 (23) 1 (12) (9) (10) (20) (6) (9) (33) (19) (15) (22) (19) 6 Additional information As at Client assets (CHF billion) Regulatory equity allocated (average) Fair value of employee stock options granted Headcount (full-time equivalents) 31.12.02 31.12.01 31.12.00 % change from 31.12.01 557 1,750 447 3,346 672 1,850 3,281 1,550 2,860 (17) (5) 2 1 Excludes the amortization of goodwill and other intangible assets. 3 In the second quarter 2002 invested assets of CHF 7.7 billion were transferred from Mutual Funds (now renamed Wholesale Intermediary). Prior years are shown according 5 Calculated using the former definition of assets under management. to the old classification. 6 Income / average invested assets. 7 For informational purposes only. These pre-tax amounts have not been recorded in the Income statement. For details on the fair value calculation, refer to Note 32e to the Financial Statements. 4 Excludes interest and dividend income. 2 Operating expenses / operating income. John A. Fraser Chairman and CEO UBS Global Asset Management 52 Components of Operating Income UBS Global Asset Management generates its revenue from the asset management services it provides to institu- tional and wholesale intermediary clients. Fees charged to institutional clients and wholesale intermediary clients are based on the market value of invested assets and on suc- cessful investment performance. As a result, UBS Global Asset Management’s revenues are affected by changes in market and currency valuation levels as well as flows of client funds, and relative investment performance. Significant financial events There were no significant financial events that affected this Business Group in 2002, 2001 or 2000. 2002 Key performance indicators For 2002, the pre-goodwill cost/income ratio was 77%, up 2 percentage points from a year earlier. The increase was primarily due to lower invested asset values, which resulted in lower asset-based revenues. Those developments, however, were partially offset by lower operating expenses prompted by ongoing initiatives to control costs. Pre-goodwill cost/income ratio (%) 80 70 60 50 40 0 0 0 2 1 0 0 2 2 0 0 2 Net new money; Institutional (CHF billion) 0 0 0 2 1 0 0 2 2 0 0 2 10 0 –10 –20 –30 –40 –50 –60 –70 –80 Full-year gross margin was 29 basis points, a decrease of 8 basis points from 2001 due to lower performance fees and a lower proportion of assets in alternative investments. Gross margin on invested assets; Institutional (bps) 40 35 30 25 20 15 10 5 0 0 0 0 2 1 0 0 2 2 0 0 2 Institutional Institutional invested assets, at CHF 279 billion on 31 December 2002, declined 15% from their level on 31 December 2001. The decrease in assets was due to the decline seen in financial markets during the year as well as the drop of the US dollar against the Swiss franc over the year. For full-year 2002, the outflow of net new money was CHF 0.6 billion. This is a disap- pointing figure compared to the net new money inflow of CHF 6.2 billion recorded in 2001. Strong inflows into equity mandates were more than offset by outflows from alternative asset and fixed income mandates. Wholesale Intermediary Invested assets stood at CHF 278 billion on 31 De- cember 2002, down from CHF 344 billion on 31 December 2001. The decline was primarily the result of negative currency impacts and declining markets as well as slightly negative net new money. For full-year 2002, the outflow of net new money was CHF 1.8 billion compared to an inflow of CHF 28.7 billion in 2001. The outflow was largely due to CHF 7.0 billion in money market funds, primarily in the Americas. Inflows of CHF 3.2 billion into equity and private mar- ket mandates globally in all business areas as well as an inflow of CHF 3.0 billion into alter- 53 Review of Business Group Performance UBS Global Asset Management Net new money; Wholesale Intermediary (CHF billion) 30 25 20 15 10 5 0 –5 0 0 0 2 1 0 0 2 1 0 Q 1 2 0 0 2 native investments, primarily at GAM, largely offset the outflow. The gross margin rose to 34 basis points in 2002 from 32 basis points in 2001 as a result of the asset mix improving towards higher margin asset classes. Gross margin on invested assets; Wholesale Intermediary (bps) 40 35 30 25 20 15 10 5 0 0 0 0 2 1 0 0 2 2 0 0 2 Investment capabilities and performance Global equity markets ended the year in signi- ficantly negative territory with the US market, as measured by the S&P 500, posting its first consecutive three-year decline since the Second World War. Markets outside the US have now fallen further from peak to trough than in their most significant previous contraction in the mid-1970s. Contributing to the erosion of equity values was the investor realization that any recovery would not be as robust as hoped, both with regard to economic fundamentals and earnings. The majority of UBS Global Asset Manage- ment funds finished the year strongly, well above benchmark in the fourth quarter 2002. The Global Equity Composite led the way, beat- ing MSCI World Equity Free Index benchmark returns for the year, 3- and 5-year periods by significant margins. The UK Balanced Equity portfolio continued to perform well against the FTSE All-Share Index for the same periods and our US Equity Composite surpassed the Wilshire 5000 benchmark by more than 5 per- centage points in 2002. It also remains ahead of the benchmark for 3-, and 5-year periods. Emerging equities also showed good results for the year and have also outperformed their benchmark, the MSCI Emerging Equity Markets Free Index, for each of the past 3- and 5-year periods as well. The deteriorating global economy and a flight to quality by equity investors provided the backdrop for a rally in the global sovereign bond market during the year. UBS Global Asset Management’s Global Bond Composite exceed- ed the Salomon WGBI index for the year and the 3-year period as well, but trailed the index for 5-year annualized returns. The US Bond Composite also exceeded the Lehman US Aggregate Index for the 3-, and 5-year periods. Credit research has been strong, with the Global Aggregate Composite finishing well ahead of the Lehman Global Aggregate in 2002, but Emerging Markets Debt ended the year poorly, albeit preserving its 3- and 5-year outperfor- mance against the JP Morgan EMBI Global index. Balanced portfolios also fared well this past year, as exemplified by the Global Multi-Asset Fund, which outperformed the Multiple Markets Index by 4.6 percentage points. Security selec- tion within the component asset classes and cur- rency strategies favoring the euro at the expense of the US dollar were primarily responsible. In the 1-, 3-, and 5-year periods, returns continued to be significantly ahead of the benchmark. Results UBS Global Asset Management reported for full-year 2002 a pre-tax profit of CHF 187 mil- lion, a decrease of 33% from 2001’s pre-tax profit of CHF 279 million. The declines in equity markets experienced throughout 2002 resulted in lower invested asset levels and subsequently, lower asset-based revenues. These develop- ments were partially offset by ongoing initia- tives to control costs. Over the year, personnel expenses decreased due to a decline in incentive compensation while general and administrative 54 Performance before tax (CHF million) 400 300 200 100 0 e g a r e v A 9 9 0 0 0 2 0 0 Q 2 0 0 Q 3 1 0 0 2 1 0 Q 1 1 0 Q 2 2 0 0 2 1 0 Q 4 expenses fell due to lower IT and premises expenditures. Operating income In full-year 2002, operating income declined CHF 265 million, or 12%, to CHF 1,953 mil- lion, primarily due to the declines in financial markets during the year feeding through to asset- based revenues and the US dollar’s weakening against the Swiss franc. Institutional revenues fell to CHF 899 million in full-year 2002 from CHF 1,174 million a year earlier due to the US dollar’s weakening against the Swiss franc, lower performance fees at O’Connor, and the effect of market declines on asset-based revenues. For full-year 2002, Wholesale Intermediary revenues, at CHF 1,054 million, increased slightly from CHF 1,044 million a year earlier due to an increase in higher margin assets invested with GAM. Operating expenses For full-year 2002, operating expenses declined to CHF 1,766 million from CHF 1,939 million a year earlier, primarily due to cost saving initia- tives. Personnel expenses were CHF 946 million in 2002, CHF 92 million lower than in 2001, reflecting lower incentive-based compensation partially offset by higher severance expenses. General and administrative expenses fell to CHF 513 million from CHF 569 million in the same period, reflecting a weaker US dollar, and lower project-related expenses. Over the year, depreciation decreased from CHF 46 million to CHF 37 million as some assets became fully depreciated. Amortization declined CHF 16 million to CHF 270 million, reflecting the drop in the US dollar against the Swiss franc. Headcount Headcount, at 3,346 on 31 December 2002, was up from 3,281 on 31 December 2001. The increase of 2% primarily reflects additional headcount at GAM and a reclassification from contractors to employees at O’Connor. Headcount (full-time equivalents) 3.5 3.0 2.5 2.0 1.5 1.0 0.5 0 (in thousands) 0 0 . 2 1 . 1 3 1 0 . 2 1 . 1 3 2 0 . 2 1 . 1 3 2001 Key performance indicators Invested assets increased 5% during the year from CHF 642 billion on 31 December 2000 to CHF 672 billion on 31 December 2001. Net new money was CHF 34.9 billion for the year, reflecting the recognition of strong relative investment performance and business develop- ment efforts. The pre-goodwill cost/income ratio rose from 69% in 2000 to 75% in 2001, principally reflecting the higher cost/income ratio of the Brinson Advisors (now rebranded UBS Global Asset Management) business trans- ferred from UBS PaineWebber at the start of the year. Institutional Institutional invested assets increased from CHF 323 billion on 31 December 2000 to CHF 328 billion on 31 December 2001. This 2% increase was due to CHF 6.2 billion in net new money and a CHF 34 billion increase in invested assets from the acquisition of RT Capital (now rebranded UBS Global Asset Management) which more than offset negative market per- formance. Net new money in 2001 was CHF 6.2 billion, a great improvement from the net outflows of CHF 70.8 billion in 2000, as clients start to rec- ognize the success of our integrated global invest- 55 Review of Business Group Performance UBS Global Asset Management ment management platform, which delivered strong relative investment performance in both 2001 and 2000. Full-year gross margin was 37 basis points, a decrease of 1 basis point from 2000, primarily due to lower performance fees in O’Connor and the addition of the lower margin Brinson Advisors business. Wholesale Intermediary Wholesale Intermediary’s invested assets in- creased CHF 25 billion, from CHF 319 billion at 31 December 2000 to CHF 344 billion at 31 December 2001, driven by net new money. Market performance was limited to a negative impact on invested assets of less than 1%. Net new money of CHF 28.7 billion in 2001, compared to CHF 2.9 billion in 2000, reflected much better asset-gathering performance in both Europe and the Americas, particularly in fixed income mandates. The gross margin in 2001 decreased 4 basis points to 32 basis points due to the addition of Brinson Advisors, which has a high proportion of lower margin money market funds, partially off- set by the introduction of a new pricing structure for UBS Investment Funds. Results Pre-tax profit of CHF 279 million in 2001 was 28% lower than 2000. Despite market declines and lower performance fees in the O’Connor business, income increased as a result of the new investment funds pricing structure introduced in 2001, the acquisition of RT Capital and the inclusion of Brinson Advisors. This was more than offset by higher personnel expenses and general and administrative expenses driven by spending on growth initiatives, the integration of Brinson Advisors and the acquisition of RT Capital in third quarter. Operating income Operating income increased CHF 140 million, or 7%, from 2000 to CHF 2,218 million in 2001, as a result of the inclusion of Brinson Advisors, the new pricing structure introduced this year for investment funds and the acquisition of RT Capital. These effects were partially offset by lower performance fees at O’Connor, our alter- native investment business, and the effect on asset-based revenues of market declines in 2001 and institutional asset outflows in 2000 which led to lower average assets compared to 2000. Institutional income fell 5% in 2001 com- pared to 2000, to CHF 1,174 million, while Wholesale Intermediary revenue increased 25% from 2000 to CHF 1,044 million in 2001. Operating expenses Operating expenses increased 15% to CHF 1,939 million in 2001, driven by the addition of Brinson Advisors and RT Capital. General and administrative expenses increased 31% from CHF 434 million in 2000 to CHF 569 million in 2001, principally reflecting the addition of Brinson Advisors. Personnel expenses increased 10% from CHF 941 million in 2000 to CHF 1,038 million in 2001, again mostly due to the addition of Brinson Advisors, which more than offset a con- siderable decline in performance-related com- pensation. Depreciation decreased 6% from CHF 49 mil- lion in 2000 to CHF 46 million in 2001. Amorti- zation of goodwill and other intangible assets increased 7% to CHF 286 million in 2001, reflecting the effect of the acquisition RT Capital. Headcount Headcount increased by 421 in 2001, from 2,860 at 31 December 2000 to 3,281 at 31 December 2001, mostly due to the integration of Brinson Advisors and RT Capital. 56 Review of Business Group Performance UBS Warburg UBS Warburg Corporate and Institutional Clients net profit before tax in 2002, at CHF 3,129 million, was 17% lower than in 2001. Market conditions remained challenging, although our Fixed Income, Rates and Currencies business held up well. UBS Capital recorded a pre-tax loss of CHF 1,761 million, with challenging market conditions and a slowdown in corporate activity leading to deteriorating valuations in all markets and industries. Business Group reporting CHF million, except where indicated For the year ended Income Credit loss expense 1 Total operating income Personnel expenses General and administrative expenses Depreciation Amortization of goodwill and other intangible assets Total operating expenses Business Group performance before tax Business Group performance before tax and goodwill 2 Additional information Cost / income ratio (%) 3 Cost / income ratio before goodwill (%) 2, 3 Net new money (CHF billion) 4 Invested assets (CHF billion) Client assets (CHF billion) Regulatory equity allocated (average) Fair value of employee stock options granted 31.12.02 31.12.01 31.12.00 % change from 31.12.01 12,498 (128) 12,370 7,878 2,378 382 364 11,002 1,368 1,732 88 85 0.5 3 133 13,100 5825 14,715 (112 ) 14,603 8,354 2,650 456 402 11,862 2,741 3,143 81 78 0.1 1 109 14,300 18,240 (243 ) 17,997 9,451 2,755 564 192 12,962 5,035 5,227 71 70 1 10,800 (15) 14 (15) (6) (10) (16) (9) (7) (50) (45) 200 22 (8) Business Group reporting adjusted for Significant Financial Events CHF million, except where indicated For the year ended 31.12.02 31.12.01 31.12.00 % change from 31.12.01 John P. Costas Chairman and CEO UBS Warburg 1 In management accounts, statistically derived actuarial expected loss adjusted by deferred releases rather than the net IFRS actual credit loss is reported in the Business Groups (see Note 2 to the Financial Statements). 2 Excludes the amortization of goodwill and other intangible assets. Income Credit loss expense 1 3 Operating expenses / operating income Total operating income before credit loss expense. 4 Excludes interest and dividend income. 5 For informational purposes only. These pre-tax amounts have not been recorded in the Income statement. For details on the fair value calculation, refer to Note 32e to the Financial Statements. 6 Excludes significant financial events: Personnel expenses, CHF 86 million, General and administrative expenses, CHF 13 million and Depreciation, CHF 7 million (all PaineWebber integration costs). Personnel expenses General and administrative expenses Depreciation Amortization of goodwill and other intangible assets Total operating expenses Business Group performance before tax Business Group performance before tax and goodwill 2 Additional information Cost / income ratio (%) 3 Cost / income ratio before goodwill (%) 2, 3 12,498 (128) 12,370 7,878 2,378 382 364 11,002 1,368 1,732 88 85 14,715 (112 ) 14,603 8,354 2,650 456 402 11,862 2,741 3,143 81 78 18,240 (243 ) 17,997 9,3656 2,7426 5576 192 12,856 5,141 5,333 70 69 (15) 14 (15) (6) (10) (16) (9) (7) (50) (45) 57 Review of Business Group Performance UBS Warburg Corporate and Institutional Clients Business Unit reporting CHF million, except where indicated For the year ended Investment Banking 1 Equities Fixed Income, Rates and Currencies 2 Non-core business Income Credit loss expense 3 Total operating income Personnel expenses 4 General and administrative expenses Depreciation Amortization of goodwill and other intangible assets Total operating expenses Business unit performance before tax Business unit performance before tax and goodwill 6 KPIs Compensation ratio (%) 7 Cost / income ratio (%) 8 Cost / income ratio before goodwill (%) 6, 8 Non-performing loans / gross loans outstanding (%) Impaired loans / gross loans outstanding (%) Average VaR (10-day 99%) 31.12.02 31.12.01 31.12.00 % change from 31.12.01 1,915 5,625 6,490 70 14,100 (128) 13,972 7,784 2,314 381 364 10,843 3,129 3,493 55 77 74 1.6 3.2 275 2,541 6,422 6,350 274 15,587 (112 ) 15,475 8,258 2,586 454 402 11,700 3,775 4,177 53 75 72 2.6 5.4 252 2,700 10,300 4,590 280 17,870 (243 ) 17,627 9,2235 2,6955 5555 190 12,663 4,964 5,154 52 71 70 2.8 5.6 242 (25) (12) 2 (74) (10) 14 (10) (6) (11) (16) (9) (7) (17) (16) 9 Additional information As at or for the year ended Deferred releases included in credit loss expense 3 Regulatory equity allocated (average) Fair value of employee stock options granted Headcount (full-time equivalents) 31.12.02 31.12.01 31.12.00 (2) 12,550 5679 15,964 38 13,600 36 10,250 15,562 15,262 % change from 31.12.01 (8) 3 2 Formerly Fixed Income and Foreign Exchange. 3 In management accounts, statistically derived actuarial 1 Formerly Corporate Finance. expected loss adjusted by deferred releases rather than the net IFRS actual credit loss is reported in the Business Groups (see Note 2 to the Financial Statements). Deferred releases represent amortization of historical differences between actual credit losses and actuarial expected loss 4 Includes retention payments in respect of the (for more information, please refer to pages 39 and 40 of the UBS Financial Report 2002). PaineWebber acquisition. 2002: CHF 54 million, 2001: CHF 46 million, 2000: CHF 11 million 5 Excludes significant financial events: Personnel expenses, CHF 86 million, General and administrative expenses, CHF 13 million and Depreciation, CHF 7 million (all PaineWebber integration 7 Personnel expenses/operating income before credit loss expense. costs). 8 Operating expenses/operating income before credit loss expense. 9 For informational purposes only. These pre-tax amounts have not been recorded in the Income statement. For details on the fair value calculation, refer to Note 32e to the Financial Statements. 6 Excludes the amortization of goodwill and other intangible assets. 58 Components of Operating Income The Corporate and Institutional Clients unit generates operating income from: – commissions on agency transactions and spreads or markups on principal transactions; – fees from debt and equity capital markets transactions, leveraged finance, and the structuring of derivatives and complex transactions; – mergers and acquisitions and other advisory fees; – interest income on principal transactions and from the – gains and losses on market making, proprietary, and arbitrage positions. As a result, Corporate and Institutional Clients’ operating income is affected by movements in market conditions, interest rate swings, the level of trading activity in primary and secondary markets and the extent of merger and acquisition activity. These and other factors have had, and may in the future have, a significant impact on results of operations from year to year. loan portfolio; and Significant financial events PaineWebber integration costs were treated as a significant financial event in 2000, and are not reflected in adjusted business unit results on the previous page. The amounts involved were per- sonnel expenses of CHF 86 million, general and administrative expenses of CHF 13 million, and depreciation of CHF 7 million. There were no significant financial events that affected this business unit in 2002 or 2001. The results in the discussion below exclude significant financial events. 2002 Key performance indicators Our performance in 2002 reflects the worldwide downturn in market conditions. However, as a result of our strong client franchise and continu- ing efforts to manage costs, results have proven relatively resilient. We continue to maintain a tight focus on cost management in light of the current operating environment. Over the full year, the pre-goodwill cost/income ratio increased slightly to 74% from 72% in 2001. Pre-goodwill cost/income ratio (%) Our compensation ratio in 2002 was 55%, a slight increase on the 53% recorded in 2001, reflecting the relatively strong performance of many of our businesses compared to competitors and to market conditions. Compensation ratio (%) 60 55 50 45 40 0 0 0 2 1 0 0 2 2 0 0 2 Average Value at Risk (VaR) for Corporate and Institutional Clients increased from CHF 252 million in 2001 to CHF 275 million in 2002, remaining within the normal ranges. Average VaR (10-day 99%) 300 250 200 150 100 50 0 0 0 0 2 1 0 0 2 2 0 0 2 0 0 0 2 1 0 0 2 2 0 0 2 Total loans increased by 2% from CHF 61 bil- lion on 31 December 2001 to CHF 62 billion on 31 December 2002, due to an increase in short- term money market deposits although this was par- tially offset by repayments from European multi- 59 80 75 70 65 60 55 50 Review of Business Group Performance UBS Warburg nationals, reflecting the continued reduction of our non-core commercial lending activities as well as the drop in the US dollar against the Swiss franc. Continued successful recovery efforts led the ratio of impaired loans to total loans to fall from 5.4% on 31 December 2001 to 3.2% at the end of 2002. The non-performing loans to total loans ratio declined from 2.6% to 1.6% over the same period. Impaired loans/gross loans (%) 6 5 4 3 2 1 0 Results 0 0 . 2 1 . 1 3 1 0 . 2 1 . 1 3 2 0 . 2 1 . 1 3 UBS Warburg’s Corporate and Institutional Clients business unit reported 2002 pre-tax prof- it of CHF 3,129 million, a decrease of 17% from 2001, reflecting difficult economic conditions, particularly for the investment banking and equi- ties businesses. This was partially offset by the strong result of our fixed income, rates and cur- rencies business. Over the full year, overall expenses dropped by 7% reflecting lower per- sonnel expenses driven by a reduction in incen- tive compensation as well as the success of our continued cost containment initiatives. Performance before tax (CHF million) 5000 4000 3000 2000 1000 0 0 0 0 2 1 0 0 2 2 0 0 2 Operating income Full-year revenues of CHF 14,100 million were 10% lower than in 2001. Investment Banking revenues for the full-year dropped by 25% from CHF 2,541 million to CHF 1,915 million in 2002, due to much lower corporate activity, which translated into a 22% drop in the global fee pool compared to 2001. Equities revenues for the full-year were also lower than in 2001, down from CHF 6,422 mil- lion to CHF 5,625 million, reflecting falling indices worldwide and much lower market activ- ity. Full-year primary revenues remained flat, because of market share gains in the US and in Asia, which compensated for the drop in overall market activity. Over the full year Fixed Income, Rates and Currencies revenues increased 2% to CHF 6,490 million, primarily due to substantial growth in our Emerging Markets and Principal Finance businesses, offset by reductions in our Interest Rates and Foreign Exchange business lines. Revenues related to gains in credit default swaps economic hedging credit exposures in the loan book also positively impacted the result. Our foreign exchange business increased vol- umes and spreads compared to 2001. Non-core revenues in 2002, at CHF 70 mil- lion, were 74% lower than in 2001 reflecting our continued reduction of our non-core lending portfolio. Income by business area (CHF million) 20 15 10 5 0 2000 2001 2002 Equities Investment Banking Non-core business Fixed Income, Rates and Currencies Operating expenses Total operating expenses dropped by 7% from 2001 to CHF 10,843 million in 2002. The under- lying decline in 2002 is even more marked than these figures would suggest as the 2002 results include a provision of CHF 90 million (USD 65 million) for the US equity research settlement and a CHF 72 million charge for the restructuring of our Energy trading business. The significant 60 underlying reduction of 9% from last year’s expense levels reflects the continuing success of our cost containment initiatives accentuated by the drop of the US dollar against the Swiss franc. In total, personnel expenses in 2002, at CHF 7,784 million, were CHF 474 million or 6% lower than 2001, mainly driven by a reduction in incentive compensation in line with lower revenues and the weaker US dollar. Full-year general and administrative expenses were CHF 2,314 million in 2002, down 11% from 2001’s CHF 2,586 million, as cost saving programs implemented during the course of 2002 helped to lower IT and other costs, particularly travel, advertising costs and professional fees. In full-year 2002, depreciation declined to CHF 381 million from CHF 454 million a year earlier, reflecting our cost control initiatives, which helped to lower charges for new computer workstations and other IT-related equipment. Amortization of goodwill and other intangibles fell 9% for the full-year, reflecting the fact that various assets became fully amortized in 2002. Headcount Headcount, at 15,964 on 31 December 2002, increased by 402 or 3% from 31 December 2001 reflecting the expansion in our fixed income, rates and currency area (which includes UBS Warburg Energy) as well as the transfer of the prime brokerage and Australian private clients businesses from UBS PaineWebber. Headcount (full-time equivalents) revenues, looking at both personnel costs and non-personnel costs on this basis. The pre-goodwill cost/income ratio of 72% in 2001, was up slightly from 70% in 2000 as a result of the reduced revenues in difficult market conditions. The ratio of personnel costs to income was 53% in 2001, only a slight increase on the 52% recorded in 2000, comparing favor- ably with our peer group. Average VaR for Corporate and Institutional Clients increased only slightly from CHF 242 million in 2000 to CHF 252 million in 2001. In general, market risk exposures stayed within the normal ranges. There was, however, a short-term but significant increase in VaR in December 2001 resulting from sizeable client-driven equity trans- actions. The need for a temporary increase in limits was anticipated and pre-approved by the Group Executive Board. The trades were success- fully executed and the risk reduced to normal levels. Total loans decreased by 18% from CHF 74 billion at 31 December 2000 to CHF 61 bil- lion at 31 December 2001, due to a reduction in Japanese government exposures, and repayments from European multinationals, reflecting the continued reduction of our commercial lending risk profile. Continued successful recovery efforts led the ratio of impaired loans to total loans to fall from 5.6% at 31 December 2000 to 5.4% at the end of 2001. The non-performing loans to total loans ratio declined from 2.8% to 2.6% over the same period. (in thousands) Results 17 16 15 14 13 12 11 10 0 0 . 2 1 . 1 3 1 0 . 2 1 . 1 3 2 0 . 2 1 . 1 3 2001 Key performance indicators Corporate and Institutional Clients measures its expense base primarily in terms of percentage of We recorded a strong performance in 2001, relative to the much weaker markets this year. Pre-tax profit in 2001 was CHF 3,775 million, a decline of 24% over 2000, our best year ever. Equities and Investment Banking both suffered from the economic downturn and the consequent weakness in their global markets, while the Fixed Income, Rates and Currencies business delivered record results, driven by interest rate reductions and increased volatility, and supported by the expansion of businesses acquired from Paine- Webber. Investment Banking continued to out- perform 2000 in terms of market share, with full- year analysis showing us with a 4.4% share of fees, compared to 3.6% in 2000. 61 Review of Business Group Performance UBS Warburg Operating income Operating income of CHF 15,475 million in 2001 was 12% lower than in 2000. Investment Banking revenues were CHF 2,541 million in 2001, 6% lower than in 2000, as our improved share of fees in 2001 was more than offset by the general contraction experi- enced in corporate finance in 2001. Equities revenues for 2001 were also lower than in 2000, down 38% from CHF 10,300 million to CHF 6,422 million in 2001. This decline principally reflects reduced trading rev- enues, driven by the lack of mergers and acqui- sitions activity and increased volatility, together with a cautious approach to risk in difficult market conditions. Commission revenues have been broadly consistent with levels in 2000, reflecting the breadth and depth of our client franchise. Fixed Income, Rates and Currencies per- formed very strongly in 2001, with revenues up 38% from 2000, at CHF 6,350 million. This reflects the effect of interest rate reductions, which led to increased issuance and higher volatility, and the inclusion of businesses taken over from PaineWebber. Non-core revenues in 2001 were 2% lower than in 2000, at CHF 274 million. Operating expenses Personnel expenses declined 10%, from CHF 9,223 million in 2000 to CHF 8,258 million in 2001, driven by reductions in incentive com- pensation in line with labor market conditions and full-year results. General and administrative expenses in 2001 were 4% lower than in 2000, at CHF 2,586 mil- lion, reflecting the impact of cost control meas- ures put in place during 2001. (Fourth quarter 2001 general and administrative expenses were 27% lower than in fourth quarter 2000.) Depreciation fell 18% from 2000 to CHF 454 million in 2001, driven by reductions in IT expenditure as a result of cost control initiatives. Amortization of goodwill and other intan- gibles increased by CHF 212 million to CHF 402 million in 2001 mainly driven by additional goodwill amortization due to the acquisition of PaineWebber. Headcount Headcount at 31 December 2001 remained little changed, at 15,562 compared to 15,262 at the end of 2000. We did not engage in widespread headcount reductions that might have had a long- term detrimental impact on our client franchises, but upgraded staff quality in selected areas. 62 UBS Capital Business unit reporting CHF million, except where indicated For the year ended 31.12.02 31.12.01 31.12.00 % change from 31.12.01 Total operating income (1,602) (872 ) Personnel expenses General and administrative expenses Depreciation Amortization of goodwill and other intangible assets Total operating expenses Business unit performance before tax Business unit performance before tax and goodwill 1 94 64 1 0 159 96 64 2 0 162 (1,761) (1,761) (1,034 ) (1,034 ) 370 142 47 2 2 193 177 179 (84) (2) 0 (50) (2) (70) (70) KPIs Value creation (CHF billion) (1.4) (1.4 ) 0.6 0 As at Investment (CHF billion) 2 Additional information As at Portfolio fair value (CHF billion) Regulatory equity allocated (average) Fair value of employee stock options granted Headcount (full-time equivalents) 31.12.02 31.12.01 31.12.00 % change from 31.12.01 3.1 5.0 5.5 (38) 31.12.02 31.12.01 31.12.00 % change from 31.12.01 3.8 550 153 73 5.6 700 128 6.9 550 129 (32) (21) (43) 1 Excludes the amortization of goodwill and other intangible assets. 2 Historic cost of investments made, less divestments and impairments. 3 For informational purposes only. These pre-tax amounts have not been recorded in the Income statement. For details on the fair value calcu- lation, refer to Note 32e to the Financial Statements. Components of Operating Income UBS Capital’s primary source of operating income is capi- tal gains from the disposal or sale of its investments, which are recorded at the time of ultimate divestment. As a result, appreciation in fair market value is recognized as operating income only at the time of sale. The level of annual operating income from UBS Capital is directly affected by the level of investment disposals that take place during the year. Similarly, depreciation in fair market value is only recognized against operating income if an investment becomes permanently impaired and has to be written down. Writedowns of the value of its investments can negatively affect UBS Capital’s operating income. 63 Review of Business Group Performance UBS Warburg Significant financial events There were no significant financial events that affected this business unit in 2002, 2001 or 2000. 2002 Key performance indicators The level of our private equity investments was CHF 3.1 billion on 31 December 2002, a decline of 38% from CHF 5.0 billion on 31 December 2001. This reduction reflects writedowns made on direct investments and third party funds, as well as suc- cessfully executed exits. In full-year 2002, write- downs included in operating income totaled CHF 1.7 billion, up from CHF 1.1 billion a year earlier. Investment (CHF billion) 6 5 4 3 2 1 0 0 0 . 2 1 . 1 3 1 0 . 2 1 . 1 3 2 0 . 2 1 . 1 3 Results Full-year results for UBS Capital reflect continued tough economic conditions, impacting private equity valuations across a range of sectors, a fac- tor that was compounded by the prolonged down- turn suffered by all major equity markets. The challenging economic environment has adversely affected many of the companies in the portfolio while the continued hostile climate for divest- ments has restricted capital gains from exit oppor- tunities. Against this background, UBS Capital posted a pre-tax loss in 2002 of CHF 1,761 mil- lion, CHF 727 million worse than in 2001. Total operating income for 2002 was negative CHF 1,602 million, compared to negative CHF 872 million in 2001. Challenging economic con- ditions have led to deteriorating valuations in all markets and industries. The level of writedowns in the portfolio has therefore been high and there have been few opportunities to make significant divestments in 2002. Personnel expenses in 2002 were CHF 94 mil- lion, down from CHF 96 million in 2001. This reflects falling headcount and lower perform- ance-related incentive payments. General and administrative expenses remained unchanged at CHF 64 million. Performance before tax (CHF million) The fair value of the portfolio on 31 Decem- ber 2002 was CHF 3.8 billion, down from CHF 5.6 billion on 31 December 2001, reflecting divestments in the portfolio and value reductions for existing investments. The level of net unre- alized gains was CHF 0.8 billion on 31 Decem- ber 2002, up from CHF 0.6 billion on 31 Decem- ber 2001. 250 0 –250 –500 –750 –1000 –1250 –1500 –1750 –2000 0 0 0 2 1 0 0 2 2 0 0 2 Value creation (CHF billion) 0 0 0 2 1 0 0 2 2 0 0 2 0.8 0.4 0.0 –0.4 –0.8 –1.2 –1.6 2001 Full-year results for UBS Capital reflect the very challenging market in 2001, with few opportunities for divestments, and writedowns of several investments as a result of the prob- lems caused for some of our investment compa- nies by the deteriorating economic conditions. The pre-tax loss for 2001 was CHF 1,034 mil- lion, compared to a pre-tax profit of CHF 177 million in 2000. 64 Key performance indicators Results UBS Capital’s private equity investments de- creased to CHF 5.0 billion on 31 December 2001 from CHF 5.5 billion at the end of 2000, with the decline due to writedowns on the book value of investments, as well as a small number of divest- ments during the year, which more than offset drawdowns of previously committed investments and the low level of other new investments dur- ing the year. The fair value of the portfolio at the end of December 2001 was CHF 5.6 billion, down 19% from CHF 6.9 billion on 31 December 2000. The fair value included net unrealized gains of CHF 0.6 billion. Value reduction during 2001 was CHF 1.4 billion, compared to value creation of CHF 0.6 billion in 2000. UBS Capital recorded an operating loss of CHF 872 million in 2001, compared to operating income of CHF 370 million in 2000. Challenging markets and the continued slowdown in corpo- rate activity meant that there were few opportu- nities for significant divestments in 2001, while weak economic conditions led to deteriorating valuations across a range of industry sectors, resulting in a high level of writedowns of invest- ments in the portfolio. Personnel expenses were CHF 96 million in 2001, down from CHF 142 million in 2000, reflecting lower incentive compensation which is driven by realized gains on divestments. General and administrative expenses were CHF 64 million, up from CHF 47 million in 2000, due principally to professional fees relating to our strategic review of the business. 65 Review of Business Group Performance UBS PaineWebber UBS PaineWebber UBS PaineWebber’s pre-tax loss adjusted for SFEs in 2002 was CHF 566 million, with the depreciation of the US dollar against the Swiss franc weighing on results. Excluding acqui- sition costs, operating pre-tax profit was CHF 632 million compared to CHF 693 million a year earlier. Joseph J. Grano, Jr. Chairman and CEO, UBS PaineWebber Business Group reporting1 CHF million, except where indicated For the year ended Income Credit loss expense 2 Total operating income Personnel expenses 3 General and administrative expenses Depreciation Amortization of goodwill and other intangible assets Total operating expenses Business Group performance before tax Business Group performance before tax and goodwill 4 Business Group performance before tax and acquisition costs 12 Mark B. Sutton President and Chief Operating Officer UBS PaineWebber KPIs Invested assets (CHF billion) Net new money (CHF billion) 5 Interest and dividend income (CHF billion) 7 Cost / income ratio (%) 8 Cost / income ratio before goodwill (%) 4, 8 Recurring fees 9 Financial advisors (full-time equivalents) 31.12.02 31.12.01 31.12.00 % change from 31.12.01 5,561 (13) 5,548 4,245 1,263 149 1,691 7,348 (1,800) (109) 632 584 18.5 17.9 132 102 2,199 8,857 6,391 (18 ) 6,373 5,019 1,441 124 502 7,086 (713 ) (211 ) 693 769 33.2 21.5 111 103 2,366 8,718 1,214 (3 ) 1,211 1,098 344 42 84 1,568 (357 ) (273 ) (72 ) 765 14.56 129 122 434 8,731 (13) (28) (13) (15) (12) 20 237 4 152 (48) (9) (24) (17) (7) 2 Additional information As at Client assets (CHF billion) Regulatory equity allocated (average) Fair value of employee stock options granted Headcount (full-time equivalents) 31.12.02 31.12.01 31.12.00 650 7,450 7310 19,563 841 8,550 9,200 20,413 21,567 % change from 31.12.01 (23) (13) (4) 66 Business Group reporting adjusted for Significant Financial Events CHF million, except where indicated For the year ended 31.12.02 31.12.01 31.12.00 % change from 31.12.01 Income Credit loss expense 2 Total operating income Personnel expenses 3 General and administrative expenses Depreciation Amortization of goodwill and other intangible assets Total operating expenses Business Group performance before tax Business Group performance before tax and goodwill 4 Business Group performance before tax and acquisition costs 12 KPIs Gross margin on invested assets (bps) 13 Gross margin on invested assets before acquisition costs (bps) 12, 13 Cost / income ratio (%) 8 Cost / income ratio before goodwill (%) 4, 8 Cost / income ratio before acquisition costs (%) 8, 12 5,561 (13) 5,548 4,245 1,263 149 45711 6,114 (566) (109) 632 82 88 110 102 89 6,391 (18 ) 6,373 5,019 1,441 124 502 7,086 (713 ) (211 ) 693 84 90 111 103 90 1,214 (3 ) 1,211 1,098 344 42 84 1,568 (357 ) (273 ) (72 ) 67 71 129 122 105 (13) (28) (13) (15) (12) 20 (9) (14) (21) (48) (9) (2) (2) 4 Excludes the amortization of goodwill and other intangible assets. 6 Calculated using the former definition of assets under management. 1 Business Groups results include PaineWebber from the date of acquisition, 3 November 2000. 2 In management accounts, statistically derived actuarial expected loss adjusted by deferred releases rather than the net IFRS actual credit loss is reported in the Business Groups (see Note 2 to 3 Includes retention payments in respect of the PaineWebber acquisition. 2002: CHF 351 million, 2001: CHF 436 mil- the Financial Statements). 5 Excludes the interest and dividend income lion, 2000: CHF 117 million. 7 For purposes of comparison with US peers. noted below. 9 Asset-based and advisory revenues including fees from mutual funds, 8 Operating expenses / operating income before credit loss expense. 10 For informational purposes only. wrap fee products and insurance products. Comparative amounts for 2001 and 2000 have been restated. These pre-tax amounts have not been recorded in the Income statement. For details on the fair value calculation, refer to Note 32e to the 12 Acquisition costs 11 Excludes significant financial event: Writedown of PaineWebber brand of CHF 1,234 million. Financial Statements. include goodwill and intangible asset amortization and related funding, net of risk-free return on the corresponding equity allocated, and reten- tion payments. 13 Income / average invested assets. Components of Operating Income UBS PaineWebber principally derives its operating income from: – fees for financial planning and wealth management services – fees for discretionary management services and – transaction-related fees. These fees are based on the market value of invested assets and the level of transaction-related activity. As a result, operating income is affected by such factors as fluctuations in invested assets, change in market condi- tions, investment performance and inflows and outflows of client funds, and investor activity levels. 67 Review of Business Group Performance UBS PaineWebber Significant financial events The pre-tax non-cash writedown of CHF 1,234 million for the value of the PaineWebber brand that was held as an intangible asset on our bal- ance sheet was treated as a significant financial event in 2002 and is therefore not reflected in the adjusted Business Group results on the previous page. The writedown followed a strategic deci- sion announced in November 2002 to move all our businesses to the single UBS brand. The new brand structure will be implemented in June 2003. There were no significant financial events that affected this Business Group in 2001 or 2000. The results in the discussion below exclude sig- nificant financial events. PaineWebber UBS PaineWebber became part of UBS following the merger between UBS and Paine Webber Group, Inc., which was completed on 3 November 2000. At the merger, it became a business unit of UBS Warburg. On 1 January 2002, UBS PaineWebber became a separate Business Group within UBS. The merger was accounted for using purchase accounting, so the results shown for UBS Paine- Webber for 2000 reflect the inclusion of the PaineWebber businesses only for the period from 3 November 2000 until 31 December 2000. Results for 2001 and 2002 reflect a full-year’s contribution. 2002 Key performance indicators At the end of 2002, UBS PaineWebber had CHF 584 billion in invested assets, compared to CHF 769 billion on 31 December 2001. This decline of 24% was partly due to the effect of the Invested assets (CHF billion) 800 700 600 500 400 300 200 100 0 0 0 . 2 1 . 1 3 1 0 . 2 1 . 1 3 2 0 . 2 1 . 1 3 US dollar’s weakening against the Swiss franc. Excluding the impact of currency fluctuations, invested assets fell 8% during the year, mainly due to US equity market declines although that was partially offset by net new money inflows. Net new money in 2002 was CHF 18.5 billion, 44% below the CHF 33.2 billion result reported for 2001. The decline reflects weaker investor sentiment, as well as the closure of the Japanese domestic private client business, resulting in out- flows of approximately CHF 1.6 billion. Net new money (CHF billion) 1 35 30 25 20 15 10 5 0 0 0 0 2 1 0 0 2 2 0 0 2 1 Includes PaineWebber from the date of acquisition on 3 November 2000. The gross margin on invested assets was 82 basis points for full-year 2002, down from 84 basis points in 2001. The gross margin on invested assets before acquisition costs (goodwill, net funding costs and retention payments) was 88 basis points, down from 90 basis points in 2001. Revenues declined more than invested assets due to lower customer activity levels. This was partially offset by higher revenues from our municipal securities busi- ness which had a record result in 2002. The cost/income ratio before acquisition costs was 89% for full-year 2002, compared to 90% in 2001. The improvement in the cost/income ratio Gross margin on invested assets before acquisition costs (bps) 1 100 80 60 40 0 0 0 2 1 0 0 2 2 0 0 2 1 Includes PaineWebber from the date of acquisition on 3 November 2000. 68 is a direct result of cost management initiatives implemented in 2002, among them reductions in non-financial advisor headcount, professional fees, advertising and office-related costs. Cost/income ratio before acquisition costs (%) 1 110 100 90 80 0 0 0 2 1 0 0 2 2 0 0 2 1 Includes PaineWebber from the date of acquisition on 3 November 2000. In 2002, recurring fees were CHF 2,199 mil- lion compared to CHF 2,366 million a year earlier because of the weakening of the US dol- lar against the Swiss franc. Excluding currency translation effects, recurring fees rose 2% in 2002 from a year earlier. The increase is due to higher account-based fees and higher recurring fees in the municipal securities business. These increases were offset by lower asset-based fees, which fell in line with the decline in asset levels. Recurring fees (CHF million) 1 2500 2000 1500 1000 500 0 0 0 0 2 1 0 0 2 2 0 0 2 We continue to invest in our distribution channels and advisory personnel. In 2002, the number of financial advisors rose by 139 from 8,718 to 8,857 with recruiting and retention success partially offset by higher attrition rates among less experienced and less productive financial advisors. Results In 2002, political, economic and financial uncer- tainty continued to adversely affect investor activ- ity. The UBS Index of Investor Optimism dropped significantly during 2002, reached an all-time low in October and only slightly recovered by the end of the year. Daily average client transaction vol- umes were 10% lower than in 2001. Because our business is almost entirely con- ducted in US dollars, comparisons of 2002 results to 2001 are affected by the depreciation of the US dollar versus the Swiss franc. Over the full year, UBS PaineWebber reported a pre-tax loss of CHF 566 million in 2002 compared to a loss of CHF 713 million in 2001. Performance before tax and acquisition costs showed a profit of CHF 632 million in 2002 compared to CHF 693 million a year earlier. Excluding the effects of cur- rency movements, 2002 performance before tax and acquisition costs was 3% higher than in 2001. Despite a decline in transactional revenues and lower asset-based revenues following further market drops, strict cost management discipline enabled us to improve our full-year operating performance. Excluding the USD 15 million (CHF 21 million) equity research settlement charge, full- year results in USD terms would have improved by 6% over 2001. On a US dollar basis, performance was the third best ever for our US private clients business behind 1999 and 2000. 1 Includes PaineWebber from the date of acquisition on 3 November 2000. Performance before tax and acquisition costs (CHF million) 1 Financial advisors (full-time equivalents) 9000 8500 8000 7500 7000 0 0 . 2 1 . 1 3 1 0 . 2 1 . 1 3 2 0 . 2 1 . 1 3 800 600 400 200 0 –200 0 0 0 2 1 0 0 2 2 0 0 2 1 Includes PaineWebber from the date of acquisition on 3 November 2000. 69 Review of Business Group Performance UBS PaineWebber Operating income For full-year 2002, total operating income was CHF 5,548 million, compared to CHF 6,373 mil- lion in 2001. Excluding the effects of currency translation, operating income declined approxi- mately 5% from 2001. This decline in operating income is attributable to lower asset-based fees, a drop in levels of customer activity, lower margin lending, the transfer of prime brokerage business to UBS Warburg and the closure of the Japanese domestic private client business. These declines were partially offset by increased revenues in the municipal securities business, which had a record year. Operating expenses Total operating expenses fell 14% to CHF 6,114 million in 2002 from CHF 7,086 million in 2001. Excluding the effects of the weaker US dollar against the Swiss franc, operating expenses declined 5% from 2001, reflecting lower per- formance-driven compensation and lower reten- tion expenses. In addition, cost management ini- tiatives implemented during the course of 2002, the transfer of the prime brokerage business to UBS Warburg and the closure of the Japanese domestic private client businesses helped to reduce overall expenses. Personnel expenses dropped 15% from CHF 5,019 million in 2001 to CHF 4,245 million in 2002. Excluding the effects of currency transla- tion, personnel expenses were 7% lower than 2001, reflecting lower performance-driven com- pensation due to a decline in revenues, a fall in non-financial advisor headcount, the transfer of the prime brokerage business to UBS Warburg, the closure of the Japanese domestic private client business and lower retention expenses. General and administrative expenses fell 12% from CHF 1,441 million in 2001 to CHF 1,263 million in 2002. Excluding the impact of the falling US dollar against the Swiss franc, general and administrative expenses dropped by 4% compared to 2001 due to the cost management initiatives implemented during the course of 2002, reducing our professional fees, advertising, travel and other office-related costs. In addition, general and administrative expenses were reduced by the trans- fer of prime brokerage business to UBS Warburg and the closure of the Japanese private client busi- nesses. This was partially offset by the equity research settlement charge of CHF 21 million. Depreciation increased CHF 25 million to CHF 149 million in 2002 from CHF 124 million in 2001. Excluding currency movements, the increase in depreciation of 32% was due to higher technology equipment charges. Goodwill and other intangible amortization dropped from CHF 502 million in 2001 to CHF 457 million in 2002 as a result of the weakening US dollar against the Swiss franc. Headcount UBS PaineWebber’s headcount decreased 4% dur- ing the year to 19,563 reflecting our continued cost management initiatives. Non-financial advi- sor headcount was down by 989 or 8% compared to end of 2001. Further, we closed our Japanese domestic private client business and transferred the prime brokerage business to UBS Warburg. At the same time we expanded our financial advisor headcount by 139, reflecting our continued aim to extend the reach of our business. Headcount (full-time equivalents) (in thousands) 0 0 . 2 1 . 1 3 1 0 . 2 1 . 1 3 2 0 . 2 1 . 1 3 23 22 21 20 19 18 2001 Comparisons of full-year 2001 results to full- year 2000 reflect the very different scale of this Business Group prior to the acquisition of Paine- Webber in November 2000. Key performance indicators At the end of 2001, UBS PaineWebber had CHF 769 billion of invested assets, compared to CHF 765 billion at 31 December 2000, a change of 1%, with negative market performance during the year nearly offset by strong net new money flows. Net new money for the year was CHF 33.2 bil- lion, compared to CHF 14.5 billion in 2000, more than half of which was earned in the last quarter of 2000 after the integration of Paine- 70 Webber. UBS PaineWebber’s ability to continue to generate high levels of net new money despite the uncertain markets in 2001 reflects the strength of its client franchise amongst high net worth individuals in the US. Gross margin on invested assets before acqui- sition costs (retention payments and goodwill amortization) increased to 90 basis points, from 71 basis points in 2000, reflecting the addition of PaineWebber. Gross margin in the pre-existing business for the nine months to 30 September 2000, before the addition of PaineWebber was 36 basis points. The gross margin fell slightly during 2001, reflecting the effect of uncertain markets on transaction volumes. The cost/income ratio before acquisition costs was 90% in 2001 compared to 105% in 2000. Until the addition of PaineWebber, the pre-exist- ing business was loss making, reflecting the rela- tively early stage of its business development. Cost control has remained a strong focus during the year, with the cost/income ratio in fourth quarter 2001 the same as in fourth quarter 2000. Recurring fees were CHF 2,366 million in 2001. This metric was not tracked prior to the integration of PaineWebber in November 2000. During 2001, recurring fees declined 6% to CHF 566 million in fourth quarter 2001 compared to CHF 601 million in first quarter 2001, due to the effects of market depreciation on client assets – recurring fees are priced based on the asset level at the end of the prior quarter. At the end of December 2001, UBS Paine- Webber had 8,718 financial advisors, a number virtually unchanged from the end of 2000. Although we continued to recruit and train new financial advisors in 2001, the difficult market conditions led to higher turnover amongst the least productive advisors. Results Pre-tax loss for 2001 was CHF 713 million. Excluding acquisition costs, UBS PaineWebber posted a profit of CHF 693 million, a strong result relative to our peers, achieved against a particularly poor market environment, with two successive years of market declines in the US for the first time since the late 1970s leading to much lower transaction volumes. In 2000, UBS Paine- Webber incurred a loss of CHF 357 million – excluding acquisition costs the loss was CHF 72 million. Operating income Operating income for the year was CHF 6,373 million, compared to CHF 1,211 million in 2000. Revenues were resilient during 2001, declining just 12% from first quarter to fourth quarter, despite recession and market uncertainty in the US. Operating expenses Total operating expenses were CHF 7,086 million in 2001 compared to CHF 1,568 million in 2000. UBS PaineWebber implemented a number of cost control initiatives in 2001, aimed at reduc- ing discretionary expenditure and support costs, while protecting the business’s ability to serve its clients to the highest standards. Personnel expenses were CHF 5,019 million in 2001, compared to CHF 1,098 million in 2000, reflecting the completely different scale of the business. Expenses in 2001 included CHF 436 million of retention payments for key UBS PaineWebber staff, compared to CHF 117 mil- lion in 2000. Through 2001 personnel expenses reduced, from CHF 1,296 million in first quarter to CHF 1,200 million in fourth quarter, reflecting lower performance-related and variable compen- sation and a reduction of support headcount. General and administrative expenses were CHF 1,441 million in 2001, compared to CHF 344 million in 2000. Cost control efforts drove expenses down during 2001, with fourth quarter general and administrative expenses 3% lower than in first quarter. Depreciation expenses were CHF 124 million in 2001, compared to CHF 42 million in 2000, reflecting the addition of PaineWebber. Amorti- zation of goodwill and other intangible assets increased from CHF 84 million to CHF 502 mil- lion, reflecting the amortization costs due to the PaineWebber acquisition. Headcount Headcount decreased 5% in 2001 from 21,567 at 31 December 2000 to 20,413 at 31 December 2001. We continued to monitor market con- ditions, but prudent cost control in previous years meant that we have not needed to make franchise-threatening cuts to our headcount. Financial advisor headcount is almost unchanged from 2000, but we continued to implement effi- ciency measures to help manage support head- count downwards. 71 Review of Business Group Performance Corporate Center Corporate Center Business Group reporting CHF million, except where indicated For the year ended Income Credit loss recovery 1 Total operating income Personnel expenses General and administrative expenses Depreciation Amortization of goodwill and other intangible assets Total operating expenses Business Group performance before tax Business Group performance before tax and goodwill 2 31.12.02 31.12.01 31.12.00 % change from 31.12.01 1,387 249 1,636 645 601 473 24 1,743 (107) (83) 800 236 1,036 592 537 372 24 1,525 (489 ) (465 ) 385 1,161 1,546 522 754 320 43 1,639 (93 ) (50 ) 73 6 58 9 12 27 0 14 (78) (82) Additional information As at Regulatory equity allocated (average) Fair value of employee stock options granted Headcount (full-time equivalents) 31.12.02 31.12.01 31.12.00 9,400 323 1,185 8,250 1,132 12,300 986 % change from 31.12.01 14 5 Business Group reporting adjusted for Significant Financial Events CHF million, except where indicated For the year ended 31.12.02 31.12.01 31.12.00 % change from 31.12.01 Income Credit loss recovery 1 Total operating income Personnel expenses General and administrative expenses Depreciation Amortization of goodwill and other intangible assets Total operating expenses Business Group performance before tax Business Group performance before tax and goodwill 2 1,3154 249 1,564 645 601 473 24 1,743 (179) (155) 800 236 1,036 592 537 372 24 1,525 (489 ) (465 ) 385 1,161 1,546 4905 6045 320 43 1,457 89 132 64 6 51 9 12 27 0 14 (63) (67) 1 In order to show the relevant Business Group performance over time, adjusted expected loss figures rather than the net IFRS actual credit loss expenses are reported for all Business Groups. The difference between the adjusted expected loss figures and the net IFRS actual credit loss 2 Excludes the amortization of expenses recorded at Group level is reported in the Corporate Center (see Note 2 to the Financial Statements). 3 For informational purposes only. These pre-tax amounts have not been recorded in the Income state- goodwill and other intangible assets. 4 Excludes significant financial event: Income, ment. For details on the fair value calculation, refer to Note 32e to the Financial Statements. 5 Excludes significant financial events: Personnel expenses, CHF 32 million (PaineWebber CHF 72 million (Gain on disposal of Klinik Hirslanden). integration costs); General and administrative expenses, CHF 150 million (Net additional provision relating to the US Global Settlement). 72 Significant financial events There were no significant financial events in Corporate Center in 2001. Operating expenses Total operating expenses were CHF 1,743 mil- lion in 2002, 14% higher than in 2001. Significant financial events booked in Cor- porate Center in 2002 and 2000 were: – Operating income of CHF 72 million from the sale of Klinik Hirslanden in 2002. – Personnel expenses of CHF 32 million relating to the integration of PaineWebber into UBS in 2000. – General and administrative costs of CHF 150 million in 2000 in connection with the US Global Settlement of World War II-relat- ed claims. None of these events are reflected in the adjusted Business Group results in the table on the previous page. The results in the discussion below exclude significant financial events. 2002 Results Corporate Center recorded a pre-tax loss of CHF 179 million in 2002, compared to the pre- tax loss of CHF 489 million in 2001. Operating income UBS Group recorded an actual credit loss of CHF 206 million in 2002 and CHF 498 million in 2001. The difference between adjusted expected losses charged to the business units and the actual credit loss expense recognized in the Group Financial Statements is booked as credit loss expense or recovery in the Corporate Center. In 2002, the actual loss was lower than the overall adjusted credit loss expense charged to the busi- ness units, resulting in a credit loss recovery in Corporate Center of CHF 249 million, compared to a credit loss recovery of CHF 236 million in 2001. Full-year total operating income increased by 51% from CHF 1,036 million in 2001 to CHF 1,564 million in 2002. This was primarily due to higher interest income at Group Treasury, gains from the sale of financial investments and an unrealized gain on derivatives used to economi- cally hedge interest rate risk related to structured notes issued. These developments, however, were partially offset by writedowns on financial investments. Over the full year, personnel expenses in- creased by 9% from CHF 592 million in 2001 to CHF 645 million in 2002, mainly reflecting higher expenses at Klinik Hirslanden, although that was partially offset by lower performance- related compensation. General and administrative expenses for 2002, at CHF 601 million, were CHF 64 million higher than in 2001. This was mainly due to higher pro- visions for legal cases, advertising expenditures and higher expenses at Klinik Hirslanden. At CHF 473 million in 2002, depreciation increased by 27% compared to a year earlier. This was mainly due to higher software depreciation which was previously capitalized as well as higher depreciation levels for Klinik Hirslanden. Headcount Headcount increased 5% during 2002 to 1,185 at 31 December 2002, reflecting hiring in Group Human Resources and Group Controller areas as well as transfers of staff from the Business Groups. 2001 Results Corporate Center recorded a pre-tax loss of CHF 489 million in 2001, compared to a pre-tax profit of CHF 89 million in 2000, adjusted for significant financial events. Operating income The credit loss expense or recovery booked in Corporate Center represents the difference between the adjusted expected losses charged to the business units and the actual credit loss rec- ognized in the Group income statement. UBS Group’s credit loss expense increased to CHF 498 million in 2001, compared to a recovery of CHF 130 million in 2000. For both 2000 and 2001, actual credit loss was less than the charge to the business units, resulting in a credit loss recovery in Corporate Center of CHF 236 mil- lion in 2001, compared to a recovery of CHF 1,161 million in 2000. 73 Review of Business Group Performance Corporate Center Operating income decreased by CHF 510 mil- lion from 2000 to CHF 1,036 million in 2001, principally reflecting the swing in the credit loss results, offset by higher income from treasury activities. Operating expenses Total operating expenses were CHF 1,525 mil- lion in 2001, 5% higher than in 2000. In 2001 personnel expenses were CHF 592 mil- lion, an increase of 21% compared to 2000, driven by severance payments and the full-year cost of senior management and other additional personnel added through the PaineWebber merger. General and administrative expenses for 2001, at CHF 537 million, were CHF 67 million lower than in 2000. This was due to lower corporate real estate costs and lower professional fees con- nected to the US Global Settlement of World War II-related claims, offset by higher IT costs and one-off charges relating to the bankruptcy of SAir Group. Headcount Headcount increased 15% during 2001 to 1,132 at 31 December 2001, driven by the transfer of International Mobility Program participants to Corporate Center headcount and the transfer of human resources staff from UBS Warburg. The International Mobility Program provides out- standing young employees of UBS with opportu- nities for work experience overseas. 74 75 76 UBS Group Financial Statements 77 UBS Group Financial Statements Table of Contents Financial Statements Table of Contents Financial Statements UBS Group Income Statement UBS Group Balance Sheet UBS Group Statement of Changes in Equity UBS Group Statement of Cash Flows Notes to the Financial Statements 1 2a 2b Summary of Significant Accounting Policies Segment Reporting by Business Group Segment Reporting by Geographic Location Income Statement 3 4 5 6 7 8 Net Interest and Trading Income Net Fee and Commission Income Other Income Personnel Expenses General and Administrative Expenses Earnings per Share (EPS) and Shares Outstanding Balance Sheet: Assets 9a 9b 9c 9d 10 Due from Banks and Loans Allowances and Provisions for Credit Losses Impaired Loans Non-Performing Loans Securities Borrowing, Securities Lending, Repurchase and Reverse Repurchase Agreements Trading Portfolio Financial Investments Investments in Associates Property and Equipment Goodwill and Other Intangible Assets Other Assets 11 12 13 14 15 16 Balance Sheet: Liabilities 17 18 19 20 21 22 23 Due to Banks and Customers Debt Issued Other Liabilities Provisions Income Taxes Minority Interests Derivative Instruments 78 80 80 81 82 84 86 86 96 99 100 100 101 101 102 102 103 104 104 105 105 106 107 108 109 110 111 111 113 114 114 114 120 120 120 122 122 Off-Balance Sheet Information 24 25 26 Fiduciary Transactions Commitments and Contingent Liabilities Operating Lease Commitments Additional Information 27 28 29 Pledged Assets Litigation Financial Instruments Risk Position a) Market Risk Interest Rate Risk (a)(i) Overview (a)(ii) (a)(iii) Currency Risk (a)(iv) Equity Risk Issuer Risk (a)(v) b) Credit Risk c) Liquidity Risk d) Capital Adequacy Fair Value of Financial Instruments Retirement Benefit Plans and Other Employee Benefits Equity Participation Plans a) Equity Participation Plans Offered b) UBS Share Awards c) UBS Option Awards d) Compensation Expense e) Pro-Forma Net Income Related Parties Post–Balance Sheet Events Significant Subsidiaries and Associates Acquisition of Paine Webber Group, Inc. Currency Translation Rates Swiss Banking Law Requirements Reconciliation to US GAAP Additional Disclosures Required under US GAAP and SEC Rules 30 31 32 33 34 35 36 37 38 39 40 Report of the Group Auditors 127 127 127 129 130 130 130 130 131 131 131 133 135 135 135 138 139 141 143 147 147 148 149 150 150 151 153 153 157 157 157 160 172 177 79 UBS Group Financial Statements Financial Statements Financial Statements UBS Group Income Statement CHF million, except per share data For the year ended Operating income Interest income Interest expense Net interest income Credit loss (expense) / recovery Net interest income after credit loss expense Net fee and commission income Net trading income Other income Total operating income Operating expenses Personnel expenses General and administrative expenses Depreciation of property and equipment Amortization of goodwill and other intangible assets Total operating expenses Operating profit before tax and minority interests Tax expense Net profit before minority interests Minority interests Net profit Basic earnings per share (CHF) Basic earnings per share before goodwill (CHF) 1 Diluted earnings per share (CHF) Diluted earnings per share before goodwill (CHF) 1 Note 31.12.02 31.12.01 31.12.00 % change from 31.12.01 3 3 4 3 5 6 7 14 15 21 22 8 8 8 8 39,963 (29,417) 10,546 (206) 10,340 18,221 5,572 (12) 34,121 18,524 7,072 1,521 2,460 29,577 4,544 678 3,866 (331) 3,535 2.92 4.73 2.87 4.65 52,277 (44,236 ) 8,041 (498 ) 7,543 20,211 8,802 558 37,114 19,828 7,631 1,614 1,323 30,396 6,718 1,401 5,317 (344 ) 4,973 3.93 4.97 3.78 4.81 51,745 (43,615 ) 8,130 130 8,260 16,703 9,953 1,486 36,402 17,163 6,765 1,608 667 26,203 10,199 2,320 7,879 (87 ) 7,792 6.44 7.00 6.35 6.89 (24) (33) 31 (59) 37 (10) (37) (8) (7) (7) (6) 86 (3) (32) (52) (27) (4) (29) (26) (5) (24) (3) 1 Excludes the amortization of goodwill and other intangible assets. 80 UBS Group Balance Sheet CHF million Note 31.12.02 31.12.01 % change from 31.12.01 Assets Cash and balances with central banks Due from banks Cash collateral on securities borrowed Reverse repurchase agreements Trading portfolio assets Positive replacement values Loans Financial investments Accrued income and prepaid expenses Investments in associates Property and equipment Goodwill and other intangible assets Other assets Total assets Total subordinated assets 1 Liabilities Due to banks Cash collateral on securities lent Repurchase agreements Trading portfolio liabilities Negative replacement values Due to customers Accrued expenses and deferred income Debt issued Other liabilities Total liabilities Minority interests 9 10 10 11 23 9 12 13 14 15 16, 21 17 10 10 11 23 17 18 19, 20, 21 4,271 32,468 139,052 294,086 371,436 82,092 211,647 8,391 6,453 705 7,869 13,696 8,952 20,990 27,526 162,938 269,256 397,886 73,447 226,545 28,803 7,554 697 8,695 19,085 9,875 1,181,118 1,253,297 3,652 2,732 83,178 36,870 366,858 106,453 81,282 306,876 15,331 129,411 12,339 106,531 30,317 368,620 105,798 71,443 333,781 17,289 156,218 15,658 1,138,598 1,205,655 22 3,529 4,112 Shareholders’ equity Share capital Share premium account Net gains / (losses) not recognized in the income statement, net of tax Retained earnings Treasury shares Total shareholders’ equity 1,005 12,638 (159) 32,638 (7,131) 38,991 3,589 14,408 (193 ) 29,103 (3,377 ) 43,530 Total liabilities, minority interests and shareholders’ equity 1,181,118 1,253,297 Total subordinated liabilities 10,102 13,818 1 The subordinated assets for 2001 have been restated to include the subordinated traded assets of CHF 2,325 million. (80) 18 (15) 9 (7) 12 (7) (71) (15) 1 (9) (28) (9) (6) 34 (22) 22 0 1 14 (8) (11) (17) (21) (6) (14) (72) (12) 18 12 (111) (10) (6) (27) 81 UBS Group Financial Statements Financial Statements UBS Group Statement of Changes in Equity CHF million For the year ended 31.12.02 31.12.01 31.12.00 Issued and paid up share capital Balance at the beginning of the year Issue of share capital Capital repayment by par value reduction 1 Cancellation of second trading line treasury shares (2000 Program) Cancellation of second trading line treasury shares (2001 Program) Balance at the end of the year Share premium Balance at the beginning of the year Premium on shares issued and warrants exercised Net premium / (discount) on treasury share and own equity derivative activity Share premium increase due to PaineWebber acquisition Borrow of own shares to be delivered Settlement of own shares to be delivered Cancellation of second trading line treasury shares (2000 Program) Cancellation of second trading line treasury shares (2001 Program) Balance at the end of the year 3,589 6 (2,509) (81) 1,005 14,408 157 282 (2,209) 12,638 Net gains / (losses) not recognized in the income statement, net of taxes Foreign currency translation Balance at the beginning of the year Movements during the year 2 Subtotal – balance at the end of the year (769) (80) (849) Net unrealized gains / (losses) on available for sale investments, net of taxes Balance at the beginning of the year Change in accounting policy Net unrealized gains / (losses) on available for sale investments Impairment charges reclassified to the income statement Gains reclassified to the income statement Losses reclassified to the income statement (144) 635 (600) 20 1,035 Subtotal – balance at the end of the year 946 4,309 135 4,444 12 (683 ) (184 ) 3,589 4,444 20,885 80 (239 ) (2,502 ) (3,816 ) 14,437 139 (391) 4,198 5,895 (3,393) 14,408 20,885 (687 ) (82 ) (769 ) 0 1,5773 (139 ) 47 (461 ) 11 1,035 (442) (245) (687) (687) 20,327 20,327 7,792 (3,928) 24,191 (8,023) (16,330) 20,353 (4,000) 44,833 Change in fair value of derivative instruments designated as cash flow hedges, net of taxes Balance at the beginning of the year Change in accounting policy Net unrealized gains / (losses) on the revaluation of cash flow hedges Net (gains) / losses reclassified to the income statement (11) 214 0 (380)3 (316 ) 237 (459) 1 On 16 July 2001, UBS made a distribution to shareholders of CHF 1.60 per share, paid in the form of a reduction in the par value of its shares, from CHF 10.00 to CHF 8.40. At the same time, UBS split its share 3 for 1, resulting in a new par value of CHF 2.80 per share. On 10 July 2002 UBS made a distribution of CHF 2.00 to shareholders which reduced the par value from CHF 2.80 to CHF 0.80. 2 Included are gains and losses from match- funding of net investments in foreign entities as follows: CHF 849 million net gain for 2002 and CHF 43 million net loss for 2001. 3 Opening adjustments to reflect the adoption of IAS 39 (see Note 1: Summary of Significant Accounting Policies). 4 Dividends declared per share were CHF 1.50 in 2000 and CHF 1.83 in 1999, both paid in the year 2000. 82 Subtotal – balance at the end of the year Balance at the end of the year Retained earnings Balance at the beginning of the year Change in accounting policy Balance at the beginning of the year (restated) Net profit for the year Dividends paid 1, 4 (256) (159) 29,103 29,103 3,535 (459 ) (193 ) 24,191 (61)3 24,130 4,973 Balance at the end of the year 32,638 29,103 Treasury shares, at cost Balance at the beginning of the year Acquisitions Disposals Cancellation of second trading line treasury shares (2000 Program) Cancellation of second trading line treasury shares (2001 Program) Balance at the end of the year Total shareholders’ equity (3,377) (8,313) 2,269 2,290 (7,131) 38,991 (4,000 ) (13,506 ) 10,129 4,000 (3,377 ) 43,530 UBS Group Statement of Changes in Equity (continued) Shares issued For the year ended Balance at the beginning of the year Issue of share capital Issue of share capital due to PaineWebber acquisition Cancellation of second trading line treasury shares (2000 Program) Cancellation of second trading line treasury shares (2001 Program) Number of shares % change from 31.12.02 31.12.01 31.12.00 31.12.01 1,281,717,499 3,398,869 1,333,139,187 3,843,661 1,292,679,486 4,459,701 (4) (12) 36,000,000 (55,265,349 ) (28,818,690) Balance at the end of the year 1,256,297,678 1,281,717,499 1,333,139,187 (2) Treasury shares For the year ended 31.12.02 31.12.01 31.12.00 31.12.01 Number of shares % change from Balance at the beginning of the year Acquisitions Disposals Cancellation of second trading line treasury shares (2000 Program) Cancellation of second trading line treasury shares (2001 Program) 41,254,951 110,710,741 (25,965,908) 55,265,349 162,818,045 (121,563,094 ) 110,621,142 257,121,477 1 (312,477,270) 1 (25) (32) (79) (55,265,349 ) (28,818,690) Balance at the end of the year 97,181,094 41,254,951 55,265,349 136 1 Number of shares in 2000 has been adjusted. During the year a total of 28,818,690 shares acquired under the second trading line buyback pro- gram 2001 were cancelled. At 31 December 2002, a maximum of 9,590,918 shares can be issued against the exercise of options from former PaineWebber employee option plans. These shares are shown as conditional share capital in the UBS AG (Parent Bank) disclosure. Out of the total number of 97,181,094 treasury shares, 74,035,080 shares (CHF 5,416 million) were acquired under the sec- ond trading line buyback program 2002 and are earmarked for cancellation. The Board of Directors will propose to the Annual General Meeting on 16 April 2003 to reduce the issued number of shares and the share capital by the number of shares purchased for cancellation. All issued shares are fully paid. 83 UBS Group Financial Statements Financial Statements UBS Group Statement of Cash Flows CHF million For the year ended Cash flow from / (used in) operating activities Net profit Adjustments to reconcile net profit to cash flow from / (used in) operating activities Non-cash items included in net profit and other adjustments: Depreciation of property and equipment Amortization of goodwill and other intangible assets Credit loss expense / (recovery) Equity in income of associates Deferred tax expense / (benefit) Net loss / (gain) from investing activities Net (increase) / decrease in operating assets: Net due from / to banks Reverse repurchase agreements and cash collateral on securities borrowed Trading portfolio and net replacement values Loans / due to customers Accrued income, prepaid expenses and other assets Net increase / (decrease) in operating liabilities: Repurchase agreements, cash collateral on securities lent Accrued expenses and other liabilities Income taxes paid Net cash flow from / (used in) operating activities Cash flow from / (used in) investing activities Investments in subsidiaries and associates Disposal of subsidiaries and associates Purchase of property and equipment Disposal of property and equipment Net (investment in) / divestment of financial investments Net cash flow from / (used in) investing activities Cash flow from / (used in) financing activities Net money market paper issued / (repaid) Net movements in treasury shares and own equity derivative activity Capital issuance Capital repayment by par value reduction Dividends paid Issuance of long-term debt Repayment of long-term debt Increase in minority interests Dividend payments to / and purchase from minority interests 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 the year 31.12.02 31.12.01 31.12.00 3,535 4,973 7,792 1,521 2,460 206 (7) (509) 986 1,614 1,323 498 (72 ) 292 513 (22,382) 27,306 (944) 21,967 (11,537) 2,875 4,791 (4,754) (572) (2,364) (60) 984 (1,763) 67 2,153 1,381 (26,206) (5,605) 6 (2,509) 17,132 (14,911) 0 (377) (32,470) (462) (33,915) 116,259 (60,536 ) (78,456 ) 42,813 (424 ) 80,006 (5,235 ) (1,742 ) 12,873 (467 ) 95 (2,021 ) 380 (5,770 ) (7,783 ) 24,226 (6,038 ) 12 (683 ) 18,233 (18,477 ) 1,291 (461 ) 18,103 (304 ) 22,889 93,370 1,608 667 (130) (58) 544 (730) (915) (81,054) 11,553 12,381 6,923 50,762 3,313 (959) 11,697 (9,729) 669 (1,640) 335 (8,770) (19,135) 10,125 (647) 15 (3,928) 14,884 (24,640) 2,683 (73) (1,581) 112 (8,907) 102,277 93,370 2,979 66,454 23,937 93,370 Cash and cash equivalents, end of the year 82,344 116,259 Cash and cash equivalents comprise: Cash and balances with central banks Money market paper 1 Due from banks maturing in less than three months Total 4,271 46,183 31,890 82,344 20,990 69,938 25,331 116,259 1 Money market paper is included in the Balance sheet under Trading portfolio assets and Financial investments. CHF 10,475 million, CHF 29,895 million and CHF 28,395 million were pledged at 31 December 2002, 31 December 2001 and 31 December 2000, respectively. 84 UBS Group Statement of Cash Flows (continued) Significant non-cash investing and financing activities CHF million For the year ended 31.12.02 31.12.01 31.12.00 Paine Webber Group, Inc. acquisition Value of shares issued (121,741,710 shares issued) Value of options issued (18,975,810 options issued) Solothurner Bank SOBA, Solothurn, deconsolidation Investments in associates Property and equipment Debt issued Hyposwiss, Zurich, deconsolidation Financial investments Property and equipment Debt issued Hirslanden Holding AG, Zurich, deconsolidation Financial investments Property and equipment Goodwill and other intangible assets Consolidation of special purpose entities Debt issued 0 0 0 0 0 53 18 63 3 718 15 2,322 0 0 0 0 0 0 0 0 0 0 0 0 10,246 992 1 77 493 0 0 0 0 0 0 0 85 UBS Group Financial Statements Notes to the Financial Statements Notes to the Financial Statements Note 1 Summary of Significant Accounting Policies a) Basis of accounting UBS AG and subsidiaries (“UBS” or the “Group”) provide a broad range of financial services including advisory services, underwrit- ing, financing, market making, asset manage- ment, brokerage, and retail banking on a global level. The Group was formed on 29 June 1998 when Swiss Bank Corporation and Union Bank of Switzerland merged. The merger was account- ed for using the uniting of interests method of accounting. The consolidated financial statements of the Group (the “Financial Statements”) are prepared in accordance with International Financial Reporting Standards (“IFRS”) and stated in Swiss francs (CHF), the currency of the country in which UBS AG is incorporated. On 11 February 2003 the Board of Directors approved them for issue. b) Use of estimates in the preparation of Financial Statements In preparing the Financial Statements, manage- ment is required to make estimates and assump- tions that affect reported income, expenses, assets, liabilities and disclosure of contingent assets and liabilities. Use of available information and application of judgement are inherent in the formation of estimates. Actual results in the future could differ from such estimates and the differences may be material to the Financial Statements. c) Consolidation The Financial Statements comprise those of the parent company (UBS AG), its subsidiaries and certain special purpose entities, presented as a single economic entity. The effects of intra-group transactions are eliminated in preparing the Financial Statements. Subsidiaries and special purpose entities which are directly or indirectly controlled by the Group are consolidated. Subsidiaries acquired are consolidated from the date control is transferred to the Group. Subsidiaries to be divested are consolidated up to the date of disposal. Temporarily controlled entities that are acquired and held with a view to their subsequent disposal, are recorded as Financial investments. Assets held in an agency or fiduciary capacity are not assets of the Group and are not reported in the Financial Statements. Equity and net income attributable to minori- ty interests are shown separately in the Balance sheet and Income statement, respectively. Investments in associates in which the Group has a significant influence are accounted for under the equity method of accounting. Signifi- cant influence is normally evidenced when UBS owns 20% or more of a company’s voting rights. Investments in associates are initially recorded at cost and the carrying amount is increased or decreased to recognize the Group’s share of the investee’s profits or losses after the date of acquisition. Investments in associates for which significant influence is intended to be temporary because the investments are acquired and held exclusively with a view to their subse- quent disposal, are recorded as Financial invest- ments. The Group sponsors the formation of compa- nies, which may or may not be directly or indi- rectly owned subsidiaries, for the purpose of asset securitization transactions and structured debt issuance, and to accomplish certain narrow and well defined objectives. These companies may acquire assets directly or indirectly from UBS or its affiliates. Some of these companies are bankruptcy-remote entities whose assets are not available to satisfy the claims of creditors of the Group or any of its subsidiaries. Such companies are consolidated in the Group’s Financial Statements when the substance of the relation- ship between the Group and the company indi- cates that the company is controlled by the Group. Certain transactions of consolidated enti- 86 ties meet the criteria for derecognition of finan- cial assets. Derecognition of a financial asset takes place when the Group loses control of the contractual rights that comprise the financial asset. These transactions do not affect the con- solidation status of an entity. d) Foreign currency translation Foreign currency transactions are recorded at the rate of exchange on the date of the transaction. 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 cur- rency monetary assets and liabilities, are recog- nized in the income statement. Exchange differences on non-monetary finan- cial assets are a component of the change in their fair value. Depending on the classification of a non-monetary financial asset, exchange differ- ences are either recognized in the income state- ment (applicable for example for equity securities held for trading), or within Shareholder’s equity if non-monetary financial assets are classified as available-for-sale financial investments. When preparing consolidated financial state- ments, assets and liabilities of foreign entities are translated at the exchange rates at the balance sheet date, while income and expense items are translated at weighted average rates for the period. Differences resulting from the use of clos- ing and weighted average exchange rates and from revaluing a foreign entity’s opening net asset balance at closing rate are recognized directly in Foreign currency translation within Shareholders’ equity. e) Business and geographical segments The Group is organized on a worldwide basis into four Business Groups and the Corporate Center. This organizational structure is the basis upon which the Group reports its primary seg- ment information. Segment income, segment expenses and seg- ment performance include transfers between business segments and between geographical seg- ments. Such transfers are accounted for at prices in line with charges to unaffiliated customers for similar services. f) Cash and cash equivalents Cash and cash equivalents consist of Cash and balances with central banks, balances included in Due from banks that mature in less than three months, and Money market paper included in Trading portfolio assets and Financial investments. g) Fee income Brokerage fees earned from executing securities transactions are recorded when the service has been provided. Portfolio and other management, advisory and other service fees are recognized based on the terms of the applicable service contracts. Asset management fees related to investment funds are recognized ratably over the period the service is provided. The same principle is applied for fees earned for wealth management, financial planning and custody services that are continuously provided over an extended period of time. Transaction-related fees earned from merg- er and acquisition and other advisory services, securities underwriting, fund raising, and from other investment banking and similar services that have a non-recurring character, are recog- nized at the time the service has been completed. h) Securities borrowing and lending Securities borrowed and securities lent are recorded at the amount of cash collateral advanced or received, plus accrued interest. Securities borrowed and securities received as collateral under securities lending transactions are not recognized in the balance sheet unless control of the contractual rights that comprise these secu- rities received is gained. Securities lent and securi- ties provided as collateral under securities borrow- ing transactions are not derecognized from the balance sheet unless control of the contractual rights that comprise these securities transferred is relinquished. The Group monitors the market value of the securities borrowed and lent on a daily basis and provides or requests additional collater- al in accordance with the underlying agreements. Fees and interest received or paid are recorded as interest income or interest expense, on an accrual basis. i) Repurchase and reverse repurchase transactions Securities purchased under agreements to resell (reverse repurchase agreements) and securities 87 UBS Group Financial Statements Notes to the Financial Statements sold under agreements to repurchase (repurchase agreements) are generally treated as collateral- ized financing transactions and are carried at the amounts of cash advanced or received, plus accrued interest. Securities received under reverse repurchase agreements and securities delivered under repur- chase agreements are not recognized in the bal- ance sheet or derecognized from the balance sheet, unless control of the contractual rights that comprise these securities is relinquished. The Group monitors the market value of the securi- ties received or delivered on a daily basis, and provides or requests additional collateral in accordance with the underlying agreements. Interest earned on reverse repurchase agree- ments and interest incurred on repurchase agree- ments is recognized as interest income or interest expense, over the life of each agreement. The Group offsets reverse repurchase agree- ments and repurchase agreements with the same counterparty for transactions covered by legally enforceable master netting agreements when net or simultaneous settlement is intended. j) Trading portfolio Trading portfolio assets consist of money market paper, other debt instruments, including traded loans, equity instruments and precious metals which are owned by the Group (“long” posi- tions). Obligations to deliver trading securities sold but not yet purchased are reported as Trading portfolio liabilities. Trading portfolio liabilities consist of money market paper, other debt instruments and equity instruments which the Group has sold to third parties but does not own (“short” positions). The trading portfolio is carried at fair value, which includes valuation allowances for instru- ments for which liquid markets do not exist. Gains and losses realized on disposal or redemp- tion and unrealized gains and losses from changes in the fair value of trading portfolio assets or liabilities are reported as Net trading income. Interest and dividend income and expense on trading portfolio assets or liabilities are included in Interest and dividend income or Interest and dividend expense, respectively. The Group uses settlement date accounting when recording trading portfolio transactions. It recognizes from the date the transaction is entered into (trade date) in the income statement any unrealized profits and losses arising from revaluing that contract to fair value. Subsequent to the trade date, when the transaction is con- summated (settlement date) a resulting financial asset or liability is recognized on the balance sheet at the fair value of the consideration given or received plus the change in fair value of the contract since the trade date. When the Group becomes party to a sales contract of a financial asset classified in its trading portfolio it derecog- nizes the asset on the day of its transfer. The determination of fair values of trading portfolio assets or liabilities is based on quoted market prices in active markets or dealer price quotations, pricing models (using assumptions based on market and economic conditions), or management’s estimates, as applicable. k) Loans originated by the Group Loans originated by the Group include loans where money is provided directly to the bor- rower, other than those that are originated with the intent to be sold immediately or in the short term, which are recorded as Trading portfolio assets. A participation in a loan from another lender is considered to be originated by the Group, provided it is funded on the date the loan is originated by the lender. Purchased loans are classified either as Financial investments avail- able for sale, or as Trading portfolio assets, as appropriate. Loans originated by the Group are recognized when cash is advanced to borrowers. They are initially recorded at cost, which is the fair value of the cash given to originate the loan, including any transaction costs, and are subsequently measured at amortized cost using the effective interest rate method. Interest on loans originated by the Group is included in Interest earned on loans and advances and is recognized on an accrual basis. Fees and direct costs relating to loan origination, financing or restructuring and to loan commitments are deferred and amortized to Interest earned on loans and advances over the life of the loan using the straight-line method which approximates the effec- tive interest rate method. Fees received for commit- ments which are not expected to result in a loan are included in Credit-related fees and commissions over the commitment period. Loan syndication fees where UBS does not retain a portion of the syndi- cated loan are credited to commission income. 88 l) Allowance and provision for credit losses An allowance for credit losses is established if there is objective evidence that the Group will be unable to collect all amounts due on a claim according to the original contractual terms or the equivalent value. A “claim” means a loan, a com- mitment such as a letter of credit, guarantee or commitment to extend credit, or a derivative or other credit product. An allowance for credit loss is reported as a reduction of the carrying value of a claim on the balance sheet, whereas for an off-balance sheet item such as a commitment a provision for cred- it loss is reported in Other liabilities. Additions to the allowances and provisions for credit losses are made through credit loss expense. Allowances and provisions for credit losses are evaluated at a counterparty-specific and/or country-specific level based on the following principles: Counterparty-specific: A claim is considered impaired when management determines that it is probable that the Group will not be able to col- lect all amounts due according to the original contractual terms or the equivalent value. Individual credit exposures are evaluated based upon the borrower’s character, overall financial condition, resources and payment record; the prospects for support from any finan- cially responsible guarantors; and, where appli- cable, the realizable value of any collateral. The estimated recoverable amount is the pres- ent value of expected future cash flows which may result from restructuring or liquidation. Impairment is measured and allowances for cred- it losses are established for the difference between the carrying amount and its estimated recoverable amount. If there are indications of significant probable losses in the portfolio that have not been specifi- cally identified, allowances for credit losses would also be provided for on a portfolio basis. Upon impairment the accrual of interest income based on the original terms of the claim is discontinued, but the increase of the present value of impaired claims due to the passage of time is reported as interest income. An impaired loan is classified as non-perform- ing when the contractual payments of principal and/or interest are in arrears for 90 days or more. All impaired claims are reviewed and analyzed at least annually. Any subsequent changes to the amounts and timing of the expected future cash flows compared to the prior estimates will result in a change in the allowance for credit losses and be charged or credited to credit loss expense. An allowance for an impairment is reversed only when the credit quality has improved such that there is reasonable assurance of timely col- lection of principal and interest in accordance with the original contractual terms of the claim agreement. A write-off is made when all or part of a claim is deemed uncollectible or forgiven. Write- offs are charged against previously established allowances for credit losses or directly to credit loss expense and reduce the principal amount of a claim. Recoveries in part or in full of amounts previously written off are credited to credit loss expense. Country-specific: Where, in management’s opinion, it is probable that some claims may be affected by systemic crisis, transfer restrictions or non-enforceability, specific country allowances for probable losses are established. They are based on country-specific scenarios, taking into consideration the nature of the individual expo- sures, but excluding those amounts covered by counterparty-specific allowances. m) Securitizations The Group securitizes various consumer and commercial financial assets, which generally results in the sale of these assets to special- purpose vehicles which, in turn issue securities to investors. Financial assets are partially or wholly derecognized when the Group gives up control of the contractual rights that comprise the finan- cial asset. Interests in the securitized financial assets may be retained in the form of senior or subordinated tranches, interest-only strips or other residual interests (“retained interests”). Retained interests are primarily recorded in Trading portfolio assets and carried at fair value. The determination of fair values of retained interest is generally based on quoted market prices or to a lesser extent by determining the present value of expected future cash flows using pricing models that incorporate management’s best estimates of critical assump- tions which may include credit losses, discount rates, yield curves and other factors. Gains or losses on securitization depend in part on the carrying amount of the transferred 89 UBS Group Financial Statements Notes to the Financial Statements financial assets, allocated between the financial assets derecognized and the retained interests based on their relative fair values at the date of the transfer. Gains or losses on securitization are recorded in Net trading income. n) Financial investments Financial investments are classified as available- for-sale and recorded on a settlement date basis. Management determines the appropriate classifi- cation of its investments at the time of the pur- chase. Financial investments consist of money market paper, other debt instruments and equity instruments, including private equity investments. Available-for-sale financial investments may be sold in response to needs for liquidity or changes in interest rates, foreign exchange rates or equity prices. Available-for-sale financial investments are carried at fair value. Unrealized gains or losses on available-for-sale investments are reported in Shareholders’ equity, net of applicable taxes, until such investment is sold, collected or other- wise disposed of, or until such investment is determined to be impaired. The determination of fair values of available- for-sale financial investments is generally based on quoted market prices in active markets, dealer price quotations, discounted expected cash flows using market rates commensurate with the credit quality and maturity of the investment or based upon review of the investee’s financial results, condition and prospects including comparisons to similar companies for which quoted market prices are available. If an available-for-sale investment is deter- mined to be impaired, the cumulative unrealized loss previously recognized in Shareholders’ equity is included in net profit or loss for the period and reported in Other income. A financial investment is considered impaired if its cost exceeds the recoverable amount. For non-quoted equity investments, the recoverable amount is determined by applying recognized valuation techniques. The standard method applied is based on multiple of earnings observed in the market for comparable companies. For quoted financial investments, the recoverable amount is determined by reference to the market price. They are considered impaired if objective evidence indicates that the decline in market price has reached a level that recovery of the cost value cannot be reasonably expected within the foreseeable future. On disposal of an available-for-sale invest- ment, the accumulated unrealized gain or loss included in Shareholders’ equity is transferred to net profit or loss for the period and reported in Other income. Gains and losses on disposal are determined using the average cost method. Interest and dividend income on available-for- sale financial investments is included in Interest and dividend income from financial investments. o) Property and equipment Property and equipment includes bank-occupied properties, investment properties, software, IT and communication and other machines and equipment. Bank-occupied property is defined as prop- erty held by the Group for use in the supply of services or for administrative purposes whereas investment property is defined as property held by the Group to earn rentals and/or for capital appreciation. If a property of the Group in- cludes a portion that is bank-occupied and another portion that is held to earn rentals or for capital appreciation, the classification is based on whether or not these portions can be sold separately. If both portions of the property can be sold separately these portions are accounted for as bank-occupied property and investment property, respectively. If the por- tions cannot be sold separately, the whole prop- erty is classified as bank-occupied property unless the portion used by the bank is minor. The classification of property is reviewed on a regular basis to account for major changes in its usage. Software development costs are capitalized when they meet certain criteria relating to identi- fiability, it is probable that future economic benefits will flow to the enterprise, and the cost can be measured reliably. Internally developed software meeting these criteria and purchased software are classified in Property and equipment on the balance sheet. Property and equipment is carried at cost less accumulated depreciation and accumulated impairment losses. Property and equipment is periodically reviewed for impairment. Property and equipment is depreciated on a straight-line basis over its estimated useful life as follows: 90 Properties, excluding land Not exceeding 50 years Other machines and equipment Not exceeding 10 years IT, software and communication Not exceeding 3 years Property formerly bank-occupied or leased to third parties under an operating lease, which the Group has decided to dispose of and foreclosed property are defined as Properties held for resale and disclosed in Other assets. They are carried at the lower of cost or recoverable value. When the cost model is applied, IAS 40, Investment Property, requires the disclosure of the investment property’s fair value (see Note 14) and how fair value is determined. UBS employs internal real estate experts who determine the fair value of investment property by applying rec- ognized valuation techniques. In cases where prices of recent market transactions of compa- rable objects are available, fair value is deter- mined by reference to these transactions. p) Goodwill and other intangible assets Goodwill represents the excess of the cost of an acquisition over the fair value of the Group’s share of net identifiable assets of the acquired entity at the date of acquisition. Other intangible assets are comprised of sepa- rately identifiable intangible items arising from acquisitions and certain purchased trademarks and similar items. Goodwill and other intangible assets are rec- ognized as assets and are amortized using the straight-line basis over their estimated useful economic life, not exceeding 20 years. At each balance sheet date, goodwill and other intangible assets are reviewed for indications of impairment or changes in estimated future benefits. If such indications exist an analysis is performed to assess whether the carrying amount of goodwill or other intangible assets is fully recoverable. A write-down is made if the carrying amount exceeds the recoverable amount. q) Income taxes Income tax payable on profits, based on the appli- cable tax laws in each jurisdiction, is recognized as an expense in the period in which profits arise. The tax effects of income tax losses available for carry- forward are recognized as an asset when it is prob- able that future taxable profit will be available against which those losses can be utilized. 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 temporary differences which will result in 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 in the period in which the asset will be realized or the liability will be settled based on enacted rates. 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 income tax benefit or expense except for (i) deferred taxes recognized or disposed of upon the acquisition or disposal of a subsidiary, and (ii) unrealized gains or losses on available for sale investments and changes in fair value of deriva- tive instruments designated as cash flow hedges, which are recorded net of taxes in Gains or loss- es not recognized in the income statement within Shareholders’ equity. r) Debt issued Debt issued is initially measured at cost, which is the fair value of the consideration received, net of transaction costs incurred. Subsequent measure- ment is at amortized cost, using the effective interest rate method to amortize cost at inception to the redemption value over the life of the debt. Combined debt instruments that are related to non-UBS AG equity instruments, foreign exchange, credit instruments or indices are con- sidered structured instruments. The embedded derivative is separated from the host contract and accounted for as a stand-alone derivative if the criteria for separation are met. The host contract is subsequently measured at amortized cost. Debt instruments with embedded derivatives that are related to UBS AG shares or to a deriv- ative instrument that has UBS AG shares as underlying are separated into a liability and an equity component at issue date, if they will be physically settled. Initially, a portion of the net proceeds from issuing the combined debt instru- 91 UBS Group Financial Statements Notes to the Financial Statements ment are allocated to the equity component based on its fair value and reported in Share pre- mium account. The determination of fair values is generally based on quoted market prices or option pricing models. Subsequent changes in fair value of the separated equity component are not recognized. The remaining amount is allo- cated to the liability component and reported as Debt issued. The liability component is subse- quently measured at amortized cost. However, if the combined instrument or the embedded deriv- ative related to UBS AG shares is cash settled or the holder of the hybrid instrument has the right to require cash settlement, then the separated derivative is accounted for as a trading instru- ment with changes in fair value recorded in income. It is the Group’s policy to hedge the fixed interest rate risk on debt issues (except for certain subordinated long-term notes issues, see Note 30a) and apply fair value hedge accounting. The effect is such that when hedge accounting is applied to fixed rate debt instruments, the carry- ing value of debt issues is adjusted for changes in fair value related to the hedged exposure rather than carried at amortized cost. See v) Derivative instruments for further discussion. Own bonds held as a result of market making activities or deliberate purchases in the market are treated as a redemption of debt. A gain or loss on redemption is recorded depending on whether the repurchase price of the bond was lower or higher than its carrying value in the books. A subsequent sale of own bonds in the market is treated as a re-issuance of debt. Interest expense on debt instruments is includ- ed in Interest on debt issued. s) Treasury shares UBS AG shares held by the Group are classified in Shareholders’ equity as Treasury shares and accounted for at weighted average cost. The dif- ference between the proceeds from sales of treas- ury shares and their cost (net of tax, if any) is classified as Share premium. Contracts that require physical settlement or net share settlement in UBS AG shares or provide the Group with a choice to physically settle are classified as Shareholders’ equity and reported as Share premium. Upon settlement of such con- tracts the proceeds received less cost (net of tax, if any), are reported as Share premium. Contracts on UBS AG shares that require net cash settlement or provide the counterparty with a choice of net cash settlement are classified as trading instruments, with the changes in fair value reported in the income statement. t) Retirement benefits The Group sponsors a number of retirement benefit plans for its employees worldwide. These plans include both defined benefit and defined contribution plans and various other retirement benefits such as post-employment medical bene- fits. Group contributions to defined contribution plans are expensed when employees have ren- dered services in exchange for such contribu- tions, generally in the year of contribution. The Group uses the projected unit credit actuarial method to determine the present value of its defined benefit plans and the related current service cost and, where applicable, past service cost. The principal actuarial assumptions used by the actuary are set out in Note 32. The Group recognizes a portion of its actu- arial gains and losses as income or expenses if the net cumulative unrecognized actuarial gains and losses at the end of the previous reporting period exceeded the greater of: a) 10% of present value of the defined benefit obligation at that date (before deducting plan assets); and b) 10% of the fair value of any plan assets at that date. The unrecognized actuarial gains and losses exceeding the greater of the two values are recog- nized in the income statement over the expected average remaining working lives of the employ- ees participating in the plans. If an excess of the fair value of the plan assets over the present value of the defined benefit obli- gation cannot be recovered fully through refunds or reductions in future contributions, no gain is recognized solely as a result of deferral of an actuarial loss or past service cost in the current period or no loss is recognized solely as a result of deferral of an actuarial gain in the current period. u) Equity participation plans The Group provides various equity participa- tion plans in the form of stock plans and stock option plans. UBS generally uses the intrinsic 92 value method of accounting for such awards. Consequently, compensation expense is meas- ured as the difference between the quoted mar- ket price of the stock at the grant date less the amount, if any, that the employee is required to pay, or by the excess of stock price over option strike price, if any. The Group’s policy is to rec- ognize compensation expense for equity awards at the date of grant. v) Derivative instruments and hedging All derivative instruments of the Group are carried at fair value on the balance sheet and are reported as Positive or Negative replacement values. Fair values are obtained from quoted market prices, dealer price quotations, dis- counted cash flow models and option pricing models, which incorporate current market and contractual prices for the underlying instrument, time to expiry, yield curves and volatility of the underlying. The Group offsets positive and nega- tive replacement values with the same counter- party for transactions covered by legally enforce- able master netting agreements, as explained in Note 23. Where the Group enters into derivatives for trading purposes, realized and unrealized gains and losses are recognized in Net trading income. The Group also uses derivative instruments as part of its asset and liability management activi- ties to manage exposures to interest rate, foreign currency and credit risks, including exposures arising from forecast transactions. The Group applies either fair value or cash flow hedge accounting when transactions meet the specified criteria to obtain hedge accounting treatment. At the time a financial instrument is desig- nated as a hedge, the Group formally documents the relationship between the hedging instru- ment(s) and hedged item(s), including its risk management objectives and its strategy in under- taking the hedge transaction, which must be in accordance with the Group’s risk management policies, together with the methods that will be used to assess the effectiveness of the hedging relationship. Accordingly, the Group formally assesses, both at the inception of the hedge and on an ongoing basis, whether the hedging deriva- tives have been “highly effective” in offsetting changes in the fair value or cash flows of the hedged items. A hedge is normally regarded as highly effective if, at inception and throughout its life, the Group can expect changes in the fair value or cash flows of the hedged item to be almost fully offset by the changes in the fair value or cash flows of the hedging instrument, and actual results are within a range of 80% to 125%. In the case of hedging a forecast trans- action, the transaction must be highly probable and must present an exposure to variations in cash flows that could ultimately affect reported net profit or loss. The Group discontinues hedge accounting when it is determined that a deriva- tive is not, or has ceased to be, highly effective as a hedge; when the derivative expires, or is sold, terminated, or exercised; when the hedged item matures or is sold or repaid; or when a forecast transaction is no longer deemed highly probable. “Hedge ineffectiveness” represents the amount by which the changes in the fair value of the hedging derivative differ from changes in the fair value of the hedged item or the amount by which changes in the cash flow of the hedging derivative differ from changes (or expected changes) in the cash flow of the hedged item. Such gains and losses are recorded in current period earnings, as are gains and losses on components of a hedging derivative that are excluded from assessing hedge effectiveness. For qualifying fair value hedges, the change in fair value of the hedging derivative is recognized in net profit and loss. Those changes in fair value of the hedged item which are attributable to the risks hedged with the derivative instrument are reflected in an adjustment to the carrying value of the hedged item, which is also recognized in net profit or loss. If the hedge relationship is termi- nated for reasons other than the derecognition of the hedged item, the difference between the car- rying value of the hedged item at that point and the value at which it would have been carried had the hedge never existed (the “unamortized fair value adjustment”), is, in the case of interest bearing instruments, amortized to net profit or loss over the remaining term of the original hedge, while for non-interest bearing instruments that amount is immediately recognized in earn- ings. If the hedged instrument is derecognized, e.g. is sold or repaid, the unamortized fair value adjustment is recognized immediately in net profit and loss. A fair valuation gain or loss associated with the effective portion of a derivative designated as a cash flow hedge is recognized initially in Share- 93 UBS Group Financial Statements Notes to the Financial Statements holders’ equity. When the cash flows that the derivative is hedging (including cash flows from transactions that were only forecast when the derivative hedge was effected) materialize, result- ing in income or expense, then the associated gain or loss on the hedging derivative is simulta- neously transferred from Shareholders’ equity to the corresponding income or expense line item. If a cash flow hedge for a forecast transaction is deemed to be no longer effective, or the hedge relationship is terminated, the cumulative gain or loss on the hedging derivative previously report- ed in Shareholders’ equity remains in Share- holders’ equity until the committed or forecast transaction occurs, at which point it is trans- ferred from Shareholders’ equity to net trading income. Derivative instruments transacted as eco- nomic hedges but not qualifying for hedge accounting are treated in the same way as deriv- ative instruments used for trading purposes, i. e. realized and unrealized gains and losses are rec- ognized in Net trading income. In particular, the Group has entered into economic hedges of cred- it risk within the loan portfolio using credit default swaps to which it does not apply hedge accounting. In the event that the Group recog- nizes an impairment on a loan that is economi- cally hedged in this way, the impairment is rec- ognized in Credit loss expense whereas the gain on the credit default swap is recorded in Net trading income – see Note 23 for additional information. A derivative may be embedded in a “host con- tract”. Such combinations are known as hybrid instruments and arise predominantly from the issuance of certain structured debt instruments. If the host contract is not carried at fair value with changes in fair value reported in net profit or loss, the embedded derivative is separated from the host contract and accounted for as a stand- alone derivative instrument at fair value if, and only if: the economic characteristics and risks of the embedded derivative are not closely related to the economic characteristics and risks of the host contract and the embedded derivative actually meets the definition of a derivative. w) Earnings per Share (EPS) Basic earnings per share is calculated by dividing the net profit or loss for the period attributable to ordinary shareholders by the weighted average number of ordinary shares outstanding during the period. Diluted earnings per share is computed using the same method as for basic EPS, but the deter- minants are adjusted to reflect the potential dilu- tion that could occur if options, warrants, con- vertible debt securities or other contracts to issue ordinary shares were converted or exercised into ordinary shares. x) Comparability Amended IAS 19, Employee Benefits The Group adopted in 2002 the amended stan- dard IAS 19 “Employee Benefits”. The amend- ments introduce an asset ceiling provision that applies for defined benefit plans that have a sur- plus of plan assets over benefit obligations. The implementation of the amended standard had no material impact. IFRIC Interpretations Interpretations of the International Financial Reporting Interpretations Committee (IFRIC) became effective during 2002 but had no impact on the Group’s Financial Statements. Segment Reporting As at 1 January 2002, UBS PaineWebber was separated from UBS Warburg and became a stand-alone Business Group. Note 2 to these Group Financial Statements reflects the new Business Group structure. Comparative prior year amounts have been restated to conform to the current year presentation. IAS 39, Recognition and Measurement of Financial Instruments The Group adopted IAS 39 prospectively as at 1 January 2001. The Standard provides compre- hensive guidance on accounting for financial instruments. Upon adoption, the Group decided to record unrealized gains and losses arising from changes in the fair value of available-for-sale financial investments directly in Shareholders’ equity until such investment is disposed of or until such investment is determined to be impaired. As a result of the adoption of IAS 39, the following adjustments or changes in classifica- tion occurred: Gains/losses not recognized in the income statement is a new component of Shareholders’ 94 equity as at 1 January 2001. It includes unreal- ized gains and losses on available for sale finan- cial investments and on derivatives designated as cash flow hedges as well as Foreign currency translation. The opening adjustment as at 1 January 2001 to financial investments recorded as available for sale was a net unrealized gain of CHF 1,769 million (CHF 1,577 million net of taxes), and for derivatives designated as cash flow hedges an unrealized net loss of CHF 506 million (CHF 380 million net of taxes). Available-for-sale financial investments were previously carried at the lower of cost or market value and private equity investments were carried at cost less write-downs for impairments in value. Reductions of the carrying amount of available- for-sale financial investments and private equity investments and reversals of such reductions as well as gains and losses on disposal are included in Other income. As at 1 January 2001 these financial investments are now classified as avail- able-for-sale financial investments and carried at fair value. Changes in fair value are reported in Gains/losses not recognized in the income state- ment within Shareholders’ equity until these investments are disposed of. At the time an avail- able-for-sale financial investment is determined to be impaired, the cumulative unrealized loss previ- ously recognized in Shareholders’ equity is includ- ed in net profit or loss for the period. The opening adjustment to Retained earnings, a net debit of CHF 61 million as at 1 January 2001, consisted of CHF 19 million reflecting the impact of adopting the new hedge accounting rules and CHF 42 million reflecting the impact of remeasuring assets to either amortized cost or fair value as required under IAS 39. Properties held for resale include properties formerly bank-occupied or leased to third parties under an operating lease, which the Group has decided to dispose of, and foreclosed properties which the Group received in satisfaction of a secured loan and which it does not intend to occupy. As at 1 January 2001, Properties held for resale in the amount of CHF 984 million were reclassified from Financial investments to Other assets. Comparative amounts have been reclassi- fied accordingly. 95 UBS Group Financial Statements Notes to the Financial Statements Note 2a Segment Reporting by Business Group Based on our integrated business model, UBS is organized into the four Business Groups: UBS Wealth Management & Business Banking, UBS Global Asset Management, UBS Warburg and UBS PaineWebber, and our Corporate Center. UBS Wealth Management & Business Banking UBS Wealth Management & Business Banking comprises two business units. Private Banking offers a comprehensive range of products and services individually tailored to affluent international and Swiss clients, operat- ing from offices around the world. Business Banking Switzerland provides indi- vidual and corporate clients in Switzerland with a complete portfolio of banking and securities services, focused on customer service excellence, profitability and growth, by using a multi-chan- nel distribution. The two business units share technological and physical infrastructure, and have joint departments supporting major functions such as e-commerce, financial planning and wealth management, investment policy and strategy. UBS Global Asset Management UBS Global Asset Management provides invest- ment products and services to institutional investors and wholesale intermediaries around the globe. Clients include corporate and public pension plans, financial institutions and advisors, central banks as well as charities, foundations and individual investors. UBS Warburg UBS Warburg operates globally as a client-driven investment banking and securities firm with two business units. Corporate and Institutional Clients provides innovative products, research, advice and com- plete access to the world’s capital markets for intermediaries, governments, corporate and insti- tutional clients and other parts of UBS. UBS Capital is the private equity business unit of UBS Warburg, investing UBS and third party funds, primarily in unlisted companies. UBS PaineWebber UBS PaineWebber is a US financial services firm providing sophisticated wealth management services to affluent US clients through a highly trained financial advisor network. Corporate Center Corporate Center ensures that the Business Groups operate as a coherent and effective whole with a common set of values and principles in such areas as risk management, financial report- ing, marketing and communications, funding, capital and balance sheet management and man- agement of foreign exchange earnings. 96 Note 2a Segment Reporting by Business Group The Business Group results are presented on a management reporting basis. Internal charges and transfer pricing adjustments are reflected in the performance of each business. Revenue sharing agreements are used to allocate external customer revenues to a Business Group on a reasonable basis. Transactions between Business Groups are conducted at arm’s length. The segment reporting for all peri- ods reflects the changes in the structure implemented during 2002. Prior year amounts have been restated to conform to current year presentation. For the year ended 31 December 2002 CHF million Income 1 Credit loss expense 2 Total operating income Personnel expenses General and administrative expenses Depreciation Amortization of goodwill and other intangible assets 3 Total operating expenses Business Group performance before tax Tax expense Net profit before minority interests Minority interests Net profit Other information as at 31 December 2002 4 Total assets Total liabilities and minority interests Capital expenditure UBS Wealth Management & Business Banking UBS Global Asset Management UBS Warburg UBS PaineWebber Corporate Center UBS Group 12,928 (314 ) 12,614 4,810 2,317 480 111 7,718 4,896 1,953 0 1,953 946 513 37 270 1,766 187 12,498 (128 ) 12,370 7,878 2,378 382 364 11,002 1,368 5,561 (13 ) 5,548 4,245 1,263 149 1,691 7,348 (1,800) 1,387 249 1,636 645 601 473 24 1,743 (107) 34,327 (206) 34,121 18,524 7,072 1,521 2,460 29,577 4,544 678 3,866 (331) 3,535 310,722 302,272 380 4,428 2,937 20 933,962 921,446 473 39,610 33,225 185 (107,604 ) (117,753 ) 705 1,181,118 1,142,127 1,763 1 Impairments on private equity and other financial investments for the year ended 31 December 2002 were as follows: UBS Wealth Management & Business Banking CHF 32 million; UBS Global 2 In order to show the relevant Business Group performance over time, adjusted expected Asset Management CHF 1 million; UBS Warburg CHF 1,703 million; Corporate Center CHF 208 million. loss figures rather than the IFRS actual net credit loss expense are reported for each Business Group. The adjusted expected loss is the statistically derived actuarial expected loss which reflects the inherent counterparty and country risks in the respective portfolios, plus the deferred releases representing the amortized historical differences between actual credit losses and actuarial expected loss. The difference between the adjusted expected loss figures and the IFRS actual net credit loss expense recorded at Group level for financial reporting purposes is reported in the Corporate Center. The Business Group breakdown of the net credit loss expense for financial reporting purposes of CHF 206 million for the year ended 31 December 2002 is as follows: UBS Wealth Management & Business Banking CHF 241 million expense, UBS Warburg CHF 35 million recovery, UBS PaineWebber CHF 15 million expense and Corporate Center CHF 15 million 4 The funding surplus or require- recovery. ment is reflected in each Business Group and adjusted in Corporate Center. 3 For further information about goodwill and other intangible assets by Business Group, please see Note 15: Goodwill and Other Intangible Assets. 97 UBS Group Financial Statements Notes to the Financial Statements For the year ended 31 December 2001 CHF million Income 1 Credit loss expense 2 Total operating income Personnel expenses General and administrative expenses Depreciation Amortization of goodwill and other intangible assets Total operating expenses Business Group performance before tax Tax expense Net profit before minority interests Minority interests Net profit Other information as at 31 December 2001 3 Total assets Total liabilities and minority interests Capital expenditure UBS Wealth Management & Business Banking UBS Global Asset Management UBS Warburg UBS PaineWebber Corporate Center UBS Group 13,488 (604 ) 12,884 4,825 2,434 616 109 7,984 4,900 2,218 0 2,218 1,038 569 46 286 1,939 279 14,715 (112 ) 14,603 8,354 2,650 456 402 11,862 2,741 6,391 (18 ) 6,373 5,019 1,441 124 502 7,086 (713) 800 236 1,036 592 537 372 24 1,525 (489) 37,612 (498) 37,114 19,828 7,631 1,614 1,323 30,396 6,718 1,401 5,317 (344) 4,973 313,800 304,988 540 6,335 4,367 37 1,005,397 992,272 337 39,747 31,556 296 (111,982 ) (123,416 ) 811 1,253,297 1,209,767 2,021 1 Impairments on private equity and other financial investments for the year ended 31 December 2001 were as follows: UBS Wealth Management & Business Banking CHF 109 million; UBS Global 2 In order to show the relevant Business Group performance over time, adjusted expect- Asset Management CHF 3 million; UBS Warburg CHF 1,143 million; Corporate Center CHF 39 million. ed loss figures rather than the IFRS actual net credit loss expense are reported for each Business Group. The adjusted expected loss is the statistically derived actuarial expected loss which reflects the inherent counterparty and country risks in the respective portfolios, plus the deferred releases representing the amortized historical differences between actual credit losses and actuarial expected loss. The difference between the adjusted expected loss figures and the IFRS actual net credit loss expense recorded at Group level for financial reporting purposes is reported in the Corporate Center. The Business Group breakdown of the net credit loss expense for financial reporting purposes of CHF 498 million for the year ended 31 December 2001 is as follows: UBS 3 The funding surplus or require- Wealth Management & Business Banking CHF 123 million expense, UBS Warburg CHF 360 million expense and UBS PaineWebber CHF 15 million expense. ment is reflected in each Business Group and adjusted in Corporate Center. For the year ended 31 December 2000 CHF million Income 1 Credit loss expense / recovery 2 Total operating income Personnel expenses General and administrative expenses Depreciation Amortization of goodwill and other intangible assets Total operating expenses Business Group performance before tax Tax expense Net profit before minority interests Minority interests Net profit Other information as at 31 December 2000 3 Total assets Total liabilities and minority interests UBS Wealth Management & Business Banking UBS Global Asset Management UBS Warburg UBS PaineWebber Corporate Center UBS Group 14,355 (785 ) 13,570 5,151 2,478 633 81 8,343 5,227 2,078 0 2,078 941 434 49 267 1,691 387 18,240 (243 ) 17,997 9,451 2,755 564 192 12,962 5,035 1,214 (3 ) 1,211 1,098 344 42 84 1,568 (357) 385 1,161 1,546 522 754 320 43 1,639 (93) 36,272 130 36,402 17,163 6,765 1,608 667 26,203 10,199 2,320 7,879 (87) 7,792 281,984 272,173 7,558 5,787 817,264 803,159 50,691 41,826 (69,945 ) (80,226 ) 1,087,552 1,042,719 1 Impairments on private equity and other financial investments for the year ended 31 December 2000 were as follows: UBS Warburg CHF 442 million; Corporate Center CHF 65 million. 2 In order to show the relevant Business Group performance over time, adjusted expected loss figures rather than the IFRS actual net credit loss expense are reported for each Business Group. The adjusted expected loss is the statistically derived actuarial expected loss which reflects the inherent counterparty and country risks in the respective portfolios, plus the deferred releases representing the amortized historical differences between actual credit losses and actuarial expected loss. The difference between the adjusted expected loss figures and the IFRS actual net credit loss expense recorded at Group level for financial reporting purposes is reported in the Corporate Center. The Business Group breakdown of the net credit loss recovery for financial reporting purposes of CHF 130 million for the year ended 31 December 2000 is as follows: UBS Wealth Management & Business Banking CHF 695 million recovery, UBS Warburg CHF 562 million expense and UBS PaineWebber CHF 3 million expense. 3 The funding surplus or requirement is reflected in each Business Group and adjusted in Corporate Center. 98 Note 2b Segment Reporting by Geographic Location The geographic analysis of total assets is based on customer domicile whereas operating income and capital expenditure 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 integrated basis worldwide, with a view to profitability by product line. The geographical analysis of operating income, total assets, and capital expenditure is provided in order to comply with IFRS, and does not reflect the way the Group is managed. Management believes that analysis by Business Group, as shown in Note 2a to these Financial Statements, is a more meaningful representation of the way in which the Group is managed. For the year ended 31 December 2002 Total operating income Total assets Capital expenditure CHF million Share % CHF million Share % CHF million Share % 14,307 6,837 11,055 1,909 13 34,121 42 20 32 6 0 174,878 256,110 669,823 78,270 2,037 15 22 56 7 0 885 199 635 44 0 51 11 36 2 0 100 1,181,118 100 1,763 100 Total operating income Total assets Capital expenditure CHF million Share % CHF million Share % CHF million Share % 14,223 7,411 13,587 1,859 34 37,114 38 20 37 5 0 195,321 236,775 691,157 126,725 3,319 16 19 55 10 0 100 1,253,297 100 1,039 303 630 48 1 2,021 52 15 31 2 0 100 Switzerland Rest of Europe Americas Asia / Pacific Africa / Middle East Total For the year ended 31 December 2001 Switzerland Rest of Europe Americas Asia / Pacific Africa / Middle East Total For the year ended 31 December 2000 Switzerland Rest of Europe Americas Asia / Pacific Africa / Middle East Total Total operating income Total assets Capital expenditure CHF million Share % CHF million Share % CHF million Share % 15,836 10,907 6,976 2,626 57 36,402 44 30 19 7 0 211,851 305,342 474,617 87,831 7,911 19 28 44 8 1 100 1,087,552 100 1,135 311 1,169 36 8 2,659 43 12 44 1 0 100 99 UBS Group Financial Statements Notes to the Financial Statements Income Statement Note 3 Net Interest and Trading Income Net interest Income CHF million For the year ended 31.12.02 31.12.01 31.12.00 % change from 31.12.01 Interest income Interest earned on loans and advances Interest earned on securities borrowed and reverse repurchase agreements Interest and dividend income from financial investments Interest and dividend income from trading portfolio Total Interest expense Interest on amounts due to banks and customers Interest on securities lent and repurchase agreements Interest and dividend expense from trading portfolio Interest on debt issued Total 11,600 16,955 20,413 11,184 165 17,014 39,963 6,383 10,081 8,366 4,587 29,417 18,337 453 16,532 52,277 14,088 14,517 7,815 7,816 44,236 19,088 402 11,842 51,745 15,660 14,915 5,309 7,731 43,615 Net interest income 10,546 8,041 8,130 (32) (39) (64) 3 (24) (55) (31) 7 (41) (33) 31 Net trading income CHF million For the year ended Equities Fixed income 1 Foreign exchange and other Net trading income 1 Includes commodities trading income. 31.12.02 31.12.01 31.12.00 % change from 31.12.01 2,638 1,061 1,873 5,572 4,026 2,731 2,045 8,802 7,754 912 1,287 9,953 (34) (61) (8) (37) Net interest and trading income CHF million For the year ended Net interest income Net trading income Total net interest and trading income Breakdown by business activity: Net income from interest margin products Net income from trading activities Net income from treasury activities Other 1 Total net interest and trading income 31.12.02 31.12.01 31.12.00 % change from 31.12.01 10,546 5,572 16,118 5,275 10,605 1,667 (1,429) 16,118 8,041 8,802 16,843 5,694 11,529 1,424 (1,804 ) 16,843 8,130 9,953 18,083 5,430 12,642 762 (751 ) 18,083 31 (37) (4) (7) (8) 17 21 (4) 1 Principally external funding costs of the Paine Webber Group, Inc. acquisition. 100 Note 4 Net Fee and Commission Income CHF million For the year ended 31.12.02 31.12.01 31.12.00 % change from 31.12.01 Underwriting fees Corporate finance fees Brokerage fees Investment fund fees Fiduciary fees Custodian fees Portfolio and other management and advisory fees Insurance-related and other fees Total securities trading and investment activity fees Credit-related fees and commissions Commission income from other services Total fee and commission income Brokerage fees paid Other Total fee and commission expense 2,134 848 5,987 4,033 300 1,302 4,065 417 19,086 275 1,006 20,367 1,349 797 2,146 2,158 1,339 6,445 4,276 355 1,356 4,650 538 1,434 1,772 5,742 2,821 351 1,439 3,666 111 21,117 17,336 307 946 310 802 22,370 18,448 1,281 878 2,159 1,084 661 1,745 Net fee and commission income 18,221 20,211 16,703 (1) (37) (7) (6) (15) (4) (13) (22) (10) (10) 6 (9) 5 (9) (1) (10) Note 5 Other Income CHF million For the year ended Gains/losses from disposal of associates and subsidiaries Net gain from disposal of: Consolidated subsidiaries Investments in associates Total Financial investments available for sale Net gain from disposal of: Private equity investments Other financial investments Impairment charges on private equity investments and other financial investments Total Net income from investments in property Equity in income of associates Other Total other income 31.12.02 31.12.01 31.12.00 % change from 31.12.01 228 0 228 273 457 (1,944) (1,214) 90 7 877 (12) 3 0 3 454 256 (1,294 ) (584 ) 68 72 999 558 57 26 83 919 162 (507 ) 574 96 58 675 1,486 (40) 79 (50) (108) 32 (90) (12) 101 UBS Group Financial Statements Notes to the Financial Statements Note 6 Personnel Expenses CHF million For the year ended Salaries and bonuses Contractors Insurance and social contributions Retirement benefit expenses Other personnel expenses Total personnel expenses 31.12.02 31.12.01 31.12.00 % change from 31.12.01 14,219 579 939 676 2,111 18,524 15,238 729 984 603 2,274 19,828 13,523 725 959 475 1,481 17,163 (7) (21) (5) 12 (7) (7) Note 7 General and Administrative Expenses CHF million For the year ended 31.12.02 31.12.01 31.12.00 % change from 31.12.01 Occupancy Rent and maintenance of machines and equipment Telecommunications and postage Administration Marketing and public relations Travel and entertainment Professional fees IT and other outsourcing Other Total general and administrative expenses 1,354 665 1,019 819 453 600 568 1,036 558 7,072 1,314 632 1,213 906 574 700 667 1,224 401 7,631 979 520 914 750 480 656 660 1,246 560 6,765 3 5 (16) (10) (21) (14) (15) (15) 39 (7) 102 Note 8 Earnings per Share (EPS) and Shares Outstanding For the year ended 31.12.02 31.12.01 31.12.00 % change from 31.12.01 Basic Earnings (CHF million) Net profit Amortization of goodwill and other intangible assets Net profit before goodwill amortization 1 Diluted Earnings (CHF million) Net profit Less: profit on own equity derivative contracts deemed dilutive Net profit for diluted EPS Amortization of goodwill and other intangible assets 3,535 2,1792 5,714 3,535 (20) 3,515 2,1792 Net profit for diluted EPS before goodwill amortization 1 5,694 4,973 1,323 6,296 7,792 667 8,459 4,973 7,792 (99 ) 4,874 1,323 6,197 (14 ) 7,778 667 8,445 Weighted average shares outstanding Weighted average shares outstanding Potentially dilutive ordinary shares resulting from options and warrants outstanding 3 Weighted average shares outstanding for diluted EPS 1,208,586,678 1,266,038,193 1,209,087,927 14,796,264 22,539,745 16,489,773 1,223,382,942 1,288,577,938 1,225,577,700 Earnings per share (CHF) Basic EPS Basic EPS before goodwill amortization 1 Diluted EPS Diluted EPS before goodwill amortization 1 2.92 4.73 2.87 4.65 3.93 4.97 3.78 4.81 6.44 7.00 6.35 6.89 (29) 65 (9) (29) 80 (28) 65 (8) (5) (34) (5) (26) (5) (24) (3) 2 Includes an income tax benefit of CHF 281 million for the writedown 1 Excludes the amortization of goodwill and other intangible assets. 3 Total equivalent shares outstanding on options that were not dilutive for the respective periods but could of the PaineWebber brandname. potentially dilute earnings per share in the future were 75,385,368, 28,741,886 and 27,524,280 for the years ended 31 December 2002, 31 December 2001 and 31 December 2000, respectively. Shares outstanding As at Total ordinary shares issued Own shares to be delivered Second trading line treasury shares 2000 program 2001 program 2002 first program 2002 second program Other treasury shares Total treasury shares Shares outstanding 31.12.02 31.12.01 31.12.00 1,256,297,678 1,281,717,499 1,333,139,187 28,444,788 55,265,349 23,064,356 67,700,000 6,335,080 23,146,014 18,190,595 0 97,181,094 41,254,951 55,265,349 1,159,116,584 1,240,462,548 1,306,318,626 % change from 31.12.01 (2) 27 136 (7) 103 UBS Group Financial Statements Notes to the Financial Statements Balance Sheet: Assets Note 9a Due from Banks and Loans By type of exposure CHF million Banks Allowance for credit losses Net due from banks Loans Mortgages Other loans Subtotal Allowance for credit losses Net loans Net due from banks and loans thereof subordinated By geographical region (based on the location of the borrower) CHF million Switzerland Rest of Europe Americas Asia / Pacific Africa / Middle East Subtotal Allowance for credit losses Net due from banks and loans By type of collateral CHF million Secured by real estate Collateralized by securities Guarantees and other collateral Unsecured Subtotal Allowance for credit losses Net due from banks and loans 31.12.02 31.12.01 32,911 (443) 32,468 127,869 88,590 216,459 (4,812) 211,647 244,115 115 31.12.02 151,604 38,131 48,412 10,002 1,221 249,370 (5,255) 244,115 31.12.02 129,525 26,769 12,398 80,678 249,370 (5,255) 244,115 28,261 (735) 27,526 126,211 107,512 233,723 (7,178) 226,545 254,071 249 31.12.01 158,996 42,279 42,809 15,986 1,914 261,984 (7,913) 254,071 31.12.01 128,259 30,635 20,217 82,873 261,984 (7,913) 254,071 104 Note 9b Allowances and Provisions for Credit Losses CHF million Specific Country risk allowances and allowances and provisions provisions Total 31.12.02 Total 31.12.01 Balance at the beginning of the year Write-offs Recoveries Increase / (decrease) in credit loss allowance and provision Foreign currency translation and other adjustments Balance at the end of the year CHF million As a reduction of Due from banks As a reduction of Loans Subtotal Included in other liabilities related to commitments and contingent liabilities Total allowances and provisions for credit losses 7,212 (2,508) 63 365 (247) 4,885 1,006 (28) 7 (159) (90) 736 8,218 (2,536) 70 206 (337) 5,621 10,581 (3,008) 81 498 66 8,218 31.12.02 31.12.01 443 4,812 5,255 366 5,621 735 7,178 7,913 305 8,218 Note 9c Impaired Loans CHF million Impaired loans 1, 2 Amount of allowance for credit losses related to impaired loans Average impaired loans 3 31.12.02 31.12.01 10,365 4,892 12,623 14,629 7,294 16,555 1 All impaired loans have a specific allowance for credit losses. million for 2001. 3 Average balances were calculated from quarterly data. 2 Interest income on impaired loans was CHF 428 million for 2002 and CHF 504 105 UBS Group Financial Statements Notes to the Financial Statements Note 9d Non-Performing Loans An impaired loan is classified as non-performing when the contractual payments of principal and/or interest are in arrears for 90 days or more. CHF million 31.12.02 31.12.01 Non-performing loans Amount of allowance for credit losses related to non-performing loans Average non-performing loans 1 1 Average balances are calculated from quarterly data. CHF million Non-performing loans at beginning of the year Net additions / (reductions) Write-offs and disposals Non-performing loans at the end of the year By type of exposure CHF million Banks Loans Mortgages Other Total loans Total non-performing loans By geographical region (based on the location of the borrower) CHF million Switzerland Rest of Europe Americas Asia / Pacific Africa / Middle East Total non-performing loans 6,029 3,485 7,361 8,639 5,374 9,648 31.12.02 31.12.01 8,639 (509) (2,101) 6,029 10,452 1,111 (2,924) 8,639 31.12.02 311 31.12.01 386 1,972 3,746 5,718 6,029 2,659 5,594 8,253 8,639 31.12.02 31.12.01 4,609 379 499 300 242 6,029 6,531 466 737 653 252 8,639 106 Note 10 Securities Borrowing, Securities Lending, Repurchase and Reverse Repurchase Agreements The Group enters into collateralized reverse repurchase and repurchase agreements and securities borrowing and securities lending transactions that may result in credit exposure in the event that the counterparty to the transaction is unable to fulfill its contractual obligations. The Group controls credit risk associated with these activities by monitoring counterparty credit exposure and collateral values on a daily basis and requiring additional collateral to be deposited with or returned to the Group when deemed necessary. Balance sheet assets CHF million By counterparty: Banks Customers Total Balance sheet liabilities CHF million By counterparty: Banks Customers Total Cash collateral on securities borrowed 31.12.02 Reverse Repurchase agreements 31.12.02 Cash collateral on securities borrowed 31.12.01 122,764 16,288 139,052 201,269 92,817 294,086 155,214 7,724 162,938 Cash collateral on securities lent 31.12.02 Repurchase agreements 31.12.02 Cash collateral on securities lent 31.12.01 29,748 7,122 36,870 200,904 165,954 366,858 27,640 2,677 30,317 Reverse Repurchase agreements 31.12.01 197,902 71,354 269,256 Repurchase agreements 31.12.01 213,942 154,678 368,620 Under reverse repurchase and securities borrowing arrangements, the Group obtains securities on terms which permit it to repledge or resell the securities to others. Amounts on such terms as at 31 December 2002 and 31 December 2001 were as follows: CHF million 31.12.02 31.12.01 Securities received under reverse repurchase and / or securities borrowing arrangements which can be repledged or resold 641,341 592,903 thereof repledged / transferred to others in connection with financing activities or to satisfy commitments under short sale transactions 530,188 474,963 107 UBS Group Financial Statements Notes to the Financial Statements Note 11 Trading Portfolio The Group trades money market paper, debt, equity, precious metals, foreign currency and deriva- tives to meet the financial needs of its customers and to generate revenue through its trading activi- ties. Note 23 provides a description of the various classes of derivatives together with the related notional amounts, whereas Note 10 provides further details about cash collateral on securities bor- rowed and lent and repurchase and reverse repurchase agreements. CHF million Trading portfolio assets Money market paper thereof pledged as collateral with central banks Debt instruments Swiss government and government agencies US Treasury and government agencies Other government agencies Corporate listed Other unlisted Total thereof pledged as collateral thereof can be repledged or resold by the counterparty Equity instruments Listed Unlisted Total thereof pledged as collateral thereof can be repledged or resold by the counterparty Traded loans Precious metals 31.12.02 31.12.01 45,310 10,475 1,140 71,884 50,296 73,268 39,613 236,201 132,221 92,460 66,150 4,841 70,991 18,614 17,905 11,533 7,401 63,164 29,895 1,246 95,203 18,811 108,114 26,642 250,016 153,464 101,517 67,772 6,367 74,139 21,264 19,939 6,139 4,428 Total trading portfolio assets 371,436 397,886 Trading portfolio liabilities Debt instruments Swiss government and government agencies US Treasury and government agencies Other government agencies Corporate listed Other unlisted Total Equity instruments 1,807 38,327 19,722 14,177 8,296 82,329 24,124 565 25,117 12,187 10,868 30,793 79,530 26,268 Total trading portfolio liabilities 106,453 105,798 108 Note 12 Financial Investments (available for sale) CHF million 31.12.02 31.12.01 Money market paper Other debt instruments Listed Unlisted Total Equity investments Listed Unlisted Total Private equity investments Total financial investments thereof eligible for discount at central banks 873 290 885 1,175 596 1,443 2,039 4,304 8,391 261 6,774 1,194 10,348 11,542 1,949 1,819 3,768 6,719 28,803 10,370 The following tables show the unrealized gains and losses not recognized in the income statement for the years ended 2002 and 2001. CHF million Fair value Gross gains Gross losses Net, before tax Tax effect Net, after tax Unrealized gains/losses not recognized in the income statement 31 December 2002 Money market paper Debt securities issued by the Swiss national government and agencies Debt securities issued by Swiss local governments Debt securities issued by US Treasury and agencies Debt securities issued by foreign governments and official institutions Corporate debt securities Mortgage-backed securities Other debt securities Equity securities Private equity investments Total 873 16 42 0 81 964 23 49 2,039 4,304 8,391 0 1 2 0 1 7 1 1 335 966 1,314 0 0 0 0 0 0 0 1 31 223 255 0 1 2 0 1 7 1 0 304 743 0 0 0 0 0 1 0 0 82 30 1,059 113 0 1 2 0 1 6 1 0 222 713 946 CHF million Fair value Gross gains Gross losses Net, before tax Tax effect Net, after tax Unrealized gains/losses not recognized in the income statement 31 December 2001 Money market paper Debt securities issued by the Swiss national government and agencies Debt securities issued by Swiss local governments Debt securities issued by US Treasury and agencies Debt securities issued by foreign governments and official institutions Corporate debt securities Mortgage-backed securities Other debt securities Equity securities Private equity investments Total 6,774 36 45 32 10,089 1,218 5 117 3,768 6,719 28,803 1 1 1 2 31 4 0 0 627 1,189 1,856 0 0 0 0 1 2 0 0 65 539 607 1 1 1 2 30 2 0 0 562 650 1,249 0 0 0 1 11 0 0 0 187 15 214 1 1 1 1 19 2 0 0 375 635 1,035 109 UBS Group Financial Statements Notes to the Financial Statements Note 12 Financial Investments (available for sale) (continued) Contractual maturities of the investments in debt instruments1 CHF million, except percentages Amount Yield (%) Amount Yield (%) Amount Yield (%) Amount Yield (%) Within 1 year 1–5 years 5–10 years Over 10 years 31 December 2002 Swiss national government and agencies Swiss local governments Foreign governments and official institutions Corporate debt securities Mortgage-backed securities Other debt securities Total fair value 0 8 35 675 4 1 723 0.00 4.02 4.63 2.23 2.25 4.77 7 30 45 249 15 48 394 4.88 3.94 3.13 2.64 3.97 2.65 8 4 1 19 4 0 36 3.86 3.59 6.12 3.41 4.03 0.00 1 0 0 21 0 0 22 4.00 0.00 0.00 8.02 0.00 0.00 1 Money market papers have contractual maturities of less than one year. Proceeds from sales and maturities of investment securities available for sale, excluding private equity, were as follows: CHF million Proceeds Gross realized gains Gross realized losses Note 13 Investments in Associates CHF million Carrying amount at the beginning of the year Additions Disposals Income Write-offs Dividend paid Foreign currency translation Carrying amount at the end of the year 31.12.02 1,820 479 (21) 31.12.01 27,910 223 (28) 31.12.02 31.12.01 697 51 (1) 24 (17) (44) (5) 705 880 11 (216)1 74 (2) (48) (2) 697 1 Includes a transfer of CHF 172 million to Financial Investments following a review of the level of influence by the bank over certain investees. The impact of this reclassification on net profit is immaterial. 110 Note 14 Property and Equipment CHF million Historical cost Balance at the beginning of the year Additions Disposals / write-offs 2 Reclassifications Foreign currency translation Balance at the end of the year Accumulated depreciation Balance at the beginning of the year Depreciation Disposals / write-offs 2 Reclassifications Foreign currency translation Balance at the end of the year Bank- occupied Investment properties1 properties IT, soft- ware and communi- Other machines and cation equipment 9,297 147 (62 ) (34 ) (41 ) 9,307 4,039 224 (34 ) (10 ) (9 ) 4,210 893 366 (747 ) 50 (2 ) 560 239 28 (100 ) 44 0 211 349 5,146 811 (1,330 ) 51 (339 ) 4,3394 3,932 926 (1,316 ) (2 ) (300 ) 3,240 1,099 4,143 439 (449 ) (53 ) (336 ) 3,744 2,574 343 (336 ) 3 (164 ) 2,420 1,324 31.12.02 31.12.01 19,479 1,763 (2,588) 14 (718) 17,950 10,784 1,521 (1,786) 35 (473) 10,081 18,631 2,021 (715) (482) 24 19,479 9,721 1,654 (403) (189) 1 10,784 7,869 8,695 Net book value at the end of the year 3 5,097 1 The fair value of Investment properties was CHF 539 million at 31 December 2002 and CHF 990 million at 31 December 2001. write-offs of fully depreciated assets. 4 Includes accumulated costs for projects in progress of CHF 234 million at 31 December 2002 (CHF 351 million at 31 December 2001). 2 Includes 3 Fire insurance value of property and equipment is CHF 14,221 million (2001: CHF 15,531 million). Note 15 Goodwill and Other Intangible Assets CHF million Goodwill Other intangible assets Total Brand- name Infra- structure Customer lists and other Historical cost Balance at the beginning of the year 16,819 9 Additions and reallocations (98 ) Disposals and other reductions Write-offs 1 0 (2,773 ) Foreign currency translation 13,957 Balance at the end of the year Accumulated amortization Balance at the beginning of the year Amortization Disposals Write-offs 1 Foreign currency translation Balance at the end of the year 2,241 930 (13 ) 0 (382 ) 2,776 1,293 281 0 (1,350 ) (224 ) 0 76 1,306 0 (1,350 ) (32 ) 0 1,293 0 0 0 (224 ) 1,069 76 54 0 0 (14 ) 116 2,387 0 (17 ) 0 (374 ) 1,996 314 170 (15 ) 0 (35 ) 434 Total 31.12.02 31.12.01 4,973 281 (17 ) (1,350 ) (822 ) 3,065 466 1,530 (15 ) (1,350 ) (81 ) 550 21,792 290 (115) (1,350) (3,595) 17,022 2,707 2,460 (28) (1,350) (463) 3,326 21,166 456 0 (247) 417 21,792 1,629 1,323 0 (247) 2 2,707 Net book value at the end of the year 11,181 0 953 1,562 2,515 13,696 19,085 1 Represents write-offs of fully amortized goodwill and other intangible assets. 111 UBS Group Financial Statements Notes to the Financial Statements Note 15 Goodwill and Other Intangible Assets (continued) The following table presents the disclosure of goodwill and other intangible assets by Business Group for the year ended 31 December 2002. CHF million Goodwill UBS Wealth Management & Business Banking UBS Global Asset Management UBS Warburg UBS PaineWebber Corporate Center UBS Group Other Intangible Assets UBS Wealth Management & Business Banking UBS Global Asset Management UBS Warburg UBS PaineWebber Corporate Center UBS Group Balance at the beginning of the year Additions and reallo- cations 1,305 2,926 4,950 5,390 7 14,578 65 2 390 3,942 108 4,507 0 0 0 0 9 9 0 0 0 281 0 281 Disposals and other Balance at the end reductions Amortization translation of the year Foreign currency (8 ) (5 ) (25 ) (33 ) (14 ) (85) (2 ) 0 0 0 0 (2) (81 ) (269 ) (315 ) (264 ) (1 ) (930) (30 ) (1 ) (49 ) (1,427 ) (23 ) (1,530) (213 ) (467 ) (817 ) (894 ) 0 1,003 2,185 3,793 4,199 1 (2,391) 11,181 0 0 (63 ) (662 ) (16 ) (741) 33 1 278 2,134 69 2,515 Until 31 December 2001, goodwill and other intangible assets relating to the merger of UBS and PaineWebber were reported in the UBS Warburg Business Group. With the separation of UBS PaineWebber from UBS Warburg at 1 January 2002, goodwill and other intangible assets have been allocated to the Business Groups that have benefited from the merger with PaineWebber. For further information about disclosure by Business Group, including the amortization of goodwill and other intangible assets of previous years, please see Note 2a: Segment Reporting by Business Group. The estimated, aggregated amortization expenses for Goodwill and Other intangible assets are as follows: CHF million Estimated, aggregated amortization expenses for: 2003 2004 2005 2006 2007 2008 and thereafter Total Goodwill Other intangible assets 817 769 738 702 646 7,509 11,181 189 170 166 153 144 1,693 2,515 Total 1,006 939 904 855 790 9,202 13,696 112 Note 16 Other Assets CHF million Deferred tax assets Settlement and clearing accounts VAT and other tax receivables Prepaid pension costs Properties held for resale Other receivables Total other assets Note 21 31.12.02 31.12.01 2,800 1,449 436 250 1,071 2,946 8,952 3,449 1,431 452 567 844 3,132 9,875 113 UBS Group Financial Statements Notes to the Financial Statements Balance Sheet: Liabilities Note 17 Due to Banks and Customers CHF million Due to banks Due to customers in savings and investment accounts Other amounts due to customers Total due to customers Total due to banks and customers 31.12.02 83,178 76,884 229,992 306,876 390,054 31.12.01 106,531 67,782 265,999 333,781 440,312 Note 18 Debt Issued The Group issues both CHF and non-CHF denominated fixed and floating rate debt. Float- ing rate debt generally pays interest based on the three-month or six-month London Interbank Offered Rate (LIBOR). Subordinated debt securities are unsecured obligations of the Group and are subordinated in right of payment to all present and future sen- ior indebtedness and certain other obligations of the Group. At 31 December 2002 and 31 De- cember 2001, the Group had CHF 9,933 million and CHF 13,571 million, respectively, in subor- dinated debt. Subordinated debt usually pays interest annually and provides for single prin- cipal payments upon maturity. At 31 Decem- ber 2002 and 31 December 2001, the Group had CHF 46,678 million and CHF 43,641 million, respectively, in unsubordinated debt (excluding money market paper). The Group issues debt with returns linked to equity, interest rates, foreign exchange and credit instruments or indices. As described in Note 1r), derivatives embedded in these instruments are separated from the host debt contract and reported as stand-alone derivatives. The amount recorded within Debt Issued represents the host contract after the separation of the embedded derivative. At 31 December 2002 and 31 De- cember 2001, the Group had CHF 1,389 million and CHF 1,397 million, respectively, in convert- ible and exchangeable debt on UBS shares and notes with warrants attached on UBS shares out- standing. In addition the Group uses interest rate and foreign exchange derivatives to manage the risks inherent in certain debt issues. In the case of interest rate risk management, the Group applies hedge accounting as discussed in Note 1 – Summary of Significant Accounting Policies and Note 23 – Derivative Instruments. As a result of applying hedge accounting, the carrying value of debt issued is CHF 1,361 million higher reflecting changes in fair value due to interest rate movements. 114 Note 18 Debt Issued (continued) CHF million Money market paper issued Bonds issued Shares in bond issues of the Swiss Regional or Cantonal Banks’ Central Bond Institutions Medium-term notes Total debt issued 31.12.02 72,800 51,872 517 4,222 129,411 31.12.01 99,006 51,061 934 5,217 156,218 The following table shows the split between fixed and floating rate debt issues based on the contrac- tual terms. However it should be noted that the Group uses interest rate swaps to hedge many of the fixed rate debt issues, which changes their re-pricing characteristics into those of floating rate debt. Contractual maturity date UBS AG (Parent Bank) Subsidiaries CHF million 2003 2004 2005 2006 2007 2008–2010 Thereafter Total Fixed rate 24,010 4,965 4,998 3,359 3,166 1,714 2,726 44,938 Floating rate 244 609 726 790 1,564 1,048 6,672 11,653 Fixed rate 52,095 1,432 907 8,000 1,105 2,476 269 66,284 Floating rate 70 574 382 439 70 1,949 3,052 6,536 Total 31.12.02 76,419 7,580 7,013 12,588 5,905 7,187 12,719 129,411 The table below shows the notional amount and stated interest rate on the Group’s publicly placed bonds prior to the separation of any embedded derivatives or the application of hedge accounting, where applicable. As a result, the notional amount shown does not necessarily correspond to the car- rying amount of the debt and the stated interest rate on the debt does not necessarily reflect the effec- tive interest rate the Group is paying to service its debt after the separation of embedded derivatives and the application of hedge accounting, where applicable. Publicly placed bond issues of UBS AG (Parent Bank) outstanding as at 31.12.2002 1 Year of issue Interest rate in % 2001 2002 2001 2002 1993 2001 2001 2002 2002 1997 1998 1993 1993 16.000 0.000 8.000 11.250 4.875 8.750 13.500 0.000 FRN 1.500 FRN 3.500 4.000 Remarks Maturity GOAL on Siemens CLN Linked to GECC GOAL on UBS GOAL on Royal Dutch Petroleum subordinated GOAL on General Electric GOAL on Nokia Oyj Linked to 30yr OAT CLN Linked to GECC Indexed to UBS Currency Portfolio Convertible into UBS Dutch Corporate Basket subordinated subordinated 17.01.2003 18.02.2003 26.02.2003 28.02.2003 03.03.2003 07.03.2003 10.03.2003 11.03.2003 14.03.2003 14.03.2003 20.03.2003 31.03.2003 31.03.2003 Protected Index Participation PIP Protected Equity Participation PEP GOAL Geld- oder Aktien-Lieferung (cash or share delivery) BULS Bullish Underlying Linked Securities GROI Guaranteed Return On Investment FRN CLN Floating Rate Note Credit Linked Note Early redemption option Currency Notional amounts in millions in local currency EUR EUR CHF EUR CHF USD EUR GBP USD EUR EUR CHF CHF 55 50 220 95 200 125 45 50 100 51 57 200 200 115 UBS Group Financial Statements Notes to the Financial Statements Note 18 Debt Issued (continued) Publicly placed bond issues of UBS AG (Parent Bank) outstanding as at 31.12.20021 Year of issue Interest rate in % Remarks Maturity Early redemption option Currency Notional amounts in millions in local currency 2001 2001 2002 2001 2002 2001 2001 2001 1995 2001 2002 2002 2002 1993 2002 1994 2002 2002 2002 2002 2001 1991 1999 2001 1997 1995 1995 2002 2002 1995 2002 2002 2002 1995 2002 1998 1995 2002 1995 2002 1995 2002 1999 2001 1996 1996 2000 1996 2001 Protected Index Participation PIP Protected Equity Participation PEP GOAL Geld- oder Aktien-Lieferung (cash or share delivery) BULS Bullish Underlying Linked Securities GROI Guaranteed Return On Investment FRN CLN Floating Rate Note Credit Linked Note 116 BULS on technology stock basket BULS on Celestica and others GOAL on UBS GOAL on Deutsche Bank GOAL on DJ Euro Stoxx 50 index GOAL on Aventis GOAL on Total SA GOAL on E.ON AG subordinated GOAL on Pfizer GOAL on SUEZ SA (Suez) GOAL on Royal Dutch Petroleum CLN Linked to Allianz AG 0.000 0.000 9.500 10.250 9.500 7.250 6.000 7.750 5.250 8.250 9.500 13.000 FRN 3.000 Linked to Basket of Common Stock 0.000 subordinated 6.250 7.750 GOAL on Novartis 5.125 GOAL on General Electric Company GOAL on Unilever NV 6.000 6.250 GOAL on Nestlé AG 0.000 Cliquet GROI on NASDAQ 100 Index 4.250 subordinated 3.500 1.750 7.380 4.000 5.500 0.000 0.500 5.625 0.000 Exchangeable bonds on Yukos subordinated subordinated Convertible into Nasdaq 100 Index Equity GROI Convertible into STOXX 50 Index subordinated GROI on FTSE 100 Index Principal Protected Note Linked to NASDAQ 100-Index Exchangeable Bonds on Yukos subordinated GROI – Australian Growth Guaranteed Fund II subordinated subordinated Cliquet GROI – Units on SMI Index subordinated Exchangeable Bonds on Yukos Exchangeable Bonds on Yukos Straight Bond Equity Exchangeables into Euro. Insurance Basket subordinated Straight Bond subordinated BULS on S&P 500 0.000 0.000 8.750 0.000 6.750 5.250 0.000 5.000 0.125 4.500 0.250 3.500 1.000 4.250 4.000 2.500 7.250 0.000 10.04.2003 28.04.2003 22.05.2003 30.05.2003 02.06.2003 05.06.2003 11.06.2003 17.06.2003 20.06.2003 16.07.2003 04.09.2003 06.10.2003 24.10.2003 26.11.2003 02.12.2003 06.01.2004 28.01.2004 30.01.2004 06.02.2004 14.05.2004 27.05.2004 25.06.2004 01.07.2004 31.08.2004 26.11.2004 07.02.2005 10.02.2005 07.03.2005 21.03.2005 13.04.2005 25.04.2005 04.05.2005 19.06.2005 20.06.2005 21.06.2005 15.07.2005 18.07.2005 25.07.2005 24.08.2005 19.09.2005 21.11.2005 19.12.2005 26.01.2006 01.02.2006 06.02.2006 14.02.2006 29.03.2006 17.07.2006 01.09.2006 01.02.2004 USD USD CHF EUR EUR EUR EUR EUR CHF USD EUR EUR USD CHF USD USD CHF USD EUR CHF USD CHF EUR USD GBP CHF CHF AUD EUR CHF GBP USD USD GBP AUD USD CHF CHF CHF USD CHF USD EUR EUR CHF CHF CHF USD USD 78 40 110 40 50 75 45 40 200 70 35 35 150 200 63 300 100 75 40 100 42 300 250 310 250 150 150 233 75 150 46 46 120 249 67 200 200 53 250 120 300 160 650 100 250 200 250 500 54 Note 18 Debt Issued (continued) Publicly placed bond issues of UBS AG (Parent Bank) outstanding as at 31.12.20021 Year of issue Interest rate in % Remarks Maturity Early redemption option Currency Notional amounts in millions in local currency 1996 2001 2001 2002 1995 2002 1996 2001 1997 1997 1997 2002 2002 2002 2002 2002 2002 2002 2002 2002 2002 2002 2002 1998 1997 2002 1995 1995 1997 1995 1995 1996 7.250 5.500 0.000 FRN 5.000 FRN 6.250 0.000 8.000 8.000 5.750 FRN 1.000 FRN 0.500 0.500 0.250 FRN 0.500 0.000 7.250 1.250 5.000 3.500 5.875 FRN 7.375 7.000 7.375 7.500 8.750 7.750 subordinated GOAL on UBS Cliquet GROI-Units on Nasdaq 100-Index Callable Daily Range Accrual Note subordinated Callable Daily Range Accrual Note subordinated Zero-rate Note O’Connor Fund subordinated subordinated subordinated Step-Up Callable Daily Range Accrual Note Exchangeable on DJ Euro Stoxx 50E CLN Exchangeable Bond on the S&P 500 Index Exchangeable Bond on the DJ Euro STOXX 50 Exchangeable Bond on the SMI Callable Daily Range Accrual Note Exchangeable bond on Royal Dutch Petroleum Principal Protected Notes Linked to the S&P 500 Index GOAL on Royal Dutch Petroleum Linked to Nikkei 225 Index Linked to Nikkei 225 Index subordinated Callable Daily Range Accrual Note subordinated subordinated subordinated subordinated subordinated subordinated 01.09.2006 02.10.2006 19.10.2006 07.11.2006 07.11.2006 13.11.2006 06.12.2006 29.12.2006 08.01.2007 08.01.2007 12.03.2007 15.07.2007 23.07.2007 01.09.2007 05.09.2007 05.09.2007 05.09.2007 02.10.2007 30.10.2007 07.11.2007 14.11.2007 28.11.2007 19.12.2007 27.08.2008 18.08.2009 23.10.2012 15.07.2015 15.10.2015 15.06.2017 15.07.2025 18.12.2025 01.09.2026 07.02.2003 12.02.2003 15.01.2003 02.01.2003 23.01.2003 USD CHF USD USD CHF USD EUR EUR GBP GBP EUR USD EUR USD USD EUR CHF USD EUR USD EUR JPY JPY CHF EUR USD USD USD USD USD GBP USD Protected Index Participation PIP PEP Protected Equity Participation GOAL Geld- oder Aktien-Lieferung (cash or share delivery) BULS Bullish Underlying Linked Securities GROI Guaranteed Return On Investment FRN CLN Floating Rate Note Credit Linked Note 150 106 39 56 250 40 254 40 242 302 204 67 50 50 40 35 75 61 100 52 150 7,742 5,537 300 305 64 150 300 300 350 149 300 117 UBS Group Financial Statements Notes to the Financial Statements Note 18 Debt Issued (continued) Publicly placed bond issues of UBS subsidiaries outstanding as at 31.12.2002 1 Year of issue Interest rate in % Remarks Maturity Early redemption option Currency Brooklands Euro Referenced Linked Notes 2001-1 Ltd 2002 2002 2002 2002 2001 2001 2.594 3.480 3.293 3.893 FRN FRN 15.12.2012 15.12.2012 23.12.2012 23.12.2012 20.12.2013 20.12.2013 Alpine Partners L.P. 2000 FRN North Street 2000 2002 2002 2000 2000 2000 2002 2002 2002 2002 2002 2002 2001 2001 2001 2001 FRN FRN FRN 20.000 FRN 18.000 FRN 20.000 FRN 5.160 FRN FRN FRN FRN FRN FRN UBS Americas Inc. (former PaineWebber) 1993 2000 1998 1998 1999 1999 1995 1999 1993 1996 1998 1998 1998 1996 1999 1994 7.875 1.270 6.320 6.450 FRN 6.375 8.875 2.210 6.500 6.750 6.720 6.730 6.550 7.625 7.625 7.625 Eisberg Finance Ltd. 1998 1998 1998 FRN FRN FRN 08.10.2009 08.01.2003 20.08.2003 28.04.2011 28.04.2011 28.04.2011 28.04.2011 30.10.2011 30.10.2011 30.01.2016 30.01.2016 30.01.2016 30.01.2016 30.01.2016 20.08.2030 30.04.2031 30.04.2031 30.07.2031 30.07.2031 17.02.2003 13.03.2003 18.03.2003 01.12.2003 11.05.2004 17.05.2004 15.03.2005 15.03.2005 01.11.2005 01.02.2006 01.04.2008 03.04.2008 15.04.2008 15.10.2008 01.12.2009 17.02.2014 15.06.2004 15.06.2004 15.06.2004 10.10.2003 10.10.2003 10.10.2003 EUR EUR EUR EUR EUR EUR USD USD USD USD USD USD USD USD USD USD USD USD USD USD USD USD USD USD JPY USD USD USD USD USD USD USD USD USD USD USD USD USD USD USD USD USD Notional amounts in millions in local currency 100 75 75 35 50 50 445 40 100 50 43 61 43 40 49 46 61 353 100 60 100 100 60 100 9,000 45 340 45 525 125 45 200 100 35 43 250 150 275 200 83 65 41 Protected Index Participation PIP PEP Protected Equity Participation GOAL Geld- oder Aktien-Lieferung (cash or share delivery) BULS Bullish Underlying Linked Securities GROI Guaranteed Return On Investment FRN CLN Floating Rate Note Credit Linked Note 118 Note 18 Debt Issued (continued) Publicly placed bond issues of UBS subsidiaries outstanding as at 31.12.2002 1 Year of issue Interest rate in % UBS Finance N.V., Curaçao 1997 1998 0.000 0.000 UBS Australia Holdings Ltd. 1999 5.000 UBS Warburg AG 0.000 1998 0.000 2001 0.000 2001 0.000 2001 0.000 2001 0.000 2001 0.000 2001 0.000 2002 0.000 2002 0.000 2002 0.000 2002 0.000 2002 0.000 2002 0.000 2002 0.000 2002 0.000 2002 0.000 2002 0.000 2002 0.000 2001 0.000 2001 0.000 2001 0.000 2002 0.000 2002 0.000 2001 0.000 2001 0.000 2002 Remarks Maturity Early redemption option Currency Notional amounts in millions in local currency Zero Coupons Zero Coupons 29.01.2027 03.03.2028 03.03.2003 European commercial paper 25.02.2004 19.12.2005 30.06.2006 30.06.2006 31.07.2006 08.08.2006 30.09.2006 30.09.2006 31.12.2006 31.12.2006 31.12.2006 31.12.2006 31.12.2006 31.12.2006 31.12.2006 31.12.2006 31.12.2006 31.12.2006 31.12.2006 02.01.2007 02.01.2007 02.01.2007 30.03.2007 31.12.2007 30.09.2011 31.12.2011 28.09.2012 30.06.2003 30.06.2003 30.06.2003 30.06.2003 30.06.2003 30.06.2003 30.06.2003 30.06.2003 30.06.2003 30.06.2003 30.06.2003 30.06.2003 30.06.2003 30.06.2003 30.06.2003 30.06.2003 30.06.2003 30.06.2003 30.06.2003 30.06.2003 30.06.2003 31.03.2003 30.06.2003 30.06.2003 EUR EUR AUD EUR EUR USD EUR EUR USD CHF USD EUR USD EUR EUR EUR USD EUR CHF USD USD EUR EUR EUR EUR EUR EUR EUR EUR 226 81 104 56 505 202 500 77 200 200 350 300 350 450 300 450 250 250 250 250 250 100 100 100 60 50 50 150 50 1 In this table only publicly placed bonds with a carrying value exceeding CHF 50 million (prior to the elimination of own bonds held) have been disclosed. The total carrying amount of the bonds disclosed in this table is CHF 34,320 million. The total carrying amount of publicly placed bonds of UBS Group (prior to the elimination of own bonds held) is CHF 44,759 million of the total bond issues. Protected Index Participation PIP PEP Protected Equity Participation GOAL Geld- oder Aktien-Lieferung (cash or share delivery) BULS Bullish Underlying Linked Securities GROI Guaranteed Return On Investment FRN CLN Floating Rate Note Credit Linked Note 119 UBS Group Financial Statements Notes to the Financial Statements Note 19 Other Liabilities CHF million Note 31.12.02 31.12.01 Provisions Provision for commitments and contingent liabilities Current tax liabilities Deferred tax liabilities VAT and other tax payables Settlement and clearing accounts Other payables 20 9b 21 1,375 366 2,079 2,239 613 1,354 4,313 1,748 305 1,799 2,827 622 4,473 3,884 Total other liabilities 12,339 15,658 Note 20 Provisions CHF million Operational Litigation Balance at the beginning of the year New provisions charged to income Recoveries Provisions applied Reclassifications Foreign currency translation Balance at the end of the year 1,036 210 16 (439 ) (9 ) (93 ) 721 712 478 9 (463 ) 9 (91 ) 654 Total 31.12.02 Total 31.12.01 1,748 688 25 (902) 0 (184) 1,375 2,294 384 95 (1,115) 64 26 1,748 Note 21 Income Taxes CHF million For the year ended Domestic Current Deferred Foreign Current Deferred Total income tax expense 31.12.02 31.12.01 31.12.00 938 (32) 249 (477) 678 563 231 546 61 1,401 1,325 233 451 311 2,320 The Group made net tax payments, including domestic and foreign taxes, of CHF 572 million, CHF 1,742 million and CHF 959 million for the full years of 2002, 2001 and 2000, respectively. 120 Note 21 Income Taxes (continued) The components of operating profit before tax, and the differences between income tax expense reflected in the financial statements and the amounts calculated at the Swiss statutory rate of 25% are as follows: CHF million For the year ended Operating profit before tax Domestic Foreign Income taxes at Swiss statutory rate of 25% Increase / (decrease) resulting from: Applicable tax rates differing from Swiss statutory rate Tax losses not recognized Previously unrecorded tax losses now recognized Lower taxed income Non-deductible goodwill amortization Other non-deductible expenses Adjustments related to prior years and other Change in deferred tax valuation allowance Income tax expense 31.12.02 31.12.01 31.12.00 4,544 6,510 (1,966) 1,136 (341) 51 (349) (378) 291 301 (122) 89 678 6,718 5,565 1,153 1,680 (239 ) 77 (630 ) (499 ) 429 134 371 78 10,199 7,079 3,120 2,550 (336) 164 (655) (401) 159 432 245 162 1,401 2,320 Significant components of the Group’s gross deferred income tax assets and liabilities are as follows: CHF million Deferred tax assets Compensation and benefits Allowance for credit losses Net operating loss carry forwards Trading assets Other Total Valuation allowance Net deferred tax assets Deferred tax liabilities Property and equipment Investments Other provisions Trading assets Other Total deferred tax liabilities 31.12.02 31.12.01 1,559 84 2,883 330 779 5,635 (2,835) 2,800 412 430 470 182 745 2,239 1,778 122 2,902 259 1,365 6,426 (2,977) 3,449 449 464 571 298 1,045 2,827 The change in the balance of net deferred tax assets and deferred tax liabilities does not equal the deferred tax expense in those years. This is due to the effect of foreign currency rate changes on tax assets and liabilities denominated in currencies other than CHF. Certain foreign branches and subsidiaries of the Group have deferred tax assets related to net operating loss carry forwards and other items. Due to realization of these assets being uncertain, the Group has established valuation allowances of CHF 2,835 million (CHF 2,977 million at 31 December 2001). For companies that suffered tax losses in either the current or preceding year an amount of CHF 947 million (CHF 965 million at 31 December 2001) has been recognized as deferred tax assets based on expectations that sufficient taxable income will be generated in future years to utilize the tax loss carry forwards. The Group provides deferred income taxes on undistributed earnings of non-Swiss subsidiaries except to the extent that such earnings are indefinitely invested. In the event these earnings were dis- tributed, additional taxes of approximately CHF 40 million would be due. 121 UBS Group Financial Statements Notes to the Financial Statements Note 21 Income Taxes (continued) At 31 December 2002 net operating loss carry forwards totaling CHF 6,572 million are available to reduce future taxable income of certain branches and subsidiaries. The carry forwards expire as follows: Within 1 year From 2 to 4 years After 4 years Total Note 22 Minority Interests CHF million Balance at the beginning of the year Issuance of trust preferred securities Other increases Decreases and dividend payments Foreign currency translation Minority interest in net profit Balance at the end of the year 31.12.02 29 252 6,291 6,572 31.12.02 31.12.01 4,112 0 172 (377) (709) 331 3,529 2,885 1,291 0 (461) 53 344 4,112 Note 23 Derivative Instruments Type of derivatives The Group uses the following derivative finan- cial instruments for both trading and hedging purposes: Swaps are transactions in which two parties exchange cash flows on a specified notional amount for a predetermined period. The major types of swap transaction undertaken by the Group are as follows: – Interest rate swap contracts generally entail the contractual exchange of fixed and floating rate interest payments in a single currency, based on a notional amount and an interest reference rate. – Cross currency swaps involve the exchange of interest payments based on two different currency principal balances and interest refer- ence rates and generally also entail exchange of principal amounts at the start and / or end of the contract. – Credit default swaps (CDS) are the most com- mon form of credit derivative, under which the party buying protection makes one or more payments to the party selling protection during the life of the swap in exchange for an under- taking by the seller to make a payment to the buyer following a credit event, as defined in the contract, with respect to a third party. Settle- ment following a credit event may be a cash amount, or cash in return for physical delivery of one or more deliverable obligations of the credit entity, as defined in the contract and is made regardless of whether the protection buyer has suffered a loss. After a credit event and settlement, the contract is terminated. – Total Rate of Return Swaps give the total return receiver exposure to all of the cash flow and economic benefits and risks of an under- lying security without actually owning the security, while the total return payer has a synthetic short position in the underlying reference security. Forwards and futures are contractual obligations to buy or sell financial instruments or commodi- ties on a future date at a specified price. Forward contracts are tailor-made agreements that are transacted between counterparties in the over- the-counter (OTC) market, whereas futures are 122 standardized contracts transacted on regulated exchanges. ments are explained in Note 1 v) where terms used in the following sections are explained. Options are contractual agreements under which the seller (writer) grants the purchaser the right, but not the obligation, either to buy (call option) or to sell (put option) by or at a set date, a speci- fied amount of a financial instrument or com- modity at a predetermined price. The seller receives a premium from the purchaser for this right. Options may be traded OTC or on a regulated exchange. Derivatives transacted 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 competi- tive prices to enable them to take, transfer, modify or reduce current or expected risks. Trading includes market-making, positioning and arbitrage activities: market-making involves quoting bid and offer prices to other market par- ticipants with the intention of generating rev- enues based on spread and volume; positioning means managing market risk positions with the expectation of profiting from favorable move- ments in prices, rates or indices; arbitrage activ- ities involve identifying and profiting from price differentials between markets and products. Derivatives transacted for hedging purposes The Group enters into derivative transactions which are designated and qualify as either fair value or cash flow hedges for recognized assets or liabilities or forecast transactions. It also enters into derivative transactions which provide eco- nomic hedges for risk exposures but do not meet the accounting requirements for hedge account- ing treatment. As stated in Note 1, Summary of Significant Accounting Policies, part v) Deriva- tive instruments and hedging, the Group uses CDSs as economic hedges for credit risk expo- sures in the loan and traded product portfolios but cannot apply hedge accounting to such posi- tions. Gains or losses on these CDSs have there- fore been recorded in trading income. Derivatives designated and accounted for as hedging instruments The Group’s accounting policies for derivatives designated and accounted for as hedging instru- Fair value hedges The Group’s fair value hedges principally consist of interest rate swaps that are used to protect against changes in the fair value of fixed-rate long-term debt due to changes in market interest rates. For the year ended 31 December 2002, the Group recognized a net loss of CHF 10 million (reported as Net trading income in the Financial Statements), which represents the ineffective portion of fair value hedges. As at 31 December 2002, the fair value of out- standing derivatives designated as fair value hedges was a CHF 1,925 million net positive replacement value. Cash flow hedges of individual variable rate assets and liabilities The Group uses interest rate swaps to protect against changes in cash flows of certain variable rate debt issues. For the year ended 31 December 2002, there has been no material gain or loss associated with ineffective portions of cash flow hedges. Gains and losses on derivative contracts designated as cash flow hedges are initially recorded in Shareholders’ equity but are reclas- sified to current period earnings when the hedged cash flows occur, as explained in Note 1, part v) Derivative instruments and hedging. As at 31 December 2002, deferred net gains on derivative instruments designated as cash flow hedges accumulated in Shareholders’ equity were CHF 2 million. Cash flow hedges of forecast transactions The Group applies hedge accounting for its non- trading interest rate risk in major currencies by analyzing expected cash flows on an enterprise basis. The objective is to protect against changes in future interest cash flows resulting from the impact of changes in market interest rates on reinvestment or reborrowing of current balances and expected future cash flows. The Group accu- mulates information about financial assets and liabilities, and thereby estimates and aggregates the amounts and timing of future period cash flows, based on the contractual terms of instru- ments and other factors including estimates of prepayments and defaults. The aggregate cash flows form the basis for identifying the non-trad- 123 UBS Group Financial Statements Notes to the Financial Statements ing interest rate risk of the Group, which is hedged with interest rate swaps, which extend over a twenty-four-year period. The schedule of forecast principal cash flows as at 31 December 2002 is as follows: CHF billion < 1 year 1–3 years 3–5 years 5–10 years over 10 years Cash inflows (Assets) Cash outflows (Liabilities) Net cash flows 119 159 (40) 202 247 (45) 124 193 (69) 128 324 (196) 8 237 (229) Gains and losses on derivatives designated as cash flow hedges of forecast transactions are initially recorded in Shareholders’ equity as “Gains / losses not recognized in the income statement” and transferred to current period earnings when the forecast cash flows occur. As at 31 December 2002, the fair value of outstand- ing derivatives designated as cash flow hedges of forecast transactions was a CHF 181 million net unrealized loss. Amounts reclassified from Gains / losses not recognized in the income state- ment to current period earnings due to discontin- uation of hedge accounting were immaterial. 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 trans- actions. The notional amount is a derivative’s under- lying contract amount and is the basis upon which changes in the value of derivatives are measured. It provides an indication of the under- lying volume of business transacted by the Group but does not provide any measure of risk. The majority of derivatives are negotiated as to amount, tenor and price, between the bank and its counterparty, whether other professionals or customers (OTC). The rest are standardized in terms of their amounts and settlement dates and are bought and sold in organized markets (exchange traded). Positive replacement value represents the cost to the Group of replacing all transactions with a fair value in the Group’s favour if all the relevant counterparties of the Group were to default at the same time, and transactions could be re- placed instantaneously. Negative replacement value is the cost to the Group’s counterparties of replacing all their transactions with the Group where the fair value is in their favor if the Group were to default. The total positive and negative replacement values are included in the balance sheet separately. For internal credit risk meas- urement the potential evolution of the value of the portfolio of trades with each counterparty is also modelled over its life (potential future expo- sure), taking into account legally enforceable close out netting agreements where applicable (see below). Credit mitigation The Group seeks, wherever possible, to enter into master netting agreements with OTC derivative counterparties. Where the Group has such an agreement and it has a legal opinion that it is enforceable by UBS in the event of insolvency of the counterparty, positive and negative replace- ment values of transactions covered by the agree- ment are netted and a single payable or receivable amount is included in the balance sheet. The impact of master netting agreements as at 31 December 2002 is to reduce positive and negative replacement values on OTC derivative instruments by approximately CHF 167 billion. The impact can change substantially over short periods of time, because the exposure is affected by each transaction subject to the arrangement. In line with general market trends, the Group has also entered into bilateral collateral agreements with major market participants to mitigate the potential concentrations of exposure arising from industry consolidation and the continuing increase in volumes of OTC derivatives traded. The figures in the tables do not, however, reflect the risk miti- gating effects of such collateral agreements. 124 Note 23 Derivative Instruments (continued) As at 31 December 2002 Term to maturity CHF million Interest rate contracts Over the counter (OTC) contracts Forward contracts Swaps Options Exchange-traded contracts 3 Futures Options Total Credit derivative contracts Over the counter (OTC) contracts Credit default swaps Total rate of return swaps Total Foreign exchange contracts Over the counter (OTC) contracts Forward contracts Interest and currency swaps Options Exchange-traded contracts 3 Futures Options Total Precious metals contracts Over the counter (OTC) contracts Forward contracts Options Exchange-traded contracts 3 Futures Options Total Equity / Index contracts Over the counter (OTC) contracts Forward contracts Options Exchange-traded contracts 3 Futures Options Total Commodity contracts Over the counter (OTC) contracts Forward contracts Options Total Total derivative instruments Replacement value netting Replacement values after netting Within 3 months NRV2 PRV1 3–12 months NRV PRV 1–5 years PRV NRV over 5 years PRV NRV Total PRV Total NRV 3,785 2,862 338 4,127 3,778 706 93 9,451 1,143 121 8,127 1,488 141 78,413 4,216 333 76,244 5,484 33 55,377 3,905 8 4,589 4,052 51,917 146,103 140,066 12,142 9,602 4,464 Total notional amount CHF bn 1,517.3 5,753.0 663.2 4 16 1 0 4 0 17 40.3 101.1 6,989 8,627 10,687 9,737 82,770 82,061 59,315 56,389 159,761 156,814 8,074.9 2 15 17 7 21 28 95 194 289 504 782 1,286 1,636 2,308 3,944 2,740 1,726 4,466 2,852 162 3,014 958 35 993 4,585 2,679 7,264 4,209 2,564 6,773 164.6 14.5 179.1 2,406 21,561 2,223 3,100 20,641 2,219 1,005 8,962 1,681 1,732 10,292 1,636 232 8,627 361 270 8,907 312 11 3,360 7 1 3,990 3,654 42,510 4,272 5,103 43,830 4,167 252.0 1,843.1 500.8 1 1 0 1 0 1 0.0 0.1 26,190 25,961 11,649 13,660 9,220 9,489 3,378 3,991 50,437 53,101 2,596.0 329 205 534 231 217 1 449 235 325 560 257 289 1 547 150 407 557 121 373 4 498 9 86 8 63 723 1,023 617 942 0 6 18.0 38.6 0.0 0.2 95 71 1,746 1,565 56.8 5,393 8,676 1,406 12,441 583 2,515 512 3,496 917 6,650 205 7,125 124 403 219 794 7,017 18,244 2,342 23,856 861 246 316 247 443 338 0 1,620 0 831 33.2 99.3 7.4 7.5 14,930 14,093 3,414 4,255 8,010 7,668 527 1,013 26,881 27,029 147.4 5 5 3 3 2,629 2,670 346 304 2,629 2,670 346 304 0 0 2,980 0 2,980 2,977 0 2,977 24.9 0.0 24.9 48,665 49,161 29,228 32,155 104,847 104,486 66,329 62,457 249,069 248,259 166,977 166,977 82,092 81,282 1 PRV: Positive replacement value. 2 NRV: Negative replacement value. 3 Exchange-traded products include proprietary trades only. 125 UBS Group Financial Statements Notes to the Financial Statements Note 23 Derivative Instruments (continued) As at 31 December 2001 Term to maturity CHF million Interest rate contracts Over the counter (OTC) contracts Forward contracts Swaps Options Exchange-traded contracts 3 Futures Options Total Credit derivative contracts Over the counter (OTC) contracts Credit default swaps Total rate of return swaps Total Foreign exchange contracts Over the counter (OTC) contracts Forward contracts Interest and currency swaps Options Exchange-traded contracts 3 Futures Options Total Precious metals contracts Over the counter (OTC) contracts Forward contracts Options Exchange-traded contracts 3 Futures Options Total Equity / Index contracts Over the counter (OTC) contracts Forward contracts Options Exchange-traded contracts 3 Futures Options Total Commodity contracts Over the counter (OTC) contracts Forward contracts Options Total Total derivative instruments Replacement value netting Replacement values after netting Within 3 months NRV2 PRV1 3–12 months NRV PRV 1–5 years PRV NRV over 5 years PRV NRV Total PRV Total NRV Total notional amount CHF bn 2,844 2,807 388 3,260 4,322 950 114 5,724 670 530 6,393 2,095 108 49,043 3,037 245 45,029 4,048 48 25,232 2,830 134 22,866 3,336 3,114 82,806 6,925 4,169 78,610 10,429 1,768.7 4,552.4 784.9 3 24 0 3 0 24 83.6 63.2 6,042 8,532 6,508 9,042 52,188 49,322 28,110 26,336 92,848 93,232 7,252.8 6 6 18 18 707 84 791 1,104 621 1,725 1,020 1,020 1,490 636 2,126 773 12 785 1,184 0 1,184 2,506 96 2,602 3,796 1,257 5,053 75.7 3.6 79.3 3,615 19,344 2,138 3,163 11,224 1,942 1,639 8,991 2,148 1,899 7,763 1,888 755 7,463 445 428 7,673 433 20 3,465 23 2,312 1 6,029 39,263 4,754 5,490 28,972 4,264 279.7 1,699.3 1,033.7 1 2 0 1 0 2 0.0 0.8 25,097 16,329 12,779 11,552 8,663 8,534 3,508 2,313 50,047 38,728 3,013.5 242 177 419 223 164 2 389 210 535 3 748 198 507 1 706 195 740 179 805 6 90 653 1,542 600 1,557 81 3 3 17.0 54.1 0.0 0.9 935 984 96 81 2,198 2,160 72.0 1,402 6,140 1,422 6,222 445 4,294 1,713 5,105 1,461 4,076 1,464 6,991 111 1,087 85 2,844 3,419 15,597 4,684 21,162 35.3 238.0 1,497 9,039 1,080 8,724 1,187 5,926 1,431 8,249 601 463 21 14 0 3,306 0 2,988 6,138 8,918 1,219 2,943 22,322 28,834 8 8 14 14 1 1 1 1 0 0 0 0 9 0 9 15 0 15 40,611 34,006 26,753 31,275 68,944 69,884 33,718 32,857 170,026 168,022 96,579 96,579 73,447 71,443 12.4 440.3 726.0 6.4 0.0 6.4 1 PRV: Positive replacement value. 2 NRV: Negative replacement value. 3 Exchange-traded products include proprietary trades only. 126 Off-Balance Sheet Information Note 24 Fiduciary Transactions Fiduciary placement represents funds which customers have instructed the Group to place in foreign banks. The Group is not liable to the customer for any default by the foreign bank nor do creditors of the Group have a claim on the assets placed. CHF million Placements with third parties Fiduciary credits and other fiduciary financial transactions Total fiduciary transactions 31.12.02 31.12.01 43,440 774 44,214 58,466 1,136 59,602 The Group also acts in its own name as trustee or in fiduciary capacities for the account of third par- ties. The assets managed in such capacities are not reported on the balance sheet unless they are invested with UBS. UBS earns commission and fee income from such transactions and assets. These activities potentially expose UBS to liability risks in cases of gross negligence with regard to non-com- pliance of its fiduciary and contractual duties. The risks associated with this business are covered by the standard UBS risk framework. Note 25 Commitments and Contingent Liabilities The Group utilizes various lending-related finan- cial instruments in order to meet the financial needs of its customers. The Group issues com- mitments to extend credit, standby and other let- ters of credit, guarantees, commitments to enter into repurchase agreements, note issuance facil- ities and revolving underwriting facilities. Guarantees represent irrevocable assurances, subject to the satisfaction of certain conditions, that the Group will make payment in the event that the customer fails to fulfill its obligation to third parties. The Group also enters into com- mitments to extend credit in the form of credit lines which are available to secure the liquidity needs of our customers, but not yet drawn upon by them, the majority of which range in maturity from 1 month to 5 years. The contractual amount of these instruments is the maximum amount at risk for the Group if the customer fails to meet its obligations. The risk is similar to the risk involved in extending loan facilities and is monitored with the same risk control processes and specific credit risk policies. For the years ended 31 December 2002, 2001 and 2000 the Group recognized expense in the income statement related to obligations incurred for contingencies and commitments of CHF 13 million, CHF 25 million and CHF 1 million, respectively. The Group generally enters into sub-partici- pations to mitigate the risks from the Group’s commitments and contingencies. A sub-partici- pation is an agreement with another party to fund a portion of the credit facility and to take a share of the loss in the event that the borrower fails to fulfill its obligations. The Group retains the contractual relationship with the borrower and the sub-participant has only an indirect relationship with the borrower. The Group will only enter into sub-participation agreements with banks whose rating is at least equal to or higher than that of the borrower. 127 UBS Group Financial Statements Notes to the Financial Statements Note 25 Commitments and Contingent Liabilities (continued) CHF million 31.12.02 31.12.01 Contingent liabilities Credit guarantees and similar instruments 1 Sub-participations Total Performance guarantees and similar instruments 2 Sub-participations Total Irrevocable commitments under documentary credits Sub-participations Total Gross contingent liabilities Sub-participations Net contingent liabilities Irrevocable commitments Undrawn irrevocable credit facilities Sub-participations Total Liabilities for calls on shares and other equities Gross irrevocable commitments Sub-participations Net irrevocable commitments Gross commitments and contingent liabilities Sub-participations Net commitments and contingent liabilities 11,522 (650) 10,872 3,216 (348) 2,868 1,856 (259) 1,597 16,594 (1,257) 15,337 39,306 (446) 38,860 21 39,327 (446) 38,881 55,921 (1,703) 54,218 18,566 (4,944) 13,622 4,865 (4) 4,861 2,056 0 2,056 25,487 (4,948) 20,539 50,608 (532) 50,076 98 50,706 (532) 50,174 76,193 (5,480) 70,713 1 Credit guarantees in the form of bills of exchange and other guarantees, including guarantees in the form of irrevocable letters of credit, 2 Bid bonds, performance bonds, builders’ endorsement liabilities from bills rediscounted, advance payment guarantees and similar facilities. guarantees, letters of indemnity, other performance guarantees in the form of irrevocable letters of credit and similar facilities. CHF million Overview of collateral Gross contingent liabilities Gross irrevocable commitments Liabilities for calls on shares and other equities Total 31.12.2002 Total 31.12.2001 Mortgage collateral Other collateral Unsecured Total 275 1,084 1,359 1,711 8,254 14,956 23,210 25,625 8,065 23,266 21 31,352 48,857 16,594 39,306 21 55,921 76,193 Other commitments The Group enters into commitments to fund external private equity funds and investments, which typically expire within five years. The com- mitments themselves do not involve credit or mar- ket risk as the funds purchase investments at mar- ket value at the time the commitments are drawn. The maximum amount available to fund these investments at 31 December 2002 and 31 De- cember 2001 was CHF 2,245 million and CHF 3,548 million, respectively. 128 Note 26 Operating Lease Commitments At 31 December 2002, UBS was obligated under a number of non-cancellable operating leases for premises and equipment used primarily for banking purposes. The significant premises leases usually include renewal options and escalation clauses in line with general office rental market conditions as well as rent adjustments based on price indices. However, the lease agreements do not contain contingent rent payment clauses and purchase options. The leases also do not impose any restrictions on UBS’s ability to pay dividends, engage in debt financing transactions or enter into further lease agreements. Our minimum commitments for non-cancellable leases of premises and equipment are presented as follows: CHF million Operating leases due 2003 2004 2005 2006 2007 2008 and thereafter Total commitments for minimum payments under operating leases 31.12.02 1,038 913 777 663 623 5,082 9,096 Operating expenses include CHF 1,193 million, CHF 1,092 million and CHF 816 million in respect of operating lease rentals for the year ended 31 December 2002, 31 December 2001 and 31 Decem- ber 2000, respectively. 129 UBS Group Financial Statements Notes to the Financial Statements Additional Information Note 27 Pledged Assets 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. The following table shows additional information about assets pledged or assigned as security for liabilities and assets subject to reser- vation of title for the years ended 31 December 2002 and 31 December 2001. The securities present- ed in the table below include securities pledged in respect of securities lending and repurchase agree- ments. Carrying amount 31.12.02 808 50,945 129 2 51,884 Related liability 31.12.02 506 37,038 33 0 37,577 Carrying amount 31.12.01 1,311 204,623 160 2 206,096 Related liability 31.12.01 873 163,134 89 0 164,096 CHF million Mortgage loans Securities Property and equipment Other Total pledged assets Note 28 Litigation Due to the nature of their business, the bank and other companies within the UBS Group are involved in various claims, disputes and legal proceedings, arising in the ordinary course of business. The Group makes provisions for such matters when, in the opinion of management and its professional advisors, it is probable that a pay- ment will be made by the Group, and the amount can be reasonably estimated (see Note 20). In respect of the further claims asserted against the Group of which management is aware (and which, according to the principles outlined above, have not been provided for), it is the opinion of the management that such claims are either without merit, can be successfully defended or will not have a material adverse effect on the Group’s financial condition, results of operations or liquidity. Note 29 Financial Instruments Risk Position This section presents information about the Group’s exposure to and its management and control of risks, in particular the primary risks associated with its use of financial instruments: – market risk is exposure to observable market variables such as interest rates, exchange rates and equity markets – credit risk is the risk of loss resulting from client or counterparty default and arises on credit exposure in all forms, including settle- ment risk – liquidity and funding risk is the risk that the Group is unable to fund assets or meet obliga- tions at a reasonable price or, in extreme situ- ations, at any price. This section also presents and explains the Group’s regulatory capital position. 130 Note 29 Financial Instruments Risk Position (continued) a) Market Risk (a)(i) Overview Market risk is the risk of loss arising from move- ments in observable market variables such as interest rates, exchange rates and equity markets. In addition to these and other general market risk factors, the risk of price movements specific to an individual issuer of securities is considered mar- ket risk. Market risk is incurred in UBS primarily through trading activities which are centered in the Corporate and Institutional Clients business of UBS Warburg. It arises primarily from market making, client facilitation and proprietary posi- tions in equities, fixed income and interest rate products, foreign exchange and, to a lesser extent, precious metals and energy. Such activities are mainly in OECD markets, with some business in emerging markets. Group Treasury assumes non-trading risk positions that arise from its balance sheet man- agement activities. Further market risks arise, but to a much lesser extent, in other businesses primarily from the facilitation of customer business. Market risk measures are applied to all for- eign exchange, precious metal and energy posi- tions, to the trading books of UBS Warburg, to interest rate risk in the Group Treasury book and the private banks, and to any other material mar- ket risk arising. The principal risk measures and controls on market risk are Value at Risk (VaR) and stress loss. VaR expresses the potential loss on the current portfolio assuming a specified time hori- zon before positions can be adjusted (holding period), and measured to a specified level of con- fidence, based on historical market movements. Stress loss is assessed against a set of forward- looking scenarios, approved by the Board of Directors, using stress moves in market variables. Complementary controls are also applied where appropriate, to prevent undue concentrations, including limits on exposure to individual market risk variables, such as individual interest or exchange rates, and limits on positions in the securities of individual issuers. These controls are set at levels which reflect variations in price volatility and market depth and liquidity. (a)(ii) Interest Rate Risk Interest rate risk is the risk of loss resulting from changes in interest rates. It is controlled primarily through the limit structure described in (a)(i) above. Exposure to interest rate movements can be expressed for all interest rate sensitive posi- tions, whether marked to market or subject to accrual accounting, as the impact on their fair values of a one basis point (0.01%) change in interest rates. This sensitivity, analyzed by time band, is set out below. Interest rate sensitivity is one of the inputs to the VaR model. It should be noted that, in management’s view, any representation of interest rate risk at a spe- cific date offers only a snapshot of the risks taken by the Group, since both trading and non-trading positions can vary significantly on a daily basis, because they are actively managed. As such, it may not be representative of the level of risk at other times, either in general or in specific cur- rencies or tenors. Furthermore, the presence in the portfolio of option products means that only limited inferences can be drawn about exposure to larger movements in interest rates. The table sets out the extent to which the Group was exposed to interest rate risk at 31 De- cember 2001 and 2002. It shows the net impact of a one basis point (0.01%) increase in market interest rates across all time bands on the fair val- ues of interest rate sensitive positions, including balance sheet assets and liabilities and deriva- tives. The impact of such an increase in interest rates depends on the net asset or net liability posi- tion of the Group in each category, currency and time band in the table. A negative amount in the table reflects a potential reduction in fair value as a result of an increase in interest rates, while a positive amount reflects a potential increase in fair value. 131 UBS Group Financial Statements Notes to the Financial Statements Note 29 Financial Instruments Risk Position (continued) a) Market Risk (continued) Interest rate sensitivity position Interest rate sensitivity by time bands at 31.12.2002 CHF thousand per basis point increase Within 1 month 1 to 3 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 (10 ) (42 ) (93 ) 26 114 (1 ) (78 ) (1 ) 21 0 (46 ) 0 211 (153 ) (256 ) (82 ) 33 10 200 (6 ) 12 1 (61 ) 0 3 to 12 months (287 ) (365 ) (1,021 ) (72 ) 12 (2 ) (227 ) (39 ) (502 ) 0 500 (4)- 1 to 5 years (47 ) (6,504 ) (2,668 ) (927 ) (1,387 ) (86 ) (453 ) 92 (249 ) 18 (54 ) (1) Interest rate sensitivity by time bands at 31.12.2001 CHF thousand per basis point increase 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 22 3 (299 ) 35 (129 ) (2 ) (89 ) 0 175 1 (51 ) 0 (121 ) (24 ) 35 (113 ) 73 (6 ) 27 (7) 695 0 167 (1) (35 ) (366 ) 96 (157 ) (269 ) (38 ) (520 ) (57 ) (98 ) (3 ) 126 0 1 to 5 years (297 ) (7,656 ) (960 ) (274 ) (308 ) 182 65 175 (1,386 ) 1 (404 ) (1 ) Over 5 years (18 ) (5,119 ) 2,445 (230 ) 728 (193 ) (269 ) 587 (204 ) (24 ) (286 ) (3 ) Over 5 years (314 ) (6,030 ) (2,115 ) (15 ) (806 ) 0 172 624 246 (4 ) 369 (4) Total (151) (12,183) (1,593) (1,285) (500) (272) (827) 633 (922) (5) 53 (8) Total (745) (14,073) (3,243) (524) (1,439) 136 (345) 735 (368) (5) 207 (6) Positions shown as “trading” are those which contribute to market risk regulatory capital, i. e. those considered “trading book” for regulatory capital purposes (see section d). “Non-trading” includes all other interest rate sensitive assets and liabilities including derivatives designated as hedges for accounting purposes (as explained in Note 23). This distinction differs somewhat from the accounting classification of trading and non- trading assets and liabilities. Details of money market paper and debt instruments defined as trading portfolio for accounting purposes are included in Note 11 and of debt instruments defined as financial invest- ments for accounting purposes in Note 12. Both contribute to the interest rate sensitivity shown in the table. Details of derivatives are shown in Note 23 but it should be noted that interest rate risk arises not only on interest rate contracts but also on other forwards, swaps and options, and, in particular, on forward foreign exchange con- tracts. Trading The major part of this risk arises in UBS Warburg’s fixed income securities, currency for- wards and other derivatives, and money market trading activities. 132 Note 29 Financial Instruments Risk Position (continued) a) Market Risk (continued) Non-trading Interest rate risk is inherent in many of UBS’s businesses and arises from factors such as differ- ences in timing between contractual maturity or re-pricing of assets, liabilities and derivative instruments, and the difference in re-pricing characteristics of floating rate indices, such as the savings rate and six-month LIBOR. Most non-trading interest rate risk is captured at the point of business origination and trans- ferred to a risk management unit – primarily the Cash and Collateral Trading unit of UBS Warburg or Group Treasury – where it is man- aged within the market risk limits described in (a)(i). The margin risks embedded in retail prod- ucts remain and are subject to additional analysis and control within the originating business units. Many client products have no contractual maturity date or directly market-linked rate. Their interest rate risk is transferred on a pooled basis through “replication” portfolios – port- folios of revolving transactions between the originating business unit and Group Treasury at market rates designed to approximate their aver- age cash flow and re-pricing behavior. The struc- ture and parameters of the replication portfolios are set in accordance with long-term observa- tions of market and client behavior, and are reviewed periodically. The current extraordi- narily low interest rate environment, especially in Swiss franc rates, led, at the end of 2002, to some temporary adjustment of the replication port- folios for variable rate liabilities. Interest rate risk also arises from balance sheet items such as the financing of the Group’s real estate and equity investments in associated com- panies and, in particular, the investment of the Group’s equity. These items are also transferred to Group Treasury, through replicating portfolios designed to approximate the investment or fund- ing profile mandated by the Group Executive Board. The investment of the Group’s equity ac- counts for CHF 14.2 million of the non-trading interest rate sensitivity, with CHF 11.9 million arising in CHF and the remainder mainly in USD and a smaller amount in EUR. At 31 December 2002, the Group’s equity was invest- ed in a portfolio of fixed-rate assets with an average duration of three and a half years, in line with the strategic investment targets set by the Group Executive Board. The interest rate sensitivity of these investments is directly relat- ed to the chosen investment duration and it should be recognized that, although investing in significantly shorter maturities would lead to a reduction in apparent interest rate sensitivity, it would lead to higher volatility in the Group’s interest earnings. For the currencies EUR and GBP the addition- al interest rate sensitivity arises mainly from sub- ordinated note issues which are intentionally unhedged as they are regarded as part of the Group’s equity for asset and liability manage- ment purposes. The additional interest rate sensi- tivity in USD results predominantly from the write-down of USD intangibles. (a)(iii) Currency Risk Currency risk is the risk of loss resulting from changes in exchange rates. Trading UBS is an active participant in currency markets and carries currency risk from these trading activities, conducted primarily in UBS Warburg. These trading exposures are subject to VaR, stress and concentration limits as described in (a)(i). Details of foreign exchange contracts, most of which arise from trading activities and con- tribute to currency risk, are shown in Note 23. Non-trading The Group’s reporting currency is the Swiss franc but its assets, liabilities, income and expense are denominated in many currencies, with significant amounts in USD, EUR and GBP, as well as CHF. Reported profits or losses are exchanged monthly into CHF, reducing volatility in the Group’s earnings from changes in exchange rates. Group Treasury proactively hedges significant expected foreign currency earnings/costs (mainly USD, EUR and GBP) within a time horizon of one year, in accordance with the instructions of the 133 Breakdown of assets and liabilities by currencies CHF billion CHF USD 31.12.02 31.12.01 Other CHF USD UBS Group Financial Statements Notes to the Financial Statements Note 29 Financial Instruments Risk Position (continued) a) Market Risk (continued) Group Executive Board and subject to its VaR limit. Economic hedging strategies employed include a cost-efficient option strategy, providing a safety net against unfavorable currency fluctua- tions while preserving upside potential. From late 2002 the Group has begun to diver- sify the investment of its equity into CHF, USD and EUR in proportion to the currencies of its risk-weighted assets in order to protect its Tier 1 capital ratio against adverse exchange rate move- ments against CHF. Other foreign currency assets and liabilities of the business units are required to be match-funded / invested in the relevant cur- rency or otherwise hedged to avoid currency risk. The table below shows the major currency breakdown of the Group’s balance sheet. 2.4 5.2 0.1 1.9 6.1 10.4 147.8 1.1 0.5 0.7 5.6 0.7 1.4 183.9 7.6 0.0 17.8 3.7 10.1 123.5 1.9 11.4 5.4 0.0 39.0 0.1 11.4 126.7 164.6 247.6 8.1 39.5 5.0 4.0 0.0 1.3 12.7 5.0 626.0 48.0 21.6 260.8 68.6 7.1 111.5 8.1 96.1 4.1 3.4 0.0 EUR 0.6 7.4 2.7 61.0 51.7 0.8 11.5 1.5 0.3 0.0 0.1 0.0 1.0 1.2 8.5 9.5 66.5 66.0 62.8 12.8 0.8 1.7 0.0 0.9 0.3 1.6 138.6 232.6 13.8 5.2 51.9 11.3 0.7 43.6 0.9 14.3 0.9 0.0 0.0 13.8 10.1 36.4 22.9 63.5 28.2 4.3 7.6 1.9 0.1 0.0 3.0 5.0 0.1 5.1 9.6 30.6 151.4 2.9 0.7 0.7 6.3 0.2 2.1 217.7 8.0 0.0 12.8 2.8 25.7 123.3 2.4 15.7 7.2 0.1 43.5 0.3 8.6 156.4 142.9 265.2 11.4 43.1 7.4 4.9 0.0 1.5 18.5 5.6 665.8 68.6 24.3 271.1 65.2 6.5 138.8 10.0 120.0 6.1 3.9 0.0 EUR 0.6 5.2 2.5 40.2 47.2 1.2 11.9 1.5 0.8 0.0 0.1 0.0 0.8 Other 17.1 8.7 3.9 81.1 75.9 30.2 20.1 17.0 1.2 0.0 0.8 0.4 1.4 112.0 257.8 12.9 3.2 30.7 12.5 1.6 41.5 0.9 8.8 0.9 0.0 0.0 17.0 2.8 54.0 25.3 37.7 30.2 4.0 11.7 1.5 0.1 0.0 220.4 629.3 142.6 188.8 241.5 714.5 113.0 184.3 Assets Cash and balances with central banks Due from banks Cash collateral on securities borrowed Reverse repurchase agreements Trading portfolio assets Positive replacement values Loans Financial investments Accrued income and prepaid expenses Investments in associates Property and equipment Goodwill and other intangible assets Other assets Total assets Liabilities Due to banks Cash collateral on securities lent Repurchase agreements Trading portfolio liabilities Negative replacement values Due to customers Accrued expenses and deferred income Debt issued Other liabilities Minority interests Shareholders’ equity Total liabilities, minority interests and shareholders’ equity 134 Note 29 Financial Instruments Risk Position (continued) a) Market Risk (continued) (a)(iv) Equity Risk Equity risk is the risk of loss resulting from changes in the levels of equity indices and values of individual stocks. UBS Warburg is a significant player in major equity markets and carries equity risk from these activities. These exposures are subject to VaR, stress and concentration limits as described in (a)(i) and, in the case of individual stocks, to issuer risk controls as described in (a)(v). Details of equity derivatives contracts (on indices and individual equities), which arise pri- marily from these activities, are shown in Note 23. (a)(v) Issuer Risk The values of tradable assets – equities, bonds and other traded debt instruments – are affected by factors specific to individual issuers as well as gen- eral market moves. This can include short term factors influencing price but also more fundamen- tal causes including severe financial deterioration. As an active trader and market maker in equi- ties and bonds, UBS Warburg holds positions in tradable assets, which are not only included in VaR, but are also subject to concentration limits on individual issuers, including positions arising from derivatives as well as physical holdings. b) Credit Risk Credit risk represents the loss which UBS would suffer if a client or counterparty failed to meet its contractual obligations. It is inherent in tradi- tional banking products – loans, commitments to lend and other contingent liabilities, such as letters of credit – and in foreign exchange and derivatives contracts, such as swaps and options (“traded products”). To ensure a consistent and unified approach, with appropriate checks and balances, all Busi- ness Groups where material credit risk is taken have independent credit risk control (CRC) func- tions within which credit approval authority is exercised by authorized credit officers. CRC has authority over counterparty rating, credit risk assessment and approval, and the establishment of allowances and provisions. The Group restricts its credit exposure to both individual counterparties and counterparty groups by credit limits. The size of limit depends on the assessment of their financial strength, par- ticularly the sustainable free cash flow to service obligations, and on the economic environment, industry position, and qualitative factors such as management strength. Exposure against limits is measured on a continuous basis and is subject to standard exception reporting. Exposure against limits for banking products is measured at face value. For loans, this is shown on the balance sheet and detailed in Note 9a), and for commitments detailed in Note 25. Both are included in the table below. For all traded products, credit exposure is measured for internal risk control purposes based on not only the current replacement value of contracts but also potential future changes in replacement value, and credit limits are applied on this basis. The replacement values of deriva- tives are included in the balance sheet and in the table below. For further information about deriv- atives see Note 23. Securities borrowing and lending transactions are represented on the bal- ance sheet by the values of cash collateral placed with or received from counterparties while repo / reverse repo transactions are represented by the amounts of the forward commitments – for details see Note 10. The credit exposure is generally only a small percentage of the balance sheet amounts. The amounts shown in the table below represent the mark to market values of these transactions, i.e. the difference in value between the cash or securities lent or given as col- lateral by UBS and the value of cash or securities borrowed or taken as collateral by UBS. 135 UBS Group Financial Statements Notes to the Financial Statements Note 29 Financial Instruments Risk Position (continued) b) Credit Risk (continued) Breakdown of credit exposure Amounts for each product type are shown gross before allowances and provisions. CHF million 31.12.02 31.12.01 Banking products Loans and due from banks 1 Contingent liabilities (gross – before participations) 2 Undrawn irrevocable commitments (gross – before participations) 2 Traded products 3 Derivatives positive replacement values (before collateral but after netting) 4 Securities borrowing and lending, repos and reverse repos 5, 6 Allowances and provisions 7 Total credit exposure net of allowances and provisions 8 249,370 16,594 39,306 82,092 20,120 (5,621) 401,861 261,984 25,487 50,608 73,447 14,074 (8,218) 417,382 2 See Note 25 – Commitments and Contingent Liabilities for further information. 1 See Note 9a – Due from Banks and Loans and the section about the Information Required by Industry Guide 3 in the Additional Disclosures 3 Does Required under SEC Regulations for further information. not include future potential credit exposure arising from changes in value of products with variable value, i.e. traded products. Potential future 4 See Note 23 – credit exposure is however included in internal measures of credit exposure for risk management and control purposes. 5 This figure represents the difference in value between the cash Derivative Instruments: Positive Replacement Values for further information. or securities lent or given as collateral to counterparties, and the value of cash or securities borrowed or taken as collateral from the same coun- 6 See Note 10 – Securities Borrowing, Securities Lending, Repurchase terparties under stock borrow / lend and repo / reverse repo transactions. 7 See Note 9b – Allowances and Provisions for and Reverse Repurchase Agreements for further information for these types of transactions. 8 The values of bonds, equities and other tradable obligations in the Group’s trading business area are Credit Losses for further information. also affected by credit events and default. They are not included in this table – exposure is controlled under the market risk control structure described in Note 29 – Financial Instruments Risk Position, section a). 136 Note 29 Financial Instruments Risk Position (continued) b) Credit Risk (continued) The Group is an active user of credit derivatives to hedge credit risk in banking and traded prod- ucts. It also makes use of master netting agree- ments where possible in its OTC derivatives trad- ing and, in line with general market trends, UBS Warburg has also entered into bilateral collateral agreements with market participants. Further information is given in Note 23. Concentrations of credit risk exist if clients are engaged in similar activities, or are located in the same geographic region or have comparable eco- nomic characteristics such that their ability to meet contractual obligations would be similarly affected by changes in economic, political or other conditions. The Group therefore applies stress measures to assess the impact of variations in bankruptcy rates and asset values, taking into account risk concentrations in each portfolio. Stress loss limits are applied where considered necessary, including limits on exposure to all but the best rated countries. The Group classifies a claim as impaired if the book value of the claim exceeds the present value of the cash flows actually expected in future periods – interest payments, scheduled principal repayments, or other payments due (for example on derivatives transactions), and including liqui- dation of collateral where available. Allowances or provisions are established to ensure that the carrying values of impaired claims are determined in accordance with the principles of IAS 39. For further information about accounting policy for allowance and provision for credit losses see Note 1 l). For the amounts of allowance and provision for credit losses and amounts of impaired and non-performing loans, see Note 9 b), c) and d). The occurrence of actual credit losses is erratic in both timing and amount and those that arise usually relate to transactions entered into in pre- vious accounting periods. In order to make the business ultimately accountable for any credit losses they suffer but also to give them the incen- tive to align their credit risk decisions and risk adjusted pricing with the medium term risk pro- file of their credit transactions, the Group uses the concept of “expected loss” for management purposes. Expected loss is a statistically based measure intended to reflect the annual cost that will arise, on average, over time, from transac- tions that become impaired, and is a function of the probability of default (given by the rating), current and likely future exposure to the coun- terparty and the likely severity of the loss should default actually occur. 137 UBS Group Financial Statements Notes to the Financial Statements Note 29 Financial Instruments Risk Position (continued) c) Liquidity Risk The Group’s approach to liquidity management is to ensure, as far as possible, that it will always have sufficient liquidity to meet its liabilities when due, without compromising its ability to respond quick- ly to strategic market opportunities. The Group’s centralized approach is based on an integrated framework incorporating the assessment of expect- ed cash flows and the availability of high-grade col- lateral which could be used to secure additional funding if required. The liquidity position is assessed and managed under a variety of scenarios, giving due consideration to stress factors. Scenarios encompass both normal market conditions and stressed conditions, including both UBS-specific and general market crises. The impact on both trading and client businesses is considered, taking account of potential collateral with which funds might be raised, and the possibility that customers might seek to withdraw funds or draw down unuti- lized committed credit lines. The breakdown by contractual maturity of assets and liabilities, which is the basis of the “normal market conditions” scenario, at 31 De- cember 2002 is shown in the table below. Maturity analysis of assets and liabilities CHF billion On demand Subject to notice1 Due within 3 mths Due between 3 and 12 mths Due between 1 and 5 years Due after 5 years Assets Cash and balances with central banks Due from banks Cash collateral on securities borrowed Reverse repurchase agreements Trading portfolio assets Positive replacement values Loans Financial investments Accrued income and prepaid expenses Investments in associates Property and equipment Goodwill and other intangible assets Other assets Total 31.12.2002 Total 31.12.2001 4.3 10.5 0.0 0.0 371.4 82.1 0.0 5.9 6.5 0.0 0.0 0.0 9.0 489.7 529.7 Liabilities 10.7 Due to banks 0.0 Cash collateral on securities lent 0.0 Repurchase agreements 106.5 Trading portfolio liabilities 81.3 Negative replacement values Due to customers 147.3 Accrued expenses and deferred income 15.3 0.0 Debt issued 12.3 Other liabilities Total 31.12.2002 Total 31.12.2001 373.4 362.8 0.0 0.0 2.7 0.0 0.0 21.0 0.0 0.0 0.0 0.0 0.0 0.0 23.7 30.0 2.9 0.0 0.3 0.0 0.0 2.2 0.0 0.0 0.0 5.4 6.4 20.5 138.7 230.8 0.0 0.0 86.6 1.5 0.0 0.0 0.0 0.0 0.0 478.1 513.4 64.7 36.8 329.5 0.0 0.0 150.2 0.0 54.8 0.0 636.0 700.0 0.8 0.0 55.3 0.0 0.0 34.4 0.2 0.0 0.0 0.0 0.0 0.0 90.7 74.2 2.5 0.0 36.9 0.0 0.0 5.1 0.0 21.6 0.0 66.1 93.9 0.5 0.4 3.7 0.0 0.0 64.6 0.5 0.0 0.0 0.0 0.0 0.0 69.7 63.6 2.2 0.0 0.1 0.0 0.0 1.3 0.0 33.1 0.0 36.7 29.3 0.2 0.0 1.5 0.0 0.0 4.9 0.3 0.0 0.7 7.9 13.7 0.0 29.2 42.4 0.1 0.0 0.1 0.0 0.0 0.9 0.0 19.9 0.0 21.0 13.3 Total 4.3 32.5 139.1 294.0 371.4 82.1 211.5 8.4 6.5 0.7 7.9 13.7 9.0 1,181.1 1,253.3 83.1 36.8 366.9 106.5 81.3 307.0 15.3 129.4 12.3 1,138.6 1,205.7 1 Deposits without a fixed term, on which notice of withdrawal or termination has not been given (such funds may be withdrawn by the depos- itor or repaid by the borrower subject to an agreed period of notice). 138 Note 29 Financial Instruments Risk Position (continued) d) Capital Adequacy The Group monitors the adequacy of its capital using, among other measures, the rules and ratios established by the Basel Committee on Banking Supervision (“BIS rules / ratios”). The BIS ratios compare the amount of the Group’s eligible capital (in total and Tier 1) with the total of its risk weighted assets (RWAs). While the Group monitors and reports its cap- ital ratios under BIS rules, it is the rules estab- lished by the Swiss regulator, the EBK, which ulti- mately determine the capital required to under- pin its business, and these rules, on balance, result in higher RWAs than the BIS rules. As a result, UBS’s ratios are lower when calculated under the EBK regulations than they would be if calculated under the BIS guidelines. The Group has complied with all BIS and EBK regulatory capital rules for all periods reported. BIS Eligible capital BIS eligible capital consists of two parts: Tier 1 capital comprises share capital, share premium, retained earnings including current year profit, foreign currency translation and minority inter- ests, less accrued dividends, net long positions in own shares and goodwill; Tier 2 capital includes the Group’s subordinated long-term debt. Tier 1 capital is required to be at least 4% and Total eli- gible capital at least 8% of RWAs. BIS Risk-Weighted Assets (RWAs) Three elements make up total RWAs – credit risk, other assets and market risk, each of which is described below. The credit risk component consists of on and off-balance sheet claims, measured according to regulatory formulae outlined below, weighted according to type of counterparty and collateral at 0%, 20%, 50% or 100%. The least risky claims, such as claims on OECD governments and claims collateralized by cash, are weighted at 0%, meaning that no capital support is required, while the claims deemed most risky, including unsecured claims on corporates and private customers, are weighted at 100%, mean- ing that 8% capital support is required. Securities not held for trading are included as claims, based on the net long position in the secu- rities of each issuer, including both physical hold- ings and positions derived from other transac- tions such as options. Claims arising from derivatives transactions include not only the current positive replacement value (shown in the table below under Balance sheet assets), but also an “add-on” to reflect their potential future exposure (shown in the table below under Off-balance sheet and other posi- tions – Forward and swap contracts, and Pur- chased options). Claims arising from contingent commitments and irrevocable facilities granted are converted to credit equivalent amounts based on specified per- centages of nominal value. There are other assets, most notably property and equipment, investments and intangibles, which, while not subject to credit risk, represent a risk to the bank in respect of their potential for write-down and impairment and which therefore require capital underpinning. They are weighted at 100% of book value under BIS rules but EBK weightings are generally higher. Capital is required to support market risk arising in all foreign exchange, precious metals and energy positions, and all positions held for trading in interest rate instruments and equities, including risks on individual equities, and traded debt obligations such as bonds. UBS computes this risk using a Value at Risk model approved in 1999 by the EBK, from which the market risk capital requirement is derived. Unlike the calcu- lations for credit risk and other assets, this pro- duces the capital requirement itself rather than the RWA amount. In order to compute a total capital ratio, the market risk capital requirement is therefore converted to a “RWA equivalent” (shown in the table below as Market risk posi- tions) such that the capital requirement is 8% of this RWA equivalent, i. e. the market risk capital requirement is multiplied by 12.5. 139 UBS Group Financial Statements Notes to the Financial Statements Note 29 Financial Instruments Risk Position (continued) d) Capital Adequacy (continued) Risk-weighted assets (BIS) CHF million Balance sheet assets Due from banks and other collateralized lendings 1 Net positions in securities 2 Positive replacement values 3 Loans and other collateralized lendings 1 Accrued income and prepaid expenses Property and equipment Other assets Off-balance sheet and other positions Contingent liabilities Irrevocable commitments Forward and swap contracts 4 Purchased options 4 Market risk positions 5 Total risk-weighted assets Balance sheet / notional amount 31.12.02 356,501 9,096 82,092 320,752 6,453 10,384 8,952 16,594 39,327 9,455,928 298,800 Risk- weighted amount 31.12.02 8,877 8,193 21,680 147,703 3,025 10,149 5,774 8,224 4,622 4,253 1,023 15,267 238,790 Balance sheet / notional amount 31.12.01 380,641 29,500 73,447 305,624 7,554 13,202 9,875 25,487 50,705 8,362,374 365,100 Risk- weighted amount 31.12.01 7,640 10,992 19,556 154,908 3,679 13,202 4,504 9,868 5,034 9,256 1,777 13,319 253,735 3 Represents the mark to market values of Forward and swap contracts and Purchased options, where positive. 1 Includes securities lending and reverse repo transactions. tions. represents the “add-ons” for these contracts. at Risk model, multiplied by 12.5 to give the “risk-weighted asset equivalent”. 2 Excluding positions in the trading book, which are included in Market risk posi- 4 Risk-weighted amount 5 Regulatory capital adequacy requirements for market risk, calculated using the approved Value BIS capital ratios Tier 1 of which hybrid Tier 1 Tier 2 Total BIS Capital CHF million 31.12.02 Ratio % 31.12.02 Capital CHF million 31.12.01 Ratio % 31.12.01 27,047 3,182 5,962 33,009 11.3 1.3 2.5 13.8 29,322 3,848 8,149 37,471 11.6 1.5 3.2 14.8 The Tier 1 capital includes CHF 3,182 million (USD 2,300 million) trust preferred securities at 31 December 2002 and CHF 3,848 million (USD 2,300 million) at 31 December 2001. 140 Note 30 Fair Value of Financial Instruments The following table presents the fair value of financial instruments based on the following val- uation methods and assumptions. It is presented because not all financial 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. Market prices are used to determine fair value, where an active market (such as a rec- ognized stock exchange) exists, as it is the best evidence of the fair value of a financial instru- ment. Market prices are not, however, available for a significant number of the financial assets and liabilities held and issued by the Group. There- fore, 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 tech- niques based on market conditions existing at balance sheet dates. The values derived from applying these tech- niques are significantly affected by the under- lying assumptions made concerning both the amounts and timing of future cash flows and the discount rates. The following methods and assumptions have been used: (a) trading assets, derivatives and other trans- actions undertaken for trading purposes are measured at fair value by reference to quoted market prices when available. If quoted mar- ket prices are not available, then 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) financial investments classified as available for sale are measured at fair value by refer- ence to quoted market prices when available. If quoted market prices are not available, then fair values are estimated on the basis of pricing models or other recognized valuation techniques. Prior to the adoption of IAS 39 in 2001, financial investments were carried at cost or if considered held for sale, at the lower of cost or market. Upon the adoption of the standard, all financial investments are carried at fair value. Unrealized gains and unrealized losses, excluding impairment writedowns, are recorded in Shareholders’ equity until an asset is sold, collected or other- wise disposed of; (c) the carrying amount of liquid assets and other assets maturing within 12 months is assumed to approximate their fair value. This assumption is applied to liquid assets and the short term elements of all other financial assets and financial liabilities; (d) the fair value of demand deposits and savings accounts with no specific maturity is as- sumed to be the amount payable on demand at the balance sheet date; (f) (e) the fair value of variable rate financial instruments is assumed to be approximated by their carrying amounts and, in the case of loans, does not, therefore, reflect changes in their credit quality as the impact of credit risk is recognized separately by deducting the amount of the allowance for credit losses from both book and fair values; 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 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 separately 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 in the following table. However, because other institutions may use different methods and assumptions, such fair value disclosures in this Note cannot necessarily be compared from one financial institution to another. 141 UBS Group Financial Statements Notes to the Financial Statements Note 30 Fair Value of Financial Instruments (continued) CHF billion Assets Cash and balances with central banks Due from banks Cash collateral on securities borrowed Reverse repurchase agreements Trading portfolio assets Positive replacement values Loans Financial investments Liabilities Due to banks Cash collateral on securities lent Repurchase agreements Trading portfolio liabilities Negative replacement values Due to customers Debt issued Subtotal Unrealized gains and losses recorded in shareholders’ equity before tax on: Financial investments Derivative instruments designated as cash flow hedges Net unrealized gains and losses not recognized in the income statement Carrying value 31.12.02 Fair Unrealized value gain/(loss) 31.12.02 31.12.02 Carrying value 31.12.01 Fair Unrealized gain/(loss) 31.12.01 value 31.12.01 4.3 32.5 139.1 294.1 371.4 82.1 211.8 8.4 83.4 36.9 366.9 106.5 81.3 307.4 129.8 4.3 32.5 139.1 294.1 371.4 82.1 214.1 8.4 83.4 36.9 366.9 106.5 81.3 307.5 131.7 21.0 27.7 162.9 269.3 397.9 73.4 226.7 28.8 107.2 30.3 368.6 105.8 71.4 334.0 157.5 21.0 27.7 162.9 269.3 397.9 73.4 227.0 28.8 107.2 30.3 368.6 105.8 71.4 334.0 158.6 0.0 0.0 0.0 0.0 0.0 0.0 2.3 0.0 0.0 0.0 0.0 0.0 0.0 (0.1) (1.9) 0.3 1.1 (0.3) 1.1 0.0 0.0 0.0 0.0 0.0 0.0 0.3 0.0 0.0 0.0 0.0 0.0 0.0 0.0 (1.1) (0.8) 1.2 (0.6) (0.2) The table does not reflect the fair values of non- financial assets and liabilities such as property, equipment, goodwill, prepayments and non- interest accruals. Where applicable, the interest accrued to date on financial instruments is includ- ed, for purposes of the above fair value disclosure, in the carrying value of the financial instruments. Substantially all of the Group’s commitments to extend credit are at variable rates. Accordingly, the Group has no significant exposure to fair value fluctuations resulting from interest rate movements related to these commitments. The fair values of the Group’s fixed rate loans, long- and medium-term notes and bonds issued are predominantly hedged by derivative instru- ments, mainly interest rate swaps, as explained in Note 23. The interest rate risk inherent in bal- ance sheet positions with no specific maturity is also hedged with derivative instruments based on management’s view on the effective interest repricing date of the products. The hedging derivative instruments are carried on the balance sheet at fair values, which are included in the Positive or Negative replacement values in the above table. When the interest rate risk on a fixed rate financial instrument is hedged with a derivative in a fair value hedge, the fixed rate financial instrument (or hedged portion there- of) is reflected in the above table at fair value only in relation to the interest rate risk, not the credit risk as explained in (f) above. Fair value changes are recorded in net profit. The treatment of deriv- atives designated as cash flow hedges is explained in Note 1v). The amount shown in the table as “derivative instruments designated as cash flow hedges” is the net change in fair values on such derivatives that is recorded in Shareholders’ equi- ty and not yet transferred to income or expense. The increase in the Net unrealized gains and losses during 2002 of CHF 1.3 billion is mainly attributable to the change in the unrealized gains and losses of fixed rate long-term assets, which have increased by CHF 2.0 billion from the prior year as a result of declining interest rates during 2002. This was partially offset by an increase in fair value loss from fixed rate long-term debt. 142 Note 31 Retirement Benefit Plans and Other Employee Benefits Defined benefit plans The Group has established various pension plans inside and outside of Switzerland. The major plans are located in Switzerland, the UK, the US and Germany. Independent actuarial valuations are performed for the plans in these locations. Swiss pension plan The pension plan covers practically all employ- ees in Switzerland and exceeds the minimum benefit requirements under Swiss law. Con- tributions to the pension plan are paid for by employees and the Group. The employee contri- butions are calculated as a percentage of insured annual salary and are deducted monthly. The percentages deducted from salary for full benefit coverage (including risk benefits) depend on age and vary between 7% and 10%. The Group pays a variable contribution that ranges between 150% and 220% of the sum of employees’ con- tributions. The pension plan formula is based on years of contributions and final covered salary. The bene- fits covered include retirement benefits, dis- ability, death and survivor pension. In 1999, the Group recognized a prepaid pension asset of CHF 456 million representing excess employer contributions. In 2002, CHF 323 million (2001 CHF 0 million, 2000 CHF 100 million) of this asset was used to fund the employer contributions and was recognized as pension expenses. 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 the major foreign plans. Post-retirement medical and life plans In the US and the UK the Group offers retiree medical benefits that contribute to the health care coverage of employees and beneficiaries after retirement. In addition to retiree medical benefits, the Group in the US also provides retiree life insurance benefits. The benefit obligation in excess of fair value of plan assets for those plans amounts to CHF 164 million as of 31 December 2002 (2001 CHF 142 million, 2000 CHF 111 million) and the total accrued post-retirement cost to CHF 130 million as of 31 December 2002 (2001 CHF 130 million, 2000 CHF 108 million). The net periodic post- retirement costs for the years ended 31 December 2002, 31 December 2001 and 31 December 2000 were CHF 25 million, CHF 24 million and CHF 22 million, respectively. Foreign pension plans The foreign locations of UBS operate various pension plans in accordance with local regula- tions and practices. Among these plans are defined contribution plans as well as defined benefit plans. The locations with defined bene- fit plans of a material nature are in the UK, the US and Germany. The UK and the US defined benefit plans are closed to new entrants who are covered by defined contribution plans. Defined contribution plans The Group also sponsors a number of defined contribution plans primarily in the UK and the US. Certain plans permit employees to make con- tributions and earn matching or other contribu- tions from the Group. The contributions to these plans recognized as expense for the years ended 31 December 2002, 31 December 2001 and 31 December 2000 were CHF 133 million, CHF 117 million and CHF 66 million, respectively. 143 UBS Group Financial Statements Notes to the Financial Statements Note 31 Retirement Benefit Plans and Other Employee Benefits (continued) Defined benefit plans CHF million 31.12.02 31.12.01 31.12.00 31.12.02 31.12.01 31.12.00 Swiss Foreign Defined benefit obligation at the beginning of the year Service cost Interest cost Plan amendments Special termination benefits Actuarial gain / (loss) Benefits paid Curtailment / settlement Acquisition of PaineWebber Foreign currency translation Other Defined benefit obligation at the end of the year Fair value of plan assets at the beginning of the year Actual return on plan assets Employer contributions Plan participant contributions Benefits paid Acquisition of PaineWebber Foreign currency translation Other Fair value of plan assets at the end of the year Funded status Unrecognized net actuarial (gains) / losses Unrecognized transition amount Unrecognized prior service cost Unrecognized asset (17,879) (554) (699) (17,712 ) (541 ) (674 ) (17,011 ) (545 ) (666 ) (3,553) (108) (210) (209) (681) 818 (262 ) 421 889 (211 ) 721 (177) 111 74 427 (3,406 ) (121 ) (204 ) (1 ) (345 ) 107 (12 ) 429 (2,444) (165) (162) (3) (99) 84 (740) 123 (19,204) (17,879 ) (17,712 ) (3,436) (3,553 ) (3,406) 18,289 (1,350) 236 209 (818) 19,074 (765 ) 656 213 (889 ) 18,565 535 490 205 (721 ) 2,887 (240) 164 3,378 (220 ) 258 (111) (107 ) (318) 7 (429 ) 2,880 13 23 (84) 676 (130) 16,566 18,289 19,074 2,382 2,887 3,378 (2,638) 3,892 410 961 1,362 (331 ) (1,054) 1,126 (666 ) 673 (675 ) 356 456 (590 ) 490 356 (559) 236 356 (656 ) 656 33 33 33 356 356 356 356 356 356 1 73 9 (83) 164 (17) 73 220 (147) 73 2 9 (153 ) (97 ) 258 1 9 185 (176 ) 9 (28) (81) 1 2 (47) (153) (63) (55) 13 (63) 15 (153) 53 (206) (153) (Accrued) / prepaid pension cost 33 356 (1,221) (1,015 ) Movement in the net (liability) or asset (Accrued) / prepaid pension cost at the beginning of the year Net periodic pension cost Employer contributions Acquisition of PaineWebber Foreign currency translation (Accrued) / prepaid pension cost Amounts recognized in the Balance Sheet Prepaid pension cost Accrued pension liability (Accrued) / prepaid pension cost 144 Note 31 Retirement Benefit Plans and Other Employee Benefits (continued) Defined benefit plans (continued) CHF million For the year ended Swiss Foreign 31.12.02 31.12.01 31.12.00 31.12.02 31.12.01 31.12.00 Components of net periodic pension cost Current service cost Interest cost Expected return on plan assets Adjustment to limit prepaid pension cost Amortization of unrecognized prior service cost Amortization of unrecognized net (gains) / losses Curtailment / settlement Employee contributions Net periodic pension cost Actual return on plan assets (%) Principal actuarial assumptions used (%) Discount rate Expected rate of return on plan assets Expected rate of salary increase Rate of pension increase 554 699 (900) 206 209 (209) 559 (7.5) 3.8 5.0 2.5 1.5 541 674 (947 ) 339 262 (213 ) 656 (4.0 ) 4.0 5.0 2.5 1.5 545 666 (927 ) 300 211 (205 ) 590 2.9 4.0 5.0 2.5 1.5 108 210 (199) 1 22 (59) 83 (8.7) 5.8 7.3 4.4 1.5 121 204 (228 ) 97 (7.3 ) 6.2 7.9 4.4 1.5 165 162 (243) 3 (9) (23) 55 (0.9) 6.3 8.1 4.4 1.6 Additional details to fair value of plan assets UBS financial instruments and UBS bank accounts UBS AG shares 1 Securities lent to UBS included in plan assets Other assets used by UBS included in plan assets Swiss 31.12.02 31.12.01 31.12.00 814 206 2,645 90 476 305 824 104 920 291 3,432 179 1 The number of UBS AG shares were 3,072,500, 3,639,800 and 3,295,800 as of 31 December 2002, 31 December 2001 and 31 December 2000, respectively. The amount of capital repayment and dividend received on UBS AG shares for the years ended 31 December 2002, 31 December 2001 and 31 December 2000 were CHF 7 million, CHF 2 million and CHF 11 million, respectively. 145 UBS Group Financial Statements Notes to the Financial Statements Note 31 Retirement Benefit Plans and Other Employee Benefits (continued) Post-retirement medical and life plans CHF million 31.12.02 31.12.01 31.12.00 Post-retirement benefit obligation at the beginning of the year Service cost Interest cost Plan amendments Actuarial gain / (loss) Benefits paid Acquisition of PaineWebber Foreign currency translation Post-retirement benefit obligation at the end of the year Fair value of plan assets at the beginning of the year Actual return on plan assets Employer contributions Benefits paid Fair value of plan assets at the end of the year (145) (8) (9) (3) (31) 4 26 (166) 3 0 3 (4) 2 (115 ) (7 ) (9 ) (10 ) (6 ) 4 (2 ) (145 ) 4 0 3 (4 ) 3 (117) (6) (8) (7) 27 5 (9) 0 (115) 4 0 4 (4) 4 The assumed average health care cost trend rates used in determining post-retirement benefit expense is assumed to be 10.4% for 2002 and to decrease to an ultimate trend rate of 5% in 2008. Assumed health care cost trend rates have a significant effect on the amounts reported for the health care plan. A one-percentage-point change in the assumed health care cost trend rates would change the US post- retirement benefit obligation and the service and interest cost components of the net periodic post- retirement benefit costs as follows: CHF million Effect on total service and interest cost Effect on the post-retirement benefit obligation 1% increase 1% decrease 4 17 (3) (13) 146 Note 32 Equity Participation Plans a) Equity Participation Plans Offered UBS has established several equity participation plans to further align the long-term interests of executives, managers, staff and shareholders. The plans are offered to eligible employees in approximately 50 countries and are designed to meet the complex legal, tax and regulatory requirements of each country in which they are offered. The explanations below describe the most significant plans in general, but specific plan rules and investment offerings may vary by country. Equity Plus Program (EPP): This voluntary plan replaced the Equity Investment Plan (EIP) in 2002 (see below). Prior to that time, it was only available to UBS PaineWebber employees. EPP gives eligible employees the opportunity to pur- chase UBS shares at fair market value on the pur- chase date and receive at no additional cost two UBS options for each share purchased, up to a maximum limit. The options have a strike price equal to the fair market value of the stock on the date the option is granted. Share purchases can be made annually from bonus compensation or quarterly based on regular deductions from salary. Shares purchased under EPP are restricted from resale for two years from the time of pur- chase, and the options granted have either a two- or three-year vesting requirement and expire either seven or ten years after the date of grant. Discounted Purchase Plans: All employees in Switzerland are entitled to purchase a specified number of UBS shares at a predetermined dis- counted price each year. The number of shares that can be purchased depends primarily on years of service and rank. Any such shares purchased must be held for a specified period of time. The discount is recorded as compensation expense. Equity Ownership Plan (EOP): Selected per- sonnel receive a mandatory portion of their per- formance-related compensation in UBS shares or options and are also awarded a matching contri- bution in the form of UBS options. Participants in certain countries are eligible to receive a portion of their award in Alternative Investment Vehicles (AIVs). These are generally money market funds, UBS and non-UBS mutual funds and other UBS sponsored funds. EOP awards normally vest in one-third increments over a three-year vesting period. Under certain conditions, these awards are fully forfeitable by the employee. Key employee option plans: Under these plans, key and high potential employees are granted UBS options with a strike price not less than the fair market value of the shares on the date the option is granted. Some option grants have a three- to five-year vesting period during which they cannot be exercised. Other grants vest in one-third incre- ments over a three-year period. Expiration of the options is generally from six to ten and one-half years. One option gives the right to purchase one registered UBS share at the option’s strike price. In some grants, accelerated vesting or non-for- feitability may occur if certain share appreciation targets are met. Other deferred compensation plans: UBS sponsors other deferred compensation plans for selected eligible employees. Generally, contribu- tions are made on a tax deferred basis. Partici- pants are allowed to invest in UBS shares or AIVs. No additional company match is granted, and the plan is generally not forfeitable. In addi- tion, UBS also grants deferred compensation awards to new recruits, senior management and other key employees in the form of UBS shares, options or other leveraged interests in non-UBS instruments. Equity Investment Plan (EIP) (now discontin- ued): Prior to the discontinuance of new awards under this plan in 2001, employees had the choice to invest part of their annual bonus in UBS shares, warrants or other derivatives on UBS shares. A holding period, generally three years, applied during which the instruments could not be sold or exercised. In addition, participants in the plan received a matching contribution of additional UBS shares or derivatives. Only the UBS-matching contribution was forfeitable. The last EIP vesting will take place in 2004. Staff who had the possibility to take part in EIP are now offered the opportunity to take part in EPP. 147 UBS Group Financial Statements Notes to the Financial Statements Note 32 Equity Participation Plans (continued) b) UBS share awards i) Stock compensation plans Shares granted under the various equity participation plans are as follows: Stock bonus plans 31.12.02 31.12.01 31.12.00 Unvested shares outstanding, at the beginning of the year Shares awarded during the year Vested during the year Forfeited during the year 52,299,332 13,511,655 (16,333,832) (1,340,594) 47,458,928 16,850,8591 (10,740,466)1 (1,269,989 ) 14,418,646 39,188,5281 (5,215,503) (932,743) 1 Unvested shares outstanding, at the end of the year 48,136,561 52,299,332 47,458,928 Weighted-average fair market value of shares awarded (in CHF) Fair market value of outstanding shares at the end of the year (CHF billion) 1 Restated for shares granted and fully vested at grant date. 71 3.2 90 4.4 76 4.2 The stock bonus awards for 2000 include approximately 19.8 million shares granted under the reten- tion agreements with key employees of UBS PaineWebber at the time of merger. ii) Stock purchase plans The following table shows the shares awarded and the weighted-average fair value per share for the Group’s stock purchase plans. Stock purchase plans Share quantity purchased Weighted-average purchase price (in CHF) 1 31.12.02 3,822,907 63 31.12.01 2,922,515 63 31.12.00 1,264,725 44 1 Some of the shares purchased are denominated in US dollars and were converted into CHF for purposes of this table. 148 Note 32 Equity Participation Plans (continued) c) UBS option awards Movements in options granted under the various equity participation plans mentioned above are as follows: Outstanding, at the beginning of the year Options due to the acquisition of PaineWebber Granted during the year Exercised during the year Forfeited during the year Expired unexercised Outstanding, at the end of the year Exercisable, at the end of the year Weighted average exercise price (in CHF) 31.12.021 66 71 54 71 77 67 51 Number of options 31.12.01 63,308,502 11,070,992 (10,083,075 ) (1,009,750 ) 0 63,286,669 25,550,932 Weighted average exercise price (in CHF) 31.12.011 58 94 49 74 0 66 50 Number of options 31.12.00 30,415,386 18,975,8102 21,248,0463 (5,390,307 ) (1,940,433 ) 0 63,308,502 18,310,839 Weighted average exercise price (in CHF) 31.12.00 66 34 72 50 64 0 58 34 Number of options 31.12.02 63,286,669 37,060,178 (9,595,133) (2,082,356) (505,131) 88,164,227 21,765,482 1 Some of the options in this table have exercise prices denominated in US dollars which have been converted into CHF at the year-end spot exchange rate for purposes of this table. issued options in exchange for options of PaineWebber which have been included in the purchase price for PaineWebber at a fair value of CHF 992 million. employees of UBS PaineWebber, vesting over a 3-year period, subject to employee’s continued employment and other restrictions. 2 UBS AG 3 Includes options granted to key The following table summarizes additional information about stock options outstanding at 31 December 2002: Range of exercise prices per share Number of options outstanding Weighted-average exercise price Weighted-average remaining contractual life Number of options exercisable Weighted-average exercise price Options outstanding Options exercisable CHF 56.67–70.00 70.01–85.00 85.01–106.00 56.67–106.00 USD 6.34–15.00 15.01–25.00 25.01–35.00 35.01–45.00 45.01–55.00 55.01–66.08 6.34–66.08 18,132,696 25,733,308 5,565,873 49,431,877 3,986,289 2,340,754 2,870,675 222,175 27,328,610 1,983,847 38,732,350 CHF 63.02 77.99 98.51 74.81 USD 8.91 22.52 27.05 39.24 46.85 57.96 40.54 Years 2.3 7.1 5.2 5.1 Years 1.8 2.2 4.0 9.6 7.7 5.1 6.4 5,643,680 6,406,246 31,800 12,081,726 3,986,289 2,340,754 2,870,675 0 451,038 35,000 9,683,756 CHF 58.37 79.00 90.00 69.39 USD 8.91 22.52 27.05 0 47.72 57.80 19.56 Options are normally granted with a strike price either equal to fair market value or approximately 10% greater than the fair value of the underlying share on the grant date. 149 UBS Group Financial Statements Notes to the Financial Statements Note 32 Equity Participation Plans (continued) d) Compensation Expense Generally, the Group’s policy is to recognize expense at the date of grant for equity participa- tion instruments (shares, warrants, options and other derivatives for which the underlying is the Group’s own shares). The amount of expense rec- ognized is equal to the intrinsic value of the instru- ment at such date and is calculated as follows: 1) For stock options, it is the difference between the strike price and fair market value of shares at the date of grant, if any. 2) For UBS shares and other derivative instruments, it is the fair market value. 3) For discounted share plans, the expense is equal to the difference between the fair market value and discounted value. Management’s esti- mate of the accrued expense before tax for share- based compensation for the years ended 31 December 2002, 2001 and 2000 was CHF 592 million, CHF 974 million and CHF 1,749 mil- lion, respectively. The accruals include awards earned currently but issued in the following year. e) Pro-Forma Net Income The following table presents Net income and Earnings per share for 2002, 2001 and 2000 as if the Group had adopted the fair value method of accounting for its equity participation plans, rather than the intrinsic value method described in paragraph d) above. In addition, the table shows amounts already recorded in the Income statement for equity participation plans and the total expense that would have been recognized had the fair value method been applied. CHF million, except per share data Net Income, as reported Add: Equity-based employee compensation expense included in reported net income, net of tax Deduct: Total equity-based employee compensation expense determined under the fair-value-based method for all awards, net of tax Net income, pro-forma Earnings per share Basic, as reported Basic, pro-forma Diluted, as reported Diluted, pro-forma 31.12.02 3,535 31.12.01 4,973 493 769 (1,183) 2,845 2.92 2.35 2.87 2.31 (1,116 ) 4,626 3.93 3.65 3.78 3.51 31.12.00 7,792 1,347 (1,505) 7,634 6.44 6.31 6.35 6.22 The fair value of options granted was determined using a proprietary option pricing model, substan- tially similar to the Black-Scholes model, with the following assumptions: Expected volatility Risk free interest rate (CHF) Risk free interest rate (USD) Expected dividend rate Expected life (years) 31.12.02 31.12.01 31.12.00 35% 3.28% 4.65% 3.35% 4.5 30% 3.51% 5.81% 2.67% 4.5 30% 3.27% 5.66% 2.44% 4.4 The weighted-average fair value of options granted in 2002, 2001 and 2000 was CHF 20, CHF 23 and CHF 16 per share, respectively. 150 Note 33 Related Parties For its 2002 Financial Statements, the Group defines related parties as Associated companies, private equity investees, the Board of Directors, the Group Executive Board, close family mem- bers and enterprises which are controlled by these individuals through their majority share- holding or their role as chairman and/or CEO in those companies. In 2001 and 2000, the Group Managing Board was also included in the above definition. Information Relating The change in definition is due to the “Directive on to Corporate Governance” issued by the SWX Swiss Exchange, effective from 1 July 2002 for all listed companies in Switzerland. Included in the new rules are specific disclosure require- ments for members of the Board of Directors and “management board”. For UBS, the Group Executive Board meets the definition of “man- agement board” under the directive. Members of the Group Managing Board, however, are excluded from the new SWX requirements. The modification is also a response to the expan- sion of the Group Executive Board and the Group Managing Board during 2002. The number of Group Executive Board members increased from six to ten and the Group Managing Board members from thirty to fifty- two. Prior period figures and share and option quantities are based on the definition applied for 2001 and 2000. The external members of the Board of Directors do not have employment or service contracts with UBS, and thus are not entitled to benefits upon termination of their service on the Board of Directors. Total fees paid to these indi- viduals for their services as external board mem- bers amounted to CHF 3.5 million in 2002, CHF 3.3 million in 2001 and CHF 3.3 million in 2000. The number of long-term stock options and warrants outstanding to the executive members of the Board of Directors and Group Executive Board from equity participation plans was 5,410,172 (equivalent to the same number of shares) and 24,558,529 (equivalent to 1,473,217 UBS shares) at 31 December 2002. The number of long-term stock options and warrants to these two groups plus the Group Managing Board amounted to 8,366,103 (equivalent to the same number of shares) and 60,578,417 (equivalent to 6,002,599 shares) at 31 December 2001. These plans are further explained in Note 32 Equity Participation Plans. The total number of shares held by members of the Board of Directors and the Group Executive Board was 2,139,371 at 31 December 2002. The total number of shares held by these two groups plus the Group Managing Board was 4,068,918 at 31 December 2001. No member of the Board of Directors, Group Executive Board or Group Managing Board is the beneficial owner of more than 1% of the Group’s shares at 31 December 2002 and 31 December 2001. a) Remuneration and equity holdings The executive members of the Board of Directors have top-management employment contracts and receive pension benefits upon retirement. Total remuneration to the executive members of the Board of Directors and Group Executive Board recognized in the income statement includ- ing cash, shares and accrued pension benefits amounted to CHF 131.8 million in 2002. Total remuneration to the executive members of the Board of Directors, Group Executive Board and Group Managing Board including accrued pen- sion benefits amounted to CHF 321.4 million in 2001 and CHF 272.3 million in 2000. b) Loans and advances to Board of Directors and senior executives The outstanding balance of loans to the Board of Directors and the Group Executive Board amounted to CHF 28 million at 31 December 2002. The outstanding balance of loans to these two groups plus the Group Managing Board amounted to CHF 32 million at 31 December 2001. The 2001 amount only included mort- gages. Loans and advances are granted with the same terms and conditions that are available to other employees. The terms and conditions are based on those granted to third parties adjusted for reduced credit risk. 151 UBS Group Financial Statements Notes to the Financial Statements Note 33 Related Parties (continued) c) Loans, advances to and transactions with significant associated companies CHF million Balance at the beginning of the year Additions Reductions Balance at the end of the year 31.12.02 31.12.01 65 10 (35) 40 0 65 0 65 All loans and advances to associated companies are transacted at arm’s length. At 31 December 2002 and 2001, there were trading exposures and guarantees to significant associated companies of CHF 136 million and CHF 306 million, respectively. In addition, the Group routinely receives services from associated companies at arm’s length terms. For the years ended 31 December 2002 and 31 December 2001, the amount paid to significant associates for these services was CHF 60 million and CHF 98 million, respectively. Note 35 provides a list of significant associates. d) Loans, advances to and transactions with private equity investees CHF million Balance at the beginning of the year Additions Reductions Balance at the end of the year 31.12.02 31.12.01 489 328 (479) 338 682 65 (258) 489 At 31 December 2002 and 31 December 2001 there were trading exposures and guarantees or commitments to private equity companies of CHF 73 million and CHF 177 million, respectively. In addition the Group purchased services from private equity companies at arm’s length terms for the years ended 31 December 2002 and 31 December 2001 in the amount of CHF 116 million and CHF 196 million, respectively. e) Other related party transactions During 2001 and 2002, UBS entered into the following transactions at arm’s length with companies whose Chairman and/or CEO is an external member of UBS’ Board of Directors or of which an exter- nal director is a controlling shareholder. In 2001 these companies included Unisys (Switzerland), a wholly owned subsidiary of Unisys Corporation (USA) and J Sainsbury plc. (UK). In 2002, in addition to those previously mentioned, related parties included Serono Group and its various subsidiary companies and Bertarelli & Cie (Switzerland). CHF million Goods sold and services provided by related parties to UBS Services provided to related parties by UBS (fees received) Loans granted to related parties by UBS 2002 54 13 140 2001 38 17 0 As part of its sponsorship of Team Alinghi, UBS paid CHF 12 million to AC 2003 SA during 2002. AC 2003 SA, whose controlling shareholder is UBS board member Ernesto Bertarelli, is Team Alinghi’s management company. 152 Note 34 Post-Balance Sheet Events There have been no material post-balance sheet events which would require disclosure or adjust- ment to the 31 December 2002 Financial State- ments. Bond issues have decreased by CHF 850 million from the balance sheet date to 11 February 2003. On 11 February 2003, the Board of Directors reviewed the Financial Statements and author- ized them for issue. These Financial Statements will be submitted to the Annual General Meeting of Shareholders to be held on 16 April 2003 for approval. Note 35 Significant Subsidiaries and Associates The legal entity group structure of UBS is designed to support the Group’s businesses with- in an efficient legal, tax, regulatory and funding framework. Neither the Business Groups of UBS (namely UBS Warburg, UBS PaineWebber, UBS Wealth Management & Business Banking and UBS Asset Management) nor Corporate Center are replicated in their own individual legal enti- ties but rather they generally operate out of the parent bank, UBS AG, through its Swiss and foreign branches. The parent bank structure allows UBS to capitalize on the advantages offered by the use of one legal platform by all the Business Groups. It provides for the most cost-efficient and flexible structure and facilitates efficient allocation and use of capital, comprehensive risk management and straightforward funding processes. Where, usually due to local legal, tax or regu- latory rules or due to additional legal entities joining the UBS Group via acquisition, it is either not possible or not efficient to operate out of the parent bank then local subsidiary companies host the appropriate businesses. The significant operating subsidiary companies in the Group are listed below: Significant subsidiaries Company Jurisdiction of incorporation Business Group 1 Share capital in millions Equity interest accumul- ated in % WB Berne, Switzerland WB Zurich, Switzerland WA Rio de Janeiro, Brazil WB Basel, Switzerland WB Lugano, Switzerland Singapore, Singapore WB George Town, Cayman Islands WA WB Zurich, Switzerland Armand von Ernst & Cie AG Aventic AG Banco UBS Warburg SA Bank Ehinger & Cie AG BDL Banco di Lugano BDL Banco di Lugano (Singapore) Ltd Brunswick UBS Warburg Ltd Cantrade Privatbank AG Cantrade Private Bank St. Helier, Jersey Switzerland (CI) Limited Zurich, Switzerland Crédit Industriel SA Zurich, Switzerland EIBA AG Zurich, Switzerland Factors AG Geneva, Switzerland Ferrier Lullin & Cie SA Zurich, Switzerland Fondvest AG GAM Holding AG Zurich, Switzerland Global Asset Management Limited, Bermuda Hamilton, Bermuda IL Immobilien-Leasing AG Noriba Bank BSC PaineWebber Capital Inc PT UBS Warburg Indonesia PW Trust Company SG Warburg & Co International BV WB WB WA WB WB AM AM AM WB Opfikon, Switzerland WB Manama, Bahrain PW Delaware, USA WA Jakarta, Indonesia New Jersey, USA PW Amsterdam, the Netherlands WA CHF CHF BRL CHF CHF CHF USD CHF GBP CHF CHF CHF CHF CHF CHF USD CHF USD USD IDR USD GBP 5.0 30.0 52.9 6.0 50.0 22.5 25.02 10.0 0.7 10.0 1.4 5.0 30.0 4.3 200.0 2.0 5.0 10.0 25.82 11,000.0 4.42 40.5 100.0 100.0 100.0 100.0 100.0 100.0 50.0 100.0 100.0 100.0 100.0 100.0 100.0 100.0 100.0 100.0 100.0 100.0 100.0 85.0 99.6 100.0 153 Footnotes 1 WB: UBS Wealth Management & Business Banking, AM: UBS Global Asset Management, WA: UBS Warburg, PW: UBS PaineWebber, CC: Corporate Center. 2 Share Capital and Share Premium. UBS Group Financial Statements Notes to the Financial Statements Note 35 Significant Subsidiaries and Associates (continued) Significant subsidiaries (continued) Company Jurisdiction of incorporation Business Group 1 Share capital in millions Equity interest accumul- ated in % Zurich, Switzerland WB Nassau, Bahamas WB Paris, France WB Milan, Italy WB Luxembourg, Luxembourg WB Monte Carlo, Monaco WB Sydney, Australia WA Tokyo, Japan AM Delaware, USA WA Delaware, USA WA Sydney, Australia WA Toronto, Canada WB Frankfurt, Germany WA Toronto, Canada WA St. Helier, Jersey WA Zurich, Switzerland WA WA Delaware, USA George Town, Cayman Islands WA George Town, Cayman Islands WA Amsterdam, the Netherlands WA Delaware, USA WA George Town, Cayman Islands WA WA Delaware, USA WA London, Great Britain WA Milan, Italy WB Glattbrugg, Switzerland CC St. Helier, Jersey WB Madrid, Spain Milan, Italy WB George Town, Cayman Islands CC Willemstad, Netherlands Antilles CC WA Delaware, USA CC Zurich, Switzerland AM Luxembourg, Luxembourg AM Basel, Switzerland Basel, Switzerland AM George Town, Cayman Islands AM AM Luxembourg, Luxembourg AM AM AM AM Thesaurus Continentale Effekten-Gesellschaft in Zürich UBS (Bahamas) Ltd UBS (France) SA UBS (Italia) SpA UBS (Luxembourg) SA UBS (Monaco) SA UBS (Sydney) Limited UBS (Trust and Banking) Limited UBS (USA) Inc UBS Americas Inc UBS Australia Limited UBS Bank (Canada) UBS Beteiligungs-GmbH & Co KG UBS Bunting Warburg Inc UBS Capital (Jersey) Ltd UBS Capital AG UBS Capital Americas Investments II LLC UBS Capital Americas Investments III Ltd UBS Capital Asia Pacific Limited UBS Capital BV UBS Capital II LLC UBS Capital Latin America LDC UBS Capital LLC UBS Capital Partners Limited UBS Capital SpA UBS Card Center AG UBS Employee Benefits Trust Limited UBS España SA UBS Fiduciaria SpA UBS Finance (Cayman Islands) Ltd UBS Finance (Curação) NV UBS Finance (Delaware) LLC UBS Finanzholding AG UBS Fund Holding (Luxembourg) SA UBS Fund Holding (Switzerland) AG UBS Fund Management (Switzerland) AG UBS Fund Services (Cayman) Ltd UBS Fund Services (Luxembourg) SA UBS Global Asset Management (Americas) Inc Delaware, USA UBS Global Asset Management (Australia) Ltd Sydney, Australia UBS Global Asset Management (Canada) Co Halifax, Canada UBS Global Asset Management (France) SA UBS Global Asset Management (Hong Kong) Limited UBS Global Asset Management (Italia) SIM SpA UBS Global Asset Management (Japan) Ltd UBS Global Asset Management (New York) Inc UBS Global Asset Management (Singapore) Ltd UBS Global Asset Management (Taiwan) Ltd UBS Global Asset Management (US) Inc Singapore, Singapore Taipei, Taiwan Delaware, USA Milan, Italy Tokyo, Japan Hong Kong, China New York, USA Paris, France CHF USD EUR EUR CHF EUR AUD JPY USD USD AUD CAD EUR CAD GBP CHF USD USD USD EUR USD USD USD GBP EUR CHF CHF EUR EUR USD USD USD CHF CHF CHF CHF USD CHF USD AUD CAD EUR 30.0 4.0 10.0 22.2 150.0 9.2 12.7 10,900.0 315.0 4,490.82 50.0 20.7 398.8 33.3 226.0 5.0 130.02 61.02 5.0 104.12 2.62 113.02 378.52 6.7 25.8 40.0 – 85.3 0.2 0.5 0.1 37.32 10.0 42.0 18.0 1.0 5.6 2.5 – 8.0 117.0 1.5 AM HKD 25.0 AM AM EUR JPY 2.0 2,200.0 AM USD 0.5 AM AM AM SGD TWD USD 4.0 340.0 35.32 100.0 100.0 100.0 100.0 100.0 100.0 100.0 100.0 100.0 100.0 100.0 100.0 100.0 50.0 100.0 100.0 100.0 100.0 100.0 100.0 100.0 100.0 100.0 100.0 100.0 100.0 100.0 100.0 100.0 100.0 100.0 100.0 100.0 100.0 100.0 100.0 100.0 100.0 100.0 100.0 100.0 100.0 100.0 100.0 100.0 100.0 100.0 84.1 100.0 Footnotes 1 WB: UBS Wealth Management & Business Banking, AM: UBS Global Asset Management, WA: UBS Warburg, PW: UBS PaineWebber, CC: Corporate Center. 2 Share Capital and Share Premium. 154 Note 35 Significant Subsidiaries and Associates (continued) Significant subsidiaries (continued) Company UBS Global Asset Management Holding Ltd UBS Global Trust Corporation UBS Immoleasing AG UBS International Holdings BV UBS Invest Kapitalanlagegesellschaft mbH UBS Investment Bank Limited UBS Leasing AG UBS Life AG UBS Limited UBS O’Connor LLC UBS O’Connor Trading Limited UBS PaineWebber Inc UBS PaineWebber Incorporated of Puerto Rico UBS PaineWebber Life Insurance Company UBS Portfolio LLC UBS Preferred Funding Company LLC I UBS Preferred Funding Company LLC II UBS Preferred Funding Company LLC III UBS Principal Finance LLC UBS Private Banking (Belgium) SA UBS Private Banking Deutschland AG UBS Realty Investors LLC UBS Trust (Canada) UBS Trustees (Bahamas) Ltd UBS Trustees (Cayman) Ltd UBS Trustees (Jersey) Ltd UBS Trustees (Singapore) Limited UBS UK Holding Limited UBS UK Limited UBS Warburg (France) SA UBS Warburg (Italia) SpA UBS Warburg (Japan) Limited UBS Warburg (Malaysia) Sdn Bhd UBS Warburg (Nederland) BV UBS Warburg AG UBS Warburg Asia Limited UBS Warburg Australia Corporate Finance Ltd UBS Warburg Australia Corporation Pty Limited UBS Warburg Australia Equities Ltd UBS Warburg Australia Limited UBS Warburg Derivatives Limited UBS Warburg Hong Kong Limited UBS Warburg International Ltd UBS Warburg Investments Ltd UBS Warburg LLC UBS Warburg Ltd UBS Warburg New Zealand Equities Ltd UBS Warburg Private Clients Ltd UBS Warburg Pte Ltd UBS Warburg Real Estate Securities Inc UBS Warburg Securities (España) SV SA Jurisdiction of incorporation Business Group 1 Share capital in millions Equity interest accumul- ated in % AM London, Great Britain WB St. John, Canada WB Zurich, Switzerland CC Amsterdam, the Netherlands AM Frankfurt, Germany WA London, Great Britain WB Brugg, Switzerland WB Zurich, Switzerland WA London, Great Britain Delaware, USA AM George Town, Cayman Islands AM PW Delaware, USA PW Hato Rey, Puerto Rico PW California, USA WA New York, USA WA Delaware, USA WA Delaware, USA WA Delaware, USA WA Delaware, USA WB Brussels, Belgium WB Hamburg, Germany AM Massachusetts, USA WB Toronto, Canada Nassau, Bahamas WB George Town, Cayman Islands WB WB St. Helier, Jersey WB Singapore, Singapore WA London, Great Britain WA London, Great Britain WA Paris, France Milan, Italy WA George Town, Cayman Islands WA WA Kuala Lumpur, Malaysia Amsterdam, the Netherlands WA WA Frankfurt, Germany WA Hong Kong, China GBP CAD CHF CHF EUR GBP CHF CHF GBP USD USD USD USD USD USD USD USD USD USD EUR EUR USD CAD USD USD GBP SGD GBP GBP EUR EUR JPY MYR EUR EUR HKD 8.02 0.1 3.0 13.8 6.4 10.0 10.0 25.0 10.0 1.0 350.0 1,707.52 31.62 39.32 0.1 – – – 0.1 7.3 51.0 – 12.5 2.0 2.0 0.7 3.3 5.0 609.0 22.9 1.9 50,000.0 0.5 10.9 155.7 20.0 Sydney, Australia WA AUD – Sydney, Australia Sydney, Australia Sydney, Australia Hong Kong, China Hong Kong, China London, Great Britain Sydney, Australia Delaware, USA London, Great Britain Auckland, New Zealand Melbourne, Australia Singapore, Singapore Delaware, USA Madrid, Spain WA WA WA WA WA WA WA WA WA WA WA WA WA WA AUD AUD AUD HKD HKD GBP AUD USD GBP NZD AUD SGD USD EUR 50.42 190.02 571.52 20.0 30.0 18.0 0.1 948.1 17.5 7.5 53.9 55.0 0.4 15.0 100.0 100.0 100.0 100.0 100.0 100.0 100.0 100.0 100.0 100.0 100.0 100.0 100.0 100.0 100.0 100.0 100.0 100.0 100.0 100.0 100.0 100.0 100.0 100.0 100.0 100.0 100.0 100.0 100.0 100.0 100.0 100.0 70.0 100.0 100.0 100.0 100.0 100.0 100.0 100.0 100.0 100.0 100.0 100.0 100.0 100.0 100.0 100.0 100.0 100.0 100.0 155 Footnotes 1 WB: UBS Wealth Management & Business Banking, AM: UBS Global Asset Management, WA: UBS Warburg, PW: UBS PaineWebber, CC: Corporate Center. 2 Share Capital and Share Premium. UBS Group Financial Statements Notes to the Financial Statements Note 35 Significant Subsidiaries and Associates (continued) Significant subsidiaries (continued) Company Jurisdiction of incorporation UBS Warburg Securities (South Africa) (Pty) Limited UBS Warburg Securities Co Ltd UBS Warburg Securities India Private Limited Mumbai, India UBS Warburg Securities Ltd UBS Warburg Securities Philippines Inc Sandton, South Africa Bangkok, Thailand London, Great Britain Makati City, Philippines Business Group 1 Share capital in millions WA WA WA WA WA ZAR THB INR GBP PHP 87.1 400.0 237.8 140.0 150.0 Equity interest accumul- ated in % 100.0 100.0 75.0 100.0 100.0 Consolidated companies: changes in 2002 Significant new companies BDL Banco di Lugano (Singapore) Ltd – Singapore, Singapore GAM Holding AG – Zurich, Switzerland Noriba Bank BSC – Manama, Bahrain UBS Fiduciaria SpA – Milan, Italy UBS Private Banking (Belgium) SA – Brussels, Belgium Deconsolidated companies Significant deconsolidated companies Reason for deconsolidation Hirslanden Holding AG – Zurich, Switzerland HYPOSWISS Schweizerische Hypotheken- und Handelsbank – Zurich, Switzerland Sold Sold Significant associates Company SIS Swiss Financial Services Group AG – Zurich, Switzerland Giubergia UBS Warburg SIM SpA – Milan, Italy Motor Columbus AG – Baden, Switzerland Telekurs Holding AG – Zurich, Switzerland Volbroker.com Limited – London, Great Britain Industry Financial Financial Electricity Financial Financial Equity interest in % Share capital in millions 32.9 49.9 35.6 33.3 21.0 CHF 26 EUR 15 CHF 253 CHF 45 GBP 18 None of the above investments carry voting rights that are significantly different from the propor- tion of shares held. 156 Note 36 Acquisition of Paine Webber Group, Inc. On 3 November 2000, UBS completed its acqui- sition of 100% of the outstanding common stock of the Paine Webber Group, Inc. (“Paine- Webber”), a full-service broker-dealer and one of the largest securities and commodities firms in the United States servicing both individual and institutional clients. The transaction was accounted for using the purchase method of accounting, making PaineWebber a wholly owned subsidiary of UBS. Results of operations of PaineWebber have been included in the con- solidated results beginning on the date of acqui- sition. Under IFRS, the valuation of shares and options issued was measured on the date of acquisition, 3 November 2000. Purchase consideration amounted to CHF 22.0 billion (USD 12.5 billion) consisting of shares, options and cash. Total goodwill record- ed in connection with the acquisition amounted to CHF 12.8 billion (USD 7.3 billion) at 3 No- vember 2000 and is being amortized using the straight-line method over an estimated useful life of 20 years. At 31 December 2002 and 2001, the net book value of goodwill related to the Paine- Webber acquisition amounted to CHF 9.0 billion and CHF 11.6 billion respectively. Note 37 Currency Translation Rates The following table shows the principal rates used to translate the financial statements of foreign entities into Swiss francs: 1 USD 1 EUR 1 GBP 100 JPY Spot rate As at Average rate Year ended 31.12.02 31.12.01 31.12.02 31.12.01 31.12.00 1.38 1.45 2.23 1.17 1.67 1.48 2.43 1.27 1.54 1.46 2.33 1.24 1.69 1.50 2.44 1.40 1.69 1.56 2.57 1.57 Note 38 Swiss Banking Law Requirements The consolidated financial statements of UBS are prepared in accordance with International Financial Reporting Standards. Set out below are the deviations which would result if the provi- sions of the Banking Ordinance and the Guide- lines of the Swiss Federal Banking Commission governing financial statement reporting pursuant to Article 23 through Article 27 of the Banking Ordinance were applied in the preparation of the consolidated financial statements of UBS. 1. Treasury shares Under IFRS, treasury shares are presented in the balance sheet as a deduction from Shareholders’ equity and accounted for at weighted average cost. Contracts that require physical settlement or net share settlement in UBS AG shares are classified in Shareholders’ equity as Share pre- mium and accounted for at weighted average cost. The difference between the proceeds from sales of treasury shares or contracts that require physical settlement or contracts that require net share settlement and their cost (net of tax) is reported as Share premium. The par value of shares repurchased and cancelled is debited to the issued and paid up share capital for the par value, with the remainder of the cost of the repurchased shares debited to Share premium. No dividends are paid on treasury shares. Under Swiss law, own shares held for market- making purposes are presented in the balance sheet as Trading portfolio assets. Own shares 157 UBS Group Financial Statements Notes to the Financial Statements held for other purposes are classified as Financial investments and a corresponding reserve for own shares is established within Shareholders’ equity. All derivative contracts on own shares are report- ed as Positive or Negative replacement values. Traded own shares and derivatives on own shares are carried at fair value. Gains and losses realized on disposal and unrealized gains and losses from changes in the fair value are recorded as Net trading income. Own shares reported within Financial investments are reported at the lower of cost or market value. Reductions to market value and reversals of such reductions, as well as gains and losses on disposal, are included in Other income. Own shares repurchased for cancellation are reported as financial investments and accounted for at cost. Upon cancellation, the par value of shares repurchased and cancelled is debited against Share capital for the par value, with the remainder of the purchase cost debited against General statutory reserve. 2. Financial investments Under IFRS, available for sale financial invest- ments are carried at fair value. Changes in the fair value of available for sale financial invest- ments are recorded as increases or decreases to Shareholders’ equity until an investment is sold, collected or otherwise disposed of, or until an investment is determined to be impaired. At the time an available for sale investment is deter- mined to be impaired, the cumulative unrealized loss previously recognized in Shareholders’ equi- ty is included in net profit or loss for the period. On disposal of an available for sale investment, the difference between the net disposal proceeds and the carrying amount, including any previ- ously recognized unrealized gain or loss arising from a change in fair value reported within Shareholders’ equity, is included in net profit or loss for the period. Under Swiss law financial investments are carried at the lower of cost or market value. Reductions to market value and reversals of such reductions as well as gains and losses on disposal are included in Other income. 3. Cash flow hedges The Group also uses derivative instruments to hedge against the exposure from varying cash flows receivable and payable. Under IFRS, when hedge accounting is applied for these instru- ments, the unrealized gain or loss on the effective portion of the derivatives is recorded in Share- holders’ equity until the hedged cash flows occur, at which time the accumulated gain or loss is realized and released to income. Under Swiss law, the unrealized gains or losses on the effective portion of the derivative instru- ments used to hedge cash flow exposures are deferred on the balance sheet. The deferred amounts are released to income when the hedged cash flows occur. 4. Gains/losses not recognized in the income statement Gains/losses not recognized in the income state- ment is a separate line within Shareholders’ equi- ty where under IFRS unrealized gains and losses from currency translation, changes in fair value of financial investments available for sale and of derivative instruments designated as cash flow hedges are reported. Under Swiss law, only foreign currency trans- lation differences are reported in Shareholders’ equity. The other two components are reported according to the methods described in captions 2. and 3. above. 5. Extraordinary income and expense Under IFRS, items of income and expense can only be classified as extraordinary if they are clearly distinct from the ordinary activities and their occurrence is expected to be rare. Under Swiss law, income and expense related to other accounting periods and/or not directly related to the core business activities of the enter- prise (e. g. realized gains or losses on sale of Investments in associated companies or Property and equipment) are recorded as extraordinary income or expense. The significant differences between IFRS and Swiss banking law are as follows: 158 Note 38 Swiss Banking Law Requirements (continued) CHF million Differences in the Balance Sheet Treasury shares Trading portfolio Financial investments Due to banks Negative replacement values Other liabilities Shareholders’ equity Financial investments Financial investments Other liabilities Shareholders’ equity Cash flow hedges Other liabilities Shareholders’ equity Differences in the Income Statement Treasury shares Net trading income Other income Personnel expenses Tax expenses Financial investments Other income Reclassification of extraordinary income and expense Other income Extraordinary income Extraordinary expense 31.12.02 31.12.01 371 6,623 23 (2) 293 6,680 (1,314) (113) (1,201) (256) 256 (70) (269) 4 (53) (255) (350) 361 11 128 3,253 24 0 0 3,357 (1,856) (215) (1,641) (459) 459 (70) (231) (71) (607) (95) 109 14 159 UBS Group Financial Statements Notes to the Financial Statements Note 39 Reconciliation of International Financial Reporting Standards (IFRS) to United States Generally Accepted Accounting Principles (US GAAP) Note 39.1 Valuation and income recognition differences between IFRS and US GAAP The consolidated financial statements of the Group have been prepared in accordance with IFRS. The principles of IFRS differ in certain respects from United States Generally Accepted Accounting Principles (“US GAAP”). The fol- lowing is a summary of the relevant significant accounting and valuation differences between IFRS and US GAAP. a. Purchase accounting (merger of Union Bank of Switzerland and Swiss Bank Corporation) Under IFRS, the Group accounted for the 1998 merger of Union Bank of Switzerland and Swiss Bank Corporation under the uniting of interests method. The balance sheets and income state- ments of the banks were combined, and no adjust- ments were made to the carrying values of the assets and liabilities. Under US GAAP, the busi- ness combination creating UBS AG is accounted for under the purchase method with Union Bank of Switzerland being considered the acquirer. Under the purchase method, the cost of acquisi- tion is measured at fair value and the acquirer’s interests in identifiable tangible assets and liabili- ties of the acquiree are restated to fair values at the date of acquisition. Any excess consideration paid over the fair value of net tangible assets acquired is allocated, first to identifiable intangible assets based on their fair values, if determinable, with the remainder allocated to goodwill. On 1 January 2002, the Group adopted SFAS 141, “Business Combinations” and SFAS 142, “Goodwill and Other Intangible Assets”. SFAS 141 requires reclassification of intangible assets to goodwill which no longer meet the recognition cri- teria under the new standard. SFAS 142 requires that goodwill and intangible assets with indefinite lives no longer be amortized but be tested annual- ly for impairment. Identifiable intangible assets with finite lives will continue to be amortized. Upon adoption, the amortization charges related to the 1998 business combination of Union Bank of Switzerland and Swiss Bank Cor- poration ceased to be recorded under US GAAP. For the year ended 31 December 2002, these charges would have been CHF 1,477 million. In 2002 and 2001, goodwill recorded under US GAAP was reduced by CHF 43 million and CHF 53 million respectively, due to recognition of deferred tax assets of Swiss Bank Corporation which had previously been subject to valuation reserves. Other purchase accounting adjustments The restatement of Swiss Bank Corporation’s net assets to fair value in 1998 resulted in decreasing net tangible assets by CHF 1,077 million for US GAAP. This amount is being amortized over periods ranging from two years to 20 years. b. Reversal of IFRS goodwill amortization Goodwill and intangible assets For US GAAP purposes, the excess of the con- sideration paid for Swiss Bank Corporation over the fair value of the net tangible assets received has been recorded as goodwill and was amor- tized on a straight line basis using a weighted average life of 13 years from 29 June 1998 to 31 December 2001. The adoption of SFAS 142 “Goodwill and Intan- gible Assets” resulted in two new reconciling items 1) Intangible assets on the IFRS Balance sheet with a book value of CHF 1.8 billion at 31 December 2001 were reclassified to goodwill for US GAAP. 2) The amortization of IFRS goodwill and the intangible assets reclassified to goodwill for US GAAP (CHF 1,017 million for the year ended 31 December 2002) was reversed for US GAAP. Under US GAAP until 31 December 2001, goodwill acquired before 30 June 2001 was cap- italized and amortized over its estimated useful life with adjustments for any impairment. Had the Group been required to adopt SFAS 142 for its US GAAP Financial Statements in prior years, reported Net profit and Earnings per share would have been as follows: 160 CHF million, except for per share data For the year ended Reported Net profit under US GAAP Add back: SBC purchase accounting goodwill Add back: Amortization of intangibles reclassified to goodwill for US GAAP and / or IFRS goodwill Adjusted net profit under US GAAP Reported basic earnings per share under US GAAP Add back: SBC purchase accounting goodwill Add back: Amortization of intangibles reclassified to goodwill for US GAAP and / or IFRS goodwill Adjusted basic earnings per share under US GAAP Reported diluted earnings per share under US GAAP Add back: SBC purchase accounting goodwill Add back: Amortization of intangibles reclassified to goodwill for US GAAP and / or IFRS goodwill Adjusted diluted earnings per share under US GAAP 31.12.02 31.12.01 31.12.00 5,546 0 0 5,546 4.59 0.00 0.00 4.59 4.51 0.00 0.00 4.51 3,234 1,657 886 5,777 2.58 1.32 0.71 4.61 2.46 1.30 0.70 4.46 4,437 1,679 315 6,431 3.70 1.40 0.26 5.36 3.64 1.38 0.26 5.28 The table below shows the estimated, aggregated amortization expenses for other intangible assets, which are still subject to an annual amortization, on a US GAAP basis: CHF million Estimated, aggregated amortization expense for: 2003 2004 2005 2006 2007 2008 and thereafter Total c. Restructuring provision Under IFRS, restructuring provisions are recog- nized when a legal or constructive obligation has been incurred. In 1997, the Group recognized a CHF 7,000 million restructuring provision to cover personnel, IT, premises and other costs associated with combining and restructuring the merged Group. A further CHF 300 million pro- vision was recognized in 1999, reflecting the impact of increased precision in the estimation of certain leased and owned property costs. Under US GAAP, the criteria for establishing restructuring provisions were more stringent than under IFRS prior to 2000. For US GAAP, the aggregate CHF 7,300 million restructuring provision was reversed. As a result of the busi- ness combination with Swiss Bank Corporation and the decision to combine and streamline certain activities of the banks for the purpose of reducing costs and improving efficiencies, Union Bank of Switzerland recognized a restruc- 116 97 93 80 71 765 1,222 turing provision of CHF 1,575 million during 1998 for US GAAP. CHF 759 million of this pro- vision related to estimated costs for restructuring the operations and activities of Swiss Bank Corporation, and that amount was recorded as a liability of the acquired business. The remaining CHF 816 million of estimated costs were charged to restructuring expense during 1998. The US GAAP restructuring provision was increased by CHF 600 million and CHF 130 million in 1999 and 2000, respectively. During 2001, CHF 112 million restructuring costs were expensed as incurred under US GAAP. These costs were already part of the restructuring provision under IFRS, but were not eligible for recognition under US GAAP until 2001. The restructuring plan was completed and the re- maining balance of the US GAAP restructuring provision was used substantially in accordance with previously disclosed plans. At 31 December 2001, the restructuring provision for both IFRS and US GAAP had been fully utilized. 161 UBS Group Financial Statements Notes to the Financial Statements d. Derivative instruments Derivative instruments held or issued for hedging activities Prior to 1 January 2001, the Group applied no hedge accounting for derivative instruments under US GAAP. As a result, all derivative instru- ments were carried on the balance sheet at fair value, with changes in fair value recorded in the Income statement. Under IFRS, the Group accounted for derivative instruments hedging non-trading positions in the Income statement using the accrual or deferral method, which was the same as the accounting methodology applied to the underlying item hedged. On 1 January 2001, the Group adopted IAS 39 for its IFRS Financial Statements and SFAS 133, “Accounting for Derivative Instruments and Hedging Activities” for its US GAAP Financial Statements. These standards introduce new rules for the accounting and reporting of derivative instruments, including certain derivative instru- ments embedded in other contracts, and of hedging activities. The adoption of SFAS 133 did not result in any transition items for the Group on 1 January 2001 as the Group previously did not apply hedge accounting under US GAAP for derivative instruments. With the adoption of IAS 39 on 1 January 2001, an opening adjustment was made in 2001 to reduce Retained earnings by CHF 61 million, con- sisting of CHF 19 million reflecting the impact of the new hedge accounting rules and CHF 42 mil- lion reflecting the impact of remeasuring assets to either amortized cost or fair value as required under the standard. For US GAAP purposes, the first adjustment was not required (because all derivatives were previously recorded in the Income statement) and was reversed, and the second adjustment was recorded in the Income statement. Under IAS 39, the Group is permitted to hedge interest rate risk based on forecasted cash inflows and outflows on a group basis. For this purpose, the Group accumulates information about finan- cial assets, financial liabilities, and forward com- mitments which is then used to estimate and aggre- gate cash flows and to schedule the future periods in which these cash flows are expected to occur. Appropriate derivative instruments are then used to hedge the estimated future cash flows. SFAS 133 does not permit hedge accounting for hedges of future cash flows determined by this methodology. Accordingly, for US GAAP such items continue to be carried at fair value with changes in fair value recognized in Net trading income. Since 1 January 2001, the Group’s derivative hedging relationships have been treated the same under both IFRS and US GAAP, except for hedges of interest rate risk of forecasted cash flows on a group basis as mentioned in the previ- ous paragraph. In addition, amounts deferred under previous hedging relationships that now do not qualify as hedges under IAS 39 are being amortized against IFRS net profit over the remaining life of the hedging relationship. Such amounts have been reversed for US GAAP as they have never been treated as hedges. Derivative instruments indexed to UBS shares US GAAP, like IFRS, generally requires that derivatives indexed to a company’s own stock be recorded as an equity instrument if settlement is required in actual shares or the company has the choice to settle the contract by delivery or receipt of its own shares. If, however, the derivative con- tract requires cash settlement or the counterpar- ty may choose cash settlement, then the deriva- tive must be classified as an asset or liability, with changes in fair value recorded in income. Asset or liability classification is also required under US GAAP if a company may not have suffi- cient issuable shares available to settle a contract in its own shares. This is determined by the maximum number of shares a company could be forced to issue to settle a contract. Under IFRS, however, such contracts are recorded in Shareholders’ equity. In 2001 and 2000, the Group had no con- tracts for which the accounting treatment under US GAAP differed from IFRS, and there was no reconciling item for these derivative instruments. In 2002, however, the Group issued net-share settled put options as part of its share repurchases in 2002. Such contracts are recorded under IFRS in Shareholders’ equity and under US GAAP as a liability with changes in fair value reflected in Net income. Such contracts increased US GAAP Net income by CHF 12 million in 2002. UBS Warburg acts as a liquidity provider to the equity futures markets and as a market maker in UBS shares and derivatives. Trading income of CHF 125 million under IFRS (CHF 137 million under US GAAP) in 2002, CHF 261 million under both IFRS and US GAAP in 2001 and CHF 162 42 million under both IFRS and US GAAP in 2000 was recorded in the financial statements from trading in cash settled derivative instru- ments indexed to UBS shares. Bifurcation of embedded issuer calls out of structured debt instruments The Group issues certain structured debt instru- ments that contain an embedded issuer call option. If the embedded derivatives contained in the structured debt are not clearly and closely related to the host debt instrument, IFRS requires that a combined derivative is separated, includ- ing the issuer call, and accounted for as a stand alone derivative contract. Under US GAAP, how- ever, certain issuer calls must remain with the host contract and are therefore not separated. The impact of not separating these issuer call fea- tures was to reduce US GAAP Net income by CHF 55 million before tax at 31 December 2002. e. Financial investments (prior to the adoption of IAS 39) Prior to the adoption of IAS 39 on 1 January 2001, financial investments were classified as either current investments or long-term invest- ments under IFRS. The Group considered current financial investments to be held for sale and carried at lower of cost or market value (“LOCOM”). The Group accounted for long- term financial investments at cost, less any impairments. Under US GAAP, the Group’s finan- cial investments are classified as available for sale (debt and marketable equity securities), and are carried at fair value with changes in fair value recorded in Other comprehensive income. Gains and losses are recognized in Net profit in the peri- od sold, and losses are recognized in the period of impairment for IFRS and US GAAP. For the IFRS to US GAAP reconciliation, debt and marketable equity securities were adjusted from LOCOM to fair value and classified as available for sale investments. Unrealized gains or unrealized losses relating to these investments were recorded in Other comprehensive income. f. Financial investments and private equity Financial investments available for sale With the adoption of IAS 39 on 1 January 2001, the accounting for financial investments avail- able for sale generally became the same under IFRS and US GAAP. Three exceptions exist, how- ever: 1) Non-marketable equity financial invest- ments (excluding private equity investments dis- cussed below), which are classified as available for sale and carried at fair value under IFRS, con- tinue to be carried at cost less “other than tem- porary” impairments under US GAAP. The open- ing adjustment and subsequent changes in fair value recorded directly in Shareholders’ equity on non-marketable equity financial instruments due to the implementation on IAS 39 have been reversed under US GAAP to reflect the difference between the two standards in measuring such investments. 2) Write-downs on impaired assets can be fully or partially reversed under IFRS if the value of the impaired assets increases. Such reversals of impairment write-downs are not allowed under US GAAP. Reversals under IFRS were not significant in 2002 or 2001. 3) Private equity investments, as described below. Private equity investments Since the adoption of IAS 39 on 1 January 2001, the Group has accounted for private equity invest- ments as available for sale securities in its primary Financial Statements under IFRS, with changes in fair value recognized in Shareholders’ equity. Under US GAAP, these investments continued to be accounted for at cost less “other than tempo- rary” impairments. On 1 January 2002, the Group adopted the provisions of Statement of Financial Accounting Standards (“SFAS”) 144 “Accounting for the Impairment or Disposal of Long-Lived Assets” for its US GAAP Financial Statements. The statement primarily addresses financial accounting and reporting for the impairment or disposal of long- lived assets. In addition, SFAS 144 eliminated the exception to consolidation for subsidiaries for which control is likely to be temporary, as previ- ously contained in Accounting Research Bulletin 51 “Consolidated Financial Statements” as amended by SFAS 94 “Consolidation of All Majority-Owned Subsidiaries”. Therefore, on adopting SFAS 144, the Group changed its US GAAP accounting for certain private equity invest- ments by accounting for those investments held within separate investment subsidiaries in accor- dance with the “AICPA Audit and Accounting Guide, Audits of Investment Companies”. The effect of this change for US GAAP reporting pur- 163 UBS Group Financial Statements Notes to the Financial Statements poses is that certain private equity investments are now recorded at fair value, with changes in fair value recognized in US GAAP net profit. The remaining private equity investments continue to be accounted for at cost less impairment. For the IFRS to US GAAP reconciliation, fair value adjustments on certain private equity investments recorded directly in Shareholders’ equity under IFRS had to be shown in the Income statement for US GAAP purposes. At 1 January 2002, the date of adoption of SFAS 144, the cumulative effect of this change in accounting on US GAAP net profit was an increase of CHF 639 million, after tax. For the year ended 31 De- cember 2002, the effect of applying the new stan- dard on the reconciliation of IFRS net profit to US GAAP was to increase US GAAP net profit by an additional CHF 83 million, after tax. The pro-forma Net profit assuming that the change in accounting principle were applied retroactively for all periods presented, would be as follows: CHF million, except for per share data For the year ended Net profit under US GAAP Basic earnings per share Diluted earnings per share 31.12.02 31.12.01 31.12.00 4,907 4.06 3.99 2,763 2.21 2.09 5,523 4.61 4.53 See Note 2 for information regarding impairment charges recorded for private equity investments. g. Retirement benefit plans Under IFRS, the Group recognizes pension ex- pense based on a specific method of actuarial val- uation used to determine the projected plan lia- bilities for accrued service, including future expected salary increases, and expected return on plan assets. Plan assets are recorded at fair value and are held in a separate trust to satisfy plan lia- bilities. Under IFRS the recognition of a prepaid asset is subject to certain limitations, and any unrecognized prepaid asset is recorded as pen- sion expense. US GAAP does not allow a limita- tion on the recognition of prepaid assets record- ed in the Balance Sheet. Under US GAAP, pension expense is based on the same actuarial method of valuation of liabil- ities and assets as under IFRS. Differences in the amounts of expense and liabilities (or prepaid assets) exist due to different transition date rules, stricter provisions for recognition of a prepaid asset, and the treatment of the 1998 merger of Union Bank of Switzerland and Swiss Bank Corporation. In addition, under US GAAP, if the fair value of plan assets falls below the accumulated bene- fit obligation (current value of accrued benefits without allowance for future salary increases), an additional minimum liability must be shown in the balance sheet. If an additional minimum liability is recognized, an equal amount will be recognized as an intangible asset up to the amount of any unrecognized past service cost. Any amount not recognized as an intangible asset is reported in Other comprehensive income. The additional minimum liability required under US GAAP before tax amounts to CHF 1,225 million and CHF 306 million as at 31 December 2002 and 2001, respectively. The amount recognized in intangible assets was CHF 2 million and CHF 3 million and the amount recognized in Other comprehensive income was CHF 1,223 million, before taxes and CHF 303 million, before taxes as at 31 December 2002 and 2001 respectively. h. Other employee benefits Under IFRS, the Group has recorded expenses and liabilities for post-retirement, medical and life insurance benefits, determined under a methodol- ogy similar to that described above under retire- ment benefit plans. Under US GAAP, expenses and liabilities for post-retirement medical and life insurance bene- fits are determined under the same methodology as under IFRS. Differences in the levels of expens- es and liabilities have occurred due to different transition date rules and the treatment of the merger of Union Bank of Switzerland and Swiss Bank Corporation under the purchase method. 164 i. Equity participation plans IFRS does not specifically address the recognition and measurement requirements for equity par- ticipation plans. US GAAP permits the recognition of compen- sation cost on the grant date for the estimated fair value of equity instruments issued (SFAS 123) or based on the intrinsic value of equity instruments issued (Accounting Principles Board “APB” No. 25), with the disclosure of the pro- forma effects of equity participation plans on net profit and earnings per share, as if the fair value had been recorded on the grant date. Under IFRS, the Group recognizes only intrinsic values at the grant date with subsequent changes in value not recognized. Under US GAAP, the Group applies the APB No. 25 intrinsic value method, which requires adjustments to intrinsic values subse- quent to the grant date in certain circumstances. The shares and other diversified instruments of the Group’s equity participation plans are held in trusts on behalf of the participants. Certain of these trusts are recorded on the Group’s balance sheet for US GAAP presentation, the effect of which is to increase assets by CHF 396 million and CHF 1,485 million, liabilities by CHF 429 million and CHF 1,607 million, and decrease Shareholders’ equity by CHF 33 million and CHF 122 million (for UBS AG shares held by the trusts which are treated as treasury shares) at 31 December 2002 and 2001 respectively. For US GAAP, certain of the Group’s option awards have been determined to be variable pur- suant to APB No. 25, primarily because they may be settled in cash or because the Group has offered to hedge the value of the award. The effect of applying variable accounting to the option awards in the US GAAP reconciliation for the years ended 31 December 2002, 2001 and 2000, is a CHF 51 million decrease in compensation expense, CHF 30 million decrease in compensation expense and CHF 85 million increase in compensation expense, respectively. In addition, certain of the Group’s share plans have been deemed variable under APB No. 25 or required a new expense measurement date due to diversification or cash settlement of awards. Additional expense was also recorded related to social tax payments on exercised options record- ed directly in Shareholders’ equity for IFRS. For US GAAP, the net effect of these transactions is a decrease to compensation expense of CHF 12 million, an increase to compensation expense of CHF 41 million and an increase to compensa- tion expense of CHF 82 million for the years ended 31 December 2002, 2001 and 2000, respectively. j. Software capitalization Under IFRS, effective 1 January 2000, certain costs associated with the acquisitions or develop- ment of internal use software must be capital- ized. Once the software is ready for its intended use, the costs capitalized are amortized to the Income statement over the estimated life of the software. Under US GAAP, the same principle applies, however this standard was effective 1 January 1999. For US GAAP, the costs associ- ated with the acquisition or development of internal use software that met the US GAAP software capitalization criteria in 1999 have been reversed from Operating expenses and amortized over a life of two years from the time that the software is ready for its intended use. From 1 January 2000, the only remaining reconcilia- tion item is the amortization of software capital- ized in 1999 for US GAAP purposes. At 31 De- cember 2002, this amount was fully utilized and there is no longer a difference between IFRS and US GAAP. k. Recently issued US accounting standards In April 2002, the Financial Accounting Standards Board (FASB) issued SFAS No. 145, “Rescission of FASB Statements No. 4, 44, and 64, Amendment of FASB Statement No. 13, and Technical Corrections”. The new standard is effective for fiscal years beginning after 15 May 2002. UBS will adopt the new standard for its fiscal year 2003, but does not expect that it will have a significant effect on the financial state- ments. In June 2002, the FASB issued SFAS No. 146, “Accounting for Costs Associated with Exit or Disposal Activities”. SFAS No. 146 addresses primarily recognition and measurement of cost for employee termination benefits, contract ter- minations, closure or consolidation of facilities, relocation, and similar items associated with exit or disposal activities. The new standard requires that a liability for such costs should be recog- 165 UBS Group Financial Statements Notes to the Financial Statements nized at its fair value in the period in which the liability is incurred and not at the time an entity commits to an exit or disposal plan. SFAS No. 146 is applicable prospectively for exit or dis- posal activities initiated after 31 December 2002. UBS does not expect that the new stan- dard will have a significant impact on its finan- cial statements. In December 2002, the FASB issued SFAS No. 148, “Accounting for Stock-based Compensa- tion – Transition and Disclosure”, an amend- ment of FASB Statement No. 123, which was effective for financial years ending after 15 De- cember 2002. UBS adopted SFAS No. 148 for the year ended 31 December 2002. The new stan- dard requires additional disclosures in respect to pro-forma disclosures had the fair value based method for valuing employee stock option awards been applied. These additional disclo- sures are included in Note 32. Other than addi- tional disclosures, SFAS No. 148 currently has no impact on the financial statements. In January 2003, the FASB issued FASB Interpretation (FIN) No. 46, “Consolidation of Variable Interest Entities”, an interpretation of Accounting Research Bulletin No. 51. FIN 46 applies to certain entities in which equity in- vestors do not have the characteristics of a con- trolling financial interest or do not have suffi- cient equity at risk for the entity to finance its activities without additional subordinated finan- cial support from other parties. Such entities are called variable interest entities (VIE) under the new interpretation, which requires consolidation of a VIE if the variable interest either absorbs the majority of the expected losses, or receives the majority of the expected gains, or both. FIN 46 applies to all VIEs created before 1 February 2003 no later than the beginning of the first inter- im or annual reporting period beginning after 15 June 2003. The new interpretation applies imme- diately to all VIEs created after 31 January 2003. FIN 46 also establishes disclosure requirements for VIEs that an enterprise will consolidate or in which it will have a significant variable interest. These disclosure requirements became effective for financial statements issued after 31 January 2003 and are provided in Note 40.2. In November 2002, the Emerging Issues Task Force (EITF) reached a consensus on EITF Issue No. 02-3, “Issues Involved in the Accounting for Derivative Contracts Held for Trading Purposes and Contracts Involved in Energy Trading and Risk Management”. The consensus precludes mark-to-market accounting for energy trading contracts that are not derivatives pursuant to SFAS No. 133, “Accounting for Derivative Instruments and Hedging Activities”. UBS has adopted the provisions of EITF Issue 02-3 relat- ed to energy trading contracts as at 1 January 2003 for contracts that existed on or before 25 October 2002, the date when this consensus was issued. For contracts entered into after 25 October 2002, the consensus was applied with immediate effect. The effect of adoption was not material either for contracts entered into after or those that existed on 25 October 2002. Included in EITF Issue 02-3 is the FASB staff’s view that an entity should not recognize an un- realized gain or loss at inception of a derivative instrument unless the fair value of that instru- ment is obtained from a quoted market price in an active market or is otherwise evidenced by comparison to observable market data. Management is in the process of completing the evaluation of the impact of this view on the Group’s financial condition and profit. As required, the Group applied this view to trans- actions entered into after the effective date of 21 November 2002. The impact was not signifi- cant. The impact of this issue is dependent upon the level of transactions executed that rely on data not observable in the market. Accordingly, it is not possible to project the impact this mat- ter could have on the Group’s 2003 financial statements. 166 Note 39.2 Reconciliation of IFRS Shareholders’ equity and Net profit to US GAAP CHF million Note 39.1 Reference Shareholders’ equity Net profit 31.12.02 31.12.01 31.12.02 31.12.01 31.12.00 Amounts determined in accordance with IFRS Adjustments in respect of: SBC purchase accounting goodwill and other purchase accounting adjustments Reversal of IFRS goodwill amortization Restructuring provision Derivative instruments Financial investments (prior to the adoption of IAS 39) Financial investments and private equity Retirement benefit plans Other employee benefits Equity participation plans Software capitalization Tax adjustments 38,991 43,530 3,535 4,973 7,792 a b c d e f g h i j 15,285 1,017 0 (138) 0 (30) 621 (1) (164) 0 (5) 15,413 0 0 (169 ) 0 (709 ) 1,714 (8 ) (186 ) 60 (363 ) (128) 1,017 0 354 0 767 (156) 7 63 (60) 147 (1,614 ) 0 (112 ) 25 0 0 119 8 (12 ) (169 ) 16 (1,669) 0 (238) (1,353) 28 0 59 8 (167) (160) 137 Total adjustments 16,585 15,752 2,011 (1,739 ) (3,355) Amounts determined in accordance with US GAAP 55,576 59,282 5,546 3,234 4,437 Note 39.3 Earnings per share Under both IFRS and US GAAP, basic earnings per share (“EPS”) is computed by dividing income available to common shareholders by the weighted-average number of common shares outstanding. Diluted EPS includes the determinants of basic EPS and, in addition, gives effect to dilutive potential common shares that were outstanding during the period. The computations of basic and diluted EPS for the years ended 31 December 2002, 31 December 2001 and 31 December 2000 are presented in the following table. 31.12.02 31.12.01 31.12.00 For the year ended US GAAP IFRS US GAAP IFRS US GAAP IFRS Net profit available for ordinary shares (CHF million) Net profit for diluted EPS (CHF million) Weighted-average shares outstanding Diluted weighted average shares outstanding Basic earnings per share (CHF) Diluted earnings per share (CHF) 5,546 5,520 1,208,055,132 1,222,862,165 4.59 4.51 3,535 3,515 1,208,586,678 1,223,382,942 2.92 2.87 3,234 3,135 1,251,180,815 1,273,720,560 2.58 2.46 4,973 4,874 1,266,038,193 1,288,577,938 3.93 3.78 4,437 4,423 1,198,680,193 1,215,169,966 3.70 3.64 7,792 7,778 1,209,087,927 1,225,577,700 6.44 6.35 167 UBS Group Financial Statements Notes to the Financial Statements Note 39.4 Presentation differences between IFRS and US GAAP In addition to the differences in valuation and income recognition, other differences, essentially related to presentation, exist between IFRS and US GAAP. Although there is no impact on IFRS and US GAAP reported Shareholders’ equity and Net profit due to these differences, it may be use- ful to understand them to interpret the financial statements presented in accordance with US GAAP. The following is a summary of presenta- tion differences that relate to the basic IFRS financial statements. 1. Settlement date vs. trade date accounting The Group’s transactions from securities activi- ties are recorded under IFRS on the settlement date. This results in recording a forward trans- action during the period between the trade date and the settlement date. Forward positions relat- ing to trading activities are revalued to fair value and any unrealized profits and losses are recog- nized in Net profit. Under US GAAP, trade date accounting is required for spot purchases and sales of securi- ties. Therefore, all such transactions with a trade date on or before the balance sheet date with a settlement date after the balance sheet date have been recorded at trade date for US GAAP. This has resulted in receivables and payables to bro- ker-dealers and clearing organizations recorded in Other assets and Other liabilities in the US GAAP Balance sheet. 2. Financial investments Under IFRS, the Group’s private equity invest- ments and non-marketable equity financial investments are included in Financial invest- ments. For US GAAP presentation, non-mar- ketable equity financial investments are reclassi- fied to Other assets, and private equity invest- ments are shown separately on the Balance sheet. 3. Securities received as proceeds in a securities for securities lending transaction When the Group acts as the lender in a securities lending agreement and receives securities as collat- eral that can be pledged or sold, it recognizes the securities received and a corresponding obligation to return them. These securities are reflected on the US GAAP balance sheet in the line “Securities received as collateral” on the asset side of the bal- ance sheet. The offsetting liability is presented in the line “Obligation to return securities received as collateral”. 4. Reverse repurchase, repurchase, securities borrowing and securities lending transactions The Group enters into certain specific reverse repurchase, repurchase, securities borrowing and securities lending transactions that result in a dif- ference between IFRS and US GAAP. Under IFRS, they are considered borrowing and lending trans- actions which are not reflected in the balance sheet except to the extent of cash collateral advanced or received. Under US GAAP, however, they are con- sidered purchase and sale transactions due to the fact that the contracts do not meet specific collat- eral or margining requirements under SFAS 140. Due to the different treatment of these transac- tions under IFRS and US GAAP, interest income and expense recorded under IFRS must be reclas- sified to Net trading income or Other income for US GAAP. Additionally under US GAAP, the secu- rities received are recognized on the balance sheet as a spot purchase (Trading portfolio assets) with a corresponding forward sale transaction (Re- placement values) and a receivable (Cash collater- al on securities borrowed) is reclassified, as appli- cable. The securities delivered are recognized as a spot sale (Trading portfolio liabilities) with a cor- responding forward repurchase transaction (Replacement values) and a liability (Cash collat- eral on securities lent) is reclassified, as applicable. 168 Note 39.5 Consolidated Income Statement The following is a Consolidated Income Statement of the Group, for the years ended 31 December 2002, 31 December 2001 and 31 December 2000, restated to reflect the impact of valuation and income recognition differences and presentation differences between IFRS and US GAAP. CHF million For the year ended Operating income Interest income Interest expense Net interest income Credit loss expense / (recovery) Net interest income after credit loss expense / (recovery) 31.12.02 31.12.01 31.12.00 Reference US GAAP IFRS US GAAP IFRS US GAAP IFRS a, d, 4 a, 4 39,679 (29,334) 39,963 (29,417) 51,907 (44,096 ) 52,277 (44,236 ) 51,565 (43,584 ) 51,745 (43,615) 10,345 (206) 10,546 (206) 7,811 (498 ) 8,041 (498 ) 7,981 130 8,130 130 10,139 10,340 7,313 7,543 8,111 8,260 Net fee and commission income Net trading income Other income 1 d, 4 e, f, 4 18,221 6,031 96 18,221 5,572 (12) 20,211 8,959 534 20,211 8,802 558 16,703 8,597 1,514 16,703 9,953 1,486 Total operating income 34,487 34,121 37,017 37,114 34,925 36,402 Operating expenses Personnel expenses General and administrative expenses Depreciation of property and equipment Amortization of goodwill Amortization of other intangible assets Restructuring costs c, g, h, i c 18,610 7,072 18,524 7,072 19,713 7,631 19,828 7,631 17,262 6,813 17,163 6,765 a, j a, b b c 1,613 0 1,443 0 1,521 930 1,530 0 1,815 2,484 298 112 1,614 1,025 298 0 1,800 2,018 134 191 1,608 533 134 0 Total operating expenses 28,738 29,577 32,053 30,396 28,218 26,203 Operating profit / (loss) before tax and minority interests Tax expense / (benefit) Net profit / (loss) before minority interests Minority interests Change in accounting principle: cumulative effect of adoption of “AICPA Audit and Accounting Guide, Audits of Investment Companies” on certain financial investments, net of tax f 5,749 4,544 511 678 4,964 1,386 6,718 1,401 6,707 2,183 10,199 2,320 5,238 3,866 3,578 5,317 4,524 7,879 (331) (331) (344 ) (344 ) (87 ) (87) 639 0 0 0 0 0 Net profit 5,546 3,535 3,234 4,973 4,437 7,792 1 CHF 108 million of the difference in Other income between IFRS and US GAAP at 31 December 2002 is due to the Group’s adoption of the “AICPA Audit and Accounting Guide, Audits of Investment Companies” on certain private equity investments for its US GAAP financial statements. This amount represents the increase in fair value of these investments during 2002. Note: References above coincide with the discussions in Note 39.1 and Note 39.4. These references indicate which IFRS to US GAAP differences affect an individual financial statement caption. Certain prior year amounts have been reclassified to conform to the current year’s presentation. 169 UBS Group Financial Statements Notes to the Financial Statements Note 39.6 Condensed Consolidated Balance Sheet The following is a Condensed Consolidated Balance Sheet of the Group, as of 31 December 2002 and 31 December 2001, restated to reflect the impact of valuation and income recognition principles and presentation differences between IFRS and US GAAP. CHF million Reference US GAAP IFRS US GAAP IFRS 31.12.02 31.12.01 Assets Cash and balances with central banks Due from banks Cash collateral on securities borrowed Reverse repurchase agreements Trading portfolio assets (including assets pledged as collateral of CHF 110,365 million at 31.12.02 and CHF 121,456 million at 31.12.01) Positive replacement values Loans Financial investments Securities received as collateral Accrued income and prepaid expenses Investments in associates Property and equipment Goodwill Other intangible assets Private equity investments Other assets a, j a, b b, g 2 d, f, g, h, i, 1, 2 a 4 1, 4 1, 4 a, d f, 2 3 4 4,271 32,481 139,073 294,086 441,845 83,757 211,755 2,846 16,308 6,462 705 8,358 28,127 1,222 4,328 21,314 4,271 32,468 139,052 294,086 371,436 82,092 211,647 8,391 6,453 705 7,869 11,181 2,515 8,952 20,990 27,550 162,566 269,256 455,406 73,474 226,747 20,676 10,931 7,545 697 9,276 29,255 4,510 6,069 36,972 20,990 27,526 162,938 269,256 397,886 73,447 226,545 28,803 7,554 697 8,695 14,578 4,507 9,875 Total assets 1,296,938 1,181,118 1,361,920 1,253,297 Liabilities Due to banks Cash collateral on securities lent Repurchase agreements Trading portfolio liabilities Obligation to return securities received as collateral Negative replacement values Due to customers Accrued expenses and deferred income Debt issued Other liabilities 1, 4 3 1, 4 a, d 4 a, d d, g, h, i, 1 Total liabilities Minority interests Total shareholders’ equity Total liabilities, minority interests and shareholders’ equity 83,178 36,870 366,858 117,721 16,308 132,354 306,872 15,330 129,527 32,815 83,178 36,870 366,858 106,453 81,282 306,876 15,331 129,411 12,339 106,531 30,317 368,620 119,528 10,931 116,666 333,766 17,289 156,462 38,416 106,531 30,317 368,620 105,798 71,443 333,781 17,289 156,218 15,658 1,237,833 1,138,598 1,298,526 1,205,655 3,529 55,576 3,529 38,991 4,112 59,282 4,112 43,530 1,296,938 1,181,118 1,361,920 1,253,297 Note: References above coincide with the discussions in Note 39.1 and Note 39.4. These references indicate which IFRS to US GAAP differences affect an individual financial statement caption. Amounts have been adjusted to reflect the treatment of reverse repurchase, repurchase, securi- ties borrowing and securities lending transactions on a consistent basis. See Note 39.4.4 for details. 170 Note 39.7 Comprehensive Income Comprehensive income under US GAAP is defined as the change in Shareholders’ equity excluding transactions with shareholders. Comprehensive income has two major components: Net profit, as reported in the income statement, and Other comprehensive income. Other comprehensive income includes such items as foreign currency translation, unrealized gains / losses on available for sale securi- ties, unrealized gains / losses on changes in fair value of derivative instruments designated as cash flow hedges and additional minimum pension liability. The components and accumulated other comprehensive income amounts on a US GAAP basis for the years ended 31 December 2002, 31 December 2001 and 31 December 2000 are as follows: CHF million Foreign currency translation Unrealized gains / (losses) on available for sale securities Unrealized gains / (losses) on cash flow hedges Additional minimum pension liability Accumulated other comprehensive Comprehensive income / (loss) income / (loss) Balance at 1 January 2000 Net profit Other comprehensive income: Foreign currency translation Net unrealized gains on available for sale investments arising during the year, net of CHF 152 million tax Reclassification adjustment for gains on available for sale investments realized in net profit, net of CHF 40 million tax (442) (245 ) Other comprehensive income / (loss) Comprehensive income 16 456 (121 ) Balance at 31 December 2000 (687) 351 Net profit Other comprehensive income: Foreign currency translation Net unrealized gains on available for sale investments arising during the year, net of CHF 27 million tax Reclassification adjustment for gains on available for sale investments realized in net profit, net of CHF 26 million tax Net unrealized gains on cash flow hedges arising during the year, net of CHF 1 million tax Reclassification adjustment for losses on cash flow hedges realized in net profit, net of CHF 1 million tax Additional minimum pension liability, net of CHF 108 million tax (82 ) Other comprehensive income / (loss) Comprehensive income 109 (104 ) Balance at 31 December 2001 (769) 356 (80 ) Net profit Other comprehensive income: Foreign currency translation Net unrealized gains on available for sale investments arising during the year, net of CHF 34 million tax Impairment charges reclassified to the income statement, net of CHF 26 million tax Reclassification adjustment for gains on available for sale investments realized in net profit, net of CHF 102 million tax Net unrealized losses on cash flow hedges arising during the year, net of CHF 3 million tax Reclassification adjustment for gains on cash flow hedges realized in net profit, net of CHF 0 million tax Additional minimum pension liability, net of CHF 93 million tax Other comprehensive income / (loss) Comprehensive income 109 95 (368 ) (426) (245 ) 456 (121 ) (336) (82 ) 109 (104 ) 4 3 (195 ) (195 ) (195) (601) (80 ) 109 95 (368 ) (1 ) (8 ) (827 ) (827 ) 4 3 7 (1 ) (8 ) Balance at 31 December 2002 (849) 192 (2) (1,022) (1,681) 4,437 90 4,527 3,234 (265 ) 2,969 5,546 (1,080 ) 4,466 171 UBS Group Financial Statements Notes to the Financial Statements Note 40 Additional Disclosures Required under US GAAP and SEC Rules Note 40.1 Sales of financial assets in securitizations During the years ended 31 December 2002 and 2001, the Group securitized (i. e., transformed owned financial assets into securities through sales transactions) residential mortgage loans and securities, commercial mortgage loans and other financial assets, acting as lead or co-man- ager. The Group’s continuing involvement in these transactions was primarily limited to the temporary retention of various security interests. Proceeds received at the time of securitization from residential mortgage, commercial mort- gage and other financial asset securitizations were CHF 143.5 billion, CHF 4.0 billion and CHF 5.8 billion, respectively in 2002 and CHF 67.6 billion, CHF 4.1 billion and CHF 2.8 bil- lion, respectively in 2001. Related pre-tax gains (losses) recognized, including unrealized gains (losses) on retained interests, at the time of secu- ritization were CHF 523.9 million, CHF 206.4 million and CHF (4.5) million, respectively in 2002 and CHF 112.9 million, CHF 129.7 mil- lion and CHF 20.6 million, respectively in 2001. A significant portion of the securitization activi- ties conducted in 2002 and 2001 were derived from businesses acquired in the purchase of PaineWebber Group Inc. in November 2000. During 2000, the Group did not engage in sig- nificant securitization transactions involving the transfer of its financial assets. At 31 December 2002 and 2001, the Group retained CHF 5.2 billion and CHF 6.8 billion, respectively in agency residential mortgage secu- rities, backed by the Government National Mortgage Association (GNMA), the Federal National Mortgage Association (FNMA) and the Federal Home Loan Mortgage Corporation (FHLMC). The fair value of retained interests in residential mortgage securities is generally deter- mined using observable market prices. Retained interests in other residential mortgage, commer- cial mortgage and other securities were not mate- rial at 31 December 2002 and 2001. Note 40.2 Variable interest entities FASB interpretation (FIN) No. 46, Consolidation of Variable Interest Entities, was issued on 17 January 2003 and provides guidance for deter- mining whether or not such entities are subject to consolidation. FIN 46 requires that control over a special purpose entity be first assessed based on voting interests, and only if voting interests do not exist or differ significantly from economic interests, the assessment of control is based on variable interests. Such entities are referred to as Variable Interest Entities. (“VIE’s”). Variable interests are contractual, ownership, or other pecuniary interests in an entity that vary with changes in that entity’s net asset value, including fee payments to decision makers and to providers of guarantees (including writers of put options and other instruments with similar results) as well as the interests of related parties (including management, employees, affiliates and agents). FIN 46 is effective after 31 January 2003 for all newly acquired or created interests in VIE’s and for periods beginning after 15 June 2003 for all interests in VIE’s existing and owned prior to 1 February 2003. The table below includes infor- mation for all entities where it is reasonably pos- sible that UBS holds a significant interest which will be characterized as a VIE. 172 Note 40.2 Variable interest entities (continued) (in CHF million) SPE category Total assets Notional amount of derivatives Description of primary assets Maximum loss exposure Trust vehicles for awards to UBS employees Private equity investments Hedge fund products including direct investment funds and funds of funds Passive intermediary to a derivative transaction 2 Dispersion of risk in a pool of investments Other credit protection vehicles Other miscellaneous structures Total 31.12.2002 4,624.6 784.6 4,970.6 2,131.1 2,689.1 1,639.0 205.3 17,044.3 37,717.0 0 8,665.0 37,248.2 8,125.6 2,922.5 205.3 94,883.6 UBS shares and derivatives thereon, alternative investments Private equity investments Bonds, equities, derivatives and alternative investments Cash / corporate securities Debt securities, loan receivables and credit linked notes Cash, debt securities, asset-backed securities and credit default swaps Corporate debt and equities 4,982.21 318.4 1,643.6 876.9 333.8 528.9 194.8 8,878.6 1 In connection with certain leveraged investment opportunities available to key employees, UBS has committed to provide up to CHF 440.8 million in loans to employee investment partnerships. At 31 December 2002, a total of CHF 35.5 million in loans had actually been drawn down. Repayment of these loans is senior to the employees’ investment in the partnerships. The remaining unfunded portion of these commitments is also included in Note 25. In addition, if employees default on their future investment commitments, the Group is obliged to assume the remaining unfunded portion which amounted to CHF 137.7 million at 31 December 2002. In the event that all the investments made by these partnerships became worthless, UBS could be exposed to 2 The maximum loss exposure relating to SPE’s which function as the loss of the entire committed amount of CHF 578.5 million which is included in the CHF 4,982.2 million in the table above. a “Passive intermediary to a derivative transaction” is calculated as the discounted value of the Group’s gross contractual swap payment obligations pursuant to the underlying derivative contracts. In calculating the maximum loss, the Group has not included the effect of positive or negative replacement values which are already reflected for the Group in total on the Balance sheet and further discussed in Note 23. The table above includes information for consol- idated and non-consolidated special purpose entities. Certain entities subject to the above dis- closure have been consolidated in the Group’s Financial Statements under IFRS and US GAAP due to the Group’s significant economic interest. However, in many special purpose entities UBS has a less than significant variable interest, or control is determined based on voting interest. These entities are not included in the table. In addition, the “maximum exposure to loss” presented in the table represents worst-case sce- narios and does not consider the offsetting effects of hedges. It is the Group’s practice to hedge interest rate, credit and other market risk expo- sures. See Note 29 for a further discussion of the Group’s risk mitigation strategies. Some of the special purpose entities in the table above function as passive intermediaries to derivatives transactions and are generally estab- lished to facilitate the transfer of credit risk on portfolios to investors. The relevant size of such entities is measured by the “notional amount” of the derivatives’ underlying referenced assets; i. e., the size of the portfolio for which credit risk has been transferred. These notional amounts are also included in Note 23, Derivative Instruments. 173 UBS Group Financial Statements Notes to the Financial Statements Note 40.3 Supplemental Guarantor Information Guarantee of PaineWebber securities Following the acquisition of Paine Webber Group Inc., UBS AG made a full and unconditional guar- antee of the senior and subordinated notes and trust preferred securities (“Debt Securities”) of PaineWebber. Prior to the acquisition, Paine- Webber was an SEC Registrant. Upon the acqui- sition, PaineWebber was merged into UBS Americas Inc., a wholly owned subsidiary of UBS. Under the guarantee, if UBS Americas Inc. fails to make any timely payment under the Debt Securities agreements, the holders of the Debt Securities or the Debt Securities trustee may demand payment from UBS without first pro- ceeding against UBS Americas Inc. UBS’s obliga- tions under the subordinated note guarantee are subordinated to the prior payment in full of the deposit liabilities of UBS and all other liabilities of UBS. At 31 December 2002, the amount of senior liabilities of UBS to which the holders of the sub- ordinated debt securities would be subordinated is approximately CHF 1,129 billion. The information presented in this note is prepared in accordance with IFRS and should be read in conjunction with the consolidated financial statements of the Group of which this information is a part. At the bottom of each col- umn, Net profit and Shareholders’ equity has been reconciled to US GAAP. See Note 39 for a detailed reconciliation of the IFRS financial statements to US GAAP for the Group on a consolidated basis. Effective 1 January 2002, the ownership of all major US subsidiaries of UBS AG was transferred to UBS Americas Inc. through a capital contribution. As a result, the current disclosure note is not com- parable with those presented in previous periods. Supplemental Guarantor Consolidating Income Statement CHF million For the year ended 31 December 2002 UBS AG UBS Parent Bank1 Americas Inc. Subsidiaries Consolidating Entries UBS Group Operating income Interest income Interest expense Net interest income Credit loss expense Net interest income after credit loss expense Net fee and commission income Net trading income Income from subsidiaries Other income 25,253 18,187 7,066 (134 ) 6,932 6,841 4,420 (1,429 ) (131 ) 16,693 14,273 2,420 (15 ) 2,405 7,325 773 0 (26 ) Total operating income 16,633 10,477 Operating expenses Personnel expenses General and administrative expenses Depreciation of property and equipment Amortization of goodwill and other intangible assets Total operating expenses Operating profit / (loss) before tax and minority interests Tax expense / (benefit) 8,370 2,627 1,062 144 12,203 4,430 895 Net profit / (loss) before minority interests 3,535 Minority interests Net profit / (loss) Net profit / (loss) US GAAP 2 0 3,535 5,214 7,531 2,003 204 2,211 11,949 (1,472 ) (460 ) (1,012 ) 0 (1,012 ) (65 ) 4,520 3,460 1,060 (57 ) 1,003 4,055 379 0 145 5,582 2,623 2,443 255 104 5,425 157 243 (86 ) (331 ) (417 ) 397 (6,503 ) (6,503 ) 0 0 0 0 0 1,429 0 1,429 0 0 0 0 0 1,429 0 1,429 0 1,429 0 39,963 29,417 10,546 (206) 10,340 18,221 5,572 0 (12) 34,121 18,524 7,073 1,521 2,459 29,577 4,544 678 3,866 (331) 3,535 5,546 1 UBS AG Parent Bank prepares its financial statements in accordance with Swiss Banking Law requirements. For the purpose of this disclosure, the accounts have been adjusted to IFRS. 2 Refer to Note 39 for a description of the differences between IFRS and US GAAP. 174 Supplemental Guarantor Consolidating Balance Sheet CHF million For the year ended 31 December 2002 UBS AG UBS Parent Bank1 Americas Inc. Subsidiaries Consolidating Entries UBS Group Assets Cash and balances with central banks Due from banks Cash collateral on securities borrowed Reverse repurchase agreements Trading portfolio assets Positive replacement values Loans Financial investments Accrued income and prepaid expenses Investments in associates Property and equipment Goodwill and other intangible assets Other assets Total assets Liabilities Due to banks Cash collateral on securities lent Repurchase agreements Trading portfolio liabilities Negative replacement values Due to customers Accrued expenses and deferred income Debt issued Other liabilities Total liabilities Minority interests Total shareholders’ equity Total liabilities, minority interests and shareholders’ equity 3,609 65,992 32,248 197,168 197,184 82,087 252,625 1,613 2,343 9,730 6,144 128 3,989 854,860 85,634 35,800 136,797 56,105 89,135 339,787 7,779 58,704 6,933 816,674 0 38,186 7 14,205 139,424 150,717 148,430 3,249 25,904 1,684 3,143 20 731 12,946 4,009 504,469 89,815 32,625 295,885 43,784 3,524 19,957 6,580 7,111 2,604 501,885 55 2,529 655 82,384 1,056 40,725 25,823 17,168 14,796 5,094 1,458 81 994 622 3,603 0 (130,113 ) (33,676 ) (94,524 ) 0 (20,413 ) (81,678 ) 0 (491 ) (9,126 ) 0 0 (2,649 ) 4,271 32,468 139,052 294,086 371,437 82,091 211,647 8,391 6,453 705 7,869 13,696 8,952 194,459 (372,670 ) 1,181,118 37,842 2,121 28,700 6,564 9,036 28,810 1,463 63,596 5,451 (130,113 ) (33,676 ) (94,524 ) 0 (20,413 ) (81,678 ) (491 ) 0 (2,649 ) 83,178 36,870 366,858 106,453 81,282 306,876 15,331 129,411 12,339 183,583 (363,544 ) 1,138,598 3,474 7,402 0 (9,126 ) 3,529 38,991 854,860 504,469 194,459 (372,670 ) 1,181,118 Total shareholders’ equity – US GAAP 2 44,852 3,176 7,548 0 55,576 1 UBS AG Parent Bank prepares its financial statements in accordance with Swiss Banking Law requirements. For the purpose of this disclosure, the accounts have been adjusted to IFRS. 2 Refer to Note 39 for a description of the differences between IFRS and US GAAP. 175 UBS Group Financial Statements Notes to the Financial Statements Supplemental Guarantor Consolidating Cash Flow Statement CHF million For the year ended 31 December 2002 UBS AG UBS Parent Bank1 Americas Inc. Subsidiaries UBS Group Net cash flow from / (used in) operating activities 8,422 (927 ) (9,859 ) (2,364) Cash flow from / (used in) investing activities Investments in subsidiaries and associates Disposal of subsidiaries and associates Purchase of property and equipment Disposal of property and equipment Net (investment in)/divestment of financial investments Net cash flow from / (used in) investing activities Cash flow from / (used in) investing activities Net money market paper issued/(repaid) Net movements in treasury shares and own equity derivative activity Capital issuance Capital repayment by par value reduction Issuance of long-term debt Repayment of long-term debt Increase in minority interests Dividend payments to / and purchase from minority interests Net activity in investments in subsidiaries 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 the year Cash and cash equivalents, end of the year Cash and cash equivalents comprise: Cash and balances with central banks Money market paper 2 Due from banks maturing in less than three months Total (23 ) 984 (1,019 ) 22 931 895 (16 ) 0 (189 ) 28 307 130 (21 ) 0 (555 ) 17 915 356 (60) 984 (1,763) 67 2,153 1,381 (30,635 ) 471 3,958 (26,206) (5,605 ) 6 (2,509 ) 8,414 (11,099 ) 0 0 2,775 (38,653 ) (2,608 ) (31,944 ) 89,856 57,912 3,609 33,509 20,794 57,912 0 0 0 915 (2,780 ) 0 0 (161 ) (1,555 ) 1,919 (433 ) 15,552 15,119 7 9,615 5,497 15,119 0 0 0 7,803 (1,032 ) 0 (377) (2,614 ) 7,738 227 (1,538 ) 10,851 9,313 655 3,059 5,599 9,313 (5,605) 6 (2,509) 17,132 (14,911) 0 (377) 0 (32,470) (462) (33,915) 116,259 82,344 4,271 46,183 31,890 82,344 1 UBS AG Parent Bank prepares its Financial Statements in accordance with Swiss Banking Law requirements. For the purpose of this disclosure, 2 Money market paper is included in the Balance sheet under Trading portfolio assets and Financial the accounts have been adjusted to IFRS. investments. CHF 10,475 million was pledged at 31 December 2002. Guarantee of other securities In October 2000, UBS AG, acting through a wholly owned subsidiary, issued USD 1.5 billion (CHF 2.6 billion at issuance) 8.622% UBS Trust Preferred securities. In June 2001, UBS issued an additional USD 800 million (CHF 1.3 billion at issuance) of such securities (USD 300 million at 7.25% and USD 500 million at 7.247%). UBS AG has fully and unconditionally guaranteed these securities. UBS’s obligations under the trust preferred securities guarantee are subordinated to the prior payment in full of the deposit liabili- ties of UBS and all other liabilities of UBS. At 31 December 2002, the amount of senior liabili- ties of UBS to which the holders of the subordi- nated debt securities would be subordinated is approximately CHF 1,129 billion. 176 UBS Group Financial Statements Report of the Group Auditors 177 178 UBS AG (Parent Bank) 179 UBS AG (Parent Bank) Table of Contents UBS AG (Parent Bank) Table of Contents Parent Bank Review Financial Statements Income Statement Balance Sheet Statement of Appropriation of Retained Earnings 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 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 Pension Plans, Loans to Corporate Bodies / Related Parties Report of the Statutory Auditors Report of the Capital Increase Auditors 181 182 182 183 183 184 185 185 185 186 186 187 187 188 188 188 188 189 190 180 UBS AG (Parent Bank) Parent Bank Review Parent Bank Review Income Statement The Parent Bank UBS AG net profit increased CHF 1,179 million from CHF 4,655 million to CHF 5,834 million. Income from investments in associates increased to CHF 3,417 million from CHF 1,532 million in 2001 mainly due to higher distribution received. Sundry expense from ordi- nary activities was CHF 381 million, up from CHF 139 million in 2001. This was mainly due to higher net writedown of financial investments. Depreciation and write-offs were CHF 3,025 mil- lion, up from CHF 1,650 million in 2001 mainly caused by higher writedown on investments in associated companies. Extraordinary income con- tains CHF 260 million (2001: CHF 87 million) from the sale of subsidiaries. Balance Sheet Total assets increased by CHF 48 billion to CHF 1,064 billion by 31 December 2002. This move- ment is mostly impacted by increased trading- related assets where mainly trading balances in securities and positive replacement values have increased. Liquid assets have significantly decreased due to reduction of deposits with the Bank of Japan. 181 UBS AG (Parent Bank) Financial Statements Financial Statements Income Statement CHF million For the year ended Interest and discount income Interest and dividend income from trading portfolio Interest and dividend income from financial investments Interest expense Net interest income Credit-related fees and commissions Fee and commission income from securities and investment business Other fee and commission income Fee and commission expense Net fee and commission income Net trading income Net income from disposal of financial investments Income from investments in associated companies Income from real estate holdings Sundry income from ordinary activities Sundry ordinary expenses Other income from ordinary activities Operating income Personnel expenses General and administrative expenses Operating expenses Operating profit Depreciation and write-offs on investments in associated companies and fixed assets Allowances, provisions and losses Profit before extraordinary items and taxes Extraordinary income Extraordinary expenses Tax expense / (benefit) Profit for the period 31.12.02 31.12.01 % change from 31.12.01 20,059 7,074 23 (20,125) 7,031 252 7,249 515 (1,167) 6,849 4,634 125 3,417 50 1,908 (381) 5,119 23,633 8,916 4,379 13,295 10,338 3,025 1,053 6,260 265 7 684 5,834 29,967 8,089 185 (31,444 ) 6,797 291 8,232 524 (1,176 ) 7,871 5,015 15 1,532 54 1,183 (139 ) 2,645 22,328 9,443 4,869 14,312 8,016 1,650 1,140 5,226 95 7 659 4,655 (33) (13) (88) (36) 3 (13) (12) (2) (1) (13) (8) 733 123 (7) 61 174 94 6 (6) (10) (7) 29 83 (8) 20 179 0 4 25 182 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 investments Investments in associated companies Tangible fixed assets Accrued income and prepaid expenses Positive replacement values Other assets 31.12.02 31.12.01 % change from 31.12.01 3,609 33,671 265,106 165,938 117,677 199,546 8,377 10,275 4,633 2,342 249,064 3,734 20,215 54,384 252,226 173,690 117,706 185,306 17,253 11,331 5,624 3,231 171,798 3,725 Total assets 1,063,972 1,016,489 Total subordinated assets 1 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 Share capital General statutory reserve Reserve for own shares Other reserves Profit brought forward Profit for the period 4,717 218,915 22,131 303,023 76,687 274,431 4,220 67,759 7,846 256,278 3,281 4,177 1,005 12,392 6,623 18,285 5,834 4,219 213,954 52,604 303,036 67,664 288,684 5,213 65,471 8,707 172,469 5,795 3,959 3,589 14,507 3,253 16,883 4,655 Total liabilities Total subordinated liabilities Total amounts payable to Group companies 1,063,972 1,016,489 13,315 142,139 16,444 126,182 1 The subordinated assets for 2001 have been restated to include the subordinated traded assets of CHF 2,325 million. Statement of Appropriation of Retained Earnings CHF million The Board of Directors proposes to the Annual General Meeting the following appropriation: Profit for the financial year 2002 as per the Parent Bank’s Income Statement Appropriation to general statutory reserve Appropriation to other reserves Proposed dividends Total appropriation Dividend Distribution (82) (38) 5 (4) 0 8 (51) (9) (18) (28) 45 0 5 12 2 (58) 0 13 (5) (19) 3 (10) 49 (43) 6 (72) (15) 104 8 25 5 (19) 13 5,834 232 3,237 2,365 5,834 The Board of Directors will recommend to the Annual General Meeting on 16 April 2003 that UBS should pay a dividend of CHF 2.00 per share of CHF 0.80 par value. If the dividend is approved, the payment of CHF 2.00 per share, after deduction of 35% Swiss withholding tax would be made on 23 April 2003 for shareholders who hold UBS shares on 16 April 2003. 183 UBS AG (Parent Bank) Notes to the Financial Statements Notes to the Financial Statements Accounting and Valuation Principles The Parent Bank’s accounting and valuation policies are in compliance with Swiss banking law. The accounting and valuation policies are principally the same as for the Group Financial Statements outlined in Note 1: Summary of Sig- nificant Accounting Policies. Major differences between the Swiss banking law requirements and International Financial Reporting Standards are described in Note 38 to the Group Financial Statements. In addition, the following principles are ap- plied for the Parent Bank: Treasury shares Treasury shares is the term used to describe when an enterprise holds its own equity instruments. Under IFRS, treasury shares are presented in the balance sheet as a deduction from equity. No gain or loss is recognized in the income statement on the sale, issuance, acquisition, or cancellation of those shares. Consideration received or paid is presented in the financial statement as a change in equity. Under Swiss law, treasury shares are classified in the balance sheet as trading balances or as financial assets, short positions are included in Due to banks. Realized gains and losses on the sale, issuance or acquisition of treasury shares, and unrealized gains or losses from remeasurement of treasury shares in the trading portfolio to market value are included in the income statement. Treasury shares included in Financial investments are carried at the lower of cost or market value. Investments in associated companies Investments in associated companies are equity interests which are held for the purpose of the Parent Bank’s business activities or for strategic reasons. They are carried at cost less valuation reserves, if needed. Property and equipment Bank buildings and other real estate are carried at cost less accumulated depreciation. Depreciation of computer and telecommunication equipment, other office equipment, fixtures and fittings is recognized on a straight-line basis over the esti- mated useful lives of the related assets. The use- ful lives of Property and equipment are summa- rized in Note 1, Significant Accounting Policies, of the Group Financial Statements. Extraordinary income and expenses Certain 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 ap- propriate income or expense category. These items are separately identified below. 184 Additional Income Statement Information Net Trading Income CHF million For the year ended Equities Fixed income 1 Foreign exchange and other Total 1 Includes commodities trading income. 31.12.02 31.12.01 % change from 31.12.01 2,208 565 1,861 4,634 2,435 829 1,751 5,015 (9) (32) 6 (8) Extraordinary Income and Expenses Extraordinary income contains CHF 260 million (2001: CHF 87 million) from the sale of subsi- diaries and CHF 5 million (2001: CHF 8 million) from other disposals. Extraordinary expenses consist of immaterial items. 185 UBS AG (Parent Bank) Notes to the Financial Statements Additional Balance Sheet Information Value Adjustments and Provisions CHF million Default risks (credit and country risk) Trading portfolio risks Litigation risks Operational risks Capital and income taxes Total allowance for general credit losses and other provisions Allowances deducted from assets Balance at 31.12.01 8,032 2,133 528 1,264 901 12,858 8,899 Total provisions as per balance sheet 3,959 Provisions applied in accordance with their specified purpose (2,451 ) (235 ) (630 ) (394 ) Recoveries, doubtful interest, currency translation differences (310 ) (285 ) (39 ) (90 ) 6 New provisions charged to income 135 511 191 893 766 (3,710) (718) 2,496 Balance at 31.12.02 5,406 2,359 445 1,437 1,279 10,926 6,749 4,177 186 Statement of Shareholders’ Equity General statutory reserves: Share premium 17,370 (3,815 ) 110 Share capital 4,444 (683 ) (184 ) 12 General statutory reserves: Retained earnings Reserves for own shares Total share- holders’ equity (before Other distribution of profit) reserves 677 4,007 16,274 42,772 20 (165 ) 4,655 754 (663) (3,999) 122 0 4,655 0 165 (754 ) CHF million As at 31.12.00 and 1.1.01 Par value reduction Cancellation of own shares Capital increase Increase in reserves Profit for the period Changes in reserves for own shares As at 31.12.01 and 1.1.02 3,589 13,665 842 3,253 21,538 42,887 Par value reduction Cancellation of own shares Capital increase Increase in reserves Profit for the period Changes in reserves for own shares (2,509 ) (81 ) 6 (2,209 ) 94 As at 31.12.02 1,005 11,550 842 117 5,834 (3,370 ) (2,392) (2,290) 100 0 5,834 0 24,119 44,139 3,370 6,623 Share Capital As at 31 December 2002 Issued and paid up Conditional share capital Par value Ranking for dividends No. of shares Capital in CHF No. of shares Capital in CHF 1,256,297,678 1,005,038,142 1,182,262,598 945,810,078 9,590,918 7,672,734 0 0 187 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 31.12.02 31.12.01 Change in % Book value 10,475 808 2,495 13,778 Effective liability 506 506 Book value 29,893 1,239 5,224 36,356 Effective liability Book value Effective liability 813 813 (65 ) (35 ) (52 ) (62 ) (38) (38) Assets are pledged as collateral for securities borrowing and repo transactions, for collateralized credit lines with central banks, loans from mortgage institutions and security deposits relating to stock exchange membership. Fiduciary Transactions CHF million Deposits with other banks with Group banks Loans and other financial transactions Total 31.12.02 31.12.01 % change from 31.12.01 28,865 351 713 29,929 38,978 532 1,042 40,552 (26) (34) (32) (26) Due to UBS Pension Plans, Loans to Corporate Bodies / Related Parties CHF million Due to UBS pension plans and UBS debt instruments held by pension plans Securities borrowed from pension plans Loans to directors, senior executives and auditors 1 31.12.02 31.12.01 % change from 31.12.01 814 2,645 28 476 824 32 71 221 (13) 1 Loans to directors, senior executives and auditors are loans to members of the Board of Directors, the Group Executive 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. There are no loans to the auditors. 188 UBS AG (Parent Bank) Report of the Statutory Auditors 189 UBS AG (Parent Bank) Report of the Capital Increase Auditors 190 191 192 Additional Disclosure Required under SEC Regulations 193 Additional Disclosure Required under SEC Regulations Table of Contents Additional Disclosure Required under SEC Regulations Table of Contents A B C D Introduction Selected Financial Data Balance Sheet Data US GAAP Income Statement Data US GAAP Balance Sheet Data Ratio of Earnings to Fixed Charges Information on the Company Property, plant and equipment Information Required by Industry Guide 3 Selected statistical information Average Balances and Interest Rates Analysis of Changes in Interest Income and Expense Deposits Short-term Borrowings Loans Loan Maturities Impaired, Non-performing and Restructured Loans Cross-Boarder Outstandings Summary of Movements in Allowances and Provisions for Credit Losses Allocation of the Allowances and Provisions for Credit Losses Loans by industry sector Loss History Statistics 195 195 197 198 199 199 199 199 200 200 200 202 204 205 207 208 209 210 212 214 215 216 194 A – Introduction The following pages contain additional disclo- sure about UBS Group which is required under SEC regulations. Unless otherwise stated, UBS’s Financial Statements have been prepared in accordance with International Financial Reporting Stan- dards (IFRS) and are denominated in Swiss francs, or CHF, the reporting currency of the Group. Certain financial information has also been presented in accordance with United States Generally Accepted Accounting Principles (US GAAP). B – Selected Financial Data The tables below set forth, for the periods and dates indicated, information concerning the noon buy- ing rate for the Swiss franc, expressed in United States dollars, or USD, per one Swiss franc. The noon buying rate is the rate in New York City for cable transfers in foreign currencies as certified for customs purposes by the Federal Reserve Bank of New York. On 28 February 2003 the noon buying rate was 0.7376 USD per 1 CHF. Year ended 31 December 1998 1999 2000 2001 2002 Month September 2002 October 2002 November 2002 December 2002 January 2003 February 2003 High 0.7731 0.7361 0.6441 0.6331 0.7229 High 0.6789 0.6760 0.6928 0.7229 0.7401 0.7411 Average rate1 Low (USD per 1 CHF) At period end 0.6894 0.6605 0.5912 0.5910 0.6453 0.7281 0.6277 0.6172 0.5857 0.7229 0.6485 0.6244 0.5479 0.5495 0.5817 Low 0.6578 0.6605 0.6714 0.6736 0.7135 0.7275 1 The average of the noon buying rates on the last business day of each full month during the relevant period. 195 Additional Disclosure Required under SEC Regulations B – Selected Financial Data (continued) CHF million, except where indicated For the year ended 31.12.02 31.12.01 31.12.00 31.12.99 31.12.98 Income statement data Interest income Interest expense Net interest income Credit loss (expense) / recovery Net interest income after credit loss (expense) / recovery Net fee and commission income Net trading income Other income Operating income Operating expenses Operating profit before tax Tax expense / (benefit) Minority interests Net profit Cost / income ratio (%) 1 Cost / income ratio before goodwill (%) 1, 2 Per share data (CHF) Basic earnings per share 3 Basic earnings per share before goodwill 2, 3 Diluted earnings per share 3 Diluted earnings per share before goodwill 2, 3 Cash dividends declared per share (CHF) 4 Cash dividends declared per share (USD) 4 Dividend payout ratio (%) 4 Rates of return (%) Return on shareholders’ equity 5 Return on shareholders’ equity before goodwill 2, 5 Return on average equity Return on average assets 39,963 29,417 10,546 (206) 10,340 18,221 5,572 (12) 34,121 29,577 4,544 678 (331) 3,535 86.2 79.0 2.92 4.73 2.87 4.65 2.00 68.49 8.9 14.4 7.6 0.24 52,277 44,236 8,041 (498 ) 7,543 20,211 8,802 558 37,114 30,396 6,718 1,401 (344 ) 4,973 80.8 77.3 3.93 4.97 3.78 4.81 11.7 14.8 10.4 0.36 51,745 43,615 8,130 130 8,260 16,703 9,953 1,486 36,402 26,203 10,199 2,320 (87 ) 7,792 72.2 70.4 6.44 7.00 6.35 6.89 1.50 0.86 23.28 21.5 23.4 22.0 0.70 35,604 29,695 5,909 (956 ) 4,953 12,607 7,719 3,146 28,425 20,532 7,893 1,686 (54 ) 6,153 69.9 68.7 5.07 5.35 5.02 5.30 1.83 1.10 36.18 22.4 23.6 18.6 0.65 37,442 32,424 5,018 (951) 4,067 12,626 3,313 2,241 22,247 18,376 3,871 904 5 2,972 79.2 77.7 2.44 2.72 2.40 2.68 1.67 1.10 68.21 10.7 12.0 9.0 0.28 3 For EPS calculation, see Note 8 to the Financial Statements. 2 The amortization of goodwill and other intangible assets is excluded from 1 Operating expenses / operating income before credit loss expense. 4 Dividends are normally declared and paid in the year subse- the calculation. quent to the reporting period. In 2000, as part of the arrangements of the acquisition of PaineWebber, a dividend of CHF 1.50 was paid on 5 October 2000 in respect of the nine months ended 30 September 2000. Prior to the merger between Union Bank of Switzerland and Swiss Bank Corporation, each paid dividends in accordance with its own dividend policies. In 2001 a further amount of CHF 1.60 per share was distributed to shareholders in the form of a par value reduction, in respect of 2000. No dividend was paid out for the year 2001. A par value reduction of CHF 2.00 per share was paid on 10 July 2002. A dividend of CHF 2.00 per share will be paid on 23 April 2003, subject to approval 5 Net profit / average Share- by shareholders at the Annual General Meeting. The USD amount per share will be determined on 17 April 2003. holders’ equity excluding dividends. 196 Shares Registered ordinary shares Own shares to be delivered Treasury shares BIS capital ratios Tier 1 (%) Total BIS (%) Risk-weighted assets Invested assets (CHF billion) B – Selected Financial Data (continued) CHF million, except where indicated As at 31.12.02 31.12.01 31.12.00 31.12.99 31.12.98 Balance sheet data Total assets Shareholders’ equity Average equity to average assets (%) 1,181,118 38,991 3.14 1,253,297 43,530 3.49 1,087,552 44,833 3.17 Market capitalization 79,448 105,475 112,666 896,556 30,608 3.52 92,642 861,282 28,794 3.06 90,720 1,256,297,678 0 97,181,094 1,281,717,499 0 41,254,951 1,333,139,187 28,447,788 55,265,349 1,292,679,486 0 110,621,142 1,289,857,836 0 73,370,094 11.3 13.8 238,790 2,037 11.6 14.8 253,735 2,448 69,985 AAA AA2 AA+ 11.7 15.7 273,290 2,445 71,076 AAA Aa1 AA+ 10.6 14.5 273,107 1,744 49,058 AAA Aa1 AA+ 9.3 13.2 303,719 1,573 48,011 AAA Aa1 AA+ Headcount (full-time equivalents) 1 69,061 Long-term ratings 2 Fitch, London Moody’s, New York Standard & Poor’s, New York AAA AA2 AA+ 1 The Group headcount does not include Klinik Hirslanden headcount. Klinik Hirslanden was sold on 5 December 2002. Handbook 2002 / 2003, page 10 to 11 for information about the nature of these ratings. 2 See the UBS Balance Sheet Data CHF million As at 31.12.02 31.12.01 31.12.00 31.12.99 31.12.98 Assets Total assets Due from banks Cash collateral on securities borrowed Reverse repurchase agreements Trading portfolio assets Positive replacement values Loans 1,181,118 32,468 139,052 294,086 371,436 82,092 211,647 Liabilities Due to banks Cash collateral on securities lent Repurchase agreements Trading portfolio liabilities Negative replacement values Due to customers Debt issued Shareholders’ equity 83,178 36,870 366,858 106,453 81,282 306,876 129,411 38,991 1,253,297 27,526 162,938 269,256 397,886 73,447 226,545 106,531 30,317 368,620 105,798 71,443 333,781 156,218 43,530 1,087,552 29,147 177,857 193,801 315,588 57,875 244,842 82,240 23,418 295,513 82,632 75,923 310,679 129,635 44,833 896,556 29,907 113,162 132,391 211,932 62,957 234,858 76,365 12,832 196,914 54,638 95,786 279,960 120,987 30,608 861,282 68,495 91,695 141,285 159,179 90,511 247,926 85,716 19,171 137,617 47,033 125,847 274,850 102,310 28,794 197 Additional Disclosure Required under SEC Regulations B – Selected Financial Data (continued) US GAAP Income Statement Data Net interest income after credit loss (expense) / recovery 10,139 CHF million For the year ended Operating income Interest income Interest expense Net interest income Credit loss (expense) / recovery Net fee and commission income Net trading income Other income Total operating income Operating expenses Personnel expenses General and administrative expenses Depreciation of property and equipment Amortization of goodwill Amortization of other intangible assets Restructuring costs Total operating expenses Operating profit / (loss) before tax and minority interests Tax expense / (benefit) Net profit / (loss) before minority interests Minority interests Change in accounting principle: cumulative effect of adoption of “AICPA Audit and Accounting Guide, Audits of Investment Companies” on certain financial investments, net of tax Net profit / (loss) 39,679 (29,334) 10,345 (206) 18,221 6,031 96 34,487 18,610 7,072 1,613 0 1,443 0 28,738 5,749 511 5,238 639 5,546 31.12.02 31.12.01 31.12.00 31.12.99 31.12.98 51,907 (44,096 ) 51,565 (43,584 ) 35,404 (29,660 ) 29,136 (25,773) 7,811 (498 ) 7,313 20,211 8,959 534 37,017 19,713 7,631 1,815 2,484 298 112 32,053 4,964 1,386 3,578 7,981 130 8,111 16,703 8,597 1,514 34,925 17,262 6,813 1,800 2,018 134 191 28,218 6,707 2,183 4,524 5,744 (956 ) 4,788 12,607 7,174 3,182 27,751 12,483 6,664 1,619 1,793 42 750 23,351 4,400 1,509 2,891 3,363 (787) 2,576 8,925 455 725 12,681 7,938 6,259 1,439 936 28 1,089 17,689 (5,008) (1,339) (3,669) 4 0 (331) (344 ) (87 ) (54 ) 0 0 0 3,234 4,437 2,837 (3,665) Note: Certain prior year amounts have been reclassified to conform to the current year’s presentation. 198 B – Selected Financial Data (continued) US GAAP Balance Sheet Data CHF million As at Assets Total assets Due from banks Cash collateral on securities borrowed Reverse repurchase agreements Trading portfolio assets Positive replacement values 1 Loans Goodwill Other intangible assets Other assets Liabilities Due to banks Cash collateral on securities lent Repurchase agreements Trading portfolio liabilities Obligation to return securities received as collateral Negative replacement values 1 Due to customers Accrued expenses and deferred income Debt issued Shareholders’ equity 31.12.02 31.12.01 31.12.00 31.12.99 31.12.98 1,296,938 1,361,920 1,124,554 893,525 899,589 32,481 139,073 294,086 441,845 83,757 211,755 28,127 1,222 21,314 83,178 36,870 366,858 117,721 16,308 132,354 306,872 15,330 129,527 55,576 27,550 162,566 269,256 455,406 73,474 226,747 29,255 4,510 36,972 106,531 30,317 368,620 119,528 10,931 116,666 333,766 17,289 156,462 59,282 29,182 177,857 193,801 318,788 57,775 245,214 31,016 4,710 27,955 82,240 23,418 295,513 87,832 0 75,423 310,686 21,038 129,750 62,960 29,954 113,162 132,391 228,230 62,294 235,401 21,163 265 18,717 76,363 12,832 173,840 52,658 0 95,004 279,971 12,040 120,704 51,833 68,554 91,695 141,285 178,130 90,520 248,657 21,455 252 29,398 85,716 19,127 136,824 47,772 0 125,857 274,861 11,232 101,973 54,761 1 Positive and negative replacement values represent the fair value of derivative instruments. Note: 2001 amounts have been adjusted to reflect the treatment of reverse repurchase, repurchase, securities borrowing and securities lending transactions on a consistent basis. See Note 39.4.4 for details. Ratio of Earnings to Fixed Charges The following table sets forth UBS AG’s ratio of earnings to fixed charges, for the periods indicated. Ratios of earnings to combined fixed charges and preferred stock dividends requirements are not presented as there were no preferred share dividends in any of the periods indicated. For the year ended 31.12.02 31.12.01 31.12.00 31.12.99 31.12.98 IFRS 1 US GAAP 1, 2 1.14 1.18 1.14 1.10 1.23 1.15 1.25 1.14 1.11 0.80 1 The ratio is provided using both IFRS and US GAAP values, since the ratio is materially different under the two accounting standards. 2 The deficiency in the coverage of fixed charges by earnings before fixed charges at 31 December 1998 was CHF 5,319 million. C – Information on the Company Property, Plant and Equipment At 31 December 2002, UBS operated about 1,800 offices and branches worldwide, of which about 47% were in Switzerland, 10% in the rest of Europe, 40% in the Americas and 2% in Asia. 28% of the offices and branches in Switzer- land were owned directly by UBS with the remainder, along with most of UBS’s offices out- side Switzerland, being held under commercial leases. These premises are subject to continuous maintenance and upgrading and are considered suitable and adequate for our current and antici- pated operations. 199 Additional Disclosure Required under SEC Regulations D – Information Required by Industry Guide 3 Selected Statistical Information The tables below set forth selected statistical information regarding the Group’s banking oper- ations extracted from the Financial Statements. Unless otherwise indicated, average balances for the year ended 31 December 2002, 31 Decem- ber 2001 and 31 December 2000 are calculated from monthly data. Certain prior year balances and figures have been reclassified to conform to current year presentation. The distinction be- tween domestic and foreign is generally based on the booking location. For loans, this method is not significantly different from an analysis based on the domicile of the borrower. D – Information Required by Industry Guide 3 (continued) Average Balances and Interest Rates The following table sets forth average interest-earning assets and average interest-bearing liabilities, along with the average rates, for the years ended 31 December 2002, 2001 and 2000. CHF million, except where indicated Average balance Interest Average rate (%) Average balance Interest Average rate (%) Average balance Interest Average rate (%) 31.12.02 31.12.01 31.12.00 Assets Due from banks Domestic Foreign Cash collateral on securities borrowed and reverse repurchase agreements Domestic Foreign Trading portfolio assets Domestic Foreign – taxable Foreign – non-taxable Foreign – total Loans Domestic Foreign Financial investments Domestic Foreign – taxable Foreign – non-taxable Foreign – total Total interest-earning assets Net interest on swaps Interest income and average interest-earning assets Non-interest-earning assets Positive replacement values Fixed assets Other Total average assets 200 11,753 15,528 1,055 1,823 9.0 11.7 13,366 16,994 1,273 2,280 9.5 13.4 12,534 17,603 388 634 5,471 573,576 7,812 373,810 1,720 375,530 170,641 55,199 3,794 8,781 0 8,781 1,230,941 235 10,949 269 16,714 31 16,745 6,987 1,789 60 105 0 105 38,161 1,802 3.1 3.6 4.3 1.9 3.4 4.5 1.8 4.5 4.1 3.2 1.6 1.2 0.0 1.2 7,868 474,295 12,940 332,126 1,450 333,576 177,404 72,176 4,598 39,252 0 39,252 3.1 1,149,390 563 17,774 307 16,183 42 16,225 8,017 3,090 90 363 0 363 49,307 2,970 7.2 3.7 2.4 4.9 2.9 4.9 4.5 4.3 2.0 0.9 0.0 0.9 4.3 8,383 348,395 20,800 255,399 1,206 256,605 181,646 67,528 3,440 22,529 0 22,529 939,686 558 18,530 244 11,560 38 11,598 10,985 3,813 105 297 0 297 49,683 2,062 6.7 5.3 1.2 4.5 3.2 4.5 6.0 5.6 3.1 1.3 0.0 1.3 5.3 1,230,941 39,963 3.2 1,149,390 52,277 4.5 939,686 51,745 5.5 190,063 12,532 53,293 1,486,829 153,687 13,376 46,954 1,363,407 135,762 9,660 32,925 1,118,033 D – Information Required by Industry Guide 3 (continued) Average Balances and Interest Rates (continued) CHF million, except where indicated Liabilities and Equity Due to banks Domestic Foreign Cash collateral on securities lent and repurchase agreements Domestic Foreign Trading portfolio liabilities Domestic Foreign Due to customers Domestic – demand deposits Domestic – savings deposits Domestic – time deposits Domestic – total Foreign 1 Short-term debt Domestic Foreign Long-term debt Domestic Foreign Total interest-bearing liabilities Non-interest-bearing liabilities Negative replacement values Other Total liabilities Shareholders’ equity 31.12.02 31.12.01 31.12.00 Average balance Interest Average rate (%) Average balance Interest Average rate (%) Average balance Interest Average rate (%) 28,625 60,621 452 1,362 18,382 523,375 3,239 109,013 42,484 71,465 27,646 141,595 172,650 69 91,616 10,082 46,930 355 9,726 146 8,220 435 625 447 1,507 3,062 0 1,915 433 2,239 1.6 2.2 1.9 1.9 4.5 7.5 1.0 0.9 1.6 1.1 1.8 0.0 2.1 4.3 4.8 36,260 61,642 1,424 3,506 13,147 415,121 600 13,917 2,526 94,597 41,664 66,089 31,261 139,014 187,783 69 96,184 12,754 43,798 1 7,814 715 716 989 2,420 6,738 0 4,227 587 3,002 1,206,197 29,417 2.4 1,102,895 44,236 192,659 41,297 1,440,153 46,676 165,220 47,676 1,315,791 47,616 1,363,407 7.7 6.6 3.8 5.1 0.4 8.0 1.3 1.1 3.0 1.5 5.1 0.0 5.6 5.0 6.9 5.0 3.9 5.7 4.6 3.4 0.0 8.3 1.7 1.1 3.2 1.7 3.6 0.0 4.4 4.6 6.9 4.0 31,133 57,258 2,397 3,758 12,700 284,220 478 14,437 1,078 66,597 44,403 72,207 27,199 143,809 143,432 79 78,075 15,490 38,020 4 5,305 595 781 826 2,202 7,303 0 4,338 778 2,615 871,891 43,615 157,668 53,049 1,082,608 35,425 1,118,033 Total average liabilities and shareholders’ equity 1,486,829 Net interest income Net yield on interest-earning assets 10,546 8,041 8,130 0.9 0.7 0.9 1 Due to customers in foreign offices consists mainly of time deposits. The percentage of total average interest-earning assets attributable to foreign activities was 84% for 2002 (81% for 2001 and 76% for 2000). The percentage of total average interest-bearing lia- bilities attributable to foreign activities was 83% for 2002 (82% for 2001 and 77% for 2000). All assets and liabilities are translated into CHF at uniform month-end rates. Interest in- come and expense are translated at monthly average rates. Average rates earned and paid on assets and liabilities can change from period to period based on the changes in interest rates in general, but are also affected by changes in the currency mix included in the assets and liabilities. This is espe- cially true for foreign assets and liabilities. Tax- exempt income is not recorded on a tax-equivalent basis. For all three years presented, tax-exempt income is considered to be insignificant and there- fore the impact from such income is negligible. 201 Additional Disclosure Required under SEC Regulations D – Information Required by Industry Guide 3 (continued) Analysis of Changes in Interest Income and Expense The following tables allocate, by categories of interest-earning assets and interest-bearing liabilities, the changes in interest income and expense due to changes in volume and interest rates for the year ended 31 December 2002 compared to the year ended 31 December 2001, and for the year ended 31 December 2001 compared to the year ended 31 December 2000. Volume and rate variances have been calculated on movements in average balances and changes in interest rates. Changes due to a combination of volume and rates have been allocated proportionally. Refer to page 209 of Industry Guide 3 for a discussion of the treatment of impaired, non-performing and restructured loans. CHF million 2002 compared to 2001 2001 compared to 2000 Increase / (decrease) due to changes in Increase / (decrease) due to changes in Average volume Average rate Net change Average volume Average rate Net change Interest income from interest-earning assets Due from banks Domestic Foreign 70 243 Cash collateral on securities borrowed and reverse repurchase agreements (737) (1,432) (667) (1,189) (153 ) (196 ) (65 ) (261 ) (173) 3,673 (155) (10,498) (328) (6,825) (123) 2,043 8 2,051 (304) (730) (16) (274) 0 (274) 85 (1,512) (19) (1,531) (38) 531 (11) 520 (726) (571) (1,030) (1,301) (14) 16 0 16 (30) (258) 0 (258) (35 ) 6,673 (94 ) 3,456 8 3,464 (255 ) 260 36 217 0 217 (218) (457) 5 (756) 63 4,623 4 4,627 40 (7,429 ) 157 1,167 (4 ) 1,163 (2,713 ) (983 ) (2,968) (723) (51 ) (151 ) 0 (151 ) (15) 66 0 66 (546) 4,963 (1,547) (14,016) (2,093) (9,053) (501 ) 10,418 (2,632 ) (7,661 ) (3,133) 2,757 4,417 (15,563) (11,146) (1,168) (12,314) 9,917 (10,293 ) (376) 908 532 Domestic Foreign Trading portfolio assets Domestic Foreign – taxable Foreign – non-taxable Foreign – total Loans Domestic Foreign Financial investments Domestic Foreign – taxable Foreign – non-taxable Foreign – total Interest income Domestic Foreign Total interest income from interest-earning assets Net interest on swaps Total interest income 202 D – Information Required by Industry Guide 3 (continued) Analysis of Changes in Interest Income and Expense (continued) CHF million 2002 compared to 2001 2001 compared to 2000 Increase / (decrease) due to changes in Increase / (decrease) due to changes in Average volume Average rate Net change Average volume Average rate Net change Interest expense on interest-bearing liabilities Due to banks Domestic Foreign (298) (58) (674) (2,086) (972) (2,144) 395 289 (1,368 ) (541 ) (973) (252) Cash collateral on securities lent and repurchase agreements Domestic Foreign Trading portfolio liabilities Domestic Foreign Due to customers Domestic – demand deposits Domestic – savings deposits Domestic – time deposits Domestic – total Foreign Short-term debt Domestic Foreign Long-term debt Domestic Foreign Interest expense Domestic Foreign 241 3,681 0 1,197 14 59 (116) (43) (545) 0 (201) (123) 216 (486) (7,872) (245) (4,191) 145 (791) (294) (150) (426) (870) (3,131) 0 (2,111) (31) (979) 145 406 (280) (91) (542) (913) (3,676) 0 (2,312) (154) (763) 17 6,676 6 2,240 (36 ) (67 ) 31 (72 ) 2,262 0 1,014 (137 ) 419 105 (7,196 ) (9 ) 269 156 2 132 290 (2,827 ) 0 (1,125 ) (54 ) (32 ) (223) 4,290 (1,916) (16,970) (2,139) (12,680) 209 12,900 (1,036 ) (11,452 ) Total interest expense 4,067 (18,886) (14,819) 13,109 (12,488 ) 122 (520) (3) 2,509 120 (65) 163 218 (565) 0 (111) (191) 387 (827) 1,448 621 203 Additional Disclosure Required under SEC Regulations D – Information Required by Industry Guide 3 (continued) Deposits The following table analyzes average deposits and the average rates on each deposit category listed below for the years ended 31 December 2002, 2001 and 2000. The geographic allocation is based on the location of the office or branch where the deposit is made. Deposits by foreign depositors in domestic offices were CHF 43,914 million, CHF 54,095 million and CHF 45,815 million at 31 December 2002, 31 December 2001 and 31 December 2000, respectively. CHF million, except where indicated Average deposit Average rate (%) Average deposit Average rate (%) Average deposit Average rate (%) 31.12.02 31.12.01 31.12.00 Banks Domestic offices Demand deposits Time deposits Total domestic offices Foreign offices Interest-bearing deposits 1 Total due to banks Customer accounts Domestic offices Demand deposits Savings deposits Time deposits Total domestic offices Foreign offices Interest bearing deposits 1 Total due to customers 1 Mainly time deposits. 3,524 9,010 12,534 17,603 30,137 42,484 71,465 27,646 141,595 172,650 314,245 0.7 1.7 1.4 2.2 1.9 1.0 0.9 1.6 1.1 1.8 1.5 3,741 8,012 11,753 15,528 27,281 41,664 66,089 31,261 139,014 187,783 326,797 1.2 4.2 3.3 5.7 4.6 1.7 1.1 3.2 1.7 3.6 2.8 4,649 8,717 13,366 16,994 30,360 44,403 72,207 27,199 143,809 143,432 287,241 1.9 8.7 6.3 6.6 6.5 1.3 1.1 3.0 1.5 5.1 3.3 At 31 December 2002, the maturity of time deposits exceeding CHF 150,000, or an equivalent amount in other currencies, was as follows: CHF million Within 3 months 3 to 12 months 1 to 5 years Over 5 years Total time deposits Domestic Foreign 27,456 8,202 768 44 110,053 26,821 2,766 859 36,470 140,499 204 D – Information Required by Industry Guide 3 (continued) Short-term Borrowings The following table presents our period-end, average and maximum month-end outstanding amounts for short-term borrowings, along with the average rates and period-end rates at and for the years ended 31 December 2002, 2001 and 2000. Money market paper issued Due to banks Repurchase agreements 1 CHF million, except where indicated 31.12.02 31.12.01 31.12.00 31.12.02 31.12.01 31.12.00 31.12.02 31.12.01 31.12.00 Period-end balance Average balance Maximum month-end balance Average interest rate during the period (%) Average interest rate at period-end (%) 72,800 91,685 108,463 2.1 1.5 99,006 96,253 117,022 4.4 2.6 74,780 78,154 89,821 5.6 6.0 48,780 59,109 77,312 3.1 2.0 77,312 70,621 85,808 7.0 2.2 51,245 58,031 73,355 7.0 4.1 464,020 509,572 593,786 1.8 1.7 462,316 400,648 502,578 3.2 2.9 330,857 278,601 342,427 4.8 4.8 1 For the purpose of this disclosure, balances are presented on a gross basis. 205 Additional Disclosure Required under SEC Regulations D – Information Required by Industry Guide 3 (continued) Contractual Maturities of the Investments in Debt Instruments Due to the adoption of IAS 39, Financial investments, available for sale, are reported at fair value from 1 January 2001. 31 December 2000 amounts have not been restated. CHF million, except percentages Amount Yield (%) Amount Yield (%) Amount Yield (%) Amount Yield (%) Within 1 year 1 – 5 years 5 – 10 years Over 10 years 31 December 20021 Swiss national government and agencies Swiss local governments US Treasury and agencies Foreign governments and official institutions Corporate debt securities Mortgage-backed securities Other debt securities Total fair value 0 8 0 35 675 4 1 723 1 Money market papers have contractual maturities of less than one year. 0.00 4.02 0.00 4.63 2.23 2.25 4.77 7 30 0 45 249 15 48 394 4.88 3.94 0.00 3.13 2.64 3.97 2.65 8 4 0 1 19 4 0 36 3.86 3.59 0.00 6.12 3.41 4.03 0.00 1 0 0 0 21 0 0 22 4.00 0.00 0.00 0.00 8.02 0.00 0.00 CHF million, except percentages Amount Yield (%) Amount Yield (%) Amount Yield (%) Amount Yield (%) Within 1 year 1 – 5 years 5 – 10 years Over 10 years 31 December 20011 Swiss national government and agencies Swiss local governments US Treasury and agencies Foreign governments and official institutions Corporate debt securities Mortgage-backed securities Other debt securities Total fair value 9 3 0 5,014 63 0 2 5,091 5.26 4.36 0.00 0.97 4.53 0.00 4.77 10 38 24 5,048 1,102 5 87 6,314 4.50 3.90 4.38 1.01 4.59 5.41 3.91 16 4 8 27 30 0 28 113 3.43 3.59 5.15 2.88 3.22 0.00 3.56 4.00 0.00 0.00 0.00 15.372 0.00 0.00 1 0 0 0 23 0 0 24 1 Money market papers have contractual maturities of less than one year. not represent the yield through maturity since this is a floating rate debt instrument. 2 The yield presented is the current contractual yield based on current market rates at 31 December 2001, but may CHF million, except percentages Amount Yield (%) Amount Yield (%) Amount Yield (%) Amount Yield (%) Within 1 year 1 – 5 years 5 – 10 years Over 10 years 31 December 2000 Swiss national government and agencies Swiss local governments US Treasury and agencies Foreign governments and official institutions Corporate debt securities Mortgage-backed securities Other debt securities Total amortized cost Total market value 2 1 0 2,451 16 20 21 2,511 2,514 6.90 6.11 0.00 1.62 5.20 6.02 6.57 16 27 0 1,236 917 5 56 2,257 2,272 5.13 5.19 0.00 1.80 6.02 6.54 4.33 16 18 0 1,165 206 22 11 1,438 1,434 6.45 4.43 0.00 0.85 2.21 14.46 3.68 0.00 0.00 0.00 0.00 0.00 0.00 0.00 0 0 0 0 0 0 0 0 0 206 D – Information Required by Industry Guide 3 (continued) Loans Loans are widely dispersed over industry sectors both within and outside of Switzerland. With the exceptions of private households (foreign and domestic) and banks and financial institutions outside Switzerland and real estate and rentals in Switzerland, there is no material concentration of loans. For further discussion of the loan portfolio, see the UBS Handbook 2002 / 2003. The following table illustrates the diversification of the loan portfolio among industry sectors at 31 December 2002, 2001, 2000, 1999 and 1998. The industry categories presented are consistent with the classification of loans for reporting to the Swiss Federal Banking Commission and Swiss National Bank. CHF million 31.12.02 31.12.01 31.12.00 31.12.99 31.12.98 Domestic Banks Construction Financial institutions Hotels and restaurants Manufacturing 1 Private households Public authorities Real estate and rentals Retail and wholesale Services 2 Other 3 Total domestic 1,029 2,838 4,301 2,655 7,237 95,295 5,529 13,573 7,172 10,237 1,738 1,533 3,499 5,673 2,950 8,686 93,746 5,222 14,992 8,674 12,161 1,860 2,896 4,870 5,725 3,526 9,577 91,667 5,658 16,673 9,635 11,767 2,651 5,802 6,577 9,387 4,259 11,377 93,846 5,277 19,835 10,904 14,862 1,818 4,543 7,897 10,240 4,129 13,505 97,664 5,858 21,231 8,912 11,582 1,662 151,604 158,996 164,645 183,944 187,223 Foreign 4 Banks Chemicals Construction Electricity, gas and water supply Financial institutions Manufacturing 5 Mining Private households Public authorities Real estate and rentals Retail and wholesale Services Transport, storage and communication Other 6 Total foreign Total gross 31,882 519 153 1,105 18,378 2,300 868 33,063 2,628 616 1,367 1,654 676 2,557 97,766 249,370 26,728 1,080 266 977 14,458 4,258 1,313 25,619 6,454 10,227 1,732 4,786 2,117 2,973 27,168 1,423 773 1,584 20,348 4,596 2,070 29,470 11,754 5,077 1,862 1,585 993 11,168 102,988 261,984 119,871 284,516 24,983 65,000 69,087 94,070 278,014 78,741 143,741 330,964 1 Includes chemicals, food and beverages. personal service activities. classifications are available. 5 Includes food and beverages. 3 Includes mining and electricity, gas and water supply. 2 Includes transportation, communication, health and social work, education and other social and 4 For the years prior to the year 2000, no detailed industry 6 Includes hotels and restaurants. 207 Additional Disclosure Required under SEC Regulations D – Information Required by Industry Guide 3 (continued) Loans (continued) The following table analyzes the Group’s mortgage portfolio by geographic origin of the client and type of mortgage at 31 December 2002, 2001, 2000, 1999 and 1998. Mortgages are included in the industry categories mentioned above. 31.12.02 31.12.01 31.12.00 31.12.99 31.12.98 116,359 11,510 127,869 108,779 19,090 127,869 116,628 9,583 126,211 101,969 24,242 126,211 116,348 4,206 120,554 126,677 1,310 127,987 96,181 24,373 91,408 36,579 120,554 127,987 138,306 2,479 140,785 106,093 34,692 140,785 CHF million Mortgages Domestic Foreign Total gross mortgages Mortgages Residential Commercial Total gross mortgages Loan Maturities The following table discloses loans by maturity at 31 December 2002. The determination of maturi- ties is based on contract terms. Information on interest rate sensitivities can be found in Note 29 to the UBS Group Financial Statements. CHF million Domestic Banks Mortgages Other loans Total domestic Foreign Banks Mortgages Other loans Total foreign Total gross loans Within 1 year 1 to 5 years Over 5 years Total 969 57,875 24,905 83,749 31,285 10,711 52,447 94,443 60 55,676 7,534 63,270 373 688 1,492 2,553 0 2,808 1,777 4,585 224 111 435 770 1,029 116,359 34,216 151,604 31,882 11,510 54,374 97,766 178,192 65,823 5,355 249,370 208 D – Information Required by Industry Guide 3 (continued) Impaired, Non-performing and Restructured Loans A loan is classified as impaired if the book value of the claim exceeds the present value of the cash flows actually expected in future periods – inter- est payments, scheduled principal repayments or other payments due (for example on derivative transactions), and including liquidation of collat- eral where available. Impaired obligations are thus obligations where losses are foreseeable. An allowance for credit loss is then made with respect to the loan in question. Impaired loans include non-performing loans, for which the con- tractual payments of principal, interest or com- mission are overdue by 90 days. When loans are classified as non-performing, the recognition of interest or commission income ceases according to the original terms of the loan agreement. Allowances are provided for non-performing loans to reflect their net estimated recoverable amount. The gross interest income that would have been recorded on non-performing loans was CHF 201 million for the year ended 31 December 2002, CHF 336 million for the year ended 31 De- cember 2001 and CHF 182 million for the year ended 31 December 2000. The amount of inter- est income that was included in net income for those loans was CHF 174 million for the year ended 31 December 2002 and CHF 201 million for the year ended 31 December 2001. There was no interest income recorded in net income for non-performing loans in 2000. The table below provides an analysis of the Group’s non-per- forming loans, for further information see the UBS Handbook 2002/2003. CHF million 31.12.02 31.12.01 31.12.00 31.12.99 31.12.98 Non-performing loans: Domestic Foreign Total non-performing loans Foreign restructured loans 1 4,609 1,420 6,029 6,531 2,108 8,639 7,588 2,864 10,452 179 11,435 1,638 13,073 287 14,023 2,091 16,114 449 1 Include only performing foreign restructured loans. UBS does not, as a matter of policy, typically restructure loans to accrue interest at rates dif- ferent from the original contractual terms or reduce the principal amount of loans. Instead, specific loan allowances are established as necessary. Unrecognized interest related to foreign restructured loans was not material to the results of operations during these periods. In addition to the non-performing loans shown above, the Group had CHF 4,336 million, CHF 5,990 million, CHF 8,042 million and CHF 9,383 million in “other impaired loans” for the years ended 31 December 2002, 2001, 2000 and 1999, respectively. These are loans that are current, or less than 90 days in arrears, with respect to pay- ment of principal or interest; however, the Group’s credit officers have expressed doubts as to the abil- ity of the borrowers to repay the loans. As at 31 December 2002 specific allowances of CHF 1,407 million had been established against these loans. 209 Additional Disclosure Required under SEC Regulations D – Information Required by Industry Guide 3 (continued) Cross-Border Outstandings Cross-border outstandings consist of general banking products such as loans (including unuti- lized commitments) and deposits with third par- ties, credit equivalents of over the counter (OTC) derivatives and repurchase agreements, and the market value of the inventory of securities. Outstandings are monitored and reported on an ongoing basis by the credit risk management and control organization with a dedicated country risk information system. With the exception of the 32 most developed economies, these expo- sures are rigorously limited. Claims that are secured by third-party guar- antees are recorded against the guarantor’s coun- try of domicile. Outstandings that are secured by collateral are recorded against the country where the asset could be liquidated. This follows the “Guidelines for the Management of Country Risk”, which are applicable to all banks that are supervised by the Swiss Federal Banking Com- mission. The following tables list those countries for which cross-border outstandings exceeded 0.75% of total assets at 31 December 2002, 2001 and 2000. At 31 December 2002, there were no outstandings that exceeded 0.75% of total assets in any country currently facing liquidity prob- lems that the Group expects would materially affect the country’s ability to service its obli- gations. For more information on cross-border expo- sure, see the UBS Handbook 2002/2003. 210 D – Information Required by Industry Guide 3 (continued) CHF million United States Germany Italy United Kingdom France Australia Canada Japan Cayman Islands Netherlands CHF million United States United Kingdom Germany Japan Italy France Canada Netherlands CHF million United States Japan United Kingdom Germany Italy France Netherlands Australia 31.12.02 Banking products Banks Non-banks Traded products1 Tradable assets2 % of total assets Total 1,083 2,590 1,139 4,161 2,077 133 130 312 7 289 698 4,732 296 606 1,805 535 872 88 1,175 1,548 27,617 13,101 7,229 5,437 5,710 4,514 4,964 1,766 5,054 4,110 95,046 9,104 14,852 12,106 11,403 6,651 5,115 7,816 3,387 3,313 124,444 29,527 23,516 22,310 20,995 11,833 11,081 9,982 9,623 9,260 10.5 2.5 2.0 1.9 1.8 1.0 0.9 0.8 0.8 0.8 31.12.01 Banking products Banks Non-banks Traded products1 Tradable assets2 % of total assets Total 2,360 2,483 3,605 640 1,086 159 114 1,834 1,284 543 6,395 770 498 2,043 950 2,414 31,129 9,128 11,962 4,442 11,628 4,114 5,220 6,126 114,615 27,754 11,755 22,995 11,180 8,052 8,038 3,110 149,388 39,908 33,717 28,847 24,392 14,368 14,322 13,484 11.9 3.2 2.7 2.3 1.9 1.1 1.1 1.1 31.12.00 Banking products Banks Non-banks Traded products1 Tradable assets2 1,826 123 1,795 2,686 1,293 1,085 910 27 958 895 1,224 3,720 931 1,900 1,480 370 21,796 6,378 9,037 13,198 3,629 3,956 6,092 3,113 64,077 58,779 22,440 5,085 9,700 5,987 3,803 7,508 Total 88,657 66,175 34,496 24,689 15,553 12,928 12,285 11,018 % of total assets 8.2 6.1 3.2 2.3 1.4 1.2 1.1 1.0 1 Traded products consist of derivative instruments and repurchase agreements. In 2002, 2001 and 2000 unsecured OTC derivatives exposure is reported based on the Potential Credit Exposure measurement methodology and is therefore not directly comparable to the exposures in the 2 Tradable assets consist of equity and fixed income finan- prior years, which were measured based on Gross Replacement Values plus Add-on. cial instruments held for trading purposes, which are marked to market on a daily basis and private equity investments at the lower of book or market value. 211 Additional Disclosure Required under SEC Regulations D – Information Required by Industry Guide 3 (continued) Summary of Movements in Allowances and Provisions for Credit Losses The following table provides an analysis of movements in allowances and provisions for credit losses. As a result of Swiss bankruptcy laws, banks write-off loans against allowances only upon final set- tlement of bankruptcy proceedings, the sale of the underlying assets and / or in case of debt forgive- ness. Under Swiss law, a creditor can continue to collect from a debtor who has emerged from bank- ruptcy, unless the debt has been forgiven through a formal agreement. CHF million 31.12.02 31.12.01 31.12.00 31.12.99 31.12.98 Balance at beginning of year 8,218 10,581 13,398 14,978 16,213 0 (261 ) (178 ) (193 ) (264 ) (640 ) 0 (729 ) (160 ) (227 ) (30 ) (4 ) (296 ) (92 ) (137 ) (242 ) (598 ) 0 (823 ) (210 ) (315 ) (41 ) (2) (228) (66) (98) (214) (534) (2) (610) (178) (116) (15) (2,682 ) (2,758 ) (2,063) Write-offs Domestic Banks Construction Financial institutions Hotels and restaurants Manufacturing 1 Private households Public authorities Real estate and rentals Retail and wholesale Services 2 Other 3 0 (148) (103) (48) (275) (536) 0 (357) (101) (155) (49) Total domestic write-offs (1,772) Foreign 4 Banks Chemicals Construction Electricity, gas and water supply Financial institutions Manufacturing 5 Mining Private households Public authorities Real estate and rentals Retail and wholesale Services Transport, storage and communication Other 6 Total foreign write-offs (49) 0 0 (36) (228) (70) (1) (65) (1) (2) (10) (39) (74) (189) (764) 0 (248 ) (51 ) (52 ) (109 ) (1,297 ) 0 (317 ) (115 ) (93 ) (46 ) (2,328 ) (24 ) (2 ) (10 ) (63 ) (74 ) (119 ) (304 ) (5 ) 0 (1 ) 0 (30 ) 0 (48 ) (680 ) (15 ) 0 (13 ) (3 ) (33 ) (11 ) 0 0 (4 ) 0 (160 ) (8 ) (11 ) (55 ) (313 ) Total write-offs Recoveries Domestic Foreign Total recoveries Net write-offs Credit loss expense / (recovery) Other adjustments 7 Balance at end of year (2,536) (3,008 ) (2,995 ) (517 ) (3,275 ) (261) (2,324) 43 27 70 (2,466) 206 (337) 5,621 58 23 81 124 39 163 54 11 65 59 0 59 (2,927 ) (2,832 ) (3,210 ) (2,265) 498 66 8,218 (130 ) 145 956 674 951 79 10,581 13,398 14,978 1 Includes chemicals, food and beverages. personal service activities. are available. 3 Includes mining and electricity, gas and water supply. 6 Includes hotels and restaurants. 2 Includes transportation, communication, health and social work, education and other social and 4 For years prior to 2000, no detailed industry classifications 7 See the following table for details. 5 Includes food and beverages. 212 D – Information Required by Industry Guide 3 (continued) Summary of Movements in Allowances and Provisions for Credit Losses (continued) CHF million 31.12.02 31.12.01 31.12.00 31.12.99 31.12.98 Doubtful interest Net foreign exchange Subsidiaries sold and other Total adjustments 0 (269) (68) (337) 0 44 22 66 182 23 (60 ) 145 409 351 (86 ) 674 423 (98) (246) 79 213 Additional Disclosure Required under SEC Regulations D – Information Required by Industry Guide 3 (continued) Allocation of the Allowances and Provisions for Credit Losses The following table provides an analysis of the allocation of the allowances and provisions for credit loss by industry sectors and geographic location at 31 December 2002, 2001, 2000, 1999 and 1998. For a description of procedures with respect to allowances and provisions for credit losses, see the UBS Handbook 2002 / 2003. CHF million 31.12.02 31.12.01 31.12.00 31.12.99 31.12.98 Domestic Banks Construction Financial institutions Hotels and restaurants Manufacturing 1 Private households Public authorities Real estate and rentals Retail and wholesale Services 2 Other 3 Total domestic Foreign 4 Banks 5 Chemicals Construction Electricity, gas and water supply Financial institutions Manufacturing 6 Mining Private households Public authorities Real estate and rentals Retail and wholesale Services Transport, storage and communication Other 7 Total foreign, net of country provisions Country provisions Total foreign 8 Total allowances and provisions for credit losses 10 265 89 286 458 750 39 577 315 470 315 3,574 24 5 6 96 153 314 148 58 0 6 13 262 144 82 1,311 736 2,047 34 467 262 346 722 1,082 37 1,067 395 448 165 5,025 39 5 0 88 420 653 169 103 0 9 0 414 45 242 2,187 1,006 3,193 0 843 328 454 863 1,570 0 1,635 629 419 413 7,154 32 0 11 107 262 547 586 72 0 82 41 126 2 267 2,135 1,292 3,427 41 1,247 342 690 1,223 2,350 40 2,696 779 934 141 49 1,671 668 657 1,331 2,741 107 3,333 825 766 71 10,483 12,219 1,539 1,376 2,915 1,309 1,450 2,759 5,621 8,218 10,581 13,398 14,978 2 Includes transportation, communication, health and social work, education and other social and 1 Includes chemicals, food and beverages. 4 For years prior to 2000, no detailed industry classifications personal service activities. 5 Counterparty allowances and provisions only. Country provisions with banking counterparties amounting to CHF 409 million are available. 8 The 2002, 2001, 2000, 1999 are disclosed under country provisions. and 1998 amounts include CHF 366 million, CHF 305 million, CHF 54 million, CHF 149 million and CHF 435 million respectively of provisions and for unused commitments and contingent liabilities. 3 Includes mining and electricity, gas and water supply. 7 Includes hotels and restaurants. 6 Includes food and beverages. 214 D – Information Required by Industry Guide 3 (continued) Loans by industry sector The following table presents the percentage of loans in each industry sector and geographic location to total loans. This table can be read in conjunction with the preceding table showing the breakdown of the allowances and provisions for credit losses by industry sectors to evaluate the credit risks in each of the categories. in % 31.12.02 31.12.01 31.12.00 31.12.99 31.12.98 Domestic Banks Construction Financial institutions Hotels and restaurants Manufacturing 1 Private households Public authorities Real estate and rentals Retail and wholesale Services 2 Other 3 Total domestic Foreign 4 Banks Chemicals Construction Electricity, gas and water supply Financial institutions Manufacturing 5 Mining Private households Public authorities Real estate and rentals Retail and wholesale Services Transport, storage and communication Other 6 Total foreign Total gross loans 0.4 1.1 1.7 1.1 2.9 38.2 2.2 5.5 2.9 4.1 0.7 60.8 12.8 0.2 0.1 0.4 7.4 0.9 0.3 13.3 1.1 0.2 0.5 0.7 0.3 1.0 39.2 0.6 1.3 2.2 1.1 3.3 35.8 2.0 5.7 3.3 4.6 0.8 60.7 10.2 0.4 0.1 0.4 5.5 1.6 0.5 9.8 2.5 3.9 0.7 1.8 0.8 1.1 39.3 1.0 1.7 2.0 1.2 3.4 32.2 2.0 5.9 3.4 4.1 1.0 57.9 9.5 0.5 0.3 0.6 7.2 1.6 0.7 10.4 4.1 1.8 0.7 0.6 0.3 3.8 42.1 100.0 100.0 100.0 2.1 2.4 3.4 1.5 4.1 33.8 1.9 7.1 3.9 5.3 0.7 66.2 9.0 1.4 2.4 3.1 1.2 4.1 29.5 1.8 6.4 2.7 3.5 0.5 56.6 19.6 24.8 33.8 100.0 23.8 43.4 100.0 1 Includes chemicals, food and beverages. personal service activities. classifications are available. 2 Includes transportation, communication, health and social work, education and other social and 4 For the years prior to 2000, no detailed industry 3 Includes mining and electricity, gas and water supply. 5 Includes food and beverages. 6 Includes hotels and restaurants. 215 Additional Disclosure Required under SEC Regulations D – Information Required by Industry Guide 3 (continued) Loss History Statistics The following is a summary of the Group’s loan loss history. CHF million, except where indicated 31.12.02 31.12.01 31.12.00 31.12.99 31.12.98 Gross loans Impaired loans Non-performing loans Allowances and provisions for credit losses Net write-offs Credit loss expense / (recovery) 249,370 10,365 6,029 5,621 2,466 206 261,984 14,629 8,639 8,218 2,927 498 284,516 18,494 10,452 10,581 2,832 (130 ) 278,014 22,456 13,073 13,398 3,210 956 330,964 26,447 16,114 14,978 2,265 951 Ratios Impaired loans as a percentage of gross loans Non-performing loans as a percentage of gross loans Allowances and provisions for credit losses as a percentage of: Gross loans Impaired loans Non-performing loans Allocated allowances as a percentage of impaired loans 1 Allocated allowances as a percentage of non-performing loans 2 Net write-offs as a percentage of: Gross loans Average loans outstanding during the period Allowances and provisions for credit losses Allowances and provisions for credit losses as multiple of net write-offs 4.2 2.4 2.3 54.2 93.2 47.2 57.8 1.0 1.1 43.9 2.28 5.6 3.3 3.1 56.2 95.1 49.9 62.2 1.1 1.2 35.6 2.81 6.5 3.7 3.7 57.2 101.2 52.4 60.63 1.0 1.1 26.8 3.74 8.1 4.7 4.8 59.7 102.5 55.5 66.3 1.2 1.2 24.0 4.17 8.0 4.9 4.5 56.6 93.0 51.4 62.1 0.7 0.8 15.1 6.61 1 Allowances relating to impaired loans only. restated to account for an overallocation of allowances to non-performing loans. 2 Allowances relating to non-performing loans only. 3 31 December 2000 figure has been 216 Cautionary statement regarding forward-looking statements This communication contains statements that constitute “forward-looking statements”, including, but not limited to, statements relating to the implementation of strategic initiatives, such as the implementation of our European wealth management strategy, expansion of our corporate finance presence in the US and worldwide, the develop- ment of UBS Warburg’s energy trading operations, and other statements relating to our future business develop- ment and economic performance. While these forward- looking statements represent our judgments and future expectations concerning the development of our business, a number of risks, uncertainties and other important fac- tors could cause actual developments and results to differ materially from our expectations. These factors include, but are not limited to, (1) general market, macro-economic, governmental and regulatory trends, (2) movements in local and international securities markets, currency exchange rates and interest rates, (3) competitive pressures, (4) technological developments, (5) changes in the financial position or credit-worthiness of our customers, obligors and counterparties and developments in the markets in which they operate, (6) legislative developments, (7) man- agement changes and changes to our business group struc- ture in 2001, 2002 and 2003 and (8) other key factors that we have indicated could adversely affect our business and financial performance which are contained in other parts of this document and in our past and future filings and reports, including those filed with the SEC. More detailed information about those factors is set forth elsewhere in this document and in documents furnished by UBS and fil- ings made by UBS with the SEC, including UBS’s Annual Report on Form 20-F for the year ended 31 December 2002. UBS is not under any obligation to (and expressly dis- claims any such obligations to) update or alter its forward- looking statements whether as a result of new information, future events, or otherwise. Imprint Publisher / Copyright: UBS AG, Switzerland Languages: English, German; SAP-R / 3 80531E-0301 ab UBS AG P.O. Box, CH-8098 Zurich P.O. Box, CH-4002 Basel www.ubs.com 

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